Attached files

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EX-31.2 - CERTIFICATION OF THE CHIEF OPERATING OFFICER PURSUANT TO SECTION 302 - Federal Home Loan Bank of San Franciscodex312.htm
EX-31.1 - CERTIFICATION OF THE PRESIDENT AND CEO PURSUANT TO SECTION 302 - Federal Home Loan Bank of San Franciscodex311.htm
EX-31.4 - CERTIFICATION OF THE CONTROLLER PURSUANT TO SECTION 302 - Federal Home Loan Bank of San Franciscodex314.htm
EX-32.3 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 - Federal Home Loan Bank of San Franciscodex323.htm
EX-99.1 - COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - THREE MONTHS ENDED 03/31/10 - Federal Home Loan Bank of San Franciscodex991.htm
EX-31.3 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 - Federal Home Loan Bank of San Franciscodex313.htm
EX-32.1 - CERTIFICATION OF THE PRESIDENT AND CEO PURSUANT TO SECTION 906 - Federal Home Loan Bank of San Franciscodex321.htm
EX-10.1 - 2010 AUDIT EXECUTIVE INCENTIVE PLAN - Federal Home Loan Bank of San Franciscodex101.htm
EX-32.2 - CERTIFICATION OF THE CHIEF OPERATING OFFICER PURSUANT TO SECTION 906 - Federal Home Loan Bank of San Franciscodex322.htm
EX-32.4 - CERTIFICATION OF THE CONTROLLER PURSUANT TO SECTION 906 - Federal Home Loan Bank of San Franciscodex324.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended March 31, 2010

OR

 

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

Commission File Number: 000-51398

 

 

FEDERAL HOME LOAN BANK OF SAN FRANCISCO

(Exact name of registrant as specified in its charter)

 

 

 

Federally chartered corporation   94-6000630

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. employer

identification number)

600 California Street

San Francisco, CA

  94108
(Address of principal executive offices)   (Zip code)

(415) 616-1000

(Registrant’s telephone number, including area code)

 

 

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

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

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

 

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

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

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

 

     Shares outstanding
as of April  30, 2010

Class B Stock, par value $100

   134,525,193

 

 

 


Table of Contents

Federal Home Loan Bank of San Francisco

Form 10-Q

Index

 

PART I.

   FINANCIAL INFORMATION   

Item 1.

   Financial Statements    1
  

Statements of Condition (Unaudited)

   1
  

Statements of Income (Unaudited)

   2
  

Statements of Capital Accounts (Unaudited)

   3
  

Statements of Cash Flows (Unaudited)

   4
  

Notes to Financial Statements (Unaudited)

   6

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    52
  

Quarterly Overview

   53
  

Financial Highlights

   56
  

Results of Operations

   57
  

Financial Condition

   64
  

Liquidity and Capital Resources

   77
  

Risk Management

   80
  

Critical Accounting Policies and Estimates

   97
  

Recently Issued Accounting Standards and Interpretations

   98
  

Recent Developments

   98
  

Off-Balance Sheet Arrangements, Guarantees, and Other Commitments

   101

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk    102

Item 4.

   Controls and Procedures    109

PART II.

   OTHER INFORMATION   

Item 1.

   Legal Proceedings    110

Item 1A.

   Risk Factors    110

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds    110

Item 3.

   Defaults Upon Senior Securities    110

Item 4.

   (Removed and Reserved)    110

Item 5.

   Other Information    111

Item 6.

   Exhibits    111

Signatures

   112

 

i


Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

Federal Home Loan Bank of San Francisco

Statements of Condition

(Unaudited)

 

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

Assets

    

Cash and due from banks

   $ 2,942      $ 8,280   

Federal funds sold

     17,839        8,164   

Trading securities(a)

     29        31   

Available-for-sale securities(a)

     1,929        1,931   

Held-to-maturity securities (fair values were $33,923 and $35,682, respectively)(b)

     34,586        36,880   

Advances (includes $17,459 and $21,616 at fair value under the fair value option, respectively)

     112,139        133,559   

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

     2,909        3,037   

Accrued interest receivable

     220        355   

Premises and equipment, net

     21        21   

Derivative assets

     529        452   

Other assets

     708        152   
                

Total Assets

   $ 173,851      $ 192,862   

Liabilities and Capital

    

Liabilities:

    

Deposits:

    

Interest-bearing:

    

Demand and overnight

   $ 92      $ 192   

Term

     36        29   

Other

     1        1   

Non-interest-bearing - Other

     2        2   
                

Total deposits

     131        224   
                

Consolidated obligations, net:

    

Bonds (includes $24,241 and $37,022 at fair value under the fair value option, respectively)

     136,588        162,053   

Discount notes

     24,764        18,246   
                

Total consolidated obligations, net

     161,352        180,299   
                

Mandatorily redeemable capital stock

     4,858        4,843   

Accrued interest payable

     705        754   

Affordable Housing Program

     183        186   

Payable to REFCORP

     35        25   

Derivative liabilities

     110        205   

Other liabilities

     91        96   
                

Total Liabilities

     167,465        186,632   
                

Commitments and Contingencies (Note 12)

    

Capital:

    

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

    

86 shares and 86 shares, respectively

     8,561        8,575   

Restricted retained earnings

     1,326        1,239   

Accumulated other comprehensive loss

     (3,501     (3,584
                

Total Capital

     6,386        6,230   
                

Total Liabilities and Capital

   $ 173,851      $ 192,862   

 

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

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

 

1


Table of Contents

Federal Home Loan Bank of San Francisco

Statements of Income

(Unaudited)

 

     For the Three Months Ended March 31,  
(In millions)    2010     2009  

Interest Income:

    

Advances

   $ 332      $ 1,065   

Federal funds sold

     5        7   

Available-for-sale securities

     1          

Held-to-maturity securities

     288        435   

Mortgage loans held for portfolio

     36        43   
                

Total Interest Income

     662        1,550   
                

Interest Expense:

