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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2009
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)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Class B Stock, par value $100
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ¨ Yes x No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ¨ Yes x No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. x
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 Act). ¨ Yes x No
Registrant’s stock is not publicly traded and is only issued to members of the registrant. Such stock is issued and redeemed at par value, $100 per share, subject to certain regulatory and statutory limits. At June 30, 2009, the aggregate par value of the stock held by shareholders of the registrant was approximately $13,418 million. At February 26, 2010, the total shares of stock outstanding, including mandatorily redeemable capital stock, totaled 134,213,418.
DOCUMENTS INCORPORATED BY REFERENCE: None.
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Federal Home Loan Bank of San Francisco
2009 Annual Report on Form 10-K
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| ITEM 1. | BUSINESS |
At the Federal Home Loan Bank of San Francisco (Bank), our purpose is to enhance the availability of credit for residential mortgages and targeted community development by providing a readily available, competitively priced source of funds for housing and community lenders. We are a wholesale bank—we link our customers to the worldwide capital markets and seek to manage our own liquidity so that funds are available when our customers need them. By providing needed liquidity and enhancing competition in the mortgage market, our credit programs benefit homebuyers and communities.
We are one of 12 regional Federal Home Loan Banks (FHLBanks) that serve the United States as part of the Federal Home Loan Bank System. Each FHLBank is a separate entity with its own board of directors, management, and employees. The FHLBanks operate under federal charters and are government-sponsored enterprises (GSEs). The FHLBanks are not government agencies and do not receive financial support from taxpayers. The U.S. government does not guarantee, directly or indirectly, the debt securities or other obligations of the Bank or the FHLBank System. The FHLBanks were regulated by the Federal Housing Finance Board (Finance Board), an independent federal agency, through July 29, 2008. With the passage of the Housing and Economic Recovery Act of 2008 (Housing Act), the Federal Housing Finance Agency (Finance Agency) was established and became the new federal regulator of the FHLBanks, effective July 30, 2008. On October 27, 2008, the Finance Board merged into the Finance Agency. Pursuant to the Housing Act, all regulations, orders, determinations, and resolutions of 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 document to regulations of the Finance Agency also include the regulations of the Finance Board where they remain applicable.
We have a cooperative ownership structure. To access our products and services, a financial institution must be approved for membership and purchase capital stock in the Bank. The member’s stock requirement is generally based on its use of Bank products, subject to a minimum asset-based membership requirement that is intended to reflect the value to the member of having ready access to the Bank as a reliable source of competitively priced funds. Bank stock is issued, exchanged, redeemed, and repurchased at its stated par value of $100 per share, subject to certain regulatory and statutory limits. It is not publicly traded.
Our members are financial services firms from a number of different sectors. As of December 31, 2009, the Bank’s membership consisted of 277 commercial banks, 97 credit unions, 25 savings institutions, 8 thrift and loan companies, and 3 insurance companies. Their principal places of business are located in Arizona, California, or Nevada, the three states that make up the 11th District of the FHLBank System, but many do business in other parts of the country. Members range in size from institutions with less than $10 million in assets to some of the largest financial institutions in the United States. Effective February 4, 2010, community development financial institutions (CDFIs) that have been certified by the CDFI Fund of the U.S. Treasury Department, including community development loan funds, community development venture capital funds, and state-chartered credit unions without federal insurance, are eligible to become members of an FHLBank.
Our primary business is providing competitively priced, collateralized loans, known as advances, to our members. Advances may be fixed or adjustable rate, with terms ranging from one day to 30 years. We accept a wide range of collateral types, some of which cannot be readily pledged elsewhere or readily securitized. Members use their access to advances to support their mortgage loan portfolios, lower their funding costs, facilitate asset-liability management, reduce on-balance sheet liquidity, offer a wider range of mortgage products to their customers, and improve profitability.
To fund their operations, the FHLBanks issue debt in the form of consolidated obligation bonds and discount notes (jointly referred to as consolidated obligations) through the FHLBanks Office of Finance, the fiscal agent for the issuance and servicing of consolidated obligations on behalf of the 12 FHLBanks. Because the FHLBanks’ consolidated obligations are rated Aaa/P-1 by Moody’s Investors Service (Moody’s) and AAA/A-1+ by Standard & Poor’s Rating Services (Standard & Poor’s) and because of the FHLBanks’ GSE status, the FHLBanks are generally able to raise funds at rates that are typically priced at a small to moderate spread above U.S. Treasury security yields. Our cooperative ownership structure allows us to pass along the benefit of these low funding rates to our members.
Members also benefit from our affordable housing and economic development programs, which provide grants and below market-rate loans that support their involvement in creating affordable housing and revitalizing communities.
Our Business Model
Our cooperative ownership structure has led us to develop a business model that is different from that of a typical financial services firm. Our business model is based on the premise that we maintain a balance between our obligation to achieve our public policy
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mission—to promote housing, homeownership, and community development through our activities with members—and our objective to provide an adequate return on the private capital provided by our members. We achieve this balance by delivering low-cost credit to help our members meet the credit needs of their communities while striving to pay members a market-rate dividend.
As a cooperatively owned wholesale bank, we require our members to purchase capital stock to support their activities with the Bank. We leverage this capital by using our GSE status to borrow funds in the capital markets at rates that are generally priced at a small to moderate spread above U.S. Treasury security yields. We lend these funds to our members at rates that are competitive with the cost of most wholesale borrowing alternatives available to our largest borrowers.
We also invest in residential mortgage-backed securities (MBS), all of which are AAA-rated at the time of purchase or agency-issued and guaranteed through the direct obligation of or support from the U.S. government, up to the current Bank policy limit of three times capital. We also have a limited portfolio of residential mortgage loans purchased from members. While the mortgage assets we hold are intended to increase our earnings, they also modestly increase our interest rate risk. In addition, as a result of the distressed housing and mortgage markets, the private-label residential MBS (PLRMBS) we hold have significantly increased our credit risk exposure and have adversely affected our earnings and total capital. These mortgage portfolios have historically provided us with the financial flexibility to continue providing cost-effective credit and liquidity to our members and have enhanced the Bank’s earnings. As a result of the other-than-temporary impairment (OTTI) charges on certain PLRMBS during 2008 and 2009, however, these mortgage assets have had a negative impact on our earnings and total capital and have had a negative near-term impact on our financial flexibility.
Throughout 2009, in response to the possibility of future OTTI charges on our PLRMBS portfolio, we focused on preserving capital by building retained earnings and suspending the repurchase of members’ excess capital stock. As a result, we did not pay a dividend for the first and third quarters of 2009, and the dividends for the second and fourth quarters of 2009 were small. The dividend for the fourth quarter of 2009 was declared by the Bank’s Board of Directors on February 22, 2010, at an annualized rate of 0.27%. We recorded and expect to pay the fourth quarter dividend during the first quarter of 2010. Although we did not repurchase excess capital stock during 2009, the five-year redemption period for $16 million in mandatorily redeemable capital stock expired, and the Bank redeemed the stock at its $100 par value on the relevant expiration dates. We will continue to monitor the condition of our MBS portfolio, our 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 capital stock repurchases in future quarters.
The Bank’s business model, approved by our Board of Directors, is intended to balance the trade-off between the price we charge for credit and the dividend yield on Bank stock. We seek to keep advances prices low, and we assess the effectiveness of our low-cost credit policy by comparing our members’ total borrowings from the Bank to their use of other wholesale credit sources. We also strive to pay a market-rate return on our members’ investment in the Bank’s capital, and we assess the effectiveness of our market-rate return policy by comparing our potential dividend rate to a benchmark calculated as the combined average of (i) the daily average of the overnight Federal funds effective rate and (ii) the four-year moving average of the U.S. Treasury note yield (calculated as the average of the three-year and five-year U.S. Treasury note yields). The benchmark is consistent with our interest rate risk and capital management goals. Although we paid a small dividend for 2009, we continued to use the benchmark to measure our financial results based on the earnings that would have been available for dividends but were used to build retained earnings instead.
Our financial strategies are designed to enable us to safely expand and contract our assets, liabilities, and capital in response to changes in our member base and our members’ credit needs. Our capital grows when members are required to purchase additional capital stock as they increase their advance borrowings. Our capital shrinks when we repurchase capital stock from members as their advances or balances of mortgage loans sold to the Bank decline below certain levels. As a result of these strategies, we have generally been able to achieve our mission by meeting member credit needs and paying market-rate dividends, despite significant fluctuations in total assets, liabilities, and capital. Although we did not repurchase capital stock or pay a market-rate dividend in 2009, we continued to meet member credit needs throughout the year.
Products and Services
Advances. We offer our members a wide array of fixed and adjustable rate loans, called advances, with maturities ranging from one day to 30 years. Our advance products are designed to help members compete effectively in their markets and meet the credit needs of their communities. For members that choose to retain the mortgage loans they originate as assets (portfolio lenders), advances serve as a funding source for a variety of conforming and nonconforming mortgages. As a result, advances support an array of housing market segments, including those focused on low- and moderate-income households. For members that sell or securitize mortgages and other assets, advances can provide interim funding.
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Our credit products also help members with asset-liability management. Members can use a wide range of advance types, with different maturities and payment characteristics, to match the characteristics of their assets and reduce their interest rate risk. We offer advances that are callable at the member’s option and advances with embedded option features (such as caps, floors, corridors, and collars), which can reduce the interest rate risk associated with holding fixed rate mortgage loans and adjustable rate mortgage loans with embedded caps in portfolio.
We offer both standard and customized advance structures. Customized advances may include:
| • | advances with non-standard indices; |
| • | advances with embedded option features (such as interest rate caps, floors, corridors, and collars, and call and put options); |
| • | amortizing advances; and |
| • | advances with partial prepayment symmetry. (Partial prepayment symmetry means the Bank may charge the member a prepayment fee or pay the member a prepayment credit, depending on certain circumstances, such as movements in interest rates, if the advance is prepaid.) |
For each customized advance, we typically execute an equal and offsetting derivative with an authorized counterparty to enable us to offset the customized features embedded in the advance. As of December 31, 2009, customized advances represented 16% of total advances outstanding.
We manage 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. We also have procedures to assess the mortgage loan underwriting and documentation standards of members that pledge mortgage loan collateral. In addition, we have collateral policies and restricted lending procedures in place to help manage our exposure to members that experience difficulty in meeting their regulatory capital requirements or other standards of creditworthiness. These credit and collateral policies balance our dual goals of meeting members’ needs as a reliable source of liquidity and limiting credit loss by adjusting credit and collateral terms in response to deterioration in member creditworthiness and collateral quality.
We limit the amount we 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 our 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 pledged by the member. Under the terms of our lending agreements, the aggregate borrowing capacity of a member’s pledged 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. We monitor each member’s aggregate borrowing capacity and collateral requirements on a daily basis, by comparing the member’s borrowing capacity to its obligations to us, as required.
All advances must be fully collateralized. To secure advances, members may pledge one- to four-family first lien residential mortgage loans, multifamily mortgage loans, MBS, U.S. government and agency securities, deposits in the Bank, and certain other real estate-related collateral, such as commercial real estate loans and second lien residential mortgage loans. We may also accept secured 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 secured loans as eligible collateral from members that are community financial institutions. The Housing Act added secured loans for community development activities as collateral that we may accept from community financial institutions. The Housing Act defined community financial institutions as depository institutions insured by the Federal Deposit Insurance Corporation (FDIC) with average total assets over the preceding three-year period of $1 billion or less. The Finance Agency adjusts the average total asset cap for inflation annually. Effective January 1, 2010, the cap was $1.029 billion.
We conduct a collateral field review for each member at least every six months to three years, depending on the risk profile of the member and the types of collateral pledged by the member. During the review, we examine a statistical sample of the member’s pledged loans to validate loan ownership and to confirm that the critical legal documents are available to the Bank. As part of the loan examination, we also identify secondary market discounts, including discounts for high-risk credit attributes.
We collect collateral data from most members on a monthly or quarterly basis, or more frequently if needed, and assign borrowing capacities to each type of collateral pledged by the member. Borrowing capacity is determined based on the value assigned to the collateral and a margin for the costs and risks of liquidation. We may also apply a credit risk margin to loan collateral if the member’s financial condition has deteriorated substantially. Securities pledged as collateral typically have higher borrowing capacities than loan
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collateral because securities tend to have readily available market values, cost less to liquidate, and are delivered to the Bank when they are pledged. Our maximum borrowing capacities vary by collateral type and generally range from 30% to 100% of the market value or unpaid principal balance of the collateral. For example, Bank term deposits have a borrowing capacity of 100%, while second lien residential mortgage loans have a maximum borrowing capacity of 30%.
Throughout 2009, we regularly reviewed and adjusted our lending parameters in light of changing market conditions, and we required additional collateral, when necessary, to fully secure advances. Based on our risk assessment of prevailing mortgage market conditions and of individual members and their collateral, we periodically decreased the maximum borrowing capacity for certain collateral types and applied additional credit risk margins when needed to address the deteriorating financial condition of individual members.
We perfect our security interest in securities collateral by taking delivery of all securities at the time they are pledged. We perfect our security interest in loan collateral by filing a UCC-1 financing statement for each member. We 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), we are concerned about the member’s creditworthiness, or we are concerned about the maintenance of our collateral or the priority of our security interest. In addition, the Federal Home Loan Bank Act of 1932, as amended (FHLBank Act), provides that any security interest granted to the Bank by any member or member affiliate has priority over the claims and rights of any other party, including any receiver, conservator, trustee, or similar party that has the rights of a lien creditor, unless these claims and rights would be entitled to priority under otherwise applicable law and are held by actual purchasers or by parties that have perfected security interests.
When a nonmember financial institution acquires some or all of the assets and liabilities of a member, including outstanding advances and Bank capital stock, we may allow the advances to remain outstanding, at our discretion. The nonmember borrower is required to meet all of the Bank’s credit and collateral requirements, including requirements regarding creditworthiness and collateral borrowing capacity.
As of December 31, 2009, we had $133.6 billion of advances outstanding, including $37.0 billion to nonmember borrowers. For members and nonmembers with credit outstanding, the total borrowing capacity of pledged collateral as of that date was $231.8 billion, including $59.5 billion pledged to secure advances outstanding to nonmember borrowers. For the year ended December 31, 2009, we had average advances of $179.7 billion and average collateral pledged with an estimated borrowing capacity of $254.9 billion.
We have policies and procedures in place to manage the credit risk of advances. Based on the collateral pledged as security for advances, our credit analyses of members’ financial condition, and our credit extension and collateral policies, we expect to collect all amounts due according to the contractual terms of the advances. Therefore, no allowance for losses on advances is deemed necessary by management. We have never experienced a credit loss on an advance.
When a borrower prepays an advance prior to its original maturity, we may charge the borrower a prepayment fee, depending on certain circumstances, such as movements in interest rates, at the time the advance is prepaid. For an advance with partial prepayment symmetry, we may charge the borrower a prepayment fee or pay the member a prepayment credit, depending on certain circumstances at the time the advance is prepaid. Our prepayment fee policy is designed to recover at least the net economic costs, if any, associated with the reinvestment of the advance prepayment proceeds or the cost to terminate the funding associated with the prepaid advance, which enables us to be financially indifferent to the prepayment of the advance. In 2009, 2008, and 2007, the prepayment fees/(credits) realized in connection with prepaid advances, including advances with partial prepayment symmetry, were $34.3 million, $(4.3) million, and $1.5 million, respectively.
At December 31, 2009, we had a concentration of advances totaling $81.9 billion outstanding to three institutions, representing 62% of total advances outstanding. Advances held by these three institutions generated approximately $1.9 billion, or 51%, of advances interest income excluding the impact of interest rate exchange agreements in 2009. Because of this concentration in advances, we conduct more frequent credit and collateral reviews for these institutions. We also analyze the implications to our financial management and profitability if we were to lose the advances business of one or more of these institutions or if the advances outstanding to one or more of these institutions were not replaced when repaid. For further information on advances concentration, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Concentration Risk – Advances.”
Because of the funding alternatives available to our largest borrowers, we employ a market pricing practice for member credit to determine advances prices that reflect the market choices available to our largest members each day. We offer the same advances prices to all members each day, which means that all members benefit from this pricing strategy. In addition, if further price concessions are negotiated with any member to reflect market conditions on a given day, those price concessions are also made available to all members for the same product with the same terms on the same day.
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Standby Letters of Credit. We also provide members with standby letters of credit to support certain obligations of the members to third parties. Members may use standby letters of credit issued by the Bank to facilitate residential housing finance and community lending, to achieve liquidity and asset-liability management goals, to secure certain state and local agency deposits, and to provide credit support to certain tax-exempt bonds. Our underwriting and collateral requirements for standby letters of credit are generally the same as our underwriting and collateral requirements for advances, but may differ in cases where member creditworthiness is impaired. As of December 31, 2009, we had $5.3 billion in standby letters of credit outstanding.
Investments. We invest in high-quality financial instruments to facilitate our role as a cost-effective provider of credit and liquidity to members. We have adopted credit policies and exposure limits for investments that promote diversification and liquidity. These policies restrict the amounts and terms of our investments according to our own capital position as well as the capital and creditworthiness of the individual counterparties, with different unsecured credit limits for members and nonmembers.
We invest in short-term unsecured Federal funds sold, negotiable certificates of deposit (interest-bearing deposits), commercial paper, and corporate debentures issued under the Temporary Liquidity Guarantee Program (TLGP), which are guaranteed by the FDIC and backed by the full faith and credit of the U.S. government. We may also invest in short-term secured transactions, such as U.S. Treasury or agency securities resale agreements. When we execute non-MBS investments with members, we may give consideration to their secured credit availability and our advances price levels. Our investments also include housing finance agency bonds, limited to those issued by housing finance agencies located in the 11th District of the FHLBank System (Arizona, California, and Nevada). 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 we hold are issued by the California Housing Finance Agency (CalHFA) and insured by either Ambac Assurance Corporation, MBIA Insurance Corporation, or Assured Guaranty Municipal Corporation (formerly Financial Security Assurance Incorporated). During 2009, all of the bonds were rated at least AA by Moody’s, Standard & Poor’s, or Fitch Ratings.
In addition, our investments include agency residential MBS, which are backed by Fannie Mae, Freddie Mac, or Ginnie Mae, and PLRMBS, all of which were AAA-rated at the time of purchase. Some of these PLRMBS were issued by and/or purchased from members, former members, or their respective affiliates. As of December 31, 2009, 49% of our PLRMBS were rated above investment grade (14% had a credit rating of AAA based on the amortized cost), and the remaining 51% were rated below investment grade. Credit ratings of BB+ and lower are below investment grade. The credit ratings we use are based on the lowest of Moody’s, Standard & Poor’s, or comparable Fitch ratings. We execute all MBS investments without preference to the status of the counterparty or the issuer of the investment as a nonmember, member, or affiliate of a member.
As of December 31, 2009, our investment in MBS classified as held-to-maturity had gross unrealized losses totaling $5.5 billion, primarily relating 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 the loan collateral underlying these securities, which caused these assets to be valued at significant discounts to their acquisition cost.
We monitor our investments for substantive changes in relevant market conditions and any declines in fair value. When the fair value of an individual investment security falls below its amortized cost, we evaluate whether the decline is other than temporary. As part of this evaluation, we consider whether we intend to sell each debt security and whether it is more likely than not that we will be required to sell the security before our anticipated recovery of the amortized cost basis. If either of these conditions is met, we recognize 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, we consider whether we expect to recover the entire amortized cost basis of the security by comparing our 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 our 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. We generally view changes in the fair value of the securities caused by movements in interest rates to be temporary.
For all the securities in our available-for-sale and held-to-maturity portfolio and Federal funds sold, we do not intend to sell any security and it is not more likely than not that we will be required to sell any security before our anticipated recovery of the remaining amortized cost basis.
We have determined that, as of December 31, 2009, all of the gross unrealized losses on our short-term unsecured Federal funds sold and interest-bearing deposits 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 and interest-bearing deposits were all with issuers that had credit ratings of at least A at December 31, 2009; and all of the securities had maturity dates within 45 days of December 31, 2009.
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At December 31, 2009, our investments in housing finance agency bonds, which were issued by CalHFA, had gross unrealized losses totaling $138 million. These gross unrealized losses were mainly due to an illiquid market, causing these investments to be valued at discounts to their acquisition cost. In addition, the Bank independently modeled cash flows for the underlying collateral, using reasonable assumptions for default rates and loss severity, and concluded that the available credit support within the CalHFA structure more than offset the projected underlying collateral losses. We have determined that, as of December 31, 2009, all of the gross unrealized losses on our housing finance agency bonds are temporary because the strength of the underlying collateral and credit enhancements was sufficient to protect the Bank from losses based on current expectations and because CalHFA had a credit rating of AA– at December 31, 2009 (based on the lowest of Moody’s, Standard & Poor’s, or comparable Fitch ratings). As a result, we expect to recover the entire amortized cost basis of these securities.
For our TLGP investments and agency residential MBS, we expect to recover the entire amortized cost basis of these securities because we determined that the strength of the issuers’ guarantees through direct obligations or support from the U.S. government was sufficient to protect us from losses based on our expectations at December 31, 2009. As a result, we determined that, as of December 31, 2009, all of the gross unrealized losses on our TLGP investments and agency residential MBS are temporary.
To assess whether we expect to recover the entire amortized cost basis of our PLRMBS, we performed a cash flow analysis for all of our PLRMBS as of December 31, 2009. In performing the cash flow analysis for each security, we use two third-party models. The first model considers borrower characteristics and the particular attributes of the loans underlying our 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 assumed CBSA-level current-to-trough housing price declines ranging from 0% to 15% over the next 9 to 15 months (average price decline during this time period equaled 5.4%). Thereafter, 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.
Based on the cash flow analysis performed on our PLRMBS, we determined that 123 of our PLRMBS were other-than-temporarily impaired at December 31, 2009, because we determined it was likely that we would not recover the entire amortized cost basis of each of these securities.
During the year ended December 31, 2009, the OTTI related to credit loss of $608 million was recognized in “Other (Loss)/Income” and the OTTI related to all other factors of $3.5 billion was recognized in “Other comprehensive income/(loss).” Illiquidity in the PLRMBS market adversely affected the valuation of these PLRMBS, contributing to the large non-credit-related OTTI charge recorded in accumulated other comprehensive income (AOCI).
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. We do not intend to sell these securities and it is not more likely than not that we will be required to sell these securities before our anticipated recovery of the remaining amortized cost basis. At December 31, 2009, the estimated weighted average life of the affected securities was approximately four years.
Because there is a continuing risk that we may record additional material OTTI charges in future periods, our earnings and retained earnings and our ability to pay dividends and repurchase capital stock could be adversely affected. Throughout the year, in response to the possibility of future OTTI charges on our PLRMBS portfolio, we focused on preserving capital by building retained earnings and suspending the repurchase of members’ excess capital stock. As a result, we did not pay a dividend for the first and third quarters of 2009, and the dividends for the second and fourth quarters of 2009 were small. Although we did not repurchase excess capital stock during 2009, the five-year redemption period for $16 million in mandatorily redeemable capital stock expired, and the Bank redeemed
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the stock at its $100 par value on the relevant expiration dates. We will continue to monitor the condition of our MBS portfolio, our overall financial performance and retained earnings, developments in the mortgage and credit market, and other relevant information as the basis for determining the status of dividends and capital stock repurchases in future quarters. Additional information about our investments and OTTI charges associated with our PLRMBS is provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – Investments” and in Note 6 to the Financial Statements.
Affordable Housing Program. Through our Affordable Housing Program (AHP), we provide subsidies to assist in the purchase, construction, or rehabilitation of housing for households earning up to 80% of the median income for the area in which they live. Each year, we set aside 10% of the current year’s income for the AHP, to be awarded in the following year. Since 1990, we have awarded $602 million in AHP subsidies to support the purchase, development, or rehabilitation of approximately 94,000 affordable homes.
We allocate at least 65% of our annual AHP subsidy to our competitive AHP, under which applications for specific owner-occupied and rental housing projects are submitted by members and are evaluated and scored by the Bank in a competitive process that occurs twice a year. All subsidies for the competitive AHP are funded to affordable housing sponsors or developers through our members in the form of direct subsidies or subsidized advances.
We allocate the remainder of our annual AHP subsidy, up to 35%, to our two homeownership set-aside programs, the Individual Development and Empowerment Account Program and the Workforce Initiative Subsidy for Homeownership Program. Under these programs, members reserve funds from the Bank to be used as matching grants for eligible homebuyers.
Discounted Credit Programs. We offer members two discounted credit programs available in the form of advances and standby letters of credit. Members may use the Community Investment Program to fund mortgages for low- and moderate-income households, to finance first-time homebuyer programs, to create and maintain affordable housing, and to support other eligible lending activities related to housing for low- and moderate-income families. Members may use the Advances for Community Enterprise (ACE) Program to fund projects and activities that create or retain jobs or provide services or other benefits for low- and moderate-income people and communities. Members may also use ACE funds to support eligible community lending and economic development, including small business, community facilities, and public works projects.
In addition, we offer members a discounted credit program available only in the form of advances. Members may use the Homeownership Preservation Advance Program to modify or refinance mortgage loans to low- and moderate-income homeowners who may be at risk of losing their primary residence because of delinquency or default on their mortgage loan.
Funding Sources
We obtain most of our funds from the sale of the FHLBanks’ debt instruments (consolidated obligations), which consist of consolidated obligation bonds and discount notes. The consolidated obligations are issued through the Office of Finance using authorized securities dealers and are backed only by the financial resources of the FHLBanks. 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 regulations provide a general framework for addressing the possibility that an FHLBank may be unable to repay the consolidated obligations for which it is the primary obligor. For more information, see Note 18 to the Financial Statements. We have never been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank, and as of December 31, 2009, and through the date of this report, we do not believe that it is probable that we will be asked to do so.
The Bank’s status as a GSE is critical to maintaining its access to the capital markets. Although consolidated obligations are backed only by the financial resources of the 12 FHLBanks and are not guaranteed by the U.S. government, the capital markets have traditionally treated the FHLBanks’ consolidated obligations as comparable to federal agency debt, providing the FHLBanks with access to funding at relatively favorable rates. Moody’s has rated the FHLBanks’ consolidated obligations Aaa/P-1, and Standard & Poor’s has rated them AAA/A-1+.
Regulations govern the issuance of debt on behalf of the FHLBanks and related activities. All new debt is jointly issued by the FHLBanks through the Office of Finance, which serves as their fiscal agent in accordance with the FHLBank Act and applicable regulations. Pursuant to these regulations, the Office of Finance, often in conjunction with the FHLBanks, has adopted policies and procedures for consolidated obligations that may be issued by the FHLBanks. The policies and procedures relate to the frequency and timing of issuance, issue size, minimum denomination, selling concessions, underwriter qualifications and selection, currency of issuance, interest rate change or conversion features, call or put features, principal amortization features, and selection of clearing
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organizations and outside counsel. The Office of Finance has responsibility for facilitating and approving the issuance of the consolidated obligations in accordance with these policies and procedures. In addition, the Office of Finance has the authority to redirect, limit, or prohibit the FHLBanks’ requests to issue consolidated obligations that are otherwise allowed by its policies and procedures if it determines that its action is consistent with: (i) the regulatory requirement that consolidated obligations be issued efficiently and at the lowest all-in cost over time, consistent with prudent risk management practices, prudent debt parameters, short- and long-term market conditions, and the FHLBanks’ status as GSEs; (ii) maintaining reliable access to the short-term and long-term capital markets; and (iii) positioning the issuance of debt to take advantage of current and future capital market opportunities. The Office of Finance’s authority to redirect, limit, or prohibit the Bank’s requests for issuance of consolidated obligations has not adversely impacted the Bank’s ability to finance its operations. The Office of Finance also services all outstanding FHLBank debt, serves as a source of information for the FHLBanks on capital market developments, and prepares the FHLBanks’ combined quarterly and annual financial statements. In addition, it administers the Resolution Funding Corporation (REFCORP) and the Financing Corporation, two corporations established by Congress in the 1980s to provide funding for the resolution and disposition of insolvent savings institutions.