    

Consolidated obligations:

    

Bonds

     289        860   

Discount notes

     13        256   

Mandatorily redeemable capital stock

     3          
                

Total Interest Expense

     305        1,116   
                

Net Interest Income

     357        434   
                

Provision for credit losses on mortgage loans

              
                

Net Interest Income After Mortgage Loan Loss Provision

     357        434   
                

Other Loss:

    

Net gain on trading securities

            1   

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

     (192     (1,156

Portion of impairment loss recognized in other comprehensive income

     132        1,068   
                

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

     (60     (88

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

     (100     (183

Net (loss)/gain on derivatives and hedging activities

     (36     34   

Other

     1          
                

Total Other Loss

     (195     (236
                

Other Expense:

    

Compensation and benefits

     17        15   

Other operating expense

     12        11   

Federal Housing Finance Agency/Federal Housing Finance Board

     3        3   

Office of Finance

     2        2   

Other

     2          
                

Total Other Expense

     36        31   
                

Income Before Assessments

     126        167   
                

REFCORP

     22        30   

Affordable Housing Program

     11        14   
                

Total Assessments

     33        44   
                

Net Income

   $ 93      $ 123   
   

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

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Statements of Capital Accounts

(Unaudited)

 

     Capital Stock
Class B—Putable
    Retained Earnings     Accumulated
Other
Comprehensive

Income/(Loss)
    Total
Capital
 
(In millions)    Shares    Par Value     Restricted    Unrestricted     Total      

Balance, December 31, 2008

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

Adjustments to opening balance(a)

             570        570        (570       

Issuance of capital stock

        20                 20   

Capital stock reclassified from mandatorily redeemable capital stock, net

   6      602                 602   

Comprehensive income/(loss):

                

Net income

             123        123          123   

Other comprehensive income/(loss):

                

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

                 (1,118     (1,118

Reclassified to income for previously impaired securities

                 50        50   

Accretion of impairment loss

                 30        30   
                      

Total comprehensive income/(loss)

                   (915
                      

Transfers to restricted retained earnings

          222      (222                
      

Balance, March 31, 2009

   102    $ 10,238      $ 398    $ 471      $ 869      $ (1,615   $ 9,492   

Balance, December 31, 2009

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

Issuance of capital stock

        4                 4   

Capital stock reclassified to mandatorily redeemable capital stock, net

        (18              (18

Comprehensive income/(loss):

                

Net income

             93        93          93   

Other comprehensive income/(loss):

                

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

                 (191     (191

Reclassified to income for previously impaired securities

                 59        59   

Accretion of impairment loss

                 215        215   
                      

Total comprehensive income/(loss)

                   176   
                      

Transfers to restricted retained earnings

          87      (87                

Dividends on capital stock (0.26%)

                

Cash dividends paid

                    (6     (6       (6
      

Balance, March 31, 2010

   86    $ 8,561      $ 1,326    $      $ 1,326      $ (3,501   $ 6,386   

 

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

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

 

3


Table of Contents

Federal Home Loan Bank of San Francisco

Statements of Cash Flows

(Unaudited)

 

     For the Three Months Ended March 31,  
(In millions)    2010     2009  

Cash Flows from Operating Activities:

    

Net Income

   $ 93      $ 123   

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

    

Depreciation and amortization

     (4     (83

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

     100        183   

Change in net fair value adjustment on derivatives and hedging activities

     (115     (284

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

     60        88   

Net change in:

    

Accrued interest receivable

     152        374   

Other assets

     3        19   

Accrued interest payable

     (39     (332

Other liabilities

     3        15   
                

Total adjustments

     160        (20
                

Net cash provided by operating activities

     253        103   
                

Cash Flows from Investing Activities:

    

Net change in:

    

Federal funds sold

     (9,675     (2,953

Premises and equipment

     (2     (2

Trading securities:

    

Proceeds from maturities

     1        1   

Held-to-maturity securities:

    

Net (increase)/decrease in short-term

     (51     1,269   

Proceeds from maturities of long-term

     1,786        1,622   

Advances:

    

Principal collected

     68,372        316,521   

Made to members

     (47,113     (285,150

Mortgage loans held for portfolio:

    

Principal collected

     127        124   
                

Net cash provided by investing activities

     13,445        31,432   
                

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Statements of Cash Flows (continued)

(Unaudited)

 

     For the Three Months Ended March 31,  
(In millions)    2010     2009  

Cash Flows from Financing Activities:

    

Net change in:

    

Deposits

     (129     (501

Net payments on derivative contracts with financing elements

     30        36   

Net proceeds from consolidated obligations:

    

Bonds issued

     30,973        23,623   

Discount notes issued

     38,827        47,064   

Payments for consolidated obligations:

    

Bonds matured or retired

     (56,453     (46,856

Discount notes matured or retired

     (32,279     (72,566

Proceeds from issuance of capital stock

     4        20   

Payments for redemption of mandatorily redeemable capital stock

     (3       

Cash dividends paid

     (6       
                

Net cash used in financing activities

     (19,036     (49,180
                

Net decrease in cash and cash equivalents

     (5,338     (17,645

Cash and cash equivalents at beginning of the period

     8,280        19,632   
                

Cash and cash equivalents at end of the period

   $ 2,942      $ 1,987   

Supplemental Disclosures:

    

Interest paid during the period

   $ 344      $ 1,905   

Affordable Housing Program payments during the period

     14        12   

REFCORP payments during the period

     12          

Transfers of mortgage loans to real estate owned

     1          

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

 

5


Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements

(Unaudited)

(Dollars in millions)

Background Information

On July 30, 2008, the Housing and Economic Recovery Act of 2008 (Housing Act) was enacted. The Housing Act created a new federal agency, the Federal Housing Finance Agency (Finance Agency), which became the new federal regulator of the Federal Home Loan Banks (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 these notes to regulations of the Finance Agency also include the regulations of the Finance Board where they remain applicable.

Note 1 – Summary of Significant Accounting Policies

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

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

Descriptions of the Bank’s significant accounting policies are included in Note 1 (Summary of Significant Accounting Policies) to the Financial Statements in the Bank’s 2009 Form 10-K. Other changes to these policies as of March 31, 2010, are discussed in Note 2 to the Financial Statements.

Note 2 – Recently Issued and Adopted Accounting Guidance

Embedded Credit Derivative Features. On March 5, 2010, the Financial Accounting Standards Board (FASB) issued amendments clarifying what constitutes the scope exception for embedded credit derivative features related to the transfer of credit risk in the form of subordination of one financial instrument to another. The embedded credit derivative feature related to the transfer of credit risk that is only in the form of subordination of one financial instrument to another is not subject to potential bifurcation and separate accounting as a derivative. The amendments clarify that the circumstances listed below (among others) are not subject to the scope exception. This means that certain embedded credit derivative features, including

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

those in some collateralized debt obligations and synthetic collateralized debt obligations, will need to be assessed to determine whether bifurcation and separate accounting as a derivative are required.

 

   

An embedded derivative feature relating to another type of risk (including another type of credit risk) is present in the securitized financial instruments.

 

   

The holder of an interest in a tranche is exposed to the possibility (however remote) of being required to make potential future payments (not merely receive reduced cash inflows) because the possibility of those future payments is not created by subordination.

 

   

The holder owns an interest in a single-tranche securitization vehicle; therefore, the subordination of one tranche to another is not relevant.

The amendments are effective for the Bank as of July 1, 2010. Upon adoption, entities are permitted to irrevocably elect the fair value option for any investment in a beneficial interest in a securitized financial asset. If the fair value option is elected at adoption, whether the investment had been recorded at amortized cost or at fair value with changes recorded in other comprehensive income, the cumulative unrealized gains and losses at that date are included in the cumulative-effect adjustment to beginning retained earnings for the period of adoption. If the fair value option is not elected and the embedded credit derivative feature is required to be bifurcated and accounted for separately, the initial effect of adoption is also recorded as a cumulative-effect adjustment to the beginning retained earnings for the period of adoption. The Bank is currently assessing the potential effect of the amendments on its financial condition, results of operations, or cash flows.

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

Accounting for Consolidation of Variable Interest Entities. On June 12, 2009, the FASB issued guidance for amending certain requirements of consolidation of variable interest entities (VIEs). This guidance was to improve financial reporting by enterprises involved with VIEs and to provide more relevant and reliable information to users of financial statements. This guidance amended the manner in which entities evaluate whether consolidation is required for VIEs. An entity must first perform a qualitative analysis in determining whether it must consolidate a VIE, and if the qualitative analysis is not determinative, the entity must perform a quantitative analysis. This guidance also required that an entity continually evaluate VIEs for consolidation, rather than making such an assessment based on the occurrence of triggering events. In addition, the guidance required enhanced disclosures about how an entity’s involvement with a VIE affects its financial

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

statements and its exposure to risks. This guidance was effective as of the beginning of each reporting entity’s first annual reporting period beginning after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application was prohibited. The Bank’s investment in VIEs is limited to senior interests in mortgage-backed securities. The Bank evaluated its investments in VIEs held as of January 1, 2010, and determined that consolidation accounting is not required under the new accounting guidance because the Bank is not the primary beneficiary. The Bank does not have the power to significantly affect the economic performance of any of these investments because it does not act as a key decision maker nor does it have the unilateral ability to replace a key decision maker. In addition, because the Bank holds the senior interest, rather than the residual interest, in these investments, the Bank does not have either the obligation to absorb losses of, or the right to receive benefits from, any of its investments in VIEs that could potentially be significant to the VIEs. Furthermore, the Bank does not design, sponsor, transfer, service, or provide credit or liquidity support in any of its investments in VIEs. Therefore, the adoption of this guidance as of January 1, 2010, did not have a material impact on the Bank’s financial condition, results of operations, or cash flows.

Accounting for Transfers of Financial Assets. On June 12, 2009, the FASB issued guidance intended to improve the relevance, representational faithfulness, and comparability of the information a reporting entity provides in its financial reports about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement in transferred financial assets. Key provisions of the guidance included (i) the removal of the concept of qualifying special purpose entities; (ii) the introduction of the concept of a participating interest, in circumstances in which a portion of a financial asset has been transferred; and (iii) the requirement that to qualify for sale accounting, the transferor must evaluate whether it maintains effective control over transferred financial assets either directly or indirectly. The guidance also required enhanced disclosures about transfers of financial assets and a transferor’s continuing involvement. This guidance was effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application was prohibited. The Bank adopted this guidance as of January 1, 2010, and the adoption did not have a material impact on the Bank’s financial condition, results of operations, or cash flows.

Note 3 – Available-for-Sale Securities

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

March 31, 2010

 

      Amortized
Cost(1)
   Other-Than-
Temporary
Impairment
(OTTI)
Recognized in
Accumulated
Other
Comprehensive
Income/(Loss)
(AOCI)
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Estimated
Fair Value
   Weighted
Average
Interest
Rate
 

TLGP(2)

   $ 1,930    $    $    $ (1   $ 1,929    0.40

December 31, 2009

 

      Amortized
Cost(1)
   OTTI
Recognized in
AOCI
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Estimated
Fair Value
   Weighted
Average
Interest
Rate
 

TLGP(2)

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

 

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

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

The following table summarizes the available-for-sale securities with unrealized losses as of March 31, 2010, and December 31, 2009. The unrealized losses are aggregated by major security type and the length of time that individual securities have been in a continuous unrealized loss position.