Consolidated Obligation Bonds. Consolidated obligation bonds are issued under various programs. Typically, the maturities of these securities range from 1 to 15 years, but the maturities are not subject to any statutory or regulatory limit. The bonds may be fixed or adjustable rate, callable or non-callable, and may contain other features allowed by Office of Finance guidelines. They may be issued and distributed daily through negotiated or competitively bid transactions with approved underwriters or selling group members.
We receive 100% of the net proceeds of a bond issued via direct negotiation with underwriters of debt when we are the only FHLBank involved in the negotiation. In these cases, we are the sole primary obligor on the consolidated obligation bond. When we and one or more other FHLBanks jointly negotiate the issuance of a bond directly with underwriters, we receive the portion of the proceeds of the bond agreed upon with the other FHLBanks; in those cases, we are the primary obligor for a pro-rata portion of the bond, including all customized features and terms, based on the proceeds received.
We may also request specific amounts of specific consolidated bonds to be offered by the Office of Finance for sale via competitive auction conducted with the underwriters in a bond selling group. One or more other FHLBanks may also request amounts of those same bonds to be offered for sale for their benefit via the same auction. We may receive zero to 100% of the proceeds of the bonds issued via competitive auction depending on: (i) the amounts and costs for the consolidated obligation bonds bid by underwriters; (ii) the maximum costs we or other FHLBanks participating in the same issue, if any, are willing to pay for the bonds; and (iii) guidelines for the allocation of bond proceeds among multiple participating FHLBanks administered by the Office of Finance.
Consolidated Obligation Discount Notes. The FHLBanks also issue consolidated obligation discount notes to provide short-term funds for advances to members and for short-term investments. Discount notes have maturities ranging from one day to one year and may be offered daily through a consolidated obligation discount note selling group and through other authorized underwriters. Discount notes are issued at a discount and mature at par.
On a daily basis, we may request specific amounts of discount notes with specific maturity dates to be offered by the Office of Finance at a specific cost for sale to underwriters in the discount note selling group. One or more other FHLBanks may also request amounts of discount notes with the same maturities to be offered for sale for their benefit the same day. The Office of Finance commits to issue discount notes on behalf of the participating FHLBanks when underwriters in the selling group submit orders for the specific discount notes offered for sale. We may receive zero to 100% of the proceeds of the discount notes issued via this sales process depending on: (i) the maximum costs we or other FHLBanks participating in the same discount note issuance, if any, are willing to pay for the discount notes; (ii) the order amounts for the discount notes submitted by underwriters; and (iii) guidelines for the allocation of discount note proceeds among multiple participating FHLBanks administered by the Office of Finance.
Twice weekly, we may also request specific amounts of discount notes with fixed terms to maturity ranging from 4 to 26 weeks to be offered by the Office of Finance for sale via competitive auction conducted with underwriters in the discount note selling group. One or more other FHLBanks may also request amounts of those same discount notes to be offered for sale for their benefit via the same auction. The discount notes offered for sale via competitive auction are not subject to a limit on the maximum costs the FHLBanks are willing to pay. We may receive zero to 100% of the proceeds of the discount notes issued via competitive auction depending on: (i) the amounts and costs for the discount notes bid by underwriters and (ii) guidelines for the allocation of discount note proceeds among multiple participating FHLBanks administered by the Office of Finance. Most of the term discount notes are issued through these twice-weekly auctions.
For information regarding the impact of current market conditions on the Bank’s ability to issue consolidated obligations, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview – Funding and Liquidity.”
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Debt Investor Base. The FHLBanks have traditionally had a diversified funding base of domestic and foreign investors. Purchasers of the FHLBanks’ consolidated obligations include fund managers, commercial banks, pension funds, insurance companies, foreign central banks, state and local governments, and retail investors. These purchasers are also diversified geographically, with a significant portion of our investors historically located in the United States, Europe, and Asia. For more information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview – Funding and Liquidity.”
Segment Information
We use an analysis of the Bank’s 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 expenses associated with economic hedges that are recorded in “Net gain/(loss) 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 our held-to-maturity PLRMBS, other expenses, and assessments, is not included in the segment reporting analysis, but is incorporated into management’s overall assessment of financial performance.
The advances-related business consists of advances and other credit products, related financing and hedging instruments, liquidity and other non-MBS investments associated with our role as a liquidity provider, and capital stock. Adjusted net interest income for this segment is derived primarily from the difference, or spread, between the yield on all assets associated with the business activities in this segment and the cost of funding these activities, cash flows from associated interest rate exchange agreements, and earnings on invested capital stock.
The mortgage-related business consists of MBS investments, mortgage loans previously acquired through the Mortgage Partnership Finance® (MPF®) Program (“Mortgage Partnership Finance” and “MPF” are registered trademarks of the Federal Home Loan Bank of Chicago), the consolidated obligations specifically identified as funding those assets, and related hedging instruments. 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, less the provision for credit losses on mortgage loans.
Additional information about business segments is provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Segment Information” and in Note 15 to the Financial Statements.
Use of Interest Rate Exchange Agreements
We use interest rate exchange agreements, also known as derivatives, as part of our interest rate risk management and funding strategies to reduce identified risks inherent in the normal course of business. The types of derivatives we may use include interest rate swaps (including callable, putable, and basis swaps); swaptions; and interest rate cap, floor, corridor, and collar agreements.
The regulations governing the operations of the FHLBanks and the Bank’s Risk Management Policy establish guidelines for our use of derivatives. These regulations and policies prohibit trading in derivatives for profit and any other speculative use of these instruments. They also limit the amount of credit risk allowable from derivatives.
We primarily use derivatives to manage our exposure to changes in interest rates. The goal of our interest rate risk management strategy is not to eliminate interest rate risk, but to manage it within appropriate limits. One key way we manage interest rate risk is to acquire and maintain a portfolio of assets and liabilities, which, together with their associated derivatives, are conservatively matched with respect to the expected maturities or repricings of the assets and the liabilities.
We may also use derivatives to adjust the effective maturity, repricing frequency, or option characteristics of financial instruments (such as advances and outstanding bonds) to achieve risk management objectives. Upon request, we may also execute derivatives to act as an intermediary counterparty with member institutions for their own risk management activities.
At December 31, 2009, the total notional amount of our outstanding derivatives was $235.0 billion. The notional amount of a derivative 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.
We are subject to credit risk in derivatives transactions in which we have an unrealized fair value gain because of the potential nonperformance by the derivatives counterparty. We seek to reduce this credit risk by executing derivatives transactions only with
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highly rated financial institutions. In addition, the legal agreements governing our derivatives transactions require the credit exposure of all derivatives transactions with each counterparty to be netted and require each counterparty to deliver high quality collateral to us once a specified net unsecured credit exposure is reached. At December 31, 2009, the Bank’s maximum credit exposure related to derivatives was approximately $1.8 billion; taking into account the delivery of required collateral, the net unsecured credit exposure was approximately $36 million.
We measure the Bank’s market risk on a portfolio basis, taking into account the entire balance sheet and all derivatives transactions. The market risk of the derivatives and the hedged items is included in the measurement of our various market risk measures, including duration gap (the difference between the expected weighted average maturities of our assets and liabilities), which was four months at December 31, 2009. This low interest rate risk profile reflects our conservative asset-liability mix, which is achieved through integrated use of derivatives in our daily financial management.
Capital
From its enactment in 1932, the FHLBank Act provided for a subscription-based capital structure for the FHLBanks. The amount of capital stock that each FHLBank issued was determined by a statutory formula establishing how much FHLBank stock each member was required to purchase. With the enactment of the Gramm-Leach-Bliley Act of 1999, Congress replaced the statutory subscription-based member stock purchase formula with requirements for total capital, leverage capital, and risk-based capital for the FHLBanks and required the FHLBanks to develop new capital plans to replace the previous statutory structure.
We implemented our capital plan on April 1, 2004. The capital plan bases the stock purchase requirement on the level of activity a member has with the Bank, subject to a minimum membership requirement that is intended to reflect the value to the member of having access to the Bank as a funding source. With the approval of the Board of Directors, we may adjust these requirements from time to time within limits established in the capital plan. Any changes to our capital plan must be approved by our Board of Directors and the Finance Agency.
Bank stock cannot be publicly traded, and under the capital plan, may be issued, transferred, redeemed, and repurchased only at its stated par value of $100 per share, subject to certain regulatory and statutory limits. Under the capital plan, a member’s capital stock will be redeemed by the Bank upon five years’ notice from the member, subject to certain conditions. In addition, we have the discretion to repurchase excess stock from members. Ranges have been built into the capital plan to allow us to adjust the stock purchase requirements to meet our regulatory capital requirements, if necessary.
Competition
Demand for Bank advances is affected by many factors, including the availability and cost of other sources of funding for members, including retail and brokered deposits. We compete with our members’ other suppliers of wholesale funding, both secured and unsecured. These suppliers may include securities dealers, commercial banks, other FHLBanks for members with affiliated institutions that are members of other FHLBanks, and the Federal Reserve Banks’ various credit programs.
Under the FHLBank Act and regulations governing the operations of the FHLBanks, affiliated institutions in different FHLBank districts may be members of different FHLBanks. The three institutions with the greatest amounts of advances outstanding from the Bank as of December 31, 2009, have had and continue to have affiliated institutions that are members of other FHLBanks, and these institutions may have access, through their affiliates, to funding from those other FHLBanks. Moreover, two of these three institutions were substantially acquired, directly or indirectly, by two nonmember financial institutions in the year ended December 31, 2008. For further information about these institutions, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Concentration Risk – Advances.”
Our ability to compete successfully for the advances business of our members depends primarily on our advances prices, ability to fund advances through the issuance of consolidated obligations at competitive rates, credit and collateral terms, prepayment terms, product features such as embedded option features, ability to meet members’ specific requests on a timely basis, dividends, retained earnings policy, excess and surplus capital stock repurchase policies, and capital stock requirements.
Members may have access to alternative funding sources through sales of securities under agreements to resell. Some members, particularly larger members, may have access to many more funding alternatives, including independent access to the national and global credit markets—including the covered bond market—and more recently, the ability to issue senior unsecured debt under the Federal Deposit Insurance Corporation’s Temporary Liquidity Guarantee Program and use funds under the U.S. Treasury’s Troubled
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Asset Relief Program. The availability of alternative funding sources for members can significantly influence the demand for our advances and can vary as a result of many factors, including market conditions, members’ creditworthiness, members’ strategic objectives, and the availability of collateral.
The FHLBanks also compete with the U.S. Treasury, Fannie Mae, Freddie Mac, and other GSEs, as well as corporate, sovereign, and supranational entities, for funds raised through the issuance of unsecured debt in the national and global debt markets. Increases in the supply of competing debt products may, in the absence of increases in demand, result in higher debt costs or lower amounts of debt issued at the same cost.
Regulatory Oversight, Audits, and Examinations
The FHLBanks are supervised and regulated by the Finance Agency, an independent agency in the executive branch of the U.S. government. The Finance Agency is also responsible for supervising and regulating Fannie Mae and Freddie Mac. The Finance Agency is supported entirely by assessments from the 12 FHLBanks, Fannie Mae, and Freddie Mac. With respect to the FHLBanks, the Finance Agency is charged with ensuring that the FHLBanks carry out their housing finance mission, remain adequately capitalized and able to raise funds in the capital markets, and operate in a safe and sound manner. The Finance Agency also establishes regulations governing the operations of the FHLBanks.
The Finance Agency has broad supervisory authority over the FHLBanks, including, but not limited to, the power to suspend or remove any entity-affiliated party (including any director, officer or employee) of an FHLBank who violates certain laws or commits certain other acts; to issue and serve a notice of charges upon an FHLBank or any entity-affiliated party; to obtain a cease and desist order, or a temporary cease and desist order, to stop or prevent any unsafe or unsound practice or violation of law, order, rule, regulation, or condition imposed in writing; to issue civil money penalties against an FHLBank or an entity-affiliated party; to require an FHLBank to take certain actions, or refrain from certain actions, under the prompt corrective action provisions that authorize or require the Finance Agency to take certain supervisory actions, including the appointment of a conservator or receiver for an FHLBank under certain conditions; and to require any one or more of the FHLBanks to repay the primary obligations of another FHLBank on outstanding consolidated obligations.
Pursuant to the Housing Act, the Finance Agency published a final rule on August 4, 2009, to implement the Finance Agency’s prompt corrective action authority over the FHLBanks. The Capital Classification and Prompt Corrective Action rule establishes the criteria for each of the following capital classifications for the FHLBanks specified in the Housing Act: adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Under the rule, unless the Finance Agency has reclassified an FHLBank based on factors other than its capital levels, an FHLBank is adequately capitalized if it has sufficient total and permanent capital to meet or exceed both its risk-based and minimum capital requirements; is undercapitalized if it fails to meet one or more of its risk-based or minimum capital requirements, but is not significantly undercapitalized; is significantly undercapitalized if the total or permanent capital held by the FHLBank is less than 75 percent of what is required to meet any of its requirements, but the FHLBank is not critically undercapitalized; and is critically undercapitalized if it fails to maintain an amount of total or permanent capital equal to two percent of its total assets.
By letter dated January 12, 2010, the Director of the Finance Agency notified the Bank that, based on September 30, 2009, financial information, the Bank met the definition of adequately capitalized under the Finance Agency’s Capital Classification and Prompt Corrective Action rule.
The Housing Act and Finance Agency regulations govern capital distributions by an FHLBank, which include cash dividends, stock dividends, stock repurchases or any transaction in which the FHLBank purchases or retires any instrument included in its capital. Under the Housing Act and Finance Agency regulations, an FHLBank may not make a capital distribution if after doing so it would not be adequately capitalized or would be reclassified to a lower capital classification, or if such distribution violates any statutory or regulatory restriction, and in the case of a significantly undercapitalized FHLBank, an FHLBank may not make any capital distribution whatsoever without approval from the Director.
To assess the safety and soundness of the Bank, the Finance Agency conducts an annual on-site examination of the Bank and other periodic reviews of its financial operations. In addition, we are required to submit information on our financial condition and results of operations each month to the Finance Agency.
In accordance with regulations governing the operations of the FHLBanks, we registered our capital stock with the Securities and Exchange Commission (SEC) under Section 12(g)(1) of the Securities Exchange Act of 1934 (1934 Act), and the registration became effective on August 29, 2005. As a result of this registration, we are required to comply with the disclosure and reporting requirements of the 1934 Act and to file annual, quarterly, and current reports with the SEC, as well as meet other SEC requirements.
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Our Board of Directors has an audit committee, and we have an internal audit department. An independent registered public accounting firm audits our annual financial statements. The independent registered public accounting firm conducts these audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). The Bank, the Finance Agency, and Congress all receive the audit reports.
Like other federally chartered corporations, the 12 FHLBanks are subject to general congressional oversight. Each FHLBank must submit annual management reports to Congress, the President, the Office of Management and Budget, and the Comptroller General. These reports include a statement of financial condition, a statement of operations, a statement of cash flows, a statement of internal accounting and administrative control systems, and the report of the independent registered public accounting firm on the financial statements.
The Comptroller General has authority under the FHLBank Act to audit or examine the Finance Agency and the FHLBanks and to decide the extent to which they fairly and effectively fulfill the purposes of the FHLBank Act. Furthermore, the Government Corporations Control Act provides that the Comptroller General may review any audit of the financial statements conducted by an independent registered public accounting firm. If the Comptroller General conducts such a review, then he or she must report the results and provide his or her recommendations to Congress, the Office of Management and Budget, and the FHLBank in question. The Comptroller General may also conduct his or her own audit of any financial statements of an FHLBank.
The U.S. Treasury, or a permitted designee, is authorized under the combined provisions of the Government Corporations Control Act and the FHLBank Act to prescribe: the form, denomination, maturity, interest rate, and conditions to which the FHLBank debt will be subject; the way and time the FHLBank debt is issued; and the price for which the FHLBank debt will be sold. The U.S. Treasury may purchase FHLBank debt up to an aggregate principal amount of $4.0 billion pursuant to the standards and terms of the FHLBank Act.
All of the FHLBanks’ financial institution members are subject to federal or state laws and regulations, and changes to these laws or regulations or to related policies might adversely or favorably affect the business of the 12 FHLBanks.
Available Information
The SEC maintains a website at www.sec.gov that contains all electronically filed, or furnished reports, including our annual reports on Form 10-K, our quarterly reports on Form 10-Q, and current reports on Form 8-K, as well as any amendments. On our website (www.fhlbsf.com), we provide a link to the page on the SEC website that lists all of these reports. These reports may also be read and copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. (Further information about the operation of the Public Reference Room may be obtained at 1-800-SEC-0330.) In addition, we provide direct links from our website to our annual report on Form 10-K and our quarterly reports on Form 10-Q on the SEC website as soon as reasonably practicable after electronically filing or furnishing the reports to the SEC. (Note: The website addresses of the SEC and the Bank have been included as inactive textual references only. Information on those websites is not part of this report.)
Employees
We had 311 employees at December 31, 2009. Our employees are not represented by a collective bargaining unit, and we consider our relationship with our employees to be satisfactory.
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| ITEM 1A. | RISK FACTORS |
The following discussion summarizes certain of the risks and uncertainties that the Federal Home Loan Bank of San Francisco (Bank) faces. The list is not exhaustive and there may be other risks and uncertainties that are not described below that may also affect our business. Any of these risks or uncertainties, if realized, could negatively affect our financial condition or results of operations, or limit our ability to fund advances, pay dividends, or redeem or repurchase capital stock.
Economic weakness, including continued weakness in the housing and mortgage markets, has adversely affected the business of many of our members and our business and results of operations and could continue to do so.
Our business and results of operations are sensitive to the condition of the housing and mortgage markets, as well as general business and economic conditions. Adverse conditions and trends, including the U.S. economic recession, declining real estate values, illiquid mortgage markets, and fluctuations in both debt and equity capital markets, have adversely affected the business of many of our members and our business and results of operations. If these conditions in the housing and mortgage markets and general business and economic conditions remain adverse or deteriorate further, our business and results of operations could be further adversely affected. For example, prolonged economic weakness could result in further deterioration in many of our members’ credit characteristics, which could cause them to become delinquent or to default on their advances. In addition, further weakening of real estate prices and adverse performance trends in the residential and commercial mortgage lending sector could further reduce the value of collateral securing member credit obligations to the Bank and result in higher than anticipated actual and projected deterioration in the credit performance of the collateral supporting the Bank’s private-label residential mortgage-backed securities (PLRMBS) investments. This could increase the possibility that a member may not be able to meet additional collateral requirements, increasing the risk of failure of a member, or increase the risk of additional other-than-temporary impairment (OTTI) charges on the Bank’s PLRMBS investments.
Adverse economic conditions may contribute to further deterioration in the credit quality of our mortgage portfolio and could continue to have an adverse impact on our financial condition and results of operations and our ability to pay dividends or redeem or repurchase capital stock.
During 2009, the U.S. housing market continued to experience significant adverse trends, including significant price depreciation in some markets and high delinquency and default rates. These conditions contributed to high rates of loan delinquencies on the mortgage loans underlying our PLRMBS portfolio. OTTI credit charges on certain of our PLRMBS adversely affected our earnings in 2009. If deterioration in housing markets and housing prices is greater than our current expectations, there may be further OTTI charges and further adverse effects on our financial condition, results of operations, ability to pay dividends, and ability to redeem or repurchase capital stock. Furthermore, a slow economic recovery, either in the U.S. as a whole or in specific regions of the country, could result in rising delinquencies and increased risk of credit losses, and adversely affect our financial condition, results of operations, ability to pay dividends, and ability to redeem or repurchase capital stock.
Loan modification programs could adversely impact the value of our mortgage-backed securities.
Federal and state government authorities, as well as private entities, such as financial institutions and the servicers of residential mortgage loans, have proposed, commenced, or promoted implementation of programs designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures. 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 our mortgage-backed securities.
Market uncertainty and volatility may continue to adversely affect our business, profitability, and results of operations.
The housing and mortgage markets continue to experience very difficult conditions and volatility. The adverse conditions in these markets have resulted in a decrease in the availability of corporate credit and liquidity within the mortgage industry, causing disruptions in normal operations of major mortgage originators, including some of our largest borrowers, and have resulted in the insolvency, receivership, closure, or acquisition of a number of major financial institutions. These conditions have also resulted in less liquidity, greater volatility, a widening of credit spreads, and a lack of price transparency, and have contributed to further consolidation within the financial services industry. We operate in these markets and continue to be subject to potential adverse effects on our financial condition, results of operations, ability to pay dividends, or ability to redeem or repurchase capital stock.
Changes in or limits on our ability to access the capital markets could adversely affect our financial condition and results of operations, and our ability to fund advances, pay dividends, or redeem or repurchase capital stock.
Our primary source of funds is the sale of Federal Home Loan Bank (FHLBank) System consolidated obligations in the capital markets. Our ability to obtain funds through the sale of consolidated obligations depends in part on prevailing conditions in the capital markets, such as investor demand and liquidity in the financial markets, which are beyond our control. The sale of FHLBank System
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consolidated obligations can also be influenced by factors other than conditions in the capital markets, including legislative and regulatory developments and government programs and policies that affect the relative attractiveness of FHLBank System consolidated obligation bonds or discount notes. Based on these factors, we may not be able to obtain funding on acceptable terms. If we cannot access funding on acceptable terms when needed, our ability to support and continue our operations could be adversely affected, which could negatively affect our financial condition and results of operations and our ability to fund advances, pay dividends, or redeem or repurchase capital stock.
Prolonged interruptions in the payment of dividends and repurchase of excess capital stock may adversely affect the effective operation of the Bank’s business model.
Our business model is based on the premise that we maintain a balance between our obligation to achieve our public policy mission—to promote housing, homeownership, and community development through our activities with members—and our objective to provide an adequate return on the private capital provided by our members. We achieve this balance by delivering low-cost credit to help our members meet the credit needs of their communities while striving to pay members a market-rate dividend. Our financial strategies are designed to enable us to safely expand and contract our assets, liabilities, and capital in response to changes in our member base and our members’ credit needs. Our capital grows when members are required to purchase additional capital stock as they increase their advance borrowings. Our capital shrinks when we repurchase capital stock from members as their advances or balances of mortgage loans sold to the Bank decline below certain levels. As a result of these strategies, we have historically been able to achieve our mission by meeting member credit needs and paying market-rate dividends during stable market conditions, despite significant fluctuations in total assets, liabilities, and capital. During 2009, however, we did not pay a dividend for two quarters and did not repurchase excess capital stock in any quarter in order to preserve capital in response to the possibility of future OTTI charges. The risk of additional OTTI charges in future quarters and the need to continue to build retained earnings may limit our ability to pay dividends or to pay market-rate dividends and may limit our ability to repurchase capital stock. Any prolonged interruptions to the payment of dividends and repurchase of excess capital stock may adversely affect the effectiveness of our business model and could adversely affect the value of membership from the perspective of a member.
Changes in the credit ratings on FHLBank System consolidated obligations may adversely affect the cost of consolidated obligations.
FHLBank System consolidated obligations continue to be rated Aaa/P-1 by Moody’s Investors Service (Moody’s) and AAA/A-1+ by Standard & Poor’s Rating Services (Standard & Poor’s). Rating agencies may from time to time change a rating or issue negative reports. Because all of the FHLBanks have joint and several liability for all FHLBank consolidated obligations, negative developments at any FHLBank may affect this credit rating or result in the issuance of a negative report regardless of our financial condition and results of operations. Any adverse rating change or negative report may adversely affect our cost of funds and ability to issue consolidated obligations on acceptable terms, which could also adversely affect our financial condition and results of operations and restrict our ability to make advances on acceptable terms, pay dividends, or redeem or repurchase capital stock.
Changes in federal fiscal and monetary policy could adversely affect our business and results of operations.
Our business and results of operations are significantly affected by the fiscal and monetary policies of the federal government and its agencies, including the Federal Reserve Board, which regulates the supply of money and credit in the United States. The Federal Reserve Board’s policies directly and indirectly influence the yield on interest-earning assets and the cost of interest-bearing liabilities, which could adversely affect our financial condition, results of operations, ability to pay dividends, or ability to redeem or repurchase capital stock.
Changes in interest rates could significantly affect our financial condition, results of operations, or our ability to fund advances on acceptable terms, pay dividends, or redeem or repurchase our capital stock.
We realize income primarily from the spread between interest earned on our outstanding advances and investments and interest paid on our consolidated obligations and other liabilities. Although we use various methods and procedures to monitor and manage our exposure to changes in interest rates, we may experience instances when our interest-bearing liabilities will be more sensitive to changes in interest rates than our interest-earning assets, or vice versa. In either case, interest rate movements contrary to our position could negatively affect our financial condition and results of operations and our ability to pay dividends and redeem or repurchase capital stock. Moreover, the impact of changes in interest rates on mortgage-related assets can be exacerbated by prepayment and extension risks, which are, respectively, the risk that the assets will be refinanced by the obligor in low interest rate environments and the risk that the assets will remain outstanding longer than expected at below-market yields when interest rates increase.
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Our exposure to credit risk could adversely affect our financial condition, results of operations, and our ability to pay dividends or redeem or repurchase our capital stock.
We assume secured and unsecured credit risk exposure associated with the risk that a borrower or counterparty could default and we could suffer a loss if we could not fully recover amounts owed to us on a timely basis. In addition, we have exposure to credit risk because the market value of an obligation may decline as a result of deterioration in the creditworthiness of the obligor or the credit quality of a security instrument. We have a high concentration of credit risk exposure to financial institutions, which may currently present a higher degree of risk because of the ongoing housing market crisis, which has contributed to increased foreclosures and mortgage payment delinquencies. Credit losses could have an adverse effect on our financial condition, results of operations, ability to pay dividends, or ability to redeem or repurchase capital stock.
We depend on institutional counterparties to provide credit obligations that are critical to our business. Defaults by one or more of these institutional counterparties on their obligations to the Bank could adversely affect our results of operations or financial condition.
We face the risk that one or more of our institutional counterparties may fail to fulfill contractual obligations to us. The primary exposures to institutional counterparty risk are with derivatives counterparties; mortgage servicers that service the loans we hold as collateral on advances; third-party providers of credit enhancements on our PLRMBS investments, including mortgage insurers, bond insurers, and financial guarantors; and third-party providers of supplemental mortgage insurance for mortgage loans purchased under the Mortgage Partnership Finance® (MPF®) Program. A default by a counterparty could result in losses to the Bank if our credit exposure to the counterparty was under-collateralized or our credit obligations to the counterparty were over-collateralized, and could also adversely affect our ability to conduct our operations efficiently and at cost-effective rates, which in turn could adversely affect our results of operations or financial condition, ability to pay dividends, or ability to redeem or repurchase capital stock.
We rely on derivative transactions to reduce our interest rate risk and funding costs, and changes in our credit ratings or the credit ratings of our derivatives counterparties or changes in the legislation or the regulations affecting how derivatives are transacted may adversely affect our ability to enter into derivative transactions on acceptable terms.