March 31, 2010

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

TLGP(1)

   $ 1,821    $ 1    $    $    $ 1,821    $ 1

December 31, 2009

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

TLGP(1)

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

 

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

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

March 31, 2010

 

Year of Contractual Maturity    Amortized
Cost(1)
   Estimated
Fair Value
   Weighted
Average
Interest Rate
 

Available-for-sale securities other than mortgage-backed securities (MBS):

        

Due after one year through five years

   $ 1,930    $ 1,929    0.40

December 31, 2009

 

Year of Contractual Maturity    Amortized
Cost(1)
   Estimated
Fair Value
   Weighted
Average
Interest Rate
 

Available-for-sale securities other than MBS:

        

Due after one year through five years

   $ 1,932    $ 1,931    0.41

 

(1) Amortized cost includes unpaid principal balance and unamortized premiums and discounts.

The amortized cost of the Bank’s TLGP securities, which are classified as available-for-sale, included net premiums of $7 at March 31, 2010, and net premiums of $8 at December 31, 2009.

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

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

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

amortized cost basis of the security by comparing its best estimate of the present value of the cash flows expected to be collected from the security with the amortized cost basis of the security. If the Bank’s best estimate of the present value of the cash flows expected to be collected is less than the amortized cost basis, the difference is considered the credit loss.

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

The Bank has determined that, as of March 31, 2010, gross unrealized losses on its available-for-sale investment securities are temporary because it determined that the strength of the guarantees and the direct support from the U.S. government was sufficient to protect the Bank from losses.

Note 4 – Held-to-Maturity Securities

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

March 31, 2010

 

      Amortized
Cost(1)
   OTTI
Recognized
in AOCI(1)
    Carrying
Value(1)
   Gross
Unrecognized
Holding
Gains(2)
   Gross
Unrecognized
Holding
Losses(2)
    Estimated
Fair Value

Interest-bearing deposits

   $ 6,161    $      $ 6,161    $    $      $ 6,161

Commercial paper

     1,500             1,500                  1,500

Housing finance agency bonds

     758             758           (142     616

TLGP(3)

     303             303                  303

Subtotal

     8,722             8,722           (142     8,580

MBS:

               

Other U.S. obligations:

               

Ginnie Mae

     15             15                  15

Government-sponsored enterprises (GSEs):

               

Freddie Mac

     2,554             2,554      113      (1     2,666

Fannie Mae

     7,831             7,831      252      (24     8,059

Other:

               

PLRMBS

     18,956      (3,492     15,464      605      (1,466     14,603

Total MBS

     29,356      (3,492     25,864      970      (1,491     25,343

Total

   $ 38,078    $ (3,492   $ 34,586    $ 970    $ (1,633   $ 33,923

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

December 31, 2009

 

      Amortized
Cost(1)
   OTTI
Recognized
in AOCI(1)
    Carrying
Value(1)
   Gross
Unrecognized
Holding
Gains(2)
   Gross
Unrecognized
Holding
Losses(2)
    Estimated
Fair
Value

Interest-bearing deposits

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

Commercial paper

     1,100             1,100                  1,100

Housing finance agency bonds

     769             769           (138     631

TLGP(3)

     304             304           (1     303

Subtotal

     8,683             8,683           (139     8,544

MBS:

               

Other U.S. obligations:

               

Ginnie Mae

     16             16                  16

GSEs:

               

Freddie Mac

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

Fannie Mae

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

Other:

               

PLRMBS

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

Total MBS

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

Total

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

 

(1) Amortized cost includes unpaid principal balance, unamortized premiums and discounts, and previous other-than-temporary impairments recognized in earnings (less any cumulative-effect adjustments recognized). The carrying value of held-to-maturity securities represents amortized cost after adjustment for impairment related to all other factors recognized in AOCI.
(2) Gross unrecognized holding gains/(losses) represent the difference between estimated fair value and carrying value, while gross unrealized gains/(losses) represent the difference between estimated fair value and amortized cost.
(3) TLGP securities represent corporate debentures of the issuing party that are guaranteed by the FDIC and backed by the full faith and credit of the U.S. government.

As of March 31, 2010, all of the interest-bearing deposits had a credit rating of at least A, all of the commercial paper had a credit rating of AA, and all of the housing finance agency bonds had a credit rating of at least AA. The TLGP securities are guaranteed by the FDIC and backed by the full faith and credit of the U.S. government. In addition, as of March 31, 2010, 46% of the amortized cost of the private-label residential MBS (PLRMBS) were rated above investment grade (13% had a credit rating of AAA), and the remaining 54% were rated below investment grade. Credit ratings of BB and lower are below investment grade. The credit ratings used by the Bank are based on the lowest of Moody’s Investors Service (Moody’s), Standard & Poor’s Rating Services (Standard & Poor’s), or comparable Fitch ratings.

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

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

March 31, 2010

 

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

Interest-bearing deposits

   $ 6,161    $    $    $    $ 6,161    $

Commercial paper

     1,500                     1,500     

Housing finance agency bonds

               616      142      616      142
 

Subtotal

     7,661           616      142      8,277      142
 

MBS:

                 

Other U.S. obligations:

                 

Ginnie Mae

               5           5     

GSEs:

                 

Freddie Mac

     61      1      38           99      1

Fannie Mae

     1,093      10      142      14      1,235      24

Other:

                 

PLRMBS(2)

               14,358      4,958      14,358      4,958
 

Total MBS

     1,154      11      14,543      4,972      15,697      4,983
 

Total

   $ 8,815    $ 11    $ 15,159    $ 5,114    $ 23,974    $ 5,125
 

December 31, 2009

 

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

Interest-bearing deposits

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

Housing finance agency bonds

     30      7      600      131      630      138

TLGP(1)

     303      1                303      1
 

Subtotal

     6,843      8      600      131      7,443      139
 

MBS:

                 

Other U.S. obligations:

                 

Ginnie Mae

               13           13     

GSEs:

                 

Freddie Mac

               40      1      40      1

Fannie Mae

     1,037      10      172      3      1,209      13

Other:

                 

PLRMBS( 2 )

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

Total MBS

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

Total

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

 

(1) TLGP securities represent corporate debentures of the issuing party that are guaranteed by the FDIC and backed by the full faith and credit of the U.S. government.
(2) Includes securities with gross unrecognized holding losses of $1,466 and 1,945 at March 31, 2010, and December 31, 2009, respectively, and securities with OTTI charges of $3,492 and $3,575 that have been recognized in AOCI at March 31, 2010, and December 31, 2009, respectively.

As indicated in the tables above, as of March 31, 2010, the Bank’s investments classified as held-to-maturity had gross unrealized losses totaling $5,125, primarily relating to PLRMBS. The gross unrealized losses associated with the PLRMBS were primarily due to illiquidity in the MBS market, uncertainty about the future condition of the housing and mortgage market and the economy, and continued deterioration in the credit performance of loan collateral underlying these securities, which caused these assets to be valued at significant discounts to their acquisition cost.

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

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

March 31, 2010

 

Year of Contractual Maturity    Amortized
Cost(1)
   Carrying
Value(1)
   Estimated
Fair Value
   Weighted
Average
Interest Rate
 

Held-to-maturity securities other than MBS:

           

Due in one year or less

   $ 7,964    $ 7,964    $ 7,964    0.22

Due after one year through five years

     9      9      9    0.40   

Due after five years through ten years

     27      27      23    0.37   

Due after ten years

     722      722      584    0.47   
    

Subtotal

     8,722      8,722      8,580    0.24   
    

MBS:

           

Other U.S. obligations:

           

Ginnie Mae

     15      15      15    1.27   

GSEs:

           

Freddie Mac

     2,554      2,554      2,666    4.75   

Fannie Mae

     7,831      7,831      8,059    4.14   

Other:

           

PLRMBS

     18,956      15,464      14,603    3.59   
    

Total MBS

     29,356      25,864      25,343    3.84   
    

Total

   $ 38,078    $ 34,586    $ 33,923    3.03
   

December 31, 2009

 

Year of Contractual Maturity    Amortized
Cost(1)
   Carrying
Value(1)
   Estimated
Fair Value
   Weighted
Average
Interest Rate
 

Held-to-maturity securities other than MBS:

           

Due in one year or less

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

Due after one year through five years

     316      316      314    1.75   

Due after five years through ten years

     27      27      23    0.40   

Due after ten years

     730      730      597    0.53   
    

Subtotal

     8,683      8,683      8,544    0.24   
    

MBS:

           

Other U.S. obligations:

           

Ginnie Mae

     16      16      16    1.26   

GSEs:

           

Freddie Mac

     3,423      3,423      3,572    4.83   

Fannie Mae

     8,467      8,467      8,710    4.15   

Other:

           

PLRMBS

     19,866      16,291      14,840    3.73   
    

Total MBS

     31,772      28,197      27,138    3.95   
    

Total

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

 

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

At March 31, 2010, the carrying value of the Bank’s MBS classified as held-to-maturity included net discounts of $25, OTTI related to credit loss of $716 (including interest accretion adjustments of $28), and OTTI related to all other factors of $3,492. At December 31, 2009, the carrying value of the Bank’s MBS classified as held-to-maturity included net discounts of $16, OTTI related to credit loss of $652 (including interest accretion adjustments of $24), and OTTI related to all other factors of $3,575.

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

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

      March 31, 2010    December 31, 2009

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

     

Fixed rate

   $ 7,964    $ 7,914

Adjustable rate

     758      769
 

Subtotal

     8,722      8,683
 

Amortized cost of held-to-maturity MBS:

     

Passthrough securities:

     

Fixed rate

     2,861      3,326

Adjustable rate

     99      87

Collateralized mortgage obligations:

     

Fixed rate

     14,739      16,619

Adjustable rate

     11,657      11,740
 

Subtotal

     29,356      31,772
 

Total

   $ 38,078    $ 40,455
 

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

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

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

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

The Bank has determined that, as of March 31, 2010, the immaterial gross unrealized losses on its short-term unsecured Federal funds sold, interest-bearing deposits, and commercial paper are temporary because the gross unrealized losses were caused by movements in interest rates and not by the deterioration of the issuers’ creditworthiness; the short-term unsecured Federal funds sold, interest-bearing deposits, and commercial paper were all with issuers that had credit ratings of at least A at March 31, 2010; and all of the securities had maturity dates within 45 days of March 31, 2010. As a result, the Bank expects to recover the entire amortized cost basis of these securities.

As of March 31, 2010, the Bank’s investments in housing finance agency bonds, which were issued by the California Housing Finance Agency (CalHFA), had gross unrealized losses totaling $142. These gross unrealized losses were mainly due to an illiquid market, causing these investments to be valued at a discount to their acquisition cost. In addition, the Bank independently modeled cash flows for the underlying collateral, using assumptions for default rates and loss severity that management deemed reasonable, and concluded that the available credit support within the CalHFA structure more than offset the projected underlying collateral losses. The Bank has determined that, as of March 31, 2010, all of the gross unrealized losses on these bonds

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

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 A at March 31, 2010 (based on the lowest of Moody’s or Standard & Poor’s ratings). As a result, the Bank expects to recover the entire amortized cost basis of these securities.

The Bank also invests in corporate debentures issued under the TLGP, which are guaranteed by the FDIC and backed by the full faith and credit of the U.S. government. The Bank expects to recover the entire amortized cost basis of these securities because it determined that the strength of the guarantees and the direct support from the U.S. government is sufficient to protect the Bank from losses based on current expectations. As a result, the Bank has determined that, as of March 31, 2010, all of the gross unrealized losses on its TLGP investments are temporary.