Our financial strategies are highly dependent on our ability to enter into derivative transactions on acceptable terms to reduce our interest rate risk and funding costs. We currently have the highest long-term credit ratings of Aaa from Moody’s and AAA from Standard & Poor’s. All of our derivatives counterparties currently have high long-term credit ratings from Moody’s and Standard & Poor’s. Rating agencies may from time to time change a rating or issue negative reports, or other factors may raise questions regarding the creditworthiness of a counterparty, which may adversely affect our ability to enter into derivative transactions with acceptable counterparties on satisfactory terms in the quantities necessary to manage our interest rate risk and funding costs. Changes in legislation or regulations affecting how derivatives are transacted may also adversely affect our ability to enter into derivative transactions with acceptable counterparties on satisfactory terms. Any of these changes could negatively affect our financial condition and results of operations and impair our ability to make advances on acceptable terms, pay dividends, or redeem or repurchase capital stock.
Insufficient collateral protection could adversely affect our financial condition, results of operations, ability to pay dividends, or ability to redeem or repurchase our capital stock.
We require that all outstanding advances be fully collateralized. In addition, for mortgage loans that we purchased under the MPF Program, we require that members fully collateralize the outstanding credit enhancement obligations not covered through the purchase of supplemental mortgage insurance. We evaluate the types of collateral pledged by our members and assign borrowing capacities to the collateral based on the risks associated with that type of collateral. If we have insufficient collateral before or after an event of payment default by the member, or we are unable to liquidate the collateral for the value we assigned to it in the event of a payment default by a member, we could experience a credit loss on advances, which could adversely affect our financial condition, results of operations, ability to pay dividends, or ability to redeem or repurchase capital stock.
We may not be able to meet our obligations as they come due or meet the credit and liquidity needs of our members in a timely and cost-effective manner.
We seek to be in a position to meet our members’ credit and liquidity needs and pay our obligations without maintaining excessive holdings of low-yielding liquid investments or being forced to incur unnecessarily high borrowing costs. In addition, we maintain a contingency liquidity plan designed to enable us to meet our obligations and the liquidity needs of members in the event of operational disruptions or short-term disruptions in the capital markets. Our efforts to manage our liquidity position, including our contingency liquidity plan, may not enable us to meet our obligations and the credit and liquidity needs of our members, which could have an adverse effect on our financial condition, results of operations, ability to pay dividends, or ability to redeem or repurchase capital stock.
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We face competition for advances and access to funding, which could adversely affect our business.
Our primary business is making advances to our members. We compete with other suppliers of wholesale funding, both secured and unsecured, including investment banks, commercial banks, the Federal Reserve Banks, and, in certain circumstances, other FHLBanks. Our members may have access to alternative funding sources, including independent access to the national and global credit markets, including the covered bond market. These alternative funding sources may offer more favorable terms than we do on our advances, including more flexible credit or collateral standards. In addition, many of our competitors are not subject to the same regulations, which may enable those competitors to offer products and terms that we are not able to offer.
The FHLBanks also compete with the U.S. Treasury, Fannie Mae, Freddie Mac, and other GSEs, as well as corporate, sovereign, and supranational entities, for funds raised through the issuance of unsecured debt in the national and global debt markets. In 2009, the FHLBanks competed to a certain degree with the federally guaranteed senior unsecured debt issued by financial institutions or their holding companies under the Federal Deposit Insurance Corporation’s Temporary Liquidity Guarantee Program. Increases in the supply of competing debt products may, in the absence of increases in demand, result in higher debt costs or lower amounts of debt issued at the same cost. Increased competition could adversely affect our ability to access funding, reduce the amount of funding available to us, or increase the cost of funding available to us. Any of these results could adversely affect our financial condition, results of operations, ability to pay dividends, or ability to redeem or repurchase capital stock.
Our efforts to make advances pricing attractive to our members may affect earnings.
A decision to lower advances prices to maintain or gain volume or increase the benefits to borrowing members could result in lower earnings, which could adversely affect the amount of or our ability to pay dividends on our capital stock.
We have a high concentration of advances and capital with three institutions, and a loss or change of business activities with any of these institutions could adversely affect our results of operations, financial condition, ability to pay dividends, or ability to redeem or repurchase our capital stock.
We have a high concentration of advances and capital with three institutions, two of which are nonmembers that are not eligible to borrow new advances from the Bank or renew existing advances. All three of these institutions reduced their borrowings from the Bank significantly in 2009, contributing to a large decline in the Bank’s total assets. The nonmember institutions are expected to continue repaying their advances, and the remaining member institution may prepay or repay advances as they come due. If no other advances are made to replace the prepaid and repaid advances of these large institutions, it would result in a further reduction of our total assets. The reduction in advances could result in a reduction of capital as the Bank repurchased the institution’s excess capital stock, at its discretion, or redeemed the excess capital stock after the expiration of the five-year redemption period. The reduction in assets and capital could also reduce the Bank’s net income.
The timing and magnitude of the impact of a reduction in the amount of advances to these institutions will depend on a number of factors, including:
| • | the amount and period of time over which the advances are prepaid or repaid, |
| • | the amount and timing of any corresponding decreases in activity-based capital stock, |
| • | the profitability of the advances, |
| • | the size and profitability of our short- and long-term investments, |
| • | the extent to which consolidated obligations mature as the advances are prepaid or repaid, and |
| • | our ability to extinguish consolidated obligations or transfer them to other FHLBanks and the associated costs. |
The prepayment or repayment of a large amount of advances could also affect our ability to pay dividends or the amount of any dividend we pay and our ability to redeem or repurchase capital stock.
A material and prolonged decline in advances could adversely affect our results of operations, financial condition, ability to pay dividends, or ability to redeem or repurchase our capital stock.
During 2009, we experienced a significant decline in advances. The decline in member advance demand reflected diminished member lending activity in response to a contracting economy, tighter underwriting standards, and members’ efforts to preserve and build capital. Members also had ample deposits and access to a number of other funding options, including a variety of government lending programs. In addition, the financial condition of many members deteriorated in 2009, and some members reduced their Bank borrowings in response to changes the Bank made to their credit and collateral terms. Although the Bank’s business model is designed
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to safely expand and contract our assets, liabilities, and capital in response to changes in our member base and our members’ credit needs, if we experience a material decline in advances and the decline is prolonged, such a decline could affect our results of operations, financial condition, or ability to pay dividends.
Deteriorating market conditions increase the risk that our models will produce unreliable results.
We use market-based information as inputs to our models, which we use to inform our operational decisions and to derive estimates for use in our financial reporting processes. The downturn in the housing and mortgage markets creates additional risk regarding the reliability of our models, particularly since we are regularly adjusting our models in response to rapid changes in the responses of consumers and mortgagees to changes in economic conditions. This may increase the risk that our models could produce unreliable results or estimates that vary widely or prove to be inaccurate.
We may be limited in our ability to pay dividends or to pay market-rate dividends.
In order to preserve capital in response to the possibility of future OTTI charges, we did not pay a dividend for the first and third quarters of 2009, and the dividends for the second and fourth quarters of 2009 were small. The risk of additional OTTI charges in future quarters and the need to continue building retained earnings may limit our ability to pay dividends or to pay market-rate dividends. We may pay dividends on our capital stock only from previously retained earnings or current net earnings, and our ability to pay dividends is subject to certain statutory and regulatory restrictions and is highly dependent on our ability to continue to generate net earnings. We may not be able to maintain our past or current level of net earnings, which could limit our ability to pay dividends or change the level of dividends that we may be willing or able to pay.
We may become liable for all or a portion of the consolidated obligations for which other FHLBanks are the primary obligors.
As provided by the Federal Home Loan Bank Act of 1932, as amended (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 Federal Housing Finance Agency (Finance Agency) to require any FHLBank to repay all or any portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor, whether or not the other FHLBank has defaulted in the payment of those obligations and even though the FHLBank making the repayment received none of the proceeds from the issuance of the obligations. The likelihood of triggering the Bank’s joint and several liability obligation depends on many factors, including the financial condition and financial performance of the other FHLBanks. If we are required by the Finance Agency to repay the principal or interest on consolidated obligations for which another FHLBank is the primary obligor, our financial condition, results of operations, and ability to pay dividends or redeem or repurchase capital stock could be adversely affected.
If the Bank or any other FHLBank has not paid the principal or interest due on all consolidated obligations, we may not be able to pay dividends or redeem or repurchase any shares of our capital stock.
If the principal or interest due on any consolidated obligations has not been paid in full or is not expected to be paid in full, we may not be able to pay dividends on our capital stock or redeem or repurchase any shares of our capital stock. If another FHLBank defaults on its obligation to pay principal or interest on any consolidated obligations, the regulations governing the operations of the FHLBanks provide that the Finance Agency may allocate outstanding principal and interest payments among one or more of the remaining FHLBanks on a pro rata basis or any other basis the Finance Agency may determine. Our ability to pay dividends or redeem or repurchase capital stock could be affected not only by our own financial condition, but also by the financial condition of one or more of the other FHLBanks.
We are affected by federal laws and regulations, which could change or be applied in a manner detrimental to our operations.
The FHLBanks are government-sponsored enterprises (GSEs), organized under the authority of and governed by the FHLBank Act, and, as such, are also governed by the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, and other federal laws and regulations. Effective July 30, 2008, the Finance Agency, an independent agency in the executive branch of the federal government, became the new federal regulator of the FHLBanks, Fannie Mae, and Freddie Mac. From time to time, Congress has amended the FHLBank Act and adopted other legislation in ways that have significantly affected the FHLBanks and the manner in which the FHLBanks carry out their housing finance mission and business operations. New or modified legislation enacted by Congress or regulations or policies of the Finance Agency could have a negative effect on our ability to conduct business or our cost of doing business. In addition, new or modified legislation or regulations governing our members may affect our ability to conduct business or our cost of doing business with our members.
Changes in statutory or regulatory requirements or policies or in their application could result in changes in, among other things, the FHLBanks’ cost of funds, retained earnings and capital requirements, accounting policies, debt issuance, dividend payment limits, form of dividend payments, capital redemption and repurchase limits, permissible business activities, and the size, scope, and nature of
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the FHLBanks’ lending, investment, and mortgage purchase program activities. Changes that restrict dividend payments, the growth of our current business, or the creation of new products or services could also negatively affect our financial condition, results of operations, ability to pay dividends, or ability to redeem or repurchase capital stock. In addition, given the Bank’s relationship with other FHLBanks, we could be affected by events other than another FHLBank’s default on a consolidated obligation. Events that affect other FHLBanks, such as member failures, capital deficiencies, and OTTI charges, could lead the Finance Agency to consider whether it may require or request that an FHLBank provide capital or other assistance to another FHLBank, purchase assets from another FHLBank, or impose other forms of resolution affecting one or more of the other FHLBanks. If the Bank were called upon by the Finance Agency to take any of these steps, it could affect our financial condition, results of operations, ability to pay dividends, or ability to redeem or repurchase capital stock.
We could change our policies, programs, and agreements affecting our members.
We may change our policies, programs, and agreements affecting our members from time to time, including, without limitation, policies, programs, and agreements affecting the availability of and conditions for access to our advances and other credit products, the Affordable Housing Program (AHP), and other programs, products, and services. These changes could cause our members to obtain financing from alternative sources, which could adversely affect our financial condition, results of operations, ability to pay dividends, or ability to redeem or repurchase capital stock. In addition, changes to our policies, programs, and agreements affecting our members could adversely affect the value of membership from the perspective of a member.
The failure of the FHLBanks to set aside, in the aggregate, at least $100 million annually for the AHP could result in an increase in our AHP contribution, which could adversely affect our results of operations, ability to pay dividends, and ability to redeem or repurchase capital stock.
The FHLBank Act requires each FHLBank to establish and fund an AHP. Annually, the FHLBanks are required to set aside, in the aggregate, the greater of $100 million or ten percent of their current year income for their AHPs. If the FHLBanks do not make the minimum $100 million annual AHP contribution in a given year, we could be required to contribute more than ten percent of our regulatory income to the AHP. An increase in our AHP contribution could adversely affect our results of operations or our ability to pay dividends.
Our members are governed by federal and state laws and regulations, which could change in a manner detrimental to their ability or motivation to invest in the Bank or to use our products and services.
Our members are all highly regulated financial institutions, and the regulatory environment affecting members could change in a manner that would negatively affect their ability or motivation to acquire or own our capital stock or use our products and services. Statutory or regulatory changes that make it less attractive to hold our stock or use our products and services could negatively affect our financial condition, results of operations, ability to pay dividends, or ability to redeem or repurchase capital stock.
Changes in the status, regulation, and perception of the housing GSEs or in policies and programs relating to the housing GSEs may adversely affect our business activities, future advances balances, the cost of debt issuance, and future dividend payments.
Changes in the status of Fannie Mae and Freddie Mac resulting from their conservatorships and the expiration of government support for GSE debt, such as the Federal Reserve’s program to purchase GSE debt and the U.S. Treasury’s financing agreements to help Fannie Mae and Freddie Mac continue to meet their obligations to holders of their debt securities, may result in higher funding costs for the FHLBanks, which could negatively affect our business and financial condition. In addition, negative news articles, industry reports, and other announcements pertaining to GSEs, including Fannie Mae, Freddie Mac, and any of the FHLBanks, could create pressure on debt pricing, as investors may perceive their debt instruments as bearing increased risk.
As a result of these factors, the FHLBank System may have to pay higher spreads on consolidated obligations to make them attractive to investors. If we maintain our existing pricing on advances, an increase in the cost of issuing consolidated obligations could reduce our net interest margin (the difference between the interest rate received on advances and the interest rate paid on consolidated obligations) and cause our advances to be less profitable. If we increase the pricing of our advances to avoid a decrease in the net interest margin, the advances may no longer be attractive to our members, and our outstanding advances balances may decrease. In either case, an increase in the cost of issuing consolidated obligations could negatively affect our financial condition, results of operations, ability to pay dividends, or ability to redeem or repurchase capital stock.
We rely heavily on information systems and other technology.
We rely heavily on our information systems and other technology to conduct and manage our business. If we experience a failure or interruption in any of these systems or other technology, we may be unable to conduct and manage our business effectively, including, without limitation, our advances and hedging activities. In addition, significant initiatives undertaken by the Bank to replace
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information systems or other technology infrastructure may subject the Bank to a similar risk of failure or interruption in implementing these new systems or technology infrastructures. Although we have implemented a business continuity plan, we may not be able to prevent, timely and adequately address, or mitigate the negative effects of any failure or interruption. Any failure or interruption could adversely affect our ability to fund advances, member relations, risk management, and profitability, which could negatively affect our financial condition, results of operations, ability to pay dividends, or ability to redeem or repurchase capital stock.
| ITEM 1B. | UNRESOLVED STAFF COMMENTS |
Not applicable.
| ITEM 2. | PROPERTIES |
The Federal Home Loan Bank of San Francisco (Bank) maintains its principal offices in leased premises totaling 122,252 square feet of space at 600 California Street in San Francisco, California, and 580 California Street in San Francisco, California. The Bank also leases other offices totaling 12,040 square feet of space at 1155 15th Street NW in Washington, D.C., as well as off-site business continuity facilities located in San Francisco, California, and Rancho Cordova, California. The Bank believes these facilities are adequate for the purposes for which they are currently used and are well maintained.
| ITEM 3. | 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 and violations of state and federal securities laws, negligent misrepresentation, and rescission of contract.
Defendants named in the first complaint are as follows: Deutsche Bank Securities Inc. (Deutsche) involving four certificates sold by Deutsche to the Bank in an amount paid of approximately $404 million, Deutsche Alt-A Securities Inc. as the issuer of one of the certificates sold by Deutsche to the Bank, and DB Structured Products, Inc., as the controlling person of the issuer; J.P. Morgan Securities, Inc. (formerly known as Bear, Stearns & Co. Inc., and referred to as Bear Stearns) involving four certificates sold by Bear Stearns to the Bank in an amount paid of approximately $609 million, Structured Asset Mortgage Investments II, Inc., as the issuer of three of the certificates sold by Bear Stearns to the Bank, and The Bear Stearns Companies, LLC (formerly known as The Bear Stearns Companies, Inc.) as the controlling person of the issuer (collectively, the Bear Stearns Defendants); Countrywide Securities Corporation (Countrywide) involving two certificates sold by Countrywide to the Bank in an amount paid of approximately $125 million; Credit Suisse Securities (USA) LLC (formerly known as Credit Suisse First Boston LLC, and referred to as Credit Suisse) involving eight certificates sold by Credit Suisse to the Bank in an amount paid of approximately $1.1 billion; RBS Securities, Inc. (formerly known as Greenwich Capital Markets, Inc., and referred to as Greenwich Capital) involving three certificates sold by Greenwich Capital to the Bank in an amount paid of approximately $548 million, RBS Acceptance, Inc. (formerly known as Greenwich Capital Acceptance, Inc.) as the issuer of the three certificates that Greenwich Capital sold to the Bank, and RBS Holdings USA, Inc. (formerly known as and referred to as Greenwich Capital Holdings, Inc.) as the controlling person of the issuer; Morgan Stanley & Co. Incorporated (Morgan Stanley) involving two certificates sold by Morgan Stanley to the Bank in an amount paid of approximately $276 million; UBS Securities, LLC (UBS) involving seven certificates sold by UBS to the Bank in an amount paid of approximately $1.7 billion, and Mortgage Asset Securitization Transactions, Inc., as the issuer of three of the certificates that UBS sold to the Bank; and Merrill Lynch, Pierce, Fenner & Smith, Inc. (Merrill Lynch) involving six certificates sold by Merrill Lynch to the Bank in an amount paid of approximately $654 million.
Defendants named in the second complaint are as follows: Credit Suisse involving ten certificates sold by Credit Suisse to the Bank in an amount paid of approximately $1.2 billion, and Credit Suisse First Boston Mortgage Securities Corp. as the issuer of five of the certificates that Credit Suisse sold to the Bank; Deutsche involving twenty-one certificates sold by Deutsche to the Bank in an amount paid of approximately $4.3 billion, and Deutsche Alt-A Securities Inc. as the issuer of five of the certificates sold by Deutsche to the Bank; Bear Stearns involving ten certificates sold by Bear Stearns to the Bank in an amount paid of approximately $2.0 billion, Structured Asset Mortgage Investments II, Inc. as the issuer of six of the certificates sold by Bear Stearns to the Bank, and The Bear Stearns Companies, LLC (formerly known as and referred to as The Bear Stearns Companies, Inc.) as the controlling person of the issuer; Greenwich Capital involving three certificates sold by Greenwich Capital to the Bank in an amount paid of approximately $632 million, and RBS Acceptance, Inc. (formerly known as Greenwich Capital Acceptance, Inc.) as the issuer of one of the certificates that Greenwich Capital sold to the Bank; Morgan Stanley involving three certificates sold by Morgan Stanley to the Bank in an amount
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paid of approximately $704 million; UBS involving twelve certificates sold by UBS to the Bank in an amount paid of approximately $1.7 billion, and Mortgage Asset Securitization Transactions, Inc. as the issuer of six of the certificates that UBS sold to the Bank; Banc of America Securities LLC (Banc of America) involving fifteen certificates sold by Banc of America to the Bank in an amount paid of approximately $2.2 billion, Banc of America Funding Corporation as the issuer of seven of the certificates that Banc of America sold to the Bank, Banc of America Mortgage Securities, Inc. as the issuer of seven of the certificates that Banc of America sold to the Bank (collectively, the Banc of America Defendants); Countrywide involving six certificates sold by Countrywide to the Bank in an amount paid of approximately $1.1 billion; and CWALT, Inc. (CWALT) as the issuer of three of the certificates that Credit Suisse sold to the Bank, fifteen of the certificates that Deutsche sold to the Bank, one of the certificates that Bear Stearns sold to the Bank, two of the certificates that Greenwich Capital sold to the Bank, three of the certificates that Morgan Stanley sold to the Bank, six of the certificates that UBS sold to the Bank, one of the certificates that Banc of America sold to the Bank, and five of the certificates that Countrywide sold to the Bank, and Countrywide Financial Corporation as the controlling person of the issuer.
JPMorgan Bank and Trust Company, a member of the Bank, and JPMorgan Chase Bank, National Association, a nonmember borrower of the Bank, are not defendants in these actions, but are affiliated with the Bear Stearns Defendants.
Bank of America California, N.A., a member of the Bank, is not a defendant in these actions, but is affiliated with Countrywide, Merrill Lynch, the Banc of America Defendants, CWALT, and Countrywide Financial Corporation.
After consultation with legal counsel, management is not aware of any other legal proceedings that are expected to have a material effect on the Bank’s financial condition or results of operations or that are otherwise material to the Bank.
| ITEM 4. | (REMOVED AND RESERVED) |
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| ITEM 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
The Federal Home Loan Bank of San Francisco (Bank) has a cooperative ownership structure. The members and certain nonmembers own all the stock of the Bank, the majority of the directors of the Bank are officers or directors of members, the directors are elected by members (or selected by the Board of Directors to fill mid-term vacancies), and the Bank conducts its advances business exclusively with members. There is no established marketplace for the Bank’s stock. The Bank’s stock is not publicly traded. The Bank issues only one class of stock, Class B stock, which, under the Bank’s capital plan, may be redeemed at par value, $100 per share, upon five years’ notice from the member to the Bank, subject to certain statutory and regulatory requirements and to the satisfaction of any ongoing stock investment requirements applying to the member. The Bank may repurchase shares held by members in excess of their required stock holdings at its discretion at any time. The information regarding the Bank’s capital requirements is set forth in Note 13 to the Financial Statements under “Item 8. Financial Statements and Supplementary Data.” At February 26, 2010, the Bank had 85.7 million shares of Class B stock held by 404 members and 48.5 million shares of Class B stock held by 43 nonmembers.
The Bank’s dividend rates declared (annualized) are listed in the table below and are calculated based on the $100 per share par value.
| Quarter | 2009 Rate(1) | 2008 Rate(2) | ||||
| First |
— | % | 5.73 | % | ||
| Second |
0.84 | 6.19 | ||||
| Third |
— | 3.85 | ||||
| Fourth |
0.27 | — | ||||
|
(1) 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. On February 22, 2010, the Bank’s Board of Directors declared a cash dividend for the fourth quarter of 2009, which was recorded and is expected to be paid during the first quarter of 2010. (2) All dividends except fractional shares were paid in the form of additional shares of capital stock. |
| |||||
Additional information regarding the Bank’s dividends is set forth in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – Dividends” and in Note 13 to the Financial Statements under “Item 8. Financial Statements and Supplementary Data.”
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| ITEM 6. | SELECTED FINANCIAL DATA |
The following selected financial data of the Federal Home Loan Bank of San Francisco (Bank) should be read in conjunction with the financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere herein.
| (Dollars in millions) | 2009 | 2008 | 2007 | 2006 | 2005 | |||||||||||||||
| Selected Balance Sheet Items at Yearend |
||||||||||||||||||||
| Total Assets(1) |
$ | 192,862 | $ | 321,244 | $ | 322,446 | $ | 244,915 | $ | 223,602 | ||||||||||
| Advances |
133,559 | 235,664 | 251,034 | 183,669 | 162,873 | |||||||||||||||
| Mortgage Loans Held for Portfolio, Net |
3,037 | 3,712 | 4,132 | 4,630 | 5,214 | |||||||||||||||
| Investments(2) |
47,006 | 60,671 | 64,913 | 55,391 | 54,465 | |||||||||||||||
| Consolidated Obligations:(3) |
||||||||||||||||||||
| Bonds |
162,053 | 213,114 | 225,328 | 199,300 | 182,625 | |||||||||||||||
| Discount Notes |
18,246 | 91,819 | 78,368 | 30,128 | 27,618 | |||||||||||||||
| Mandatorily Redeemable Capital Stock(4) |
4,843 | 3,747 | 229 | 106 | 47 | |||||||||||||||
| Capital Stock – Class B – Putable(4) |
8,575 | 9,616 | 13,403 | 10,616 | 9,520 | |||||||||||||||
| Retained Earnings |
1,239 | 176 | 227 | 143 | 131 | |||||||||||||||
| Accumulated Other Comprehensive Loss |
(3,584 | ) | (7 | ) | (3 | ) | (5 | ) | (3 | ) | ||||||||||
| Total Capital |
6,230 | 9,785 | 13,627 | 10,754 | 9,648 | |||||||||||||||
| Selected Operating Results for the Year |
||||||||||||||||||||
| Net Interest Income |
$ | 1,782 | $ | 1,431 | $ | 931 | $ | 839 | $ | 683 | ||||||||||
| Provision for Credit Losses on Mortgage Loans |
1 | — | — | — | — | |||||||||||||||
| Other (Loss)/Income |
(948 | ) | (690 | ) | 55 | (10 | ) | (100 | ) | |||||||||||
| Other Expense |
132 | 112 | 98 | 90 | 81 | |||||||||||||||
| Assessments |
186 | 168 | 236 | 197 | 133 | |||||||||||||||
| Net Income |
$ | 515 | $ | 461 | $ | 652 | $ | 542 | $ | 369 | ||||||||||
| Selected Other Data for the Year |
||||||||||||||||||||
| Net Interest Margin(5) |
0.73 | % | 0.44 | % | 0.36 | % | 0.37 | % | 0.34 | % | ||||||||||
| Operating Expenses as a Percentage of Average Assets |
0.04 | 0.03 | 0.03 | 0.03 | 0.04 | |||||||||||||||
| Return on Average Assets |
0.21 | 0.14 | 0.25 | 0.23 | 0.18 | |||||||||||||||
| Return on Average Equity |
5.83 | 3.54 | 5.80 | 5.40 | 4.22 | |||||||||||||||
| Dividend Rate(6) |
0.28 | 3.93 | 5.20 | 5.41 | 4.44 | |||||||||||||||
| Spread of Dividend Rate to Dividend Benchmark(7) |
(1.61 | ) | 0.97 | 0.75 | 1.24 | 1.22 | ||||||||||||||
| Dividend Payout Ratio(8) |
5.36 | 114.32 | 87.14 | 97.70 | 102.36 | |||||||||||||||
| Selected Other Data at Yearend |
||||||||||||||||||||
| Regulatory Capital Ratio(1)(9) |
7.60 | % | 4.21 | % | 4.30 | % | 4.44 | % | 4.34 | % | ||||||||||
| Average Equity to Average Assets Ratio |
3.57 | 3.93 | 4.25 | 4.33 | 4.29 | |||||||||||||||
| Duration Gap (in months) |
4 | 3 | 2 | 1 | 1 | |||||||||||||||
| (1) | Effective January 1, 2008, the Bank changed its accounting policy to offset fair value amounts for cash collateral against fair value amounts recognized for derivative instruments executed with the same counterparty. The Bank recognized the effects as a change in accounting principle through retrospective application for all prior periods presented. |
| (2) | 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). |
| (3) | As provided by the Federal Home Loan Bank Act of 1932, as amended, 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 Federal Housing 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 December 31, 2009, and through the 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 as follows: |
| Yearend | Par amount | ||
| 2009 |
$ | 930,617 | |
| 2008 |
1,251,542 | ||
| 2007 |
1,189,706 | ||
| 2006 |
951,990 | ||
| 2005 |
937,460 | ||
| (4) | During 2008 and 2009, several members were placed into receivership or merged with nonmember institutions, including three large members. IndyMac Bank, F.S.B., and Washington Mutual Bank were placed into receivership during 2008, and Wachovia Mortgage, FSB, merged into Wells Fargo Bank, N.A., a nonmember institution, in 2009. The Bank reclassified the capital stock of these institutions from Class B capital stock to mandatorily redeemable capital stock (a liability). See Note 13 to the Financial Statements for further information on these members. |
| (5) | Net interest margin is net interest income divided by average interest-earning assets. |
| (6) | On February 22, 2010, the Bank’s Board of Directors declared a cash dividend for the fourth quarter of 2009 at an annualized dividend rate of 0.27%. The Bank recorded and expects to pay the fourth quarter dividend during the first quarter of 2010. |
| (7) | The dividend benchmark is calculated as the combined average of (i) the daily average of the overnight Federal funds effective rate and (ii) the four-year moving average of the U.S. Treasury note yield (calculated as the average of the three-year and five-year U.S. Treasury note yields). |
| (8) | This ratio is calculated as dividends per share divided by net income per share. |
| (9) | 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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| ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Statements contained in this annual report on Form 10-K, 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. 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) 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; |
| • | timing and volume of market activity. |
Readers of this report should not rely solely on the forward-looking statements and should consider all risks and uncertainties throughout this report, as well as those discussed under “Item 1A. Risk Factors.”
On July 30, 2008, the 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.
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After two tumultuous years, the financial markets appeared to have stabilized in 2009, particularly in the second half of the year. At yearend, the U.S. economy also appeared to be emerging from recession. Unemployment remains very high, however, and there is ongoing uncertainty about the speed and extent of recovery.
The housing market continues to be weak, with great variations in housing price performance from region to region throughout the country. Housing prices appear to be stabilizing in many markets, but several regions still face the potential for additional price declines. In addition, delinquency and foreclosure rates have continued to rise, although at a slower pace in many areas. While the agency mortgage-backed securities (MBS) market is active in funding new mortgage originations, the private-label residential MBS (PLRMBS) market has not recovered. In addition, the commercial real estate market is still trending downwards. Arizona, California, and Nevada were particularly hard-hit by the downturn in the housing market and the recession, and many areas in these states remain weak.
These economic conditions continued to affect the Bank’s business and results of operations and the Bank’s members in 2009 and may continue to exert a significant negative effect in the near term. In particular, the Bank experienced a significant decline in advances during 2009, as members and nonmember borrowers reduced their borrowings from $235.7 billion at December 31, 2008, to $133.6 billion at December 31, 2009. Most of this $102.1 billion decline was attributable to the Bank’s three largest borrowers, which decreased their advances by $79.7 billion. As of December 31, 2009, two of these institutions were nonmembers that were not eligible to borrow new advances from the Bank or renew existing advances. In total, 234 institutions decreased their advances, while 65 institutions increased their advances during the year. The decline in member advance demand reflected diminished member lending activity in response to a contracting economy, tighter underwriting standards, and members’ efforts to preserve and build capital. Members also had ample deposits and access to a number of other funding options, including a variety of government lending programs. In addition, the financial condition of many members deteriorated in 2009, and some members reduced their Bank borrowings in response to changes the Bank made to their credit and collateral terms. Economic conditions also contributed to the failure of a number of Bank members during 2009. Ongoing economic weakness and uncertainty could lead to additional member failures or acquisitions and a further decrease in advances, which could adversely affect the Bank’s business and results of operations.
Ongoing weakness in the economy and in housing markets also continued to affect the loan collateral underlying certain PLRMBS in the Bank’s held-to-maturity portfolio, resulting in estimated future credit losses that required the Bank to take other-than-temporary impairment (OTTI) charges on certain PLRMBS. The credit-related charges on these securities reduced the Bank’s income for the year by $608 million before assessments, and the non-credit-related charges on the securities reduced the Bank’s other comprehensive income, a component of capital, by $3.5 billion. Because there is a continuing risk that the Bank’s estimate of future credit losses on some PLRMBS may increase, requiring the Bank to record additional material OTTI charges in future periods, the Bank’s earnings and retained earnings and its ability to pay dividends and repurchase capital stock could be adversely affected. Continued illiquidity in the PLRMBS market adversely affected the valuation of the Bank’s PLRMBS, contributing to the large non-credit-related OTTI charges recorded in accumulated other comprehensive income (AOCI). Throughout the year, the Bank focused on preserving capital in response to the possibility of future OTTI charges on its PLRMBS portfolio. As a result, the Bank did not pay a dividend for the first and third quarters of 2009, and the dividends for the second and fourth quarters of 2009 were small. Although the Bank did not repurchase excess capital stock during 2009, the five-year redemption period for $16 million in mandatorily redeemable capital stock expired in 2009, and the Bank redeemed the stock at its $100 par value on the relevant expiration dates. 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 capital stock repurchases in future quarters.
On February 22, 2010, the Bank’s Board of Directors declared a cash dividend for the fourth quarter of 2009 at an annualized dividend rate of 0.27%. The Bank recorded and expects to pay the fourth quarter dividend during the first quarter of 2010. The Bank expects to pay the dividend (including dividends on mandatorily redeemable capital stock), which will total $9 million, on or about March 26, 2010.
The Bank paid the second quarter dividend and expects to pay the fourth quarter 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 December 31, 2009, the Bank’s excess capital stock totaled $6.5 billion, or 3% of total assets.
This overview should be read in conjunction with management’s discussion of its business, financial condition, and results of operations. If conditions in the mortgage and housing markets and general business and economic conditions remain adverse or deteriorate further, the Bank’s business, membership base, results of operations, capital, ability to pay dividends, and ability to redeem or repurchase capital stock could be further adversely affected.
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Despite the challenging economic environment, in 2009 the Bank continued to raise funds in the capital markets, provide liquidity to members, increase net interest income, manage the credit risk of advances by adapting its credit and collateral terms to current market conditions, and take other actions to maintain the Bank’s long-term financial strength.
Net income for 2009 increased by $54 million, or 12%, to $515 million from $461 million in 2008. The increase primarily reflected net gains associated with derivatives, hedged items, and financial instruments carried at fair value and an increase in net interest income, partially offset by an increase in OTTI charges on certain PLRMBS in the Bank’s held-to-maturity securities portfolio.
Net interest income for 2009 rose $351 million, or 25%, to $1.8 billion from $1.4 billion in 2008. Most of the increase in net interest income for 2009 was offset by net interest expense on derivative instruments used in economic hedges (reflected in other income), which totaled $452 million in 2009 and $120 million in 2008. Net interest income for 2009 also reflected a rise in the average profit spread on the MBS and mortgage loan portfolios, reflecting the favorable impact of a lower interest rate environment and a steeper yield curve. The lower interest rate environment provided the Bank with the opportunity to call fixed rate callable debt and refinance that debt at a lower cost. The increases in net interest income were partially offset by a lower yield on invested capital because of the lower interest rate environment during 2009 and lower net interest spreads on the non-MBS investment portfolio.
Other income for 2009 was a net loss of $948 million, compared to a net loss of $690 million for 2008. The losses in other income for 2009 reflected a credit-related OTTI charge of $608 million on certain PLRMBS; a net gain of $104 million associated with derivatives, hedged items, and financial instruments carried at fair value; and net interest expense of $452 million on derivative instruments used in economic hedges, which was generally offset by net interest income on the economically hedged assets and liabilities. The loss in other income for 2008 reflected an OTTI charge of $590 million, which included a credit-related charge of $20 million and a non-credit-related charge of $570 million. In early 2009, the Financial Accounting Standards Board issued additional guidance related to the recognition and presentation of OTTI (OTTI guidance). The Bank adopted this OTTI guidance as of January 1, 2009, and recognized the cumulative effect of initially applying the OTTI guidance, totaling $570 million, as an increase in retained earnings at January 1, 2009, with a corresponding decrease in AOCI. Additional information about the OTTI charges is provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – Investments” and in Note 6 to the Financial Statements.
The credit-related OTTI charges of $608 million for 2009 resulted from projected credit losses on the loan collateral underlying the Bank’s PLRMBS. Each quarter, the Bank updates its OTTI analysis to reflect current and anticipated housing market conditions and updated information on the loans underlying the Bank’s PLRMBS and revises the assumptions in its collateral loss projection models based on more recent information. The increases in projected collateral loss rates in the Bank’s OTTI analyses during 2009 were caused by increases in projected loan defaults and in the projected severity of losses on defaulted loans. Several factors contributed to these increases, including but not limited to, lower forecasted housing prices (a greater current-to-trough decline and slower housing price recovery), greater-than-expected deterioration in the credit quality of the loan collateral, and periodic changes to the Bank’s collateral loss projection model based on a variety of information sources and intended to improve the model’s forecast accuracy and reasonableness of results.
Based on the cash flow analysis performed on the PLRMBS, the Bank determined that 123 of its PLRMBS were other-than-temporarily impaired at December 31, 2009, because the Bank determined it was likely that it would not recover the entire amortized cost basis of each of these securities.
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 December 31, 2009, 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 – Credit Risk – Investments” and in Note 6 to the Financial Statements. Additional information about the Bank’s PLRMBS is also provided in “Item 3. Legal Proceedings.”
In 2009, the Bank’s restricted retained earnings increased significantly as a result of the Bank’s policy to hold a targeted amount of restricted retained earnings (in addition to any cumulative net gains resulting from valuation adjustments) to protect members’ paid-in capital from certain risks. These risks include the risk of higher-than-anticipated credit losses related to other-than-temporary impairment of PLRMBS, the risk of an extremely adverse credit event, the risk of an extremely adverse operations risk event, and the risk of an extremely high level of quarterly losses resulting from valuation adjustments related to the Bank’s derivatives and associated hedged items and financial instruments carried at fair value, especially in periods of extremely low net income resulting from an adverse
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interest rate environment. In September 2009, the Board of Directors increased the targeted amount of restricted retained earnings to $1.8 billion from $1.2 billion, primarily to address an increase in the projected losses on the collateral underlying the Bank’s PLRMBS under stress case assumptions about housing market conditions. The retained earnings restricted in accordance with this policy increased to $1.1 billion at December 31, 2009, from $124 million at December 31, 2008.
As of December 31, 2009, the Bank was in compliance with all of its regulatory capital requirements. The Bank’s total regulatory capital ratio was 7.60%, exceeding the 4.00% requirement, and its risk-based capital was $14.7 billion, exceeding its $6.2 billion requirement.
During 2009, total assets decreased $128.3 billion, or 40%, to $192.9 billion at yearend 2009 from $321.2 billion at yearend 2008, primarily as a result of a decline in advances, which decreased by $102.1 billion, or 43%, to $133.6 billion at December 31, 2009, from $235.7 billion at December 31, 2008. Held-to-maturity securities decreased to $36.9 billion at December 31, 2009, from $51.2 billion at December 31, 2008, primarily because of principal payments, prepayments, and maturities in the MBS portfolio, OTTI charges recognized on the PLRMBS, and a substantial reduction in the purchase of new MBS investments. The reduction in MBS purchases during the year was due to the Bank’s decision to limit its purchases to agency residential MBS and to the scarcity of securities that met the Bank’s risk-adjusted spreads. During 2009, the Bank purchased $0.4 billion of MBS, all of which were agency residential MBS. Cash and due from banks decreased to $8.3 billion at December 31, 2009, from $19.6 billion at December 31, 2008. The decrease was primarily in cash held at the Federal Reserve Bank of San Francisco (FRBSF), reflecting a reduction in the Bank’s short-term liquidity needs.
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. In 2009, 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 2009.
Beginning in 2008, events affecting the financial services industry resulted in significant changes in the number, ownership structure, and liquidity of some of the industry’s largest companies, including some of the Bank’s largest borrowers. The Bank is not able to predict future trends in these and other institutions’ credit needs since they are driven by complex interactions among a number of factors, including members’ mortgage loan originations, other loan portfolio growth, and deposit growth, and the attractiveness of advances compared to other wholesale borrowing alternatives. If the advances outstanding to these and other institutions are not replaced when repaid, however, the decrease in advances may result in a reduction of the Bank’s total assets, capital, and net income. The timing and magnitude of the impact of a decrease in the amount of advances would depend on a number of factors, including: the amount and the period over which the advances were prepaid or repaid; the amount and timing of any corresponding decreases in activity-based capital stock; the profitability of the advances; the extent to which consolidated obligations mature as the advances are prepaid or repaid; and the Bank’s ability to extinguish consolidated obligations or transfer them to other FHLBanks and the associated costs. A significant decrease in advances could also affect the rate of dividends paid to the Bank’s shareholders, depending on how effectively the Bank reduces operating expenses as assets decrease and its ability to redeem or repurchase Bank capital stock.
On September 25, 2008, the Office of Thrift Supervision (OTS) closed Washington Mutual Bank and appointed the Federal Deposit Insurance Corporation (FDIC) as receiver for Washington Mutual Bank. On the same day, JPMorgan Chase Bank, National Association, a nonmember, assumed Washington Mutual Bank’s outstanding Bank advances and acquired the associated Bank capital stock. The capital stock held by JPMorgan Chase Bank, National Association, is classified as mandatorily redeemable capital stock (a liability). JPMorgan Chase Bank, National Association, remains obligated for all of Washington Mutual Bank’s outstanding advances and continues to hold most of the Bank capital stock it acquired from the FDIC as receiver for Washington Mutual Bank. JPMorgan Bank and Trust Company, National Association, an affiliate of JPMorgan Chase Bank, National Association, became a member of the Bank in 2008. During the first quarter of 2009, the Bank allowed the transfer of excess stock totaling $300 million 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, totaling $2.7 billion, remains classified as mandatorily redeemable capital stock (a liability). As of March 15, 2010, JPMorgan Chase Bank, National Association, was the Bank’s second largest borrower and shareholder.
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
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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 million 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., totaling $1.6 billion, to mandatorily redeemable capital stock (a liability). As of March 15, 2010, Wells Fargo Bank, N.A. was the Bank’s fourth largest borrower and third largest shareholder.
During 2009, 25 member institutions were placed into receivership or liquidation. Four of these institutions had no advances outstanding at the time they were placed into receivership or liquidation. The advances outstanding to the other 21 institutions were either repaid prior to December 31, 2009, or assumed by other institutions, and no losses were incurred by the Bank. The Bank capital stock held by 16 of the 25 institutions totaling $162 million was classified as mandatorily redeemable capital stock (a liability). The capital stock of the other nine institutions was transferred to other member institutions.
From January 1, 2010, to March 15, 2010, three member institutions were placed into receivership. The advances outstanding to two institutions were paid off prior to March 15, 2010, and the Bank capital stock held by these two institutions totaling $14 million was classified as mandatorily redeemable capital stock (a liability). The outstanding advances and capital stock of the third institution were assumed by another member institution.
If economic conditions deteriorate further, the Bank’s business and results of operations, as well as the business and results of operations of its members, nonmember borrowers, and derivatives counterparties, could be adversely affected. The termination of membership of a large member or a large number of smaller members could result in a reduction of the Bank’s total assets, capital, net income, and rate of dividends paid to members. In addition, a default by a member, nonmember borrower, or derivatives counterparty with significant obligations to the Bank could result in significant losses to the Bank, which in turn could adversely affect the Bank’s results of operations or financial condition.
Funding and Liquidity
The U.S. government’s ongoing support of the agency debt markets improved the FHLBanks’ ability to issue term debt in 2009. On November 25, 2008, the Federal Reserve announced it would initiate a program to purchase the direct obligations of Fannie Mae, Freddie Mac, and the FHLBanks and MBS backed by Fannie Mae, Freddie Mac, and Ginnie Mae. The Federal Reserve stated that this action was taken to reduce the cost and increase the availability of credit for the purchase of homes, which in turn was expected to support housing markets and foster improved conditions in financial markets more generally. The Federal Reserve indicated that purchases of up to $100 billion in government-sponsored enterprises (GSE) direct obligations under the program would be conducted with the Federal Reserve’s primary dealers through a series of competitive auctions and would begin in early December 2008. The Federal Reserve subsequently increased the total purchase capacity to $200 billion. On November 4, 2009, the Federal Reserve announced that it would purchase a total of about $175 billion of GSE debt. The Federal Reserve stated that it would gradually slow the pace of its purchases and anticipated that these transactions would be executed by the end of the first quarter of 2010. During 2009, the Federal Reserve purchased $159.9 billion in agency term obligations, including $34.4 billion in FHLBank consolidated obligation bonds. The combination of declining FHLBank funding needs, Federal Reserve purchases of FHLBank direct obligations, and a monthly debt issuance calendar for global bonds generally improved the FHLBanks’ ability to issue debt at reasonable costs. During 2009, the FHLBanks issued $90.0 billion in global bonds and $641.3 billion in auctioned discount notes.
The FHLBanks’ funding costs for short-term discount notes relative to the London Interbank Offered Rate (LIBOR) generally increased during 2009. At the beginning of the year, LIBOR rates were relatively high because of low liquidity in the capital markets as a result of the financial crisis. Discount note rates remained low, however, as investors purchased GSE investments as part of a flight-to-quality strategy. Throughout 2009, liquidity conditions generally improved and LIBOR rates trended lower. As a result, the cost of discount notes relative to LIBOR increased to pre-credit crisis levels. As the spread between LIBOR and discount note rates rose during the second half of 2009, the Bank decreased the use of discount notes as a source of funding and increased the use of lower cost, short-lockout swapped callable bonds to meet the Bank’s liquidity needs.
In managing the Bank’s funding liquidity risk, the Bank considers the risk to three components it views as fundamental to its overall liquidity: structural liquidity, tactical liquidity, and contingency liquidity. Structural liquidity provides a framework for strategic positioning of the Bank’s long-term (greater than one year) funding needs. Tactical liquidity includes operational cash management in horizons as short as intraday to as long as one year. Contingency liquidity planning consists of stress testing the Bank’s ability to meet its funding obligations as they become due and to satisfy member requests to renew maturing advances through short-term investments in an amount at least equal to the Bank’s anticipated cash outflows under two different scenarios. One scenario assumes that the Bank cannot access the capital markets for a targeted period of 15 calendar days and that members do not renew any maturing, prepaid, or
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called advances during that time. The second scenario assumes that the Bank cannot access the capital markets for a targeted period of five calendar days and that during that period the Bank will automatically renew maturing and called advances for all members except very large, highly rated members. The Bank’s existing contingent liquidity guidelines were easily adapted to satisfy the Finance Agency’s final contingent liquidity guidelines, which were released in March 2009.
Following implementation of the U.S. government debt support programs in 2009, large domestic investors and some foreign investors resumed the purchase of GSE debt with maturities longer than one year. As a result, the Bank reduced its structural liquidity risk during 2009 through increased term issuance of bullet and swapped callable debt. The effects of the end of the U.S. government GSE debt purchase program are uncertain, may pose a risk to the Bank’s ability to issue long-term funding, and could lead the Bank to place greater reliance on short-term funding.
Comparison of 2009 to 2008
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 years ended December 31, 2009 and 2008, 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.
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Average Balance Sheets
| 2009 | 2008 | |||||||||||||||||||
| (In millions) | Average Balance |
Interest Income/ Expense |
Average Rate |
Average Balance |
Interest Income/ Expense |
Average Rate |
||||||||||||||
| Assets |
||||||||||||||||||||
| Interest-earning assets: |
||||||||||||||||||||
| Resale agreements |
$ | 6 | $ | — | 0.17 | % | $ | — | $ | — | — | % | ||||||||
| Federal funds sold |
14,230 | 23 | 0.16 | 13,927 | 318 | 2.28 | ||||||||||||||
| Trading securities: |
||||||||||||||||||||
| MBS |
33 | 1 | 3.03 | 46 | 2 | 4.35 | ||||||||||||||
| Available-for-sale securities: |
||||||||||||||||||||
| Other investments |
149 | — | 0.25 | — | — | — | ||||||||||||||
| Held-to-maturity securities: |
||||||||||||||||||||
| MBS |
35,585 | 1,449 | 4.07 | 38,781 | 1,890 | 4.87 | ||||||||||||||
| Other investments |
10,012 | 31 | 0.31 | 15,545 | 425 | 2.73 | ||||||||||||||
| Mortgage loans held for portfolio, net |
3,376 | 157 | 4.65 | 3,911 | 200 | 5.11 | ||||||||||||||
| Advances(1) |
179,689 | 2,800 | 1.56 | 251,184 | 8,182 | 3.26 | ||||||||||||||
| Loans to other FHLBanks |
239 | — | 0.11 | 23 | — | 1.93 | ||||||||||||||
| Total interest-earning assets |
243,319 | 4,461 | 1.83 | 323,417 | 11,017 | 3.41 | ||||||||||||||
| Other assets(2)(3)(4) |
4,347 | — | — | 7,767 | — | — | ||||||||||||||
| Total Assets |
$ | 247,666 | $ | 4,461 | 1.80 | % | $ | 331,184 | $ | 11,017 | 3.33 | % | ||||||||
| Liabilities and Capital |
||||||||||||||||||||
| Interest-bearing liabilities: |
||||||||||||||||||||
| Consolidated obligations: |
||||||||||||||||||||
| Bonds(1) |
$ | 174,350 | $ | 2,199 | 1.26 | % | $ | 227,804 | $ | 7,282 | 3.20 | % | ||||||||
| Discount notes |
53,813 | 472 | 0.88 | 80,658 | 2,266 | 2.81 | ||||||||||||||
| Deposits(2) |
2,066 | 1 | 0.05 | 1,462 | 24 | 1.64 | ||||||||||||||
| Borrowings from other FHLBanks |
6 | — | 0.16 | 20 | — | 1.02 | ||||||||||||||
| Mandatorily redeemable capital stock |
3,541 | 7 | 0.21 | 1,249 | 14 | 3.93 | ||||||||||||||
| Other borrowings |
7 | — | 0.10 | 17 | — | 1.69 | ||||||||||||||
| Total interest-bearing liabilities |
233,783 | 2,679 | 1.15 | 311,210 | 9,586 | 3.08 | ||||||||||||||
| Other liabilities(2)(3) |
5,052 | — | — | 6,969 | — | — | ||||||||||||||
| Total Liabilities |
238,835 | 2,679 | 1.12 | 318,179 | 9,586 | 3.01 | ||||||||||||||
| Total Capital |
8,831 | — | — | 13,005 | — | — | ||||||||||||||
| Total Liabilities and Capital |
$ | 247,666 | $ | 2,679 | 1.08 | % | $ | 331,184 | $ | 9,586 | 2.89 | % | ||||||||
| Net Interest Income |
$ | 1,782 | $ | 1,431 | ||||||||||||||||
| Net Interest Spread(5) |
0.68 | % | 0.33 | % | ||||||||||||||||
| Net Interest Margin(6) |
0.73 | % | 0.44 | % | ||||||||||||||||
| Interest-earning Assets/Interest-bearing Liabilities |
104.08 | % | 103.92 | % | ||||||||||||||||
| Total Average Assets/Regulatory Capital Ratio(7) |
20.0 | x | 23.2 | x | ||||||||||||||||
| (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 $966 million and $388 million for 2009 and 2008, respectively. Interest expense on consolidated obligation bonds includes net interest income on interest rate exchange agreements of $2.1 billion and $1.5 billion for 2009 and 2008, respectively. |
| (2) | Average balances do not reflect the effect of reclassifications of cash collateral. |
| (3) | Includes forward settling transactions and fair value adjustments for certain cash items. |
| (4) | Includes OTTI charges on held-to-maturity securities related to all other factors. |
| (5) | Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities. |
| (6) | Net interest margin is net interest income divided by average interest-earning assets. |
| (7) | For this purpose, regulatory capital includes mandatorily redeemable capital stock and excludes accumulated other comprehensive income. |
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The following Change in Net Interest Income table details the changes in interest income and interest expense for 2009 compared to 2008. Changes in both volume and interest rates influence changes in net interest income and the net interest margin.
Change in Net Interest Income: Rate/Volume Analysis
2009 Compared to 2008
| Increase/ (Decrease) |
Attributable to Changes in(1) | |||||||||||
| (In millions) | Average Volume | Average Rate | ||||||||||
| Interest-earning assets: |
||||||||||||
| Federal funds sold |
$ | (295 | ) | $ | 7 | $ | (302 | ) | ||||
| Trading securities: MBS |
(1 | ) | — | (1 | ) | |||||||
| Held-to-maturity securities: |
||||||||||||
| MBS |
(441 | ) | (147 | ) | (294 | ) | ||||||
| Other investments |
(394 | ) | (113 | ) | (281 | ) | ||||||
| Mortgage loans held for portfolio |
(43 | ) | (26 | ) | (17 | ) | ||||||
| Advances(2) |
(5,382 | ) | (1,900 | ) | (3,482 | ) | ||||||
| Loans to other FHLBanks |
— | 1 | (1 | ) | ||||||||
| Total interest-earning assets |
(6,556 | ) | (2,178 | ) | (4,378 | ) | ||||||
| Interest-bearing liabilities: |
||||||||||||
| Consolidated obligations: |
||||||||||||
| Bonds(2) |
(5,083 | ) | (1,420 | ) | (3,663 | ) | ||||||
| Discount notes |
(1,794 | ) | (585 | ) | (1,209 | ) | ||||||
| Deposits |
(23 | ) | 7 | (30 | ) | |||||||
| Mandatorily redeemable capital stock |
(7 | ) | 57 | (64 | ) | |||||||
| Total interest-bearing liabilities |
(6,907 | ) | (1,941 | ) | (4,966 | ) | ||||||
| Net interest income |
$ | 351 | $ | (237 | ) | $ | 588 | |||||
| (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 for 2009 was $1.8 billion, a 25% increase from $1.4 billion for 2008. The increase was driven primarily by the following:
| • | Interest income on non-MBS investments decreased $689 million in 2009 compared to 2008. The decrease consisted of a $583 million decrease attributable to lower average yields on non-MBS investments and a $106 million decrease attributable to a 17% decrease in average non-MBS investment balances. |
| • | Interest income from the mortgage portfolio decreased $485 million in 2009 compared to 2008. The decrease consisted of a $312 million decrease attributable to lower average yields on MBS investments and mortgage loans, a $147 million decrease attributable to an 8% decrease in average MBS outstanding, and a $26 million decrease attributable to a 14% decrease in average 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 decreased interest income by $17 million in 2009 and increased interest income by $41 million in 2008. This decrease was primarily due to slower projected prepayment speeds during 2009. |
| • | Interest income from advances decreased $5.4 billion in 2009 compared to 2008. The decrease consisted of a $3.5 billion decrease attributable to lower average yields and a $1.9 billion decrease attributable to a 28% decrease in average advances outstanding, reflecting lower member demand during 2009 relative to 2008. In addition, members and nonmember borrowers prepaid $17.6 billion of advances in 2009 compared to $12.2 billion in 2008. As a result of these advances prepayments, interest income was increased by net prepayment fees of $34 million in 2009. In 2008, interest income was decreased by net prepayment credits of $4 million. The increase in advances prepayments in 2009 reflected members’ reduced liquidity needs. |
| • | Interest expense on consolidated obligations (bonds and discount notes) decreased $6.9 billion in 2009 compared to 2008. The decrease consisted of a $4.9 billion decrease attributable to lower interest rates on consolidated obligations and a $2.0 billion decrease attributable to lower average consolidated obligation balances, which paralleled the decline in advances and MBS investments. Lower interest rates provided the Bank with the opportunity to call fixed rate callable debt and refinance that debt with new callable debt at a lower cost. |
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As a result of these factors, the net interest margin was 73 basis points for 2009, 29 basis points higher than the net interest margin for 2008, which was 44 basis points. The net interest spread was 68 basis points for 2009, 35 basis points higher than the net interest spread for 2008, which was 33 basis points. The increase in net interest income was partially offset by net interest expense on derivative instruments used in economic hedges, included in other income. In addition, the increase was partially due to a rise in the average profit spread on the mortgage portfolio, reflecting the favorable impact of a lower interest rate environment and a steeper yield curve. The lower interest rate environment provided the Bank with the opportunity to call fixed rate callable debt and refinance that debt at a lower cost. These increases were partially offset by the lower yield on invested capital because of the lower interest rate environment during 2009 and lower net interest spreads on the non-MBS investment portfolio.