For its agency MBS, the Bank expects to recover the entire amortized cost basis of these securities because it determined that the strength of the issuers’ guarantees through direct obligations or support from the U.S. government is sufficient to protect the Bank from losses based on current expectations. As a result, the Bank has determined that, as of March 31, 2010, all of the gross unrealized losses on its agency MBS are temporary.

To assess whether it expects to recover the entire amortized cost basis of its PLRMBS, the Bank performed a cash flow analysis for all of its PLRMBS as of March 31, 2010. In performing the cash flow analysis for each security, the Bank used two third-party models. The first model considers borrower characteristics and the particular attributes of the loans underlying the Bank’s securities, in conjunction with assumptions about future changes in home prices, interest rates, and other assumptions, to project prepayments, default rates, and loss severities. A significant input to the first model is the forecast of future housing price changes for the relevant states and core-based statistical areas (CBSAs) based on an assessment of the relevant housing markets. CBSA refers collectively to metropolitan and micropolitan statistical areas as defined by the United States Office of Management and Budget. As currently defined, a CBSA must contain at least one urban area of 10,000 or more people. The Bank’s housing price forecast as of March 31, 2010, assumed CBSA-level current-to-trough housing price declines ranging from 0% to 12% over the 6- to 12-month periods beginning January 1, 2010 (average price decline during this time period equaled 5%). 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.

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

For securities determined to be other-than-temporarily impaired as of March 31, 2010 (that is, securities for which the Bank determined that it does not expect to recover the entire amortized cost basis), the following table presents a summary of the significant inputs used in measuring the amount of credit loss recognized in earnings in the first quarter of 2010.

 

15


Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

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

March 31, 2010

 

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

Prime

                       

2004 and earlier

   10.7    10.7    8.2    8.2    37.3    37.3    11.3    11.3

2006

   9.4    9.4    22.2    22.2    41.2    41.2    21.8    21.8

Total Prime

   9.6    9.4 – 10.7    19.7    8.2 – 22.2    40.5    37.3 – 41.2    19.9    11.3 – 21.8
 

Alt-A

                       

2004 and earlier

   14.0    9.2 – 17.3    38.7    26.2 – 52.3    48.7    41.1 – 52.3    19.7    14.5 – 25.5

2005

   10.2    7.6 – 15.2    35.0    15.9 – 72.4    43.5    28.5 – 53.7    14.5    5.7 – 30.2

2006

   9.4    5.3 – 13.8    51.4    27.8 – 88.1    47.1    36.6 – 60.7    24.6    8.4 – 40.6

2007

   8.1    4.1 – 12.0    63.6    22.4 – 90.7    48.0    41.2 – 59.1    29.4    9.5 – 46.4

2008

   12.0    11.0 – 12.3    51.1    46.9 – 52.4    42.1    41.8 – 42.9    31.1    31.1

Total Alt-A

   9.3    4.1 – 17.3    52.4    15.9 – 90.7    46.5    28.5 – 60.7    24.5    5.7 – 46.4

Total

   9.3    4.1 – 17.3    51.8    8.2 – 90.7    46.3    28.5 – 60.7    24.4    5.7 – 46.4
 

The Bank recorded OTTI related to credit loss of $60 and $88 that was recognized in “Other Loss” for the first quarter of 2010 and 2009, respectively, and recognized OTTI related to all other factors of $132 and $1,068 in “Other comprehensive income/(loss)” for the first quarter of 2010 and 2009, respectively. For each security, the estimated impairment related to all other factors for each security is accreted prospectively, based on the amount and timing of future estimated cash flows, over the remaining life of the security as an increase in the carrying value of the security (with no effect on earnings unless the security is subsequently sold or there are additional decreases in the cash flows expected to be collected). For the first quarter of 2010 and 2009, the Bank accreted $215 and $30 from AOCI to increase the carrying value of the respective PLRMBS, respectively. The Bank does not intend to sell these securities and it is not more likely than not that the Bank will be required to sell these securities before its anticipated recovery of the remaining amortized cost basis. At March 31, 2010, the estimated weighted average life of these securities was approximately four years, respectively.

For certain other-than-temporarily impaired securities that had previously been impaired and subsequently incurred additional OTTI related to credit loss, the additional credit-related OTTI, up to the amount in AOCI, was reclassified out of non-credit-related OTTI in AOCI and charged to earnings. This amount was $59 for the first quarter of 2010 and $50 for the first quarter of 2009.

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

The following table presents the OTTI related to credit loss, which is recognized in earnings, and the OTTI related to all other factors, which is recognized in “Other comprehensive income/(loss)” for the three months ended March 31, 2010 and 2009.

 

     Three Months Ended March 31, 2010     Three Months Ended March 31, 2009  
                
     OTTI
Related to
Credit Loss
   OTTI
Related to
All Other
Factors
    Total
OTTI
    OTTI
Related to
Credit Loss
   OTTI
Related to
All Other
Factors
    Total
OTTI
 
   

Balance, beginning of the period(1)

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

Charges on securities for which OTTI was not previously recognized

     1      116        117        38      1,015        1,053   

Additional charges on securities for which OTTI was previously recognized(2)

     59      16        75        50      53        103   

Accretion of impairment related to all other factors

          (215     (215          (30     (30
   

Balance, end of the period

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

 

(1) The Bank adopted the OTTI guidance as of January 1, 2009, and recognized the cumulative effect of initially applying the OTTI guidance, totaling $570, as an increase in the retained earnings balance at January 1, 2009, with a corresponding change in AOCI.
(2) For the three months ended March 31, 2010, “securities for which OTTI was previously recognized” represents all securities that were also other-than-temporarily impaired prior to January 1, 2010. For the three months ended March 31, 2009, “securities for which OTTI was previously recognized” represents all securities that were also previously other-than-temporarily impaired prior to January 1, 2009.