The increase in net interest income was partially offset by the increase in net interest expense on derivative instruments used in economic hedges, recognized in “Other (Loss)/Income.” The increase reflected economic hedges used to hedge fixed rate advances and MBS with interest rate swaps having a fixed rate pay leg and an adjustable rate receive leg. The decrease in LIBOR—the rate received on the adjustable rate leg—throughout 2009 significantly increased the interest rate swaps’ net interest expense.
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 various components of other loss for the years ended December 31, 2009 and 2008.
| (In millions) | 2009 | 2008 | ||||||
| Other Loss: |
||||||||
| Services to members |
$ | 1 | $ | 1 | ||||
| Net gain/(loss) on trading securities |
1 | (1 | ) | |||||
| Total other-than-temporary impairment loss on held-to-maturity securities |
(4,121 | ) | (590 | ) | ||||
| Portion of impairment loss recognized in other comprehensive income/(loss) |
3,513 | — | ||||||
| Net other-than-temporary impairment loss on held-to-maturity securities |
(608 | ) | (590 | ) | ||||
| Net (loss)/gain on advances and consolidated obligation bonds held at fair value |
(471 | ) | 890 | |||||
| Net gain/(loss) on derivatives and hedging activities |
122 | (1,008 | ) | |||||
| Other |
7 | 18 | ||||||
| Total Other Loss |
$ | (948 | ) | $ | (690 | ) | ||
Net Other-Than-Temporary Impairment Loss on Held-to-Maturity Securities – The Bank recognized a $608 million OTTI credit-related charge on PLRMBS during 2009, compared to a $590 million OTTI charge, which included a credit-related charge of $20 million and a non-credit-related charge of $570 million, on PLRMBS during 2008. The main difference between the OTTI charge in 2009 compared to 2008 is the accounting treatment of the credit loss on PLRMBS in 2009 following the implementation of the new OTTI guidance. Under accounting guidance on OTTI adopted as of January 1, 2009, the portion of any OTTI related to credit loss is recognized in income, while the non-credit-related portion of any OTTI is recognized in other comprehensive income, a component of capital. Prior to the adoption of this guidance, all OTTI was recognized in income. Additional information about the OTTI charge is provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – Investments” and in Note 6 to the Financial Statements.
Net (Loss)/Gain on Advances and Consolidated Obligation Bonds Held at Fair Value – The following table presents the net (loss)/gain on advances and consolidated obligation bonds held at fair value for the years ended December 31, 2009 and 2008.
| (In millions) | 2009 | 2008 | ||||||
| Advances |
$ | (572 | ) | $ | 914 | |||
| Consolidated obligation bonds |
101 | (24 | ) | |||||
| Total |
$ | (471 | ) | $ | 890 | |||
For 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, partially offset by gains resulting from decreased swaption volatilities used in pricing fair value option putable advances during 2009. The unrealized net fair value gains on consolidated obligation bonds were primarily driven by the increased long-term interest rate environment relative to the actual coupon rates on the consolidated obligation bonds, partially offset by losses resulting from lower swaption volatilities used in pricing fair value option callable bonds during 2009.
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For 2008, the unrealized net fair value gains on advances were primarily driven by the decreased interest rate environment relative to the actual coupon rates on the Bank’s advances, partially offset by losses resulting from increased swaption volatilities used in pricing fair value option putable advances during 2008. The unrealized net fair value losses on consolidated obligation bonds were primarily driven by the decreased interest rate environment relative to the actual coupon rates of the consolidated obligation bonds, partially offset by gains resulting from increased swaption volatilities used in pricing fair value option callable bonds during 2008.
In general, transactions elected for the fair value option are in economic hedge relationships. Gains or losses on these transactions are generally offset by losses or gains on derivatives that are economically hedged to these instruments.
Net Gain/(Loss) 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 gain/(loss) on derivatives and hedging activities” in 2009 and 2008.
Sources of Gains/(Losses) Recorded in Net Gain/(Loss) on Derivatives and Hedging Activities
2009 Compared to 2008
| (In millions) | 2009 | 2008 | ||||||||||||||||||||||||||||||
| Gains/(Loss) | Net Interest Income/ (Expense) on Economic Hedges |
Gains/(Loss) | Net Interest Income/ (Expense) on Economic Hedges |
|||||||||||||||||||||||||||||
| Hedged Item | Fair Value Hedges, Net |
Economic Hedges |
Total | Fair Value Hedges, Net |
Economic Hedges |
Total | ||||||||||||||||||||||||||
| Advances: |
||||||||||||||||||||||||||||||||
| Elected for fair value option |
$ | — | $ | 598 | $ | (724 | ) | $ | (126 | ) | $ | — | $ | (908 | ) | $ | (140 | ) | $ | (1,048 | ) | |||||||||||
| Not elected for fair value option |
(36 | ) | 127 | (141 | ) | (50 | ) | 48 | (167 | ) | 4 | (115 | ) | |||||||||||||||||||
| Consolidated obligations: |
||||||||||||||||||||||||||||||||
| Elected for fair value option |
— | 68 | (54 | ) | 14 | — | (79 | ) | (203 | ) | (282 | ) | ||||||||||||||||||||
| Not elected for fair value option |
60 | (243 | ) | 467 | 284 | (38 | ) | 256 | 219 | 437 | ||||||||||||||||||||||
| Total |
$ | 24 | $ | 550 | $ | (452 | ) | $ | 122 | $ | 10 | $ | (898 | ) | $ | (120 | ) | $ | (1,008 | ) | ||||||||||||
During 2009, net gains on derivatives and hedging activities totaled $122 million compared to net losses of $1.0 billion in 2008. These amounts included net interest expense on derivative instruments used in economic hedges of $452 million in 2009, compared to net interest expense on derivative instruments used in economic hedges of $120 million in 2008. The increase in net interest expense was primarily due to the impact of the decrease in interest rates throughout 2009 on the floating leg of the interest rate swaps.
Excluding the $452 million impact from net interest expense on derivative instruments used in economic hedges, net gains for 2009 totaled $574 million as detailed above. The $574 million in net gains were primarily attributable to changes in interest rates and a decrease in swaption volatilities during 2009. Excluding the $120 million impact from net interest expense on derivative instruments used in economic hedges, net losses for 2008 totaled $888 million as detailed above. The $888 million in net losses was primarily attributable to the decline in interest rates and an increase in swaption volatilities during 2008.
Under the accounting for derivatives instruments and hedging activities, the Bank is required to carry all of its derivative instruments on the balance sheet at fair value. If derivatives meet the hedging criteria, including effectiveness measures, the underlying hedged instruments may also be carried at fair value so that some or all of the unrealized gain or loss recognized on the derivative is offset by a corresponding unrealized loss or gain on the underlying hedged instrument. The unrealized gain or loss on the “ineffective” portion of all hedges, which represents the amount by which the change in the fair value of the derivative differs from the change in the fair value of the hedged item or the variability in the cash flows of the forecasted transaction, is recognized in current period earnings. In addition, certain derivatives are associated with assets or liabilities but do not qualify as fair value or cash flow hedges under the accounting for derivatives instruments and hedging activities. These economic hedges are recorded on the balance sheet at fair value with the unrealized gain or loss recorded in earnings without any offsetting unrealized loss or gain from the associated asset or liability.
Under the fair value option, the Bank elected to carry certain assets and liabilities (advances and consolidated obligation bonds) at fair value. The Bank records the unrealized gains and losses on these assets and liabilities in “Net (loss)/gain on advances and consolidated obligation bonds held at fair value.” In general, transactions elected for the fair value option are in economic hedge relationships.
In general, nearly all of the Bank’s derivatives and hedged instruments, as well as certain assets and liabilities that are carried at fair value, are held to the maturity, call, or put date. For these financial instruments, net gains or losses 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
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contractual terms to maturity, or by the exercised call or put dates. However, the Bank may have instances in which hedging relationships are terminated prior to maturity or prior to the call or put dates. Terminating the hedging relationship 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 gains or losses on derivatives and associated hedged items and financial instruments carried at fair value (valuation adjustments) during 2009 were primarily driven by (i) changes in overall interest rate spreads; (ii) the reversal of prior period gains and losses; and (iii) decreases in swaption volatilities.
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 valuation adjustments. The effects of these valuation adjustments may lead to significant volatility in future earnings, including earnings available for dividends.
Other Expense. Other expenses were $132 million in 2009 compared to $112 million in 2008, primarily because of increases in the number of employees, salary increases, and higher consulting costs. The rise in costs was primarily in response to increased business risk management needs and complexity.
Affordable Housing Program and Resolution Funding Corporation Assessments. Although the FHLBanks are exempt from ordinary federal, state, and local taxation except real property taxes, they are required to make payments to the Resolution Funding Corporation (REFCORP). REFCORP was established in 1989 under 12 U.S.C. Section 1441b as a means of funding the Resolution Trust Corporation (RTC), a federal instrumentality established to provide funding for the resolution and disposition of insolvent savings institutions. In addition, the FHLBank Act requires each FHLBank to establish and fund an Affordable Housing Program (AHP). Each FHLBank’s AHP provides subsidies in the form of direct grants and below-market interest rate advances to members, which use the funds to assist in the purchase, construction, or rehabilitation of housing for very low-, low-, and moderate-income households. REFCORP has been designated as the calculation agent for REFCORP and AHP assessments, which are calculated simultaneously because of their interdependence. Each FHLBank provides its net income before the REFCORP and AHP assessments to REFCORP, which then performs the calculations for each quarter end.
To fund the AHP, the FHLBanks must set aside, in the aggregate, the greater of $100 million or 10% of the current year’s net earnings (income before interest expense related to mandatorily redeemable capital stock and the assessment for AHP, but after the assessment for REFCORP). To the extent that the aggregate 10% calculation is less than $100 million, then the FHLBank Act requires that each FHLBank contribute such prorated sums as may be required to assure that the aggregate contribution of the FHLBanks equals $100 million. The pro ration would be made on the basis of the income of the FHLBanks for the previous year. In the aggregate, the FHLBanks set aside $258 million, $197 million, and $318 million for their AHPs in 2009, 2008, and 2007, respectively, and there was no AHP shortfall in any of those years.
To fund REFCORP, each FHLBank is required to pay 20% of U.S. GAAP income after the assessment for the AHP, but before the assessment for REFCORP. The FHLBanks will continue to record an expense for the REFCORP assessments until the aggregate amounts actually paid by all 12 FHLBanks are equivalent to a $300 million annual annuity (or a scheduled payment of $75 million per quarter) whose final maturity date is April 15, 2030, at which point the required payment of each FHLBank to REFCORP will be fully satisfied. The Finance Agency, in consultation with the Secretary of the Treasury, selects the appropriate discounting factors to be used in this annuity calculation.
The cumulative amount to be paid to REFCORP by the Bank is not determinable at this time because it depends on the future earnings of all 12 FHLBanks and on interest rates. If the Bank experienced a net loss during a quarter, but still had net income for the year, the Bank’s obligation to REFCORP would be calculated based on the Bank’s year-to-date net income. The Bank would be entitled to a refund or credit toward future payments of amounts paid for the full year that were in excess of its calculated annual obligation. If the Bank had net income in subsequent quarters, it would be required to contribute additional amounts to meet its calculated annual obligation. If the Bank experienced a net loss for a full year, the Bank would have no obligation to REFCORP for the year.
The Finance Agency is required to extend the term of the FHLBanks’ obligation to REFCORP for each calendar quarter in which there is a deficit quarterly payment. A deficit quarterly payment occurs when the actual aggregate quarterly payment by all 12 FHLBanks falls short of $75 million.
The FHLBanks’ aggregate payments through 2009 have exceeded the scheduled payments, effectively accelerating payment of the REFCORP obligation and shortening its remaining term to April 15, 2012. The FHLBanks’ aggregate payments through 2009 have
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satisfied $2 million of the $75 million scheduled payment due on April 15, 2012, and have completely satisfied all scheduled payments thereafter. This date assumes that the FHLBanks will pay the required $300 million annual payments after December 31, 2009, until the annuity is satisfied.
The scheduled payments or portions of them could be reinstated if the actual REFCORP payments of the FHLBanks fall short of $75 million in a quarter. The maturity date of the REFCORP obligation may be extended beyond April 15, 2030, if the extension is necessary to ensure that the value of the aggregate amounts paid by the FHLBanks exactly equals a $300 million annual annuity. Any payment beyond April 15, 2030, will be paid to the U.S. Department of the Treasury.
In addition to the FHLBanks’ responsibility to fund REFCORP, the FHLBank presidents are appointed on a rotating basis to serve as two of the three directors on the REFCORP directorate.
The Bank set aside $58 million for the AHP in 2009, compared to $53 million in 2008, reflecting higher earnings in 2009. The Bank’s total REFCORP assessments equaled $128 million in 2009, compared to $115 million in 2008, reflecting higher earnings in 2009. The total assessments in 2009 and 2008 reflect the Bank’s effective “tax” rate on pre-assessment income of 27%. Since the Bank experienced a net loss in the fourth quarter of 2008, the Bank recorded a $51 million receivable from REFCORP in the Statements of Condition for the amount of the excess payments made during the nine months ended September 30, 2008. This receivable was applied as a credit toward the Bank’s 2009 REFCORP assessments.
Return on Average Equity. Return on average equity (ROE) was 5.83% in 2009, an increase of 229 basis points from 3.54% in 2008. This increase reflected the decline in average equity, which decreased 32%, to $8.8 billion in 2009 from $13.0 billion in 2008, coupled with an increase in net income in 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 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 December 31, 2009, advances maturing within five years totaled $125.2 billion, significantly in excess of the $0.2 billion of member deposits on that date. At December 31, 2008, advances maturing within five years totaled $225.1 billion, also significantly in excess of the $0.6 billion of member deposits on that date. In addition, as of December 31, 2009 and 2008, 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 gains or losses on derivatives and associated hedged items and financial instruments carried at fair value (valuation adjustments).
In general, the Bank’s derivatives and hedged instruments, as well as certain assets and liabilities that are carried at fair value, are held to the maturity, call, or put date. For these financial instruments, net gains or losses 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. However, the Bank may have instances in which hedging relationships are terminated prior to maturity or prior to the call or put dates. Terminating the hedging relationship 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.
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. In this case,
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the potential dividend payout in a given period will be substantially the same as it would have been without the effects of valuation adjustments, provided that at the end of the period the cumulative net effect since inception remains a net gain. The purpose of the valuation adjustments category of restricted retained earnings is to provide sufficient retained earnings to offset future net losses that result from the reversal of cumulative net gains, so that potential dividend payouts in future periods are not necessarily affected by the reversals of these gains. Although restricting retained earnings in accordance with this provision of the policy may help preserve the Bank’s ability to pay dividends, the reversal of cumulative net gains in any given period may result in a net loss if the reversal exceeds net earnings before the impact of valuation adjustments for that period. Also, if the net effect of valuation adjustments since inception results in a cumulative net loss, the Bank’s other retained earnings at that time (if any) may not be sufficient to offset the net loss. As a result, the future effects of valuation adjustments may cause the Bank to reduce or temporarily suspend dividend payments.
Retained earnings restricted in accordance with this provision of the Bank’s Retained Earnings and Dividend Policy totaled $181 million at December 31, 2009, and $52 million at December 31, 2008. In accordance with this provision, the amount increased by $129 million in 2009 as a result of net unrealized gains 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 credit losses related to OTTI of PLRMBS, especially in periods of extremely low net income resulting from an adverse interest rate environment.
The retained earnings restricted in accordance with this provision of the Retained Earnings and Dividend Policy totaled $1.1 billion at December 31, 2009, and $124 million at December 31, 2008. On May 29, 2009, the Bank’s Board of Directors amended the Bank’s Retained Earnings and Dividend Policy to change the way the Bank determines the amount of earnings to be restricted for the targeted buildup. Instead of retaining a fixed percentage of earnings toward the retained earnings target each quarter, the Bank will designate any earnings not restricted for other reasons or not paid out in dividends as restricted retained earnings for the purpose of meeting the target. In September 2009, the Board of Directors increased the targeted amount of restricted retained earnings to $1.8 billion from $1.2 billion. Most of the increase in the target was due to an increase in the projected losses on the collateral underlying the Bank’s PLRMBS under stress case assumptions about housing market conditions. On January 29, 2010, the Board of Directors adopted technical revisions to the Retained Earnings and Dividend Policy that did not have any impact on our methodology for calculating restricted retained earnings or the dividend.
Dividends Paid – In 2009, the Bank continued to face a number of challenges and uncertainties because of volatile market conditions, particularly in the PLRMBS market. Throughout the year, the Bank focused on preserving capital in response to the possibility of future OTTI charges on its PLRMBS portfolio. As a result, the Bank did not pay a dividend for the first and third quarters of 2009, and the dividends for the second and fourth quarters of 2009 were small. The Bank recorded and paid the second quarter dividend during the third quarter of 2009. The Bank recorded the fourth quarter dividend on February 22, 2010, the day it was declared by the Board of Directors. The Bank expects to pay the fourth quarter dividend (including dividends on mandatorily redeemable capital stock), which will total $9 million, on or about March 26, 2010. The Bank’s dividend rate for 2009, including both the second and fourth quarter dividends, was 0.28%. The Bank’s dividend rate for 2008 was 3.93%.
The Bank paid the second quarter dividend and expects to pay the fourth quarter 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, 2009, the Bank’s excess capital stock totaled $4.6 billion, or 2% of total assets. As of December 31, 2009, the Bank’s excess capital stock totaled $6.5 billion, or 3% of total assets.
The Bank will continue to monitor the condition of its MBS 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.
The Board of Directors may declare and pay dividends out of current net earnings or previously retained earnings. There is no requirement that the Board of Directors declare and pay any dividend. A decision by the Board of Directors to declare or not declare a dividend is a discretionary matter and is subject to the requirements and restrictions of the FHLBank Act and applicable regulatory requirements.
Comparison of 2008 to 2007
The Bank’s dividend rate for 2008 was 3.93%, compared to 5.20% for 2007. The 2008 dividend rate was lower than the rate for 2007 because the Bank did not pay a dividend for the fourth quarter of 2008 in anticipation of a potential OTTI charge. The OTTI charge
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incurred in the fourth quarter was partially offset by the increase in net income in 2008, which was primarily driven by a higher net interest spread on the Bank’s mortgage portfolio (MBS and mortgage loans).
During 2008, total assets decreased $1.2 billion, to $321.2 billion at yearend 2008 from $322.4 billion at yearend 2007. Advances outstanding decreased by $15.3 billion, or 6%, to $235.7 billion at December 31, 2008, from $251.0 billion at December 31, 2007. In total, 113 institutions decreased their advances, while 213 institutions increased their advances during 2008. In addition, Federal funds sold decreased by $2.3 billion, or 20%, to $9.4 billion from $11.7 billion, and held-to-maturity securities decreased by $2.0 billion, or 4%, from $53.2 billion to $51.2 billion, while cash and due from banks increased to $19.6 billion from $5 million.
Net income for 2008 decreased by $191 million, or 29%, to $461 million from $652 million in 2007. The decrease primarily reflected a decrease in other income, partially offset by growth in net interest income. The decrease in other income was chiefly due to the OTTI charge and to an increase in net interest expense on derivative instruments used in economic hedges.
Net interest income for 2008 rose $500 million, or 54%, to $1.4 billion from $931 million in 2007. The increase in net interest income was primarily driven by a higher net interest spread on the Bank’s mortgage portfolio (MBS and mortgage loans) and by higher average balances of advances and investments during 2008 compared to 2007.
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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 years ended December 31, 2008 and 2007, 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.
Average Balance Sheets
| 2008 | 2007 | |||||||||||||||||||
| (Dollars in millions) | Average Balance |
Interest Income/ Expense |
Average Rate |
Average Balance |
Interest Income/ Expense |
Average Rate |
||||||||||||||
| Assets |
||||||||||||||||||||
| Interest-earning assets: |
||||||||||||||||||||
| Resale agreements |
$ | — | $ | — | — | % | $ | 242 | $ | 13 | 5.37 | % | ||||||||
| Federal funds sold |
13,927 | 318 | 2.28 | 12,679 | 660 | 5.21 | ||||||||||||||
| Trading securities: MBS |
46 | 2 | 4.35 | 63 | 4 | 6.35 | ||||||||||||||
| Held-to-maturity securities: MBS |
38,781 | 1,890 | 4.87 | 27,250 | 1,419 | 5.21 | ||||||||||||||
| Other investments |
15,545 | 425 | 2.73 | 14,132 | 741 | 5.24 | ||||||||||||||
| Mortgage loans held for portfolio, net |
3,911 | 200 | 5.11 | 4,370 | 215 | 4.92 | ||||||||||||||
| Advances(1) |
251,184 | 8,182 | 3.26 | 201,744 | 10,719 | 5.31 | ||||||||||||||
| Loans to other FHLBanks |
23 | — | 1.93 | 7 | — | 4.34 | ||||||||||||||
| Total interest-earning assets |
323,417 | 11,017 | 3.41 | 260,487 | 13,771 | 5.29 | ||||||||||||||
| Other assets(2)(3) |
7,767 | — | — | 4,098 | — | — | ||||||||||||||
| Total Assets |
$ | 331,184 | $ | 11,017 | 3.33 | % | $ | 264,585 | $ | 13,771 | 5.20 | % | ||||||||
| Liabilities and Capital |
||||||||||||||||||||
| Interest-bearing liabilities: |
||||||||||||||||||||
| Consolidated obligations: |
||||||||||||||||||||
| Bonds(1) |
$ | 227,804 | $ | 7,282 | 3.20 | % | $ | 206,630 | $ | 10,772 | 5.21 | % | ||||||||
| Discount notes |
80,658 | 2,266 | 2.81 | 41,075 | 2,038 | 4.96 | ||||||||||||||
| Deposits(2) |
1,462 | 24 | 1.64 | 467 | 22 | 4.71 | ||||||||||||||
| Borrowings from other FHLBanks |
20 | — | 1.02 | 6 | — | 2.55 | ||||||||||||||
| Mandatorily redeemable capital stock |
1,249 | 14 | 3.93 | 126 | 7 | 5.20 | ||||||||||||||
| Other borrowings |
17 | — | 1.69 | 13 | 1 | 5.28 | ||||||||||||||
| Total interest-bearing liabilities |
311,210 | 9,586 | 3.08 | 248,317 | 12,840 | 5.17 | ||||||||||||||
| Other liabilities(2)(3) |
6,969 | — | — | 5,022 | — | — | ||||||||||||||
| Total Liabilities |
318,179 | 9,586 | 3.01 | 253,339 | 12,840 | 5.07 | ||||||||||||||
| Total Capital |
13,005 | — | — | 11,246 | — | — | ||||||||||||||
| Total Liabilities and Capital |
$ | 331,184 | $ | 9,586 | 2.89 | % | $ | 264,585 | $ | 12,840 | 4.85 | % | ||||||||
| Net Interest Income |
$ | 1,431 | $ | 931 | ||||||||||||||||
| Net Interest Spread(4) |
0.33 | % | 0.12 | % | ||||||||||||||||
| Net Interest Margin(5) |
0.44 | % | 0.36 | % | ||||||||||||||||
| Interest-earning Assets/Interest-bearing Liabilities |
103.92 | % | 104.90 | % | ||||||||||||||||
| Total Average Assets/Regulatory Capital Ratio(6) |
23.2 | x | 23.3 | x | ||||||||||||||||
| (1) | Interest income/expense and average rates include the effect of associated interest rate exchange agreements. Interest income on advances includes net interest (expense)/income on interest rate exchange agreements of $(388) million and $230 million for 2008 and 2007, respectively. Interest expense on consolidated obligation bonds includes net interest income/(expense) on interest rate exchange agreements of $1.5 billion and $(867) million for 2008 and 2007, respectively. |
| (2) | Average balances do not reflect the effect of reclassifications of cash collateral. |
| (3) | Includes forward settling transactions and fair value adjustments for certain cash items. |
| (4) | Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities. |
| (5) | Net interest margin is net interest income divided by average interest-earning assets. |
| (6) | For this purpose, regulatory capital includes mandatorily redeemable capital stock and excludes accumulated other comprehensive income. |
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The following Change in Net Interest Income table details the changes in interest income and interest expense for 2008 compared to 2007. Changes in both volume and interest rates influence changes in net interest income and the net interest margin.
Change in Net Interest Income: Rate/Volume Analysis
2008 Compared to 2007
| Increase/ (Decrease) |
Attributable to Changes in(1) | |||||||||||
| (In millions) | Average Volume | Average Rate | ||||||||||
| Interest-earning assets: |
||||||||||||
| Securities purchased under agreements to resell |
$ | (13 | ) | $ | (7 | ) | $ | (6 | ) | |||
| Federal funds sold |
(342 | ) | 60 | (402 | ) | |||||||
| Trading securities: MBS |
(2 | ) | (1 | ) | (1 | ) | ||||||
| Held-to-maturity securities: |
||||||||||||
| MBS |
471 | 567 | (96 | ) | ||||||||
| Other investments |
(316 | ) | 68 | (384 | ) | |||||||
| Mortgage loans held for portfolio |
(15 | ) | (23 | ) | 8 | |||||||
| Advances(2) |
(2,537 | ) | 2,233 | (4,770 | ) | |||||||
| Total interest-earning assets |
(2,754 | ) | 2,897 | (5,651 | ) | |||||||
| Interest-bearing liabilities: |
||||||||||||
| Consolidated obligations: |
||||||||||||
| Bonds(2) |
(3,490 | ) | 1,014 | (4,504 | ) | |||||||
| Discount notes |
228 | 1,377 | (1,149 | ) | ||||||||
| Deposits |
2 | 24 | (22 | ) | ||||||||
| Mandatorily redeemable capital stock |
7 | 10 | (3 | ) | ||||||||
| Other borrowings |
(1 | ) | — | (1 | ) | |||||||
| Total interest-bearing liabilities |
(3,254 | ) | 2,425 | (5,679 | ) | |||||||
| Net interest income |
$ | 500 | $ | 472 | $ | 28 | ||||||
| (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 for 2008 rose $500 million, or 54%, to $1.4 billion from $931 million for 2007. The increase was driven primarily by the following:
| • | Interest income on non-MBS investments decreased $671 million in 2008 compared to 2007. The decrease consisted of a $792 million decrease attributable to lower average yields on non-MBS investments, partially offset by a $121 million increase attributable to a 9% increase in average non-MBS investment balances. |
| • | Interest income from the mortgage portfolio increased $454 million in 2008 compared to 2007. The increase consisted of a $566 million increase attributable to a 42% increase in average MBS outstanding and an $8 million increase attributable to higher average yields on mortgage loans, partially offset by a $97 million decrease attributable to lower average yields on MBS investments, and a $23 million decrease attributable to an 11% decrease in average 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 $41 million in 2008 and decreased interest income by $18 million in 2007. The increased amortization of net discounts was due to a lower interest rate environment during 2008, resulting in faster projected prepayment rates. |
| • | Interest income from advances decreased $2.5 billion in 2008 compared to 2007. The decrease consisted of a $4.7 billion decrease attributable to lower average yields because of decreases in interest rates for new advances and adjustable rate advances repricing at lower rates. The decrease was partially offset by a $2.2 billion increase attributable to a 25% increase in average advances outstanding, reflecting higher member demand during 2008 relative to 2007. |
| • | Interest expense on consolidated obligations (bonds and discount notes) decreased $3.3 billion in 2008 compared to 2007. The decrease consisted of a $5.7 billion decrease attributable to lower interest rates on consolidated obligations, partially offset by a $2.4 billion increase attributable to higher average consolidated obligation balances, which were issued primarily to finance the growth in advances and MBS investments. |
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| • | Interest expense on mandatorily redeemable capital stock increased $7 million, of which $10 million was attributable to higher average balances of mandatorily redeemable capital stock in 2008 relative to 2007, partially offset by a decrease in interest expense on mandatorily redeemable capital stock of $3 million attributable to lower dividend rates in 2008. Most of the increase in interest expense was attributable to the reclassification of capital stock to mandatorily redeemable capital stock (a liability) associated with IndyMac Federal Bank, FSB, and JPMorgan Chase Bank, National Association, which increased interest expense by $4 million and $2 million, respectively. |
As a result of these factors, the net interest margin was 44 basis points for 2008, 8 basis points higher than the net interest margin for 2007, which was 36 basis points. The increase reflected higher net interest spreads on the mortgage portfolio and a higher net interest spread on advances made to members during 2008 compared to 2007. The increases were partially offset by a lower yield on invested capital due to the lower interest rate environment during 2008.