The following tables present the Bank’s other-than-temporarily impaired PLRMBS that incurred an OTTI charge during the three months ended March 31, 2010, and 2009, by loan collateral type:

 

March 31, 2010    Unpaid
Principal
Balance
   Amortized
Cost
  

Carrying

Value

   Estimated
Fair Value
 

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

           

Prime

   $ 719    $ 696    $ 453    $ 487

Alt-A, option ARM

     1,536      1,402      756      791

Alt-A, other

     5,212      4,899      3,357      3,652
 

Total

   $ 7,467    $ 6,997    $ 4,566    $ 4,930
 
March 31, 2009    Unpaid
Principal
Balance
   Amortized
Cost
  

Carrying

Value

   Estimated
Fair Value
 

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

           

Alt-A, option ARM

   $ 944    $ 919    $ 431    $ 431

Alt-A, other

     2,705      2,633      1,570      1,578
 

Total

   $ 3,649    $ 3,552    $ 2,001    $ 2,009
 
The following tables present the Bank’s other-than-temporarily impaired PLRMBS that incurred an OTTI charge anytime during the life of the securities at March 31, 2010, and December 31, 2009, by loan collateral type:
March 31, 2010    Unpaid
Principal
Balance
   Amortized
Cost
  

Carrying

Value

   Estimated
Fair Value
 

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

           

Prime

   $ 1,360    $ 1,294    $ 857    $ 940

Alt-A, option ARM

     2,026      1,801      968      1,010

Alt-A, other

     7,597      7,176      4,954      5,430
 

Total

   $ 10,983    $ 10,271    $ 6,779    $ 7,380
 

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

December 31, 2009    Unpaid
Principal
Balance
   Amortized
Cost
  

Carrying

Value

   Estimated
Fair Value
 

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

           

Prime

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

Alt-A, option ARM

     2,084      1,873      964      1,001

Alt-A, other

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

Total

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

The following tables present the Bank’s OTTI related to credit loss and OTTI related to all other factors on its other-than-temporarily impaired PLRMBS during the three months ended March 31, 2010 and 2009:

 

     Three Months Ended March 31, 2010    Three Months Ended March 31, 2009
             
     OTTI
Related to
Credit Loss
   OTTI
Related to
All Other
Factors
   

Total

OTTI

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

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

                

Prime

   $ 6    $ 53      $ 59    $    $    $

Alt-A, option ARM

     15      (14     1      25      417      442

Alt-A, other

     39      93        132      63      651      714
 

Total

   $ 60    $ 132      $ 192    $ 88    $ 1,068    $ 1,156
 

The following tables present the other-than-temporarily impaired PLRMBS for the three months ended March 31, 2010 and 2009, by loan collateral type and the length of time that the individual securities were in a continuous loss position prior to the current period write-down:

 

     Three Months Ended March 31, 2010  
     Gross Unrealized Losses
Related to Credit
       

Gross Unrealized Losses

Related to All Other Factors

 
      Less than
12 months
  

12 months

or more

   Total          Less than
12 months
   12 months
or more
    Total  

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

                   

Prime

   $    $ 6    $ 6       $    $ 53      $ 53   

Alt-A, option ARM

          15      15              (14     (14

Alt-A, other

          39      39                93        93   

Total

   $    $ 60    $ 60         $    $ 132      $ 132   
     Three Months Ended March 31, 2009  
     Gross Unrealized Losses
Related to Credit
       

Gross Unrealized Losses

Related to All Other Factors

 
      Less than
12 months
  

12 months

or more

   Total          Less than
12 months
   12 months
or more
    Total  

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

                   

Alt-A, option ARM

   $    $ 25    $ 25       $    $ 417      $ 417   

Alt-A, other

          63      63                651        651   

Total

   $    $ 88    $ 88         $    $ 1,068      $ 1,068   

For the Bank’s PLRMBS that were not other-than-temporarily impaired as of March 31, 2010, the Bank does not intend to sell these securities, it is not more likely than not that the Bank will be required to sell these securities before its anticipated recovery of the remaining amortized cost basis, and the Bank expects to recover the entire amortized cost basis of these securities. As a result, the Bank has determined that, as of March 31, 2010, the gross unrealized losses on these remaining PLRMBS are temporary. Thirty-three percent of the amortized cost of the PLRMBS that were not other-than-temporarily impaired were rated investment

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

grade (9% were rated AAA), with the remainder rated below investment grade. These securities were included in the securities that the Bank reviewed and analyzed for OTTI as discussed above, and the analyses performed indicated that these securities were not other-than-temporarily impaired. The credit ratings used by the Bank are based on the lowest of Moody’s, Standard & Poor’s, or comparable Fitch ratings.

At March 31, 2010, PLRMBS labeled Alt-A by the issuer represented 46% of the amortized cost of the Bank’s MBS portfolio. Alt-A securities are generally collateralized by mortgage loans that are considered less risky than subprime loans, but more risky than prime loans. These loans are generally made to borrowers who have sufficient credit ratings to qualify for a conforming mortgage loan, but the loans may not meet standard guidelines for documentation requirements, property type, or loan-to-value ratios. In addition, the property securing the loan may be non-owner-occupied.

Note 5 – Advances

Redemption Terms. The Bank had advances outstanding, excluding overdrawn demand deposit accounts, at interest rates ranging from 0.05% to 8.57% at March 31, 2010, and 0.01% to 8.57% at December 31, 2009, as summarized below.