The net interest spread was 33 basis points for 2008, 21 basis points higher than the net interest spread for 2007, which was 12 basis points. The increase reflected a higher net interest spread on the Bank’s mortgage portfolio, reflecting the favorable impact of a lower interest rate environment, a steeper yield curve, and wider market spreads on new MBS investments. The lower interest rate environment provided the Bank with the opportunity to call fixed rate callable debt and refinance that debt with new callable debt at a lower cost. The steeper yield curve further reduced the cost of financing the Bank’s investment in MBS and mortgage loans. In addition, lower short-term funding costs, measured as a spread below LIBOR, favorably impacted the spread on the floating rate portion of the Bank’s MBS portfolio and resulted in higher net interest spreads on new advances. The lower short-term funding costs relative to LIBOR were driven primarily by events adversely affecting the financial markets, which led to higher demand for short-term FHLBank consolidated obligations.
The increase in net interest income was partially offset by the increase in net interest expense on derivative instruments used in economic hedges, recognized in “Other (Loss)/Income.” The increase reflected economic hedges used to hedge fixed rate advances and MBS with interest rate swaps having a fixed rate pay leg and an adjustable rate receive leg. The decrease in LIBOR—the rate received on the adjustable rate leg—throughout 2008 significantly increased the interest rate swaps’ net interest expense.
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)/Income. The following table presents the various components of other loss for the years ended December 31, 2008 and 2007.
| (In millions) | 2008 | 2007 | |||||
| Other (Loss)/Income: |
|||||||
| Services to members |
$ | 1 | $ | 1 | |||
| Net loss on trading securities |
(1 | ) | — | ||||
| Other-than-temporary impairment charge on held-to-maturity securities |
(590 | ) | — | ||||
| Net gain on advances and consolidated obligation bonds held at fair value |
890 | — | |||||
| Net (loss)/gain on derivatives and hedging activities |
(1,008 | ) | 52 | ||||
| Other |
18 | 2 | |||||
| Total Other (Loss)/Income |
$ | (690 | ) | $ | 55 | ||
Other-Than-Temporary Impairment Charge on Held-to-Maturity Securities – The Bank recognized a $590 million OTTI charge on PLRMBS during 2008. Additional information about the OTTI charge is provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – Investments and in Note 5 to the Financial Statements in the Bank’s Annual Report on Form 10-K for the year ended December 31, 2008.
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Net Gain on Advances and Consolidated Obligation Bonds Held at Fair Value – The following table presents the net gains on advances and consolidated obligation bonds held at fair value for the year ended December 31, 2008. The Bank adopted the fair value measurement guidance on January 1, 2008.
| (In millions) | 2008 | |||
| Advances |
$ | 914 | ||
| Consolidated obligation bonds |
(24 | ) | ||
| Total |
$ | 890 | ||
For 2008, the unrealized net fair value gains on advances were primarily driven by the decreased interest rate environment relative to the actual coupon rates on the Bank’s advances, partially offset by losses resulting from increased swaption volatilities used in pricing fair value option putable advances during 2008. The unrealized net fair value losses on consolidated obligation bonds were primarily driven by the decreased interest rate environment relative to the actual coupon rates of the consolidated obligation bonds, partially offset by gains resulting from increased swaption volatilities used in pricing fair value option callable bonds during 2008.
In general, transactions elected for the fair value option are in economic hedge relationships. These gains or losses are generally offset by losses or gains on derivatives that are economically hedged to these instruments.
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 2008 and 2007.
Sources of Gains/(Losses) Recorded in Net (Loss)/Gain on Derivatives and Hedging Activities
2008 Compared to 2007
| (In millions) | 2008 | 2007 | |||||||||||||||||||||||||||||
| Gains/(Loss) | Net Interest (Expense) on |
Total |
Gains/(Loss) | Net Interest (Expense) on |
Total | ||||||||||||||||||||||||||
| Hedged Item | Fair Value Hedges, Net |
Economic Hedges |
Fair Value Hedges, Net |
Economic Hedges |
|||||||||||||||||||||||||||
| Advances: |
|||||||||||||||||||||||||||||||
| Elected for fair value option |
$ | — | $ | (908 | ) | $ | (140 | ) | $ | (1,048 | ) | $ | — | $ | — | $ | — | $ | — | ||||||||||||
| Not elected for fair value option |
48 | (167 | ) | 4 | (115 | ) | 2 | (4 | ) | 4 | 2 | ||||||||||||||||||||
| Consolidated obligations: |
|||||||||||||||||||||||||||||||
| Elected for fair value option |
— | (79 | ) | (203 | ) | (282 | ) | — | — | — | — | ||||||||||||||||||||
| Not elected for fair value option |
(38 | ) | 256 | 219 | 437 | (26 | ) | 84 | (8 | ) | 50 | ||||||||||||||||||||
| Total |
$ | 10 | $ | (898 | ) | $ | (120 | ) | $ | (1,008 | ) | $ | (24 | ) | $ | 80 | $ | (4 | ) | $ | 52 | ||||||||||
During 2008, net losses on derivatives and hedging activities totaled $1.0 billion compared to net gains of $52 million in 2007. These amounts included net interest expense on derivative instruments used in economic hedges of $120 million in 2008, compared to net interest expense on derivative instruments used in economic hedges of $4 million in 2007. The increase in net interest expense was primarily due to the impact of the decrease in interest rates throughout most of 2008 on the floating leg of the interest rate swaps.
Excluding the $120 million impact from net interest expense on derivative instruments used in economic hedges, net losses for 2008 totaled $888 million. The $888 million in net losses was primarily attributable to the decline in interest rates and increase in swaption volatilities during 2008. Excluding the $4 million impact from net interest expense on derivative instruments used in economic hedges, net gains for 2007 totaled $56 million.
Other Expense. Other expenses were $112 million in 2008 compared to $98 million in 2007, primarily because of increases in the number of employees, salary increases, and higher consulting costs. The rise in costs was primarily in response to increased business risk management needs and complexity, as well as increased compliance requirements related to the Sarbanes-Oxley Act of 2002.
Return on Average Equity. ROE was 3.54% in 2008, a decrease of 226 basis points from 5.80% in 2007. The decrease reflected the 29% decrease in net income, to $461 million in 2008 from $652 million in 2007. In addition, average capital increased 16% to $13.0 billion in 2008 from $11.2 billion in 2007.
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Dividends. The Bank’s dividend rate for 2008 was 3.93%, compared to 5.20% for 2007. The 2008 dividend rate was lower than the rate for 2007 primarily because the Bank did not pay a dividend for the fourth quarter of 2008 in anticipation of a potential OTTI charge. The OTTI charge incurred in the fourth quarter was partially offset by the increase in net interest income in 2008, which was primarily driven by a higher net interest spread on the Bank’s mortgage portfolio (MBS and mortgage loans), as well as higher average advances and investment balances.
The spread between the dividend rate and the dividend benchmark increased to 0.97% for 2008 from 0.75% for 2007. The increased spread reflects a decrease in the dividend benchmark, which resulted from the significant drop in short-term interest rates following the Federal Open Market Committee’s reductions in the target Federal funds rate from September 2007 through December 2008.
Total assets were $192.9 billion at December 31, 2009, a 40% decrease from $321.2 billion at December 31, 2008, primarily as a result of a decline in advances, which decreased by $102.1 billion or 43%, to $133.6 billion at December 31, 2009, from $235.7 billion at December 31, 2008. In addition to the decline in advances, cash and due from banks decreased to $8.3 billion at December 31, 2009, from $19.6 billion at December 31, 2008, Federal funds sold decreased to $8.2 billion at December 31, 2009, from $9.4 billion at December 31, 2008, and held-to-maturity securities decreased to $36.9 billion at December 31, 2009, from $51.2 billion at December 31, 2008. Average total assets were $247.7 billion for 2009, a 25% decrease compared to $331.2 billion for 2008. Average advances were $179.7 billion for 2009, a 28% decrease from $251.2 billion for 2008.
The decline in member advance demand reflected diminished member lending activity in response to a contracting economy, tighter underwriting standards, and members’ efforts to preserve and build capital. Members also had ample deposits and access to a number of other funding options, including a variety of government lending programs. In addition, the financial condition of many members deteriorated in 2009, and some members reduced their Bank borrowings in response to changes the Bank made to their credit and collateral terms. Held-to-maturity securities decreased primarily because of principal payments, prepayments, and maturities in the MBS portfolio, OTTI charges recognized on the PLRMBS, and a substantial reduction in purchases of new MBS. The reduction in MBS purchases during the year was due to the Bank’s decision to limit its purchases to agency residential MBS and to the scarcity of securities that met the Bank’s risk-adjusted spreads. During 2009, the Bank purchased $0.4 billion of MBS, all of which were agency residential MBS. The decrease in cash and due from banks was primarily in cash held at the FRBSF, reflecting a reduction in the Bank’s short-term liquidity needs.
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. Advances outstanding at December 31, 2008, included unrealized gains of $2.7 billion, of which $1.4 billion represented unrealized gains on advances hedged in accordance with the accounting for derivative instruments and hedging activities and $1.3 billion 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 on the hedged advances and advances carried at fair value from December 31, 2008, to December 31, 2009, was primarily attributable to increased long-term interest rates relative to the actual coupon rates on the Bank’s advances, partially offset by gains resulting from decreased swaption volatilities.
Total liabilities were $186.6 billion at December 31, 2009, a 40% decrease from $311.5 billion at December 31, 2008, reflecting decreases in consolidated obligations outstanding from $304.9 billion at December 31, 2008, to $180.3 billion at December 31, 2009. The decrease in consolidated obligations outstanding paralleled the decrease in assets during 2009. Average total liabilities were $238.8 billion for 2009, a 25% decrease compared to $318.2 billion for 2008. The decrease in average liabilities reflects decreases in average consolidated obligations, paralleling the decline in average assets. Average consolidated obligations were $228.2 billion for 2009 and $308.5 billion for 2008.
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. Consolidated obligations outstanding at December 31, 2008, included unrealized losses of $3.9 billion on consolidated obligation bonds hedged in accordance with the accounting for derivative instruments and hedging activities and $50 million on economically hedged consolidated obligation bonds that are carried at fair value in accordance with the fair value option. The overall decrease in the unrealized losses of the hedged consolidated obligation bonds and consolidated obligation bonds carried at fair value from December 31, 2008, to December 31, 2009, was primarily attributable to the reversal of prior period losses.
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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 December 31, 2009, 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 $930.6 billion at December 31, 2009, and $1,251.5 billion at December 31, 2008.
As of December 31, 2009, 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 December 31, 2009, Standard & Poor’s assigned ten FHLBanks, including the Bank, a long-term credit rating of AAA, the FHLBank of Seattle a long-term credit rating of AA+, and the FHLBank of Chicago a long-term credit rating of AA+. As of December 31, 2009, 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 December 31, 2009, and as of each period end presented, and determined that they have not materially increased the likelihood that the Bank may 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.”
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 expenses associated with economic hedges that are recorded in “Net gain/(loss) 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 15 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 $161.4 billion (84% of total assets) at December 31, 2009, from $278.2 billion (87% of total assets) at December 31, 2008, representing a decrease of $116.8 billion, or 42%. The decrease primarily reflected lower demand for advances by the Bank’s members and, to a lesser extent, repayment and prepayment of advances by nonmember borrowers.
Adjusted net interest income for this segment was $700 million in 2009, a decrease of $162 million, or 19%, compared to $862 million in 2008. The declines were primarily attributable to the lower yield on invested capital because of the lower interest rate environment during 2009, lower net interest spreads on the non-MBS investment portfolio, and lower average balances of advances. Members and nonmember borrowers prepaid $17.6 billion of advances in 2009 compared to $12.2 billion in 2008. As a result of these advances prepayments, interest income was increased by net prepayment fees of $34 million in 2009. In 2008, interest income was decreased by net prepayment credits of $4 million. The increase in advances prepayments in 2009 reflected members’ reduced liquidity needs, as described below.
Adjusted net interest income for this segment was $862 million in 2008, an increase of $27 million, or 3%, compared to $835 million in 2007. The increase was primarily attributable to the effect of higher interest rates on higher average advances and investment balances. Members and nonmember borrowers prepaid $12.2 billion of advances in 2008 compared to $1.7 billion in 2007. Interest income from advances was partially offset by the impact of advances prepayments, which reduced interest income by $4 million in 2008. In 2007, interest income was increased by prepayment fees of $1 million. The decrease in advances prepayments in 2008 primarily reflected net losses on the interest rate exchange agreements hedging the prepaid advances, partially offset by prepayment fees received on the advances.
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Adjusted net interest income for this segment represented 56%, 65%, and 87% of total adjusted net interest income for 2009, 2008, and 2007, respectively. The decreases in 2009 and 2008 were due to lower earnings on the Bank’s invested capital because of the lower interest rate environment and to an increase in adjusted net interest income for the mortgage-related business segment.
Advances – The par amount of advances outstanding decreased $100.6 billion, or 43%, to $132.3 billion at December 31, 2009, from $232.9 billion at December 31, 2008. The decrease reflects a $47.3 billion decrease in fixed rate advances, a $51.3 billion decrease in adjustable rate advances, and a $2.0 billion decrease in daily variable rate advances.
Advances outstanding to the Bank’s three largest borrowers totaled $81.9 billion at December 31, 2009, a net decrease of $79.7 billion from $161.6 billion at December 31, 2008. The remaining $20.9 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, 65 institutions increased their advances during 2009, while 234 institutions decreased their advances.
Average advances were $179.7 billion in 2009, a 28% decrease from $251.2 billion in 2008. The decline in member advance demand reflected diminished member lending activity in response to a contracting economy, tighter underwriting standards, and members’ efforts to preserve and build capital. Members also had ample deposits and access to a number of other funding options, including a variety of government lending programs. In addition, the financial condition of many members deteriorated in 2009, and some members reduced their Bank borrowings in response to changes the Bank made to their credit and collateral terms.
The components of the advances portfolio at December 31, 2009 and 2008, are presented in the following table.
Advances Portfolio by Product Type
| (In millions) | 2009 | 2008 | ||||
| Standard advances: |
||||||
| Adjustable – LIBOR |
$ | 60,993 | $ | 111,603 | ||
| Adjustable – other indices |
288 | 444 | ||||
| Fixed |
48,606 | 80,035 | ||||
| Daily variable rate |
1,496 | 3,564 | ||||
| Subtotal |
111,383 | 195,646 | ||||
| Customized advances: |
||||||
| Adjustable – LIBOR, with caps and/or floors |
— | 10 | ||||
| Adjustable – LIBOR, with caps and/or floors and PPS(1) |
1,125 | 1,625 | ||||
| Fixed – amortizing |
485 | 578 | ||||
| Fixed with PPS(1) |
15,688 | 30,156 | ||||
| Fixed with caps and PPS(1) |
200 | — | ||||
| Fixed – callable at member’s option |
19 | 315 | ||||
| Fixed – putable at Bank’s option |
2,910 | 4,009 | ||||
| Fixed – putable at Bank’s option with PPS(1) |
503 | 588 | ||||
| Subtotal |
20,930 | 37,281 | ||||
| Total par value |
132,313 | 232,927 | ||||
| Hedging valuation adjustments |
524 | 1,353 | ||||
| Fair value option valuation adjustments |
616 | 1,299 | ||||
| Net unamortized premiums |
106 | 85 | ||||
| Total |
$ | 133,559 | $ | 235,664 | ||
| (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 $18.8 billion as of December 31, 2009, a decrease of $2.8 billion, or 13%, from $21.6 billion as of December 31, 2008. During 2009, Federal funds sold decreased $1.2 billion, interest-bearing deposits decreased $4.7 billion, while commercial paper increased $0.9 billion and Temporary Liquidity Guarantee Program (TLGP) investments increased $2.2 billion.
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The weighted average maturity of non-MBS investments other than housing finance agency bonds has lengthened to 131 days as of December 31, 2009, from 21 days as of December 31, 2008. In the fourth quarter of 2009, the Bank purchased $2.2 billion of TLGP investments in the secondary market with one- to three-year remaining terms to maturity, which increased the weighted average maturity of the total non-MBS investment portfolio.
Cash and Due from Banks – Cash and due from banks decreased to $8.3 billion at December 31, 2009, from $19.6 billion at December 31, 2008. The decrease was primarily in cash held at the FRBSF, reflecting a reduction in the Bank’s short-term liquidity needs.
Borrowings – Consistent with the decrease in advances, total liabilities (primarily consolidated obligations) funding the advances-related business decreased $113.3 billion, or 42%, from $268.4 billion at December 31, 2008, to $155.2 billion at December 31, 2009. 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 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. At December 31, 2008, the notional amount of interest rate exchange agreements associated with the advances-related business totaled $308.9 billion, of which $87.9 billion were hedging advances and $220.7 billion were hedging consolidated obligations, and $0.3 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 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. However, starting in the third quarter of 2008, market conditions significantly increased volatility in GSE debt pricing and funding costs compared to recent historical levels. For more information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview.”
Since December 16, 2008, the Federal Open Market Committee has not changed the target Federal funds rate. During 2009, rates on long-term U.S. Treasury securities increased because of market expectations of increased Treasury issuance and investor concern about inflation. Since December 31, 2008, 3-month LIBOR declined from 1.43% to 0.25% as credit and liquidity conditions in the short-term interbank lending market improved. The following table provides selected market interest rates as of the dates shown.
| Market Instrument | December 31, 2009 |
December 31, 2008 |
||||
| Federal Reserve target rate for overnight Federal funds |
0-0.25 | % | 0-0.25 | % | ||
| 3-month Treasury bill |
0.06 | 0.13 | ||||
| 3-month LIBOR |
0.25 | 1.43 | ||||
| 2-year Treasury note |
1.14 | 0.77 | ||||
| 5-year Treasury note |
2.68 | 1.55 |
The average cost of fixed rate FHLBank System consolidated obligation bonds and discount notes was lower in 2009 than in 2008 as a result of the general decline in market interest rates and the purchase of GSE debt by the Federal Reserve.
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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 rates in 2009 and 2008. Lower issuance and strong investor demand for longer-term GSE debt resulted in lowered borrowing costs for FHLBank System bonds relative to LIBOR compared to a year ago. For short-term debt in 2009, the Bank experienced a higher cost on discount notes relative to LIBOR compared to a year ago. The higher cost reflected the decrease of LIBOR and the change of investor sentiment, as the exceptionally strong demand for short-term, high-quality investments experienced in 2008 abated in 2009.
| Spread to LIBOR of Average Cost of Consolidated Obligations for the Twelve Months Ended | ||||
| (In basis points) | December 31, 2009 |
December 31, 2008 | ||
| Consolidated obligation bonds |
–18.4 | –16.7 | ||
| Consolidated obligation discount notes (one month and greater) |
–42.4 | –73.5 | ||
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. The swapped non-callable and callable bonds combined represented 96% of the Bank’s total consolidated obligation bonds outstanding. At December 31, 2008, the Bank had $157.6 billion of swapped non-callable bonds and $8.5 billion of swapped callable bonds that primarily funded advances and non-MBS investments. These swapped non-callable and callable bonds combined represented 78% 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, less the provision for credit losses on mortgage loans.
At December 31, 2009, assets associated with this segment were $31.5 billion (16% of total assets), a decrease of $11.5 billion, or 27%, from $43.0 billion at December 31, 2008 (13% of total assets). The decrease was due to principal payments, prepayments, and maturities in the MBS portfolio, OTTI charges recognized on the PLRMBS, and a substantial reduction in the purchase of new MBS investments. The reduction in MBS purchases during the year was due to the Bank’s decision to limit its purchases to agency residential MBS and to the scarcity of securities that met the Bank’s risk-adjusted spreads. During 2009, the Bank purchased $0.4 billion of MBS, all of which were agency residential MBS. The MBS portfolio decreased $10.9 billion to $28.2 billion at December 31, 2009, from $39.1 billion at December 31, 2008, and mortgage loan balances decreased $0.7 billion to $3.0 billion at December 31, 2009, from $3.7 billion at December 31, 2008. Average MBS investments decreased $3.2 billion in 2009 to $35.6 billion compared to $38.8 billion in 2008. Average mortgage loans decreased $0.5 billion to $3.4 billion in 2009 from $3.9 billion in 2008.
Adjusted net interest income for this segment was $543 million in 2009, an increase of $72 million, or 15%, from $471 million in 2008. The increase for 2009 was primarily the result of a rise in the average profit spread on the mortgage portfolio, reflecting the favorable impact of a lower interest rate environment and a steeper yield curve. The lower interest rate environment provided the Bank with the opportunity to call fixed rate callable debt and refinance that debt at a lower cost.
Adjusted net interest income for this segment was $471 million in 2008, an increase of $344 million, or 271%, from $127 million in 2007. The increase was primarily the result of a rise in the average profit spread on the mortgage portfolio, reflecting the favorable impact of lower interest rate environment, a steeper yield curve, and wider market spreads on new MBS investments. The lower interest rate environment provided the Bank with the opportunity to call fixed rate callable debt and refinance that debt with new callable debt at a lower cost. The steeper yield curve further reduced the cost of financing the Bank’s investment in MBS and mortgage loans. Lower short-term funding costs, measured as a spread below LIBOR, also favorably impacted the spread on the floating rate portion of the Bank’s MBS portfolio. In 2008, the wider market spreads on MBS that had been prevalent since October 2007 allowed the Bank to invest in new MBS at higher than historical profit spreads, further improving the overall spread on the Bank’s portfolio of MBS and mortgage loans. The increase also reflected the impact of cumulative retrospective adjustments for the amortization of net
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purchase discounts from the acquisition dates of the MBS and mortgage loans, which increased adjusted net interest income by $41 million in 2008 and decreased adjusted net interest income by $18 million in 2007. The increased amortization of net discounts was due to a lower interest rate environment during 2008, resulting in faster projected prepayment rates.
Adjusted net interest income for this segment represented 44%, 35%, and 13% of total adjusted net interest income for 2009, 2008, and 2007, 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 loans. For more information regarding credit risk, see the discussion in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – MPF Program.”
Mortgage loans that were purchased by the Bank under the MPF Program are qualifying conventional conforming fixed rate, first lien mortgage loans with fully amortizing loan terms of up to 30 years. A conventional loan is one that is not insured by the federal government or any of its agencies. Under the MPF Program, a conforming loan is one that does not exceed the conforming loan limits for loans purchased by Fannie Mae based on data published and supervisory guidance issued by the Finance Agency, as successor to the Finance Board and the Office of Federal Housing Enterprise Oversight. All MPF loans are secured by owner-occupied, one- to four-unit residential properties or single-unit second homes.
The MPF Servicing Guide establishes the MPF Program requirements for loan servicing and servicer eligibility. At the time the Bank purchased loans under the MPF Program, the member selling those loans made representations that all mortgage loans it delivered to the Bank had the characteristics of an investment quality mortgage. An investment quality mortgage is a loan that is made to a borrower from whom repayment of the debt can be expected, is adequately secured by real property, and was originated and is being serviced in accordance with the MPF Origination Guide and MPF Servicing Guide or an approved waiver.
The Federal Home Loan Bank of Chicago (FHLBank of Chicago), which developed the MPF Program, established the minimum eligibility standards for members to participate in the program, the structure of MPF products, and the standard eligibility criteria for the loans; established pricing and managed the delivery mechanism for the loans; publishes and maintains the MPF Origination Guide and the MPF Servicing Guide; and provides operational support for the program. In addition, the FHLBank of Chicago acts as master servicer and as master custodian for the MPF loans held by the Bank and is compensated for these services through fees paid by the Bank. The FHLBank of Chicago is obligated to provide operational support to the Bank for all loans purchased as of December 31, 2009, until those loans are fully repaid.
At December 31, 2009 and 2008, 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.” Mortgage loan balances at December 31, 2009 and 2008, were as follows:
| (In millions) | 2009 | 2008 | ||||||
| MPF Plus |
$ | 2,800 | $ | 3,387 | ||||
| Original MPF |
257 | 336 | ||||||
| Subtotal |
3,057 | 3,723 | ||||||
| Net unamortized discounts |
(18 | ) | (10 | ) | ||||
| Mortgage loans held for portfolio |
3,039 | 3,713 | ||||||
| Less: Allowance for credit losses |
(2 | ) | (1 | ) | ||||
| Mortgage loans held for portfolio, net |
$ | 3,037 | $ | 3,712 | ||||
The Bank may allow one or more of the other FHLBanks to purchase participations, on a loan by loan basis, in all or a portion of the loans purchased by the Bank. As of December 31, 2009 and 2008, only the FHLBank of Chicago owned participation interests in some of the Bank’s MPF loans.
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The following table presents the balances of loans wholly owned by the Bank and loans with allocated participation interests that were outstanding as of December 31, 2009 and 2008.
Balances Outstanding on Mortgage Loans
| (Dollars in millions) | 2009 | 2008 | ||||
| Outstanding amounts wholly owned by the Bank |
$ | 1,948 | $ | 2,320 | ||
| Outstanding amounts with participation interests by FHLBank: |
||||||
| San Francisco |
1,109 | 1,403 | ||||
| Chicago |
658 | 819 | ||||
| Total |
$ | 3,715 | $ | 4,542 | ||
| Number of loans outstanding: |
||||||
| Number of outstanding loans wholly owned by the Bank |
12,296 | 13,977 | ||||
| Number of outstanding loans participated |
13,319 | 15,591 | ||||
| Total number of loans outstanding |
25,615 | 29,568 | ||||
The FHLBank of Chicago’s loan participation interest included a total of $2.0 billion of loan purchase transactions since inception in which the Bank allowed the FHLBank of Chicago to participate in lieu of receiving a program contribution fee from the Bank at the time the Bank joined the MPF Program. Under this arrangement, the Bank allowed the FHLBank of Chicago a 50% participation interest in the first $600 million of loans purchased by the Bank from its eligible members. When the cumulative amount of the FHLBank of Chicago’s participation share reached approximately $300 million, the amount of participation interest allocated to the FHLBank of Chicago on new purchases was reduced to a 25% participation interest.
Under the Bank’s agreement with the FHLBank of Chicago, the credit risk is shared pro-rata between the two FHLBanks according to: (i) their respective ownership of the loans in each Master Commitment for MPF Plus and (ii) their respective participation shares of the First Loss Account for the Master Commitment for Original MPF. The Bank is responsible for credit oversight of the member, which consists of monitoring the financial condition of the member on a quarterly basis and holding collateral to secure the member’s outstanding credit enhancement obligations. Monitoring of the member’s financial condition includes an evaluation of its capital, assets, management, earnings, and liquidity.
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 Bank established an allowance for credit losses on mortgage loans totaling $2 million at December 31, 2009, and $1 million at December 31, 2008. 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 MPF Program.”
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 December 31, 2009 and 2008.
| (Dollars in millions) | 2009 | 2008 | ||||||||
| Days Past Due | Number of Loans |
Mortgage Loan Balance |
Number of Loans |
Mortgage Loan Balance | ||||||
| Between 30 and 59 days |
243 | $ | 29 | 235 | $ | 29 | ||||
| Between 60 and 89 days |
81 | 10 | 44 | 5 | ||||||
| 90 days or more |
177 | 22 | 84 | 9 | ||||||
| Total |
501 | $ | 61 | 363 | $ | 43 | ||||
At December 31, 2009, the Bank had 501 loans that were 30 days or more delinquent totaling $61 million, of which 177 loans totaling $22 million were classified as nonaccrual or impaired. For 103 of these loans, totaling $11 million, the loan was in foreclosure
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or the borrower of the loan was in bankruptcy. At December 31, 2008, the Bank had 363 loans that were 30 days or more delinquent totaling $43 million, of which 84 loans totaling $9 million were classified as nonaccrual or impaired. For 51 of these loans, totaling $5 million, the loan was in foreclosure or the borrower of the loan was in bankruptcy.
At December 31, 2009, the Bank’s other assets included $3 million of real estate owned resulting from the foreclosure of 26 mortgage loans held by the Bank. At December 31, 2008, the Bank’s other assets included $1 million of real estate owned resulting from the foreclosure of 7 mortgage loans held by the Bank.
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 $28.2 billion, or 193% of Bank capital (as determined in accordance with regulations governing the operations of the FHLBanks), at December 31, 2009, compared to $39.1 billion, or 289% of Bank capital, at December 31, 2008. During 2009, the Bank’s MBS portfolio decreased primarily because of principal payments, prepayments, and maturities in the MBS portfolio, OTTI charges recognized on the PLRMBS, and a substantial reduction in the purchase of new MBS investments. The reduction in MBS purchases during the year was due to the Bank’s decision to limit its purchases to agency residential MBS and to the scarcity of securities that met the Bank’s risk-adjusted spreads. The Bank purchased $0.4 billion of MBS, all of which were agency residential MBS, during 2009. 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 – Credit Risk – 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 predominantly 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 $11.5 billion, or 27%, to $31.5 billion at December 31, 2009, from $43 billion at December 31, 2008, 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 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.
At December 31, 2008, the notional amount of interest rate exchange agreements associated with the mortgage-related business totaled $22.7 billion, of which $21.9 billion were economic hedges associated with consolidated obligations and $0.8 billion were fair value hedges associated with consolidated obligations.
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, which is described in “Business – Funding Sources.” The Bank’s status as a GSE is critical to maintaining its access to the capital markets. Although consolidated obligations are backed only by the financial resources of the 12 FHLBanks and are not guaranteed by the U.S. government, the capital markets have traditionally treated the FHLBanks’ consolidated obligations as comparable to federal agency debt, providing the FHLBanks with access to funding at relatively favorable rates. Moody’s has rated the FHLBanks’ consolidated obligations Aaa/P-1, and Standard & Poor’s has rated them AAA/A-1+.
During 2009, the ability of the GSEs, including the FHLBank System, to issue debt improved substantially compared to the prior year, especially in maturities of two to five years. Total debt issuance volume declined, however, because of the decline in advances outstanding in 2009. For more information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview – Funding and Liquidity.”
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The Bank’s equity capital resources are governed by its capital plan, which is described in the “Capital” section below.
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 investment opportunities, and cover unforeseen liquidity demands.
The Bank’s ability to expand in response to increased member credit needs is based on the capital stock requirements for advances and mortgage loans. A member is required to increase its capital stock investment in the Bank as its balance of outstanding advances increases (and formerly, as it sold mortgage loans to the Bank). The activity-based capital stock requirement is currently 4.7% for advances and 5.0% for mortgage loans sold to the Bank, while the Bank’s regulatory minimum regulatory capital ratio requirement is currently 4.0%. Regulatory capital includes mandatorily redeemable capital stock (which is classified as a liability) and excludes AOCI. The additional capital stock from higher balances of advances and mortgage loans supports growth in the balance sheet, which includes not only the increase in advances and mortgage loans, but also increased investment in MBS and other investments.
The Bank can also contract its balance sheet and liquidity requirements in response to members’ reduced credit needs. As changing member credit needs result in reduced advances and as mortgage loan balances decline, members will have capital stock in excess of the amount required by the capital plan. The Bank’s capital stock policies allow the Bank to repurchase a member’s excess capital stock, at the Bank’s discretion, if the member reduces its advances or the balance of mortgage loans it has sold to the Bank decreases. The Bank may allow its consolidated obligations to mature without replacement, or repurchase and retire outstanding consolidated obligations, allowing its balance sheet to shrink.
During the last several years, the Bank experienced a significant expansion and then a contraction of its balance sheet. Advances increased from $162.9 billion at December 31, 2005, to $251.0 billion at December 31, 2007, and then declined to $133.6 billion at December 31, 2009. The expansion and contraction of advances were supported by similar increases and decreases in consolidated obligations. Consolidated obligations increased from $210.2 billion at December 31, 2005, to $303.7 billion at December 31, 2007, and then declined to $180.3 billion at December 31, 2009. The expansion was also supported by an increase in capital stock purchased by members, in accordance with the Bank’s capital stock requirements. Capital stock outstanding, including mandatorily redeemable capital stock (a liability), increased from $9.6 billion at December 31, 2005, to $13.6 billion at December 31, 2007. Capital stock did not contract significantly between December 31, 2007, and December 31, 2009, however, because the Bank did not repurchase excess capital stock during 2009 in order to preserve capital in response to the possibility of future OTTI charges on its PLRMBS portfolio. In 2009, the Bank redeemed, at par value, mandatorily redeemable capital stock in the amount of $16 million that had reached the end of its five-year redemption period. Capital stock outstanding, including mandatorily redeemable capital stock (a liability), decreased slightly from $13.6 billion at December 31, 2007, to $13.4 billion at December 31, 2009.
The Bank is not able to predict future trends in member credit needs since they are driven by complex interactions among a number of factors, including members’ mortgage loan originations, other loan portfolio growth, and deposit growth, and the attractiveness of advances compared to other wholesale borrowing alternatives. The Bank regularly monitors current trends and anticipates future debt issuance needs to be prepared to fund its members’ credit needs and its investment opportunities.
Short-term liquidity management practices are described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Liquidity Risk.” The Bank manages its liquidity needs to enable it to meet all of its contractual obligations on a timely basis, to pay operating expenditures as they come due, and to support its members’ daily liquidity needs. 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. For further information and discussion of the Bank’s guarantees and other commitments, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Off-Balance Sheet Arrangements and Aggregate Contractual Obligations.” 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.”
Capital
Total capital as of December 31, 2009, was $6.2 billion, a 36% decrease from $9.8 billion as of December 31, 2008. The decrease is primarily due to the $3.5 billion impairment charge related to all other factors recorded in other comprehensive income in 2009 on the Bank’s PLRMBS. In addition, as a result of the merger of Wachovia Mortgage, FSB, into Wells Fargo Bank, N.A., the Bank
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transferred $1.6 billion in capital stock to mandatorily redeemable capital stock (a liability). These decreases were partially offset by an increase of $1.1 billion in retained earnings and the acquisition by members of $618 million in mandatorily redeemable capital stock previously held by nonmembers. Bank capital stock acquired by members from nonmembers is reclassified from mandatorily redeemable capital stock (a liability) to 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.
A member may obtain redemption of excess capital stock following a five-year redemption period, subject to certain conditions, by providing a written redemption notice to the Bank. As noted above, at its discretion, under certain conditions the Bank may repurchase excess stock at any time before the five-year redemption period has expired. Although historically the Bank has repurchased excess stock at a member’s request prior to the expiration of the redemption period, the decision to repurchase excess stock prior to the expiration of the redemption period remains at the Bank’s discretion. Stock required to meet a withdrawing member’s membership stock requirement may only be redeemed at the end of the five-year redemption period subject to statutory and regulatory limits and other conditions.
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.
When the Bank repurchases excess stock from a member, the Bank first repurchases any excess stock subject to a redemption notice submitted by that member, followed by the most recently purchased shares of excess stock not subject to a redemption notice, then by the shares of excess stock most recently acquired other than by purchase and not subject to a redemption notice, unless the Bank receives different instructions from the member.
On a quarterly basis, the Bank determines whether it will repurchase excess capital stock, including surplus capital stock. During 2009, the five-year redemption period for $16 million in mandatorily redeemable capital stock expired, and the Bank redeemed the stock at its $100 par value on the relevant expiration dates. Although the Bank continues to redeem stock upon expiration of the five-year redemption period, the Bank has not repurchased excess stock since the fourth quarter of 2008 to preserve the Bank’s capital.
The Bank repurchased surplus capital stock totaling $792 million and excess capital stock that was not surplus capital stock totaling $1.7 billion in 2008.
Excess capital stock totaled $6.5 billion as of December 31, 2009, which included surplus capital stock of $5.8 billion.
Provisions of the Bank’s capital plan are more fully discussed in Note 13 to the Financial Statements.
Capital Requirements
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 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 of the Finance Agency.
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The following table shows the Bank’s compliance with the Finance Agency’s capital requirements at December 31, 2009 and 2008. During 2009, the Bank’s required risk-based capital decreased from $8.6 billion at December 31, 2008, to $6.2 billion at December 31, 2009. 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
| 2009 | 2008 | |||||||||||||||
| (Dollars in millions) | Required | Actual | Required | Actual | ||||||||||||
| Risk-based capital |
$ | 6,207 | $ | 14,657 | $ | 8,635 | $ | 13,539 | ||||||||
| Total regulatory capital |
$ | 7,714 | $ | 14,657 | $ | 12,850 | $ | 13,539 | ||||||||
| Total regulatory capital ratio |
4.00 | % | 7.60 | % | 4.00 | % | 4.21 | % | ||||||||
| Leverage capital |
$ | 9,643 | $ | 21,984 | $ | 16,062 | $ | 20,308 | ||||||||
| Leverage ratio |
5.00 | % | 11.40 | % | 5.00 | % | 6.32 | % | ||||||||
The Bank’s total regulatory capital ratio increased to 7.60% at December 31, 2009, from 4.21% at December 31, 2008, 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, as noted previously.
The Bank’s capital requirements are more fully discussed in Note 13 to the Financial Statements.
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 capital plan and overall risk management. The Member Products Policy, which applies to products offered to members and housing associates (nonmember mortgagees approved under Title II of the National Housing Act, to which the Bank is permitted to make advances under the FHLBank Act), addresses the credit risk of secured credit by establishing credit underwriting criteria, appropriate collateralization levels, and collateral valuation methodologies.
Business Risk
Business risk is defined as the possibility of an adverse impact on the Bank’s profitability or financial or business strategies resulting from business factors that may occur in both the short and long term. Such factors may include, but are not limited to, continued financial services industry consolidation, concentration among members, the introduction of competing products and services, increased inter-FHLBank and non-FHLBank competition, initiatives to change the FHLBank System’s status as a GSE, changes in regulatory authority to make advances to members or to invest in mortgage assets, changes in the deposit and mortgage markets for the Bank’s members, and other factors that may have a significant direct or indirect impact on the ability of the Bank to achieve its mission and strategic objectives.
One significant business risk is the risk of an increase in the cost of consolidated obligation bonds and discount notes relative to benchmark interest rates such as yields on U.S. Treasury securities, MBS repurchase agreements, and LIBOR. If the relative cost of consolidated obligation bonds and discount notes increases, it could compress profit spreads on advances and investments, result in increased rates on advances offered to members, reduce the competitiveness of advances as a wholesale funding source for certain members, and lead to reduced demand for advances by some members that have alternative sources of wholesale funding. Some of the factors that may adversely affect the relative cost of FHLBank System consolidated obligations may be cyclical in nature and may reverse or subside in the future, such as the level of interest rates and the growth rate of the housing GSEs (Fannie Mae, Freddie Mac, and the FHLBanks).
Other factors that may affect the relative cost of FHLBank System consolidated obligations may not reverse in the near future. These factors may include the growing issuance volume of U.S. Treasury securities. Still other factors are event-related and may reverse or may reoccur in the future; these factors include operating issues or losses disclosed by individual GSEs and uncertainty regarding the future statutory and regulatory structure of the housing GSEs. It is not possible at this time to determine the exact impact of these factors and any other potential future events on the future relative cost of the Bank’s participation in consolidated obligations.
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The identification of business risks is an integral part of the Bank’s annual planning process, and the Bank’s strategic plan identifies initiatives and plans to address these risks.
Operations Risk
Operations risk is defined as the risk of an unexpected loss to the Bank resulting from human error, fraud, the unenforceability of legal contracts, or deficiencies in internal controls or information systems. The Bank’s operations risk is controlled through a system of internal controls designed to minimize the risk of operational losses. Also, the Bank has established and annually tests its business continuity plan under various business disruption scenarios involving offsite recovery and the testing of the Bank’s operations and information systems. In addition, an ongoing internal audit function audits significant risk areas to evaluate the Bank’s internal controls.
Concentration Risk
Advances. The following table presents the concentration in advances to institutions whose advances outstanding represented 10% or more of the Bank’s total par amount of advances outstanding as of December 31, 2009, 2008, and 2007. It also presents the interest income from these advances excluding the impact of interest rate exchange agreements associated with these advances for the years ended December 31, 2009, 2008, and 2007.
Concentration of Advances and Interest Income from Advances
| (Dollars in millions) | 2009 | 2008 | 2007 | |||||||||||||||
| Name of Borrower | Advances Outstanding(1) |
Percentage of Total Advances Outstanding |
Advances Outstanding(1) |
Percentage of Total Advances Outstanding |
Advances Outstanding(1) |
Percentage of Total Advances Outstanding |
||||||||||||
| Citibank, N.A. |
$ | 46,544 | 35 | % | $ | 80,026 | 34 | % | $ | 95,879 | 38 | % | ||||||
| JPMorgan Chase Bank, National Association(2) |
20,622 | 16 | 57,528 | 25 | 54,050 | 22 | ||||||||||||
| Wells Fargo Bank, N.A.(3) |
14,695 | 11 | 24,015 | 10 | 24,110 | 10 | ||||||||||||
| Subtotal |
81,861 | 62 | 161,569 | 69 | 174,039 | 70 | ||||||||||||
| Others |
50,452 | 38 | 71,358 | 31 | 76,375 | 30 | ||||||||||||
| Total par amount |
$ | 132,313 | 100 | % | $ | 232,927 | 100 | % | $ | 250,414 | 100 | % | ||||||
| 2009 | 2008 | 2007 | ||||||||||||||||
| Name of Borrower | Interest Income from |
Percentage of Total Interest Income from Advances |
Interest Income from |
Percentage of Total Interest Income from Advances |
Interest Income from |
Percentage of Total Interest Income from Advances |
||||||||||||
| Citibank, N.A. |
$ | 446 | 12 | % | $ | 2,733 | 32 | % | $ | 4,625 | 44 | % | ||||||
| JPMorgan Chase Bank, National Association(2) |
1,255 | 33 | 1,898 | 22 | 1,537 | 15 | ||||||||||||
| Wells Fargo Bank, N.A.(3) |
244 | 6 | 948 | 11 | 1,097 | 10 | ||||||||||||
| Subtotal |
1,945 | 51 | 5,579 | 65 | 7,259 | 69 | ||||||||||||
| Others |
1,854 | 49 | 3,014 | 35 | 3,227 | 31 | ||||||||||||
| Total |
$ | 3,799 | 100 | % | $ | 8,593 | 100 | % | $ | 10,486 | 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 September 25, 2008, the OTS closed Washington Mutual Bank and appointed the FDIC as receiver for Washington Mutual Bank. On the same day, JPMorgan Chase Bank, National Association, a nonmember, assumed Washington Mutual Bank’s outstanding Bank advances and acquired the associated Bank capital stock. JPMorgan Chase Bank, National Association, remains obligated for all of Washington Mutual Bank’s outstanding advances and continues to hold most of the Bank capital stock it acquired from the FDIC as receiver for Washington Mutual Bank. |
| (3) | 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 million 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., totaling $1.6 billion, to mandatorily redeemable capital stock (a liability). |
| (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. |
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Because of this concentration in advances, the Bank performs more frequent credit and collateral reviews for these institutions, including more frequent analysis of detailed data on pledged loan collateral to assess the credit quality and risk-based valuation of the loans. The Bank also analyzes the implications for its financial management and profitability if it were to lose the advances business of one or more of these institutions or if the advances outstanding to one or more of these institutions were not replaced when repaid.
If these institutions were to prepay the advances (subject to the Bank’s limitations on the amount of advances prepayments from a single borrower in a day or a month) or repay the advances as they came due and no other advances were made to replace them, the Bank’s assets would decrease significantly and income could be adversely affected. The loss of a significant amount of advances could have a material adverse impact on the Bank’s dividend rate until appropriate adjustments were made to the Bank’s capital level, outstanding debt, and operating expenses. The timing and magnitude of the impact would depend on a number of factors, including: (i) the amount of advances prepaid or repaid and the period over which the advances were prepaid or repaid, (ii) the amount and timing of any decreases in capital, (iii) the profitability of the advances, (iv) the size and profitability of the Bank’s short-term and long-term investments, (v) the extent to which debt matured as the advances were prepaid or repaid, and (vi) the ability of the Bank to extinguish debt or transfer it to other FHLBanks and the costs to extinguish or transfer the debt. As discussed in “Item 1. Business – Our Business Model,” the Bank’s financial strategies are designed to enable it to expand and contract its assets, liabilities, and capital in response to changes in membership composition and member credit needs while paying a market-rate dividend. Under the Bank’s capital plan, Class B stock is redeemable upon five years’ notice, subject to certain conditions. However, at its discretion, under certain conditions the Bank may repurchase excess Class B stock at any time before the five years have expired.
MPF Program. 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 December 31, 2009 and 2008.
Concentration of Mortgage Loans
| (Dollars in millions) |
|||||||||||
| 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(1) |
$ | 2,391 | 78 | % | 18,613 | 73 | % | ||||
| OneWest Bank, FSB(2) |
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 | % | ||||
| December 31, 2008 |
|||||||||||
| 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(1) |
$ | 2,879 | 77 | % | 21,435 | 72 | % | ||||
| IndyMac Federal Bank, FSB(2) |
509 | 14 | 5,532 | 19 | |||||||
| Subtotal |
3,388 | 91 | 26,967 | 91 | |||||||
| Others |
335 | 9 | 2,601 | 9 | |||||||
| Total |
$ | 3,723 | 100 | % | 29,568 | 100 | % | ||||
| (1) On September 25, 2008, the OTS closed Washington Mutual Bank and appointed the FDIC as receiver for Washington Mutual Bank. On the same day, JPMorgan Chase Bank, National Association, a nonmember, assumed Washington Mutual Bank’s obligations with respect to mortgage loans the Bank had purchased from Washington Mutual Bank. JPMorgan Chase Bank, National Association, continues to fulfill its servicing obligations under its participating financial institution agreement with the Bank and to provide supplemental mortgage insurance for its master commitments when required. (2) On July 11, 2008, the OTS closed IndyMac Bank, F.S.B., and appointed the FDIC as receiver for IndyMac Bank, F.S.B. In connection with the receivership, the OTS chartered IndyMac Federal Bank, FSB, and appointed the FDIC as conservator. IndyMac Federal Bank, FSB, assumed the obligations of IndyMac Bank, F.S.B., with respect to mortgage loans the Bank had purchased from IndyMac Bank, F.S.B. On March 19, 2009, OneWest Bank, FSB, became a member of the Bank, assumed the obligations of IndyMac Federal Bank, FSB, with respect to mortgage loans the Bank had purchased from IndyMac Bank, F.S.B., and agreed to fulfill its obligations to provide credit enhancement to the Bank and to service the mortgage loans as required. |
| ||||||||||
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Members that sold mortgage loans to the Bank through the MPF Program made representations and warranties that the loans comply with the MPF underwriting guidelines. In the event a mortgage loan does not comply with the MPF underwriting guidelines, the Bank’s agreement with the institution provides that the institution is required to repurchase the loan as a result of the breach of the institution’s representations and warranties. In the case of Washington Mutual Bank, the MPF contractual obligations were assumed by JPMorgan Chase Bank, National Association, and in the case of IndyMac Bank, F.S.B., the MPF contractual obligations were assumed by IndyMac Federal Bank, FSB, and were subsequently assumed by OneWest Bank, FSB, making JPMorgan Chase Bank, National Association, IndyMac Federal Bank, FSB, and OneWest Bank, FSB, each a successor. The Bank may, at its discretion, choose to retain the loan if the Bank determines that the noncompliance can be cured or mitigated through additional contract assurances from the institution or any successor. In addition, all participating institutions have retained the servicing on the mortgage loans purchased by the Bank, and the servicing obligation of any former participating institution is held by the successor or another Bank-approved financial institution. The FHLBank of Chicago (the MPF Provider and master servicer) has contracted with Wells Fargo Bank of Minnesota, N.A., to monitor the servicing performed by all participating institutions and successors, including JPMorgan Chase, National Association, and OneWest Bank, FSB. The Bank obtains a Type II Statement on Auditing Standards No. 70, Reports on the Processing of Transactions by Service Organizations, service auditor’s report to confirm the effectiveness of the MPF Provider’s controls over the services it provides to the Bank, including its monitoring of the participating institution’s servicing. During 2009, the FHLBank of Chicago outsourced a portion its infrastructure controls to a third party, and as a result, the Bank receives an additional report addressing the effectiveness of controls performed by the third party. The Bank has the right to transfer the servicing at any time, without paying the participating institution a servicing termination fee, in the event a participating institution or any successor does not meet the MPF servicing requirements. The Bank may also transfer servicing without cause subject to a servicing transfer fee payable to the participating institution or any successor.
Capital Stock. 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 December 31, 2009 and 2008.
Concentration of Capital Stock
Including Mandatorily Redeemable Capital Stock
| (Dollars in millions) | 2009 | 2008 | ||||||||||
| Name of Institution | Capital Stock Outstanding |
Percentage of Total Capital Stock Outstanding |
Capital Stock Outstanding |
Percentage of Total Capital Stock Outstanding |
||||||||
| Citibank, N.A. |
$ | 3,877 | 29 | % | $ | 3,877 | 29 | % | ||||
| JPMorgan Chase Bank, National Association(1) |
2,695 | 20 | 2,995 | 22 | ||||||||
| Wells Fargo Bank, N.A.(2) |
1,567 | 12 | 1,572 | 12 | ||||||||
| Subtotal |
8,139 | 61 | 8,444 | 63 | ||||||||
| Others |
5,279 | 39 | 4,919 | 37 | ||||||||
| Total |
$ | 13,418 | 100 | % | $ | 13,363 | 100 | % | ||||
| (1) On September 25, 2008, the OTS closed Washington Mutual Bank and appointed the FDIC as receiver for Washington Mutual Bank. On the same day, JPMorgan Chase Bank, National Association, a nonmember, assumed Washington Mutual Bank’s outstanding Bank advances and acquired the associated Bank capital stock. The capital stock held by JPMorgan Chase Bank, National Association, is classified as mandatorily redeemable capital stock (a liability). JPMorgan Chase Bank, National Association, remains obligated for all of Washington Mutual Bank’s outstanding advances and continues to hold most of the Bank capital stock it acquired from the FDIC as receiver for Washington Mutual Bank. JPMorgan Bank and Trust Company, National Association, an affiliate of JPMorgan Chase Bank, National Association, became a member of the Bank in 2008. During the first quarter of 2009, the Bank allowed the transfer of excess stock totaling $300 million 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, totaling $2.7 billion, remains classified as mandatorily redeemable capital stock (a liability). (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 million 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., totaling $1.6 billion, to mandatorily redeemable capital stock (a liability). |
| |||||||||||
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For more information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources – Capital.”
Derivatives Counterparties. 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 December 31, 2009 and 2008:
Concentration of Derivatives Counterparties
| (Dollars in millions) | 2009 | 2008 | ||||||||||||
| Derivatives Counterparty | Credit Rating(1) |
Notional Amount |
Percentage of Total Notional |
Notional Amount |
Percentage of Total Notional |
|||||||||
| Deutsche Bank AG |
A | $ | 36,257 | 15 | % | $ | 75,316 | 23 | % | |||||
| JPMorgan Chase Bank, National Association |
AA | 34,297 | 15 | 51,287 | 15 | |||||||||
| Barclays Bank PLC |
AA | 35,060 | 15 | 50,015 | 15 | |||||||||
| BNP Paribas |
AA | 25,388 | 11 | 22,251 | 7 | |||||||||
| Subtotal |
131,002 | 56 | 198,869 | 60 | ||||||||||
| Others |
At least A | 104,012 | 44 | 132,774 | 40 | |||||||||
| Total |
$ | 235,014 | 100 | % | $ | 331,643 | 100 | % | ||||||
| (1) The credit ratings used by the Bank are based on the lowest of Moody’s, Standard & Poor’s, or comparable Fitch ratings. |
| |||||||||||||
For more information regarding credit risk on derivatives counterparties, see the Credit Exposure to Derivatives Counterparties table in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – Derivatives Counterparties.”
Liquidity Risk
Liquidity risk is defined as the risk that the Bank will be unable to meet its obligations as they come due or to meet the credit needs of its members in a timely and cost-efficient manner. The Bank is required to maintain liquidity for operating needs and for contingency purposes in accordance with Finance Agency regulations and with the Bank’s own Risk Management Policy. In their asset-liability management planning, members may look to the Bank to provide standby liquidity. The Bank seeks to be in a position to meet its customers’ credit and liquidity needs and to meet its obligations without maintaining excessive holdings of low-yielding liquid investments or being forced to incur unnecessarily high borrowing costs. The Bank’s primary sources of liquidity are short-term investments and the issuance of new consolidated obligation bonds and discount notes. The Bank maintains short-term, high-quality money market investments in amounts that average up to three times the Bank’s capital as a primary source of funds to satisfy these requirements and objectives. Growth in advances to members may initially be funded by maturing on-balance sheet liquid investments, but within a short time the growth is usually funded by new issuances of consolidated obligations. The capital to support the growth in advances is provided by the borrowing members, through their capital requirements, which are based in part on outstanding advances. At December 31, 2009, the Bank’s total regulatory capital ratio was 7.60%, 3.60% above the minimum regulatory requirement. At December 31, 2008, the Bank’s total regulatory capital ratio was 4.21%, 0.21% above the minimum regulatory requirement.
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. Finance Agency guidelines 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 calendar days and that during that time members do not renew any maturing, prepaid, and called advances. The second scenario assumes that the FHLBank cannot access the capital markets for a targeted period of five calendar days and that during that period the Bank will automatically renew maturing and called advances for all members except very large, highly rated members. The Bank’s existing contingent liquidity guidelines were easily adapted to satisfy the Finance Agency’s final contingent liquidity guidelines, which were released in March 2009.
The Bank has a regulatory contingency liquidity requirement to maintain at least five business days of liquidity to enable it to meet its obligations without issuance of new consolidated obligations. The regulatory requirement does not stipulate that the Bank renew any maturing advances during the five-day timeframe. In addition to the regulatory requirement and Finance Agency guidelines on contingency liquidity, the Bank’s asset-liability management committee has a formal guideline to maintain at least 90 days of liquidity
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to enable the Bank to meet its obligations in the event of a longer-term consolidated obligations market disruption. This guideline allows the Bank to consider its mortgage assets as a source of funds by expecting to use those assets as collateral in the repurchase agreement markets. Under this guideline, the Bank maintained at least 90 days of liquidity at all times during 2009 and 2008. 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 Bank projects the amount and timing of expected exercises of the call options of callable bonds for which it is the primary obligor in its liquidity and debt issuance planning. The projections of expected exercises of bond calls are performed at then-current interest rates and at both higher and lower levels of interest rates. If a market or operational disruption occurred that prevented the issuance of new consolidated obligation bonds or discount notes through the capital markets, the Bank could meet its obligations by: (i) allowing short-term liquid investments to mature, (ii) using eligible securities as collateral for repurchase agreement borrowings, and (iii) if necessary, allowing advances to mature without renewal. In addition, the Bank may be able to borrow on a short-term unsecured basis from financial institutions (Federal funds purchased) or other FHLBanks (inter-FHLBank borrowings).
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 December 31, 2009 and 2008. Also shown are additional contingent sources of funds from on-balance sheet collateral available for repurchase agreement borrowings.
Principal Financial Obligations Due and Funds Available for Selected Periods
| As of December 31, 2009 | As of December 31, 2008 | ||||||||||||
| (In millions) | 5 Business Days |
90 Days | 5 Business Days |
90 Days | |||||||||
| Obligations due: |
|||||||||||||
| Commitments for new advances |
$ | 32 | $ | 32 | $ | 470 | $ | 470 | |||||
| Demand deposits |
1,647 | 1,647 | 2,552 | 2,552 | |||||||||
| Maturing member term deposits |
16 | 28 | 63 | 103 | |||||||||
| Discount note and bond maturities and expected exercises of bond call options |
7,830 | 52,493 | 14,686 | 101,157 | |||||||||
| Subtotal obligations |
9,525 | 54,200 | 17,771 | 104,282 | |||||||||
| Sources of available funds: |
|||||||||||||
| Maturing investments |
9,185 | 15,774 | 10,986 | 20,781 | |||||||||
| Cash at FRBSF |
8,280 | 8,280 | 19,630 | 19,630 | |||||||||
| Proceeds from scheduled settlements of discount notes and bonds |
30 | 1,090 | 960 | 960 | |||||||||
| Maturing advances and scheduled prepayments |
4,762 | 36,134 | 6,349 | 62,727 | |||||||||
| Subtotal sources |
22,257 | 61,278 | 37,925 | 104,098 | |||||||||
| Net funds available |
12,732 | 7,078 | 20,154 | (184 | ) | ||||||||
| Additional contingent sources of funds:(1) |
|||||||||||||
| Estimated borrowing capacity of securities available for repurchase agreement borrowings: |
|||||||||||||
| MBS |
— | 19,457 | — | 27,567 | |||||||||
| Housing finance agency bonds |
— | — | — | 561 | |||||||||
| Marketable money market investments |
3,339 | — | 5,909 | — | |||||||||
| TLGP investments |
2,186 | 2,186 | — | — | |||||||||
| Subtotal contingent sources |
5,525 | 21,643 | 5,909 | 28,128 | |||||||||
| Total contingent funds available |
$ | 18,257 | $ | 28,721 | $ | 26,063 | $ | 27,944 | |||||
| (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. |
The significant increase in net funds available in the 90-day period to a positive $7.1 billion in 2009 from a negative $184 million in 2008, as noted in the table above, was due to increased issuance of discount notes and bonds with maturities beyond 90 days in 2009 compared to 2008.
In addition, Section 11(i) of the FHLBank Act authorizes the U.S. Treasury to purchase certain obligations issued by the FHLBanks aggregating not more than $4.0 billion under certain conditions. There were no such purchases by the U.S. Treasury during the two-year period ended December 31, 2009.
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In 2008, the Bank and the other FHLBanks entered into Lending Agreements with the U.S. Treasury in connection with the U.S. Treasury’s Government-Sponsored Enterprise Credit Facility (GSE Credit Facility), as authorized by the Housing Act. None of the FHLBanks drew on the GSE Credit Facility in 2008 or in 2009, and the Lending Agreements expired on December 31, 2009. The GSE Credit Facility was designed to serve as a contingent source of liquidity for the housing GSEs, including the FHLBanks. Any borrowings by one or more of the FHLBanks under the GSE Credit Facility would have been considered consolidated obligations with the same joint and several liability as all other consolidated obligations. The terms of any borrowings were to be agreed to at the time of borrowing. Loans under the Lending Agreements were to be secured by collateral acceptable to the U.S. Treasury, which could consist of FHLBank member advances collateralized in accordance with regulatory standards or MBS issued by Fannie Mae or Freddie Mac. Each FHLBank was required to submit to the Federal Reserve Bank of New York, acting as fiscal agent of the U.S. Treasury, a listing of eligible collateral, updated on a weekly basis, that could be used as security in the event of a borrowing. The amount of collateral was subject to an increase or decrease (subject to approval of the U.S. Treasury) at any time by delivery of an updated listing of collateral.
In general, the FHLBank System’s debt issuance capability increased significantly in 2009 compared to 2008 because of the Federal Reserve’s direct purchases of U.S. agency debt, a substantial increase in large domestic investor demand, and some additional interest by foreign investors. Short-term debt issuance, as represented by discount note funding costs, returned to near pre-2007 levels. In addition, investor demand for short-lockout callable debt enabled FHLBanks to return to using these swapped instruments as a reliable source of funding. Although the overall ability and cost to issue debt improved in 2009, the improvements took place when total debt issuance volume subsided because of a significant decline in advances outstanding.
Credit Risk
Credit risk is defined as the risk that the market value, or estimated fair value if market value is not available, of an obligation will decline as a result of deterioration in the creditworthiness of the obligor. The Bank further refines the definition of credit risk as the risk that a secured or unsecured borrower will default and the Bank will suffer a loss because of the inability to fully recover, on a timely basis, amounts owed to the Bank.
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 also has procedures to assess the mortgage loan underwriting and documentation standards of the members that pledge mortgage loan collateral. In addition, the Bank has collateral policies and restricted lending procedures in place to help manage its exposure to members that experience difficulty in meeting their capital requirements or other standards of creditworthiness. These credit and collateral policies balance the Bank’s dual goals of meeting members’ needs as a reliable source of liquidity and limiting credit loss by adjusting credit and collateral terms in response to deterioration in creditworthiness. The Bank has never experienced a credit loss on an advance.
The Bank determines the maximum amount and maximum term of the advances it will make to a member based on the member’s creditworthiness and eligible collateral pledged in accordance with the Bank’s credit and collateral policies and regulatory requirements. The Bank may review and change the maximum amount and maximum term of the advances at any time. The maximum amount a member may borrow is limited by the amount and type of collateral pledged because all advances must be fully collateralized.
The Bank underwrites and actively monitors the financial condition and performance of all borrowing members to determine and periodically assess creditworthiness. The Bank uses financial information provided by the member, quarterly financial reports filed by members with their primary regulators, regulatory examination reports and known regulatory enforcement actions, and public information. In determining creditworthiness, the Bank considers examination findings, performance trends and forward-looking information, the member’s business model, changes in risk profile, capital adequacy, asset quality, profitability, interest rate risk, supervisory history, the results of periodic collateral field reviews conducted by the Bank, the risk profile of the collateral, and the amount of eligible collateral on the member’s balance sheet.
In accordance with the FHLBank Act, members may pledge the following eligible assets to secure advances: one- to four-family first lien residential mortgage loans; multifamily mortgage loans; MBS; securities issued, insured, or guaranteed by the U.S. government or any of its agencies, including without limitation MBS backed by Fannie Mae, Freddie Mac, or Ginnie Mae; cash or deposits in the Bank; and certain other real estate-related collateral, such as commercial real estate loans and second lien residential or home equity loans. The Bank may also accept secured 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 secured loans as eligible collateral from members that are community financial institutions. The Housing Act added secured loans for community development activities as collateral that the Bank may accept from community financial institutions. The Housing Act defined community financial institutions as depository institutions insured by the FDIC with average total assets over the preceding three-year period of $1 billion or less. The Finance Agency adjusts the average total asset cap for inflation annually. Effective January 1, 2010, the cap was $1.029 billion.
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Under the Bank’s written lending agreements with its members, its credit and collateral policies, and applicable statutory and regulatory provisions, the Bank has the right to take a variety of actions to address credit and collateral concerns, including calling for the member to pledge additional or substitute collateral (including ineligible collateral) at any time that advances are outstanding to the member and requiring the delivery of all pledged collateral. In addition, if a member fails to repay any advance or is otherwise in default on its obligations to the Bank, the Bank may foreclose on and liquidate the member’s collateral and apply the proceeds toward repayment of the member’s advances. The Bank’s collateral policies are designed to address changes in the value of collateral and the risks and costs relating to foreclosure and liquidation of collateral, and the Bank periodically adjusts the amount it is willing to lend against various types of collateral to reflect these factors. Market conditions, the volume and condition of the member’s collateral at the time of liquidation, and other factors could affect the amount of proceeds the Bank is able to realize from liquidating a member’s collateral. In addition, the Bank could sell collateral over an extended period of time, rather than liquidating it immediately, and the Bank would have the right to receive principal and interest payments made on the collateral it continued to hold and apply those proceeds toward repayment of the member’s advances.
The Bank perfects its security interest in securities collateral by taking delivery of all securities at the time they are pledged. The Bank perfects its security interest in loan collateral by filing a UCC-1 financing statement for each member pledging loans. The Bank may also require delivery of loan collateral under certain conditions (for example, from a newly formed institution or when a member’s creditworthiness deteriorates below a certain level). In addition, the FHLBank Act provides that any security interest granted to the Bank by any member or member affiliate has priority over the claims and rights of any other party, including any receiver, conservator, trustee, or similar entity that has the rights of a lien creditor, unless these claims and rights would be entitled to priority under otherwise applicable law and are held by actual purchasers for value or by parties that have actual perfected security interests.
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.
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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 December 31, 2009 and 2008. During 2009, the Bank’s internal member credit quality ratings reflected continued financial deterioration of some members and nonmember borrowers resulting from market conditions and other factors. Credit quality ratings are determined based on results from the Bank’s credit model and on other qualitative information, including regulatory examination reports. The Bank assigns each member and nonmember borrower an internal rating from one to ten, with one as the highest rating. Changes in the number of members and nonmember borrowers in each of the credit quality rating categories may occur because of the addition of new Bank members as well as changes to the credit quality ratings of the institutions based on the analysis discussed above.
Member and Nonmember Credit Outstanding and Collateral Borrowing Capacity
By Credit Quality Rating
| (Dollars in millions) | |||||||||||||
| December 31, 2009 |
|||||||||||||
| Member or Nonmember Borrower Credit Quality Rating |
All Members and Nonmembers |
Members and Nonmembers with Credit Outstanding | |||||||||||
| Collateral Borrowing Capacity(2) | |||||||||||||
| Number | Number | Credit Outstanding(1) | Total | Used | |||||||||
| 1-3 |
68 | 52 | $ | 23,374 | $ | 33,334 | 70 | % | |||||
| 4-6 |
204 | 143 | 107,273 | 185,845 | 58 | ||||||||
| 7-10 |
149 | 107 | 6,940 | 12,589 | 55 | ||||||||
| Total |
421 | 302 | $ | 137,587 | $ | 231,768 | 59 | % | |||||
| December 31, 2008 |
|||||||||||||
| Member or Nonmember Borrower Credit Quality Rating |
All Members and Nonmembers |
Members and Nonmembers with Credit Outstanding | |||||||||||
| Collateral Borrowing Capacity(2) | |||||||||||||
| Number | Number | Credit Outstanding(1) | Total | Used | |||||||||
| 1-3 |
124 | 104 | $ | 24,128 | $ | 49,077 | 49 | % | |||||
| 4-6 |
268 | 203 | 201,726 | 224,398 | 90 | ||||||||
| 7-10 |
49 | 40 | 12,802 | 16,144 | 79 | ||||||||
| Total |
441 | 347 | $ | 238,656 | $ | 289,619 | 82 | % | |||||
| (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. |
| ||||||||||||
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Member and Nonmember Credit Outstanding and Collateral Borrowing Capacity
By Unused Borrowing Capacity
| (Dollars in millions) | ||||||||
| December 31, 2009 |
||||||||
| Unused Borrowing Capacity | Number of Members and Nonmembers with Credit Outstanding |
Credit Outstanding(1) | Collateral Capacity(2) | |||||
| 0% – 10% |
25 | $ | 7,281 | $ | 7,611 | |||
| 11% – 25% |
43 | 33,154 | 42,353 | |||||
| 26% – 50% |
79 | 88,702 | 137,123 | |||||
| More than 50% |
155 | 8,450 | 44,681 | |||||
| Total |
302 | $ | 137,587 | $ | 231,768 | |||
| December 31, 2008 |
||||||||
| Unused Borrowing Capacity | Number of Members and Nonmembers with Credit Outstanding |
Credit Outstanding(1) | Collateral Capacity(2) | |||||
| 0% – 10% |
71 | $ | 195,344 | $ | 200,892 | |||
| 11% – 25% |
51 | 20,814 | 25,232 | |||||
| 26% – 50% |
81 | 11,051 | 17,308 | |||||
| More than 50% |
144 | 11,447 | 46,187 | |||||
| Total |
347 | $ | 238,656 | $ | 289,619 | |||
|
(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. | ||||||||
The amount of credit outstanding to institutions that were using substantially all of their available collateral borrowing capacity decreased significantly in 2009 primarily because of the reduction in advances outstanding to members and nonmembers. Total collateral borrowing capacity declined in 2009 because members and nonmembers reduced the amount of collateral they pledged to the Bank as they reduced their borrowings. 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 credit losses on advances is deemed necessary by management. The Bank has never experienced any credit losses on advances.
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 December 31, 2009, 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). None of the MBS pledged as collateral were labeled as subprime.
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The following table presents the securities collateral pledged by all members and by nonmembers with credit outstanding at December 31, 2009 and 2008.
Composition of Securities Collateral Pledged
by Members and by Nonmembers with Credit Outstanding
| (In millions) | December 31, 2009 | December 31, 2008 | ||||||||||
| Securities Type with Current Credit Rating | Current Par |
Borrowing Capacity |
Current Par |
Borrowing Capacity | ||||||||
| U.S. Treasury (bills, notes, bonds) |
$ | 1,284 | $ | 1,280 | $ | 217 | $ | 216 | ||||
| Agency (notes, subordinated debt, structured notes, indexed amortization notes, and Small Business Administration pools) |
7,366 | 7,298 | 2,004 | 1,982 | ||||||||
| Agency pools and collateralized mortgage obligations |
23,348 | 22,738 | 26,020 | 25,032 | ||||||||
| PLRMBS – publicly registered AAA-rated senior tranches |
535 | 379 | 6,523 | 3,903 | ||||||||
| Private-label home equity MBS – publicly registered AAA-rated senior tranches |
1 | — | 420 | 178 | ||||||||
| Private-label commercial MBS – publicly registered AAA-rated senior tranches |
89 | 68 | 1,394 | 817 | ||||||||
| PLRMBS – publicly registered AA-rated senior tranches |
197 | 84 | 1,619 | 545 | ||||||||
| PLRMBS – publicly registered A-rated senior tranches |
189 | 30 | 5,329 | 625 | ||||||||
| PLRMBS – publicly registered BBB-rated senior tranches |
185 | 21 | 321 | 17 | ||||||||
| PLRMBS – publicly registered AAA- or AA-rated subordinate tranches |
2 | 1 | 1,599 | 176 | ||||||||
| Private-label home equity MBS – publicly registered AAA- or AA-rated subordinate tranches |
16 | 3 | 2,279 | 509 | ||||||||
| Private-label commercial MBS – publicly registered AAA-rated subordinate tranches |
13 | 8 | 3,018 | 907 | ||||||||
| PLRMBS – private placement AAA-rated senior tranches |
— | — | 3 | 2 | ||||||||
| Term deposits with the FHLBank of San Francisco |
29 | 29 | 89 | 89 | ||||||||
| Other |
— | — | 4,403 | 440 | ||||||||
| Total |
$33,254 | $31,939 | $55,238 | $35,438 | ||||||||
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, if available, all loans secured by real estate, all loans made for commercial, corporate, or business purposes, and all participations in these loans, whether or not the individual loans are eligible to receive borrowing capacity. 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 December 31, 2009, 70% of the loan collateral pledged to the Bank was pledged by 40 institutions under specific identification, 16% was pledged by 184 institutions under blanket lien with detailed reporting, and 14% was pledged by 120 institutions under blanket lien with summary reporting.
For each member that pledges loan collateral, the Bank conducts loan collateral field reviews once every six months or every one, two, or three years, depending on the risk profile of the member and the pledged collateral. During the member’s collateral field review, the Bank examines a statistical sample of the member’s pledged loans. The loan examination validates the loan ownership and confirms the existence of the critical legal documents. The loan examination also identifies applicable secondary market discount, including discounts for high-risk credit attributes.
The Bank monitors each member’s borrowing capacity and collateral requirements on a daily basis. The borrowing capacities for loan collateral reflect the assigned value of the collateral and a margin for the costs and risks of liquidation. The Bank reviews the margins for loan collateral regularly and may adjust them at any time as market conditions change.
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The Bank assigns a value to loan collateral using one of two methods. For residential first lien mortgage loans that are reported to the Bank with detailed information on the individual loans, the Bank uses a third-party pricing vendor. The third-party vendor uses proprietary analytical tools to calculate the value of a residential mortgage loan based on the projected future cash flows of the loan. The vendor models the future performance of each individual loan and generates the monthly cash flows given the current loan characteristics and applying specific market assumptions. The value of each loan is determined based on the present value of those cash flows after being discounted by the current market yields commonly used by buyers of these types of loans. The current market yields are derived by the third-party pricing vendor from prevailing conditions in the secondary market. For residential first lien mortgage loans pledged under a blanket lien with summary reporting and for all other loan collateral types, the Bank does not use a third-party pricing vendor or its own pricing model. Instead, the Bank assigns a standard value for each collateral type using available market information.
As of December 31, 2009, the Bank’s maximum borrowing capacities for loan collateral ranged from 30% to 93% of the unpaid principal balance. For example, the maximum borrowing capacities for collateral pledged under a blanket lien with detailed reporting were as follows: 93% for first lien residential mortgage loans, 68% for multifamily mortgage loans, 60% for commercial mortgage loans, 50% for small business, small farm, and small agribusiness loans, and 30% 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 December 31, 2009 and 2008.
Composition of Loan Collateral Pledged
by Members and by Nonmembers with Credit Outstanding
| (In millions) | December 31, 2009 | December 31, 2008 | ||||||||||
| Loan Type | Unpaid Principal Balance |
Borrowing Capacity |
Unpaid Principal Balance |
Borrowing Capacity | ||||||||
| First lien residential mortgage loans |
$ | 203,874 | $ | 117,511 | $ | 260,598 | $ | 142,004 | ||||
| Second lien residential mortgage loans and home equity lines of credit |
81,562 | 17,468 | 111,275 | 34,568 | ||||||||
| Multifamily mortgage loans |
37,011 | 21,216 | 41,437 | 26,517 | ||||||||
| Commercial mortgage loans |
58,783 | 30,550 | 71,207 | 36,643 | ||||||||
| Loan participations |
21,389 | 12,097 | 20,728 | 11,679 | ||||||||
| Small business, small farm, and small agribusiness loans |
3,422 | 672 | 4,252 | 963 | ||||||||
| Other |
1,055 | 314 | 6,357 | 1,807 | ||||||||
| Total |
$ | 407,096 | $ | 199,828 | $ | 515,854 | $ | 254,181 | ||||
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 December 31, 2009 and 2008, the amount of these loans totaled $38 billion and $53 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.
MPF Program. Both the Bank and the FHLBank of Chicago approved the Bank members that became participants in the MPF Program. To be eligible for approval, members had to meet the loan origination, servicing, reporting, credit, and collateral standards established by the Bank and the FHLBank of Chicago for the program and comply with all program requirements.
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The Bank and any participating institution share in the credit risk of the loans sold by that institution as specified in a master agreement. These assets have more credit risk than advances. Loans purchased under the MPF Program generally had a credit risk exposure at the time of purchase equivalent to AA-rated assets taking into consideration the credit risk sharing structure mandated by the Finance Agency’s acquired member assets (AMA) regulation. The Bank holds additional risk-based capital when it determines that purchased loans do not have a credit risk exposure equivalent to AA-rated assets. The MPF Program structures potential credit losses on conventional MPF loans into layers with respect to each pool of loans purchased by the Bank under a single “Master Commitment” for the member selling the loans:
| 1. | The first layer of protection against loss is the liquidation value of the real property securing the loan. |
| 2. | The next layer of protection comes from the primary mortgage insurance that is required for loans with a loan-to-value ratio greater than 80%. |
| 3. | Losses that exceed the liquidation value of the real property and any primary mortgage insurance, up to an agreed-upon amount called the “First Loss Account” for each Master Commitment, are incurred by the Bank. |
| 4. | Losses in excess of the First Loss Account for each Master Commitment, up to an agreed-upon amount called the “credit enhancement amount,” are covered by the participating institution’s credit enhancement obligation. |
| 5. | Losses in excess of the First Loss Account and the participating institution’s remaining credit enhancement for the Master Commitment, if any, are incurred by the Bank. |
The First Loss Account provided by the Bank is a memorandum account, a record-keeping mechanism the Bank uses to track the amount of potential expected losses for which it is liable on each Master Commitment (before the participating institution’s credit enhancement is used to cover losses).
The credit enhancement amount for each Master Commitment, together with any primary mortgage insurance coverage, was sized to limit the Bank’s credit losses in excess of the First Loss Account to those that would be expected on an equivalent investment with a long-term credit rating of AA, as determined by the MPF Program methodology. As required by the AMA regulation, the MPF Program methodology was confirmed by a nationally recognized statistical rating organization (NRSRO) as providing an analysis of each Master Commitment that is “comparable to a methodology that the NRSRO would use in determining credit enhancement levels when conducting a rating review of the asset or pool of assets in a securitization transaction.” By requiring credit enhancement in the amount determined by the MPF Program methodology, the Bank expected to have the same probability of incurring credit losses in excess of the First Loss Account and the participating institution’s credit enhancement obligation on mortgage loans purchased under any Master Commitment as an investor would have of incurring credit losses on an equivalent investment with a long-term credit rating of AA.
Before delivering loans for purchase under the MPF Program, each member submitted data on the individual loans to the FHLBank of Chicago, which calculated the loan level credit enhancement needed. The rating agency model used considered many characteristics, such as loan-to-value ratio, property type, loan purpose, borrower credit scores, level of loan documentation, and loan term, to determine the loan level credit enhancement. The resulting credit enhancement amount for each loan purchased was accumulated under a Master Commitment to establish a pool level credit enhancement amount for the Master Commitment.
The Bank’s mortgage loan portfolio currently consists of mortgage loans purchased under two MPF products: Original MPF and MPF Plus, which differ from each other in the way the amount of the First Loss Account is determined, the options available for covering the participating institution’s credit enhancement obligation, and the fee structure for the credit enhancement fees.
Under Original MPF, the First Loss Account accumulates over the life of the Master Commitment. Each month, the outstanding aggregate principal balance of the loans at monthend is multiplied by an agreed-upon percentage (typically 4 basis points per annum), and that amount is added to the First Loss Account. As credit and special hazard losses are realized that are not covered by the liquidation value of the real property or primary mortgage insurance, they are first charged to the Bank, with a corresponding reduction of the First Loss Account for that Master Commitment up to the amount accumulated in the First Loss Account at that time. Over time, the First Loss Account may cover the expected credit losses on a Master Commitment, although losses that are greater than expected or that occur early in the life of the Master Commitment could exceed the amount accumulated in the First Loss Account. In that case, the excess losses would be charged next to the member’s credit enhancement to the extent available. As a result of declines in the credit performance of certain master commitments combined with more stringent credit enhancement requirements in the NRSRO methodology, six of the ten Original MPF master commitments, totaling $246 million and representing 95% of total current principal, could no longer achieve the specified rating because of insufficient levels of credit enhancement. The Bank considers these additional risk characteristics in the evaluation of appropriate loss allowances and in the determination of its risk-based capital requirements.
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The aggregate First Loss Account for all participating institutions for Original MPF for the years ended December 31, 2009, 2008, and 2007, was as follows:
First Loss Account for Original MPF
| (In millions) | 2009 | 2008 | 2007 | ||||||
| Balance, beginning of the year |
$ | 1.0 | $ | 0.9 | $ | 0.7 | |||
| Amount accumulated during the year |
0.1 | 0.1 | 0.2 | ||||||
| Balance, end of the year |
$ | 1.1 | $ | 1.0 | $ | 0.9 | |||
The participating institution’s credit enhancement obligation under Original MPF must be collateralized by the participating institution in the same way that advances from the Bank are collateralized, as described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – Advances.” For taking on the credit enhancement obligation, the Bank pays the participating institution a monthly credit enhancement fee, typically 10 basis points per annum, calculated on the unpaid principal balance of the loans in the Master Commitment. The Bank charges this amount to interest income, effectively reducing the overall yield earned on the loans purchased by the Bank. The Bank reduced net interest income for credit enhancement fees totaling $0.3 million in 2009, $0.4 million in 2008, and $0.4 million in 2007 for Original MPF loans.
Under MPF Plus, the First Loss Account is equal to a specified percentage of the scheduled principal balance of loans in the pool as of the sale date of each loan. The percentage of the First Loss Account was negotiated for each Master Commitment. The participating institution provides credit enhancement for loans sold to the Bank under MPF Plus by maintaining a supplemental mortgage insurance (SMI) policy that equals its credit enhancement obligation. Typically, the amount of the First Loss Account is equal to the deductible on the SMI policy. However, the SMI policy does not cover special hazard losses or credit losses on loans with a loan-to-value ratio below a certain percentage (usually 50%). As a result, credit losses on loans not covered by the SMI policy and special hazard losses may reduce the amount of the First Loss Account without reducing the deductible on the SMI policy. If the deductible on the SMI policy has not been met and the pool incurs credit losses that exceed the amount of the First Loss Account, those losses will be allocated to the Bank until the SMI policy deductible has been met. Once the deductible has been met, the SMI policy will cover credit losses on loans covered by the policy up to the maximum loss coverage provided by the policy. If the SMI provider’s claims-paying ability rating falls below a specified level, the participating institution has six months to either replace the SMI policy or assume the credit enhancement obligation and fully collateralize the obligation; otherwise the Bank may choose not to pay the participating institution its performance-based credit enhancement fee. Finally, the Bank will absorb credit losses that exceed the maximum loss coverage of the SMI policy (or the substitute credit enhancement provided by the participating institution), all credit losses on loans not covered by the policy, and all special hazard losses, if any.
At December 31, 2009, 77% of the participating institutions’ credit enhancement obligation on MPF Plus loans was met through the maintenance of SMI. At December 31, 2008, 81% of the participating members’ credit enhancement obligation on MPF Plus loans was met through the maintenance of SMI. None of the SMI was provided by participating institutions or their affiliates at December 31, 2009 and 2008.
As a result of more stringent credit enhancement requirements in the NRSRO methodology or declines in the NRSRO claims-paying ability ratings of the SMI companies, as of December 31, 2009, four of the Bank’s MPF Plus master commitments (totaling $2.5 billion and representing 88% of outstanding MPF Plus balances) were no longer the credit equivalent of an AA rating. Three of these master commitments (totaling $2.3 billion) continued to rely on SMI coverage for a portion of their credit enhancement obligation, which was provided by two SMI companies and totaled $40.0 million. The claims-paying ability ratings of these two SMI companies were below the AA rating required for the program; one was rated BBB- and the other was rated B+. The participating institutions associated with the relevant master commitments have chosen to forego their performance-based credit enhancement fees rather than assume the credit enhancement obligation. The largest of the commitments (totaling $2.1 billion) did not achieve AA credit equivalency solely because the SMI company was rated BBB-.