 

     March 31, 2010     December 31, 2009  
                
Contractual Maturity    Amount
Outstanding
  

Weighted

Average

Interest Rate

    Amount
Outstanding
  

Weighted

Average

Interest Rate

 

Overdrawn demand deposit accounts

   $ 1    0.01   $   

Within 1 year

     54,651    1.62        76,854    1.54   

After 1 year through 2 years

     31,112    1.41        30,686    1.69   

After 2 years through 3 years

     8,657    2.12        7,313    2.85   

After 3 years through 4 years

     8,068    1.84        9,211    1.77   

After 4 years through 5 years

     1,760    3.55        1,183    4.12   

After 5 years

     6,805    2.07        7,066    2.12   
             

Total par amount

     111,054    1.67     132,313    1.72
                  

Valuation adjustments for hedging activities

     480        524   

Valuation adjustments under fair value option

     516        616   

Net unamortized premiums

     89        106   
             

Total

   $ 112,139      $ 133,559   
             

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

 

Earlier of Contractual

Maturity or Next Call Date

   March 31, 2010    December 31, 2009

Overdrawn demand deposit accounts

   $ 1    $

Within 1 year

     54,651      76,864

After 1 year through 2 years

     31,120      30,686

After 2 years through 3 years

     8,657      7,318

After 3 years through 4 years

     8,065      9,201

After 4 years through 5 years

     1,760      1,183

After 5 years

     6,800      7,061

Total par amount

   $ 111,054    $ 132,313

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

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Earlier of Contractual

Maturity or Next Put Date

   March 31, 2010    December 31, 2009

Overdrawn demand deposit accounts

   $ 1    $

Within 1 year

     57,268      79,552

After 1 year through 2 years

     30,747      30,693

After 2 years through 3 years

     8,118      6,385

After 3 years through 4 years

     7,785      8,933

After 4 years through 5 years

     1,484      942

After 5 years

     5,651      5,808

Total par amount

   $ 111,054    $ 132,313

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

Credit and Concentration Risk. The Bank’s potential credit risk from advances is concentrated in four institutions whose advances outstanding represented 10% or more of the Bank’s total par amount of advances outstanding. The following tables present the concentration in advances to these four institutions as of March 31, 2010, and December 31, 2009. The tables also present the interest income from these advances before the impact of interest rate exchange agreements associated with these advances for the first quarter of 2010 and 2009.

 

20


Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Concentration of Advances

 

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

Percentage of
Total

Advances
Outstanding

    Advances
Outstanding(1)
  

Percentage of

Total

Advances
Outstanding

 
   

Citibank, N.A.

   $ 34,159    31   $ 46,544    35

JPMorgan Chase Bank, National Association

     13,615    12        20,622    16   

Bank of America California, N.A.

     13,404    12        9,304    7   

Wells Fargo Bank, N.A.(2)

     11,173    10        14,695    11   
   

Subtotal

     72,351    65        91,165    69   

Others

     38,703    35        41,148    31   
   

Total par amount

   $ 111,054    100   $ 132,313    100
   

Concentration of Interest Income from Advances

 

     Three Months Ended  
     March 31, 2010     March 31, 2009  
Name of Borrower   

Interest

Income from
Advances(3)

   Percentage of
Total Interest
Income from
Advances
    Interest
Income from
Advances(3)
   Percentage of
Total Interest
Income from
Advances
 
   

Citibank, N.A.

   $ 22    4   $ 233    18

JPMorgan Chase Bank, National Association

     137    27        397    31   

Bank of America California, N.A.

     29    6        64    5   

Wells Fargo Bank, N.A.(2)

     31    6        102    8   
   

Subtotal

     219    43        796    62   

Others

     287    57        485    38   
   

Total

   $ 506    100   $ 1,281    100
   

 

(1) Borrower advance amounts and total advance amounts are at par value, and total advance amounts will not agree to carrying value amounts shown in the Statements of Condition. The differences between the par and carrying value amounts primarily relate to unrealized gains or losses associated with hedged advances resulting from valuation adjustments related to hedging activities and the fair value option.

 

(2) On December 31, 2008, Wells Fargo & Company, a nonmember, acquired Wachovia Corporation, the parent company of Wachovia Mortgage, FSB. Wachovia Mortgage, FSB, operated as a separate entity and continued to be a member of the Bank until its merger into Wells Fargo Bank, N.A., a subsidiary of Wells Fargo & Company, on November 1, 2009. Effective November 1, 2009, Wells Fargo Financial National Bank, an affiliate of Wells Fargo & Company, became a member of the Bank, and the Bank allowed the transfer of excess capital stock totaling $5 from Wachovia Mortgage, FSB, to Wells Fargo Financial National Bank to enable Wells Fargo Financial National Bank to satisfy its initial membership stock requirement. As a result of the merger, Wells Fargo Bank, N.A., assumed all outstanding Bank advances and the remaining Bank capital stock of Wachovia Mortgage, FSB. The Bank reclassified the capital stock transferred to Wells Fargo Bank, N.A., totaling $1,567, to mandatorily redeemable capital stock (a liability).

 

(3) 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.

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

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

During the first quarter of 2010, four member institutions were placed into receivership or liquidation. All of these institutions had advances outstanding at the time they were placed into receivership or liquidation. The advances outstanding to these four institutions were either repaid prior to March 31, 2010, or assumed by other institutions, and no losses were incurred by the Bank. Bank capital stock held by three of the four institutions totaling $18 was classified as mandatorily redeemable capital stock (a liability). The capital stock of the other institution was transferred to another member institution.

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

From April 1, 2010, to April 30, 2010, two member institutions were placed into receivership. The outstanding advances and capital stock of one institution were assumed by a member institution. The advances outstanding to the other institution were assumed by another member institution, however the Bank capital stock totaling $9 was not acquired by the member institution and was classified as mandatorily redeemable capital stock (a liability). Because the estimated fair value of the collateral exceeds the carrying amount of the advances outstanding, and the Bank expects to collect all amounts due according to the contractual terms of the advances, no allowance for loan losses on the advances outstanding to this member institution was deemed necessary by management.

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

 

      March 31, 2010     December 31, 2009  

Par amount of advances:

    

Fixed rate

   $ 62,099      $ 68,411   

Adjustable rate

     48,955        63,902   

Total par amount

   $ 111,054      $ 132,313   

Note 6 – Mortgage Loans Held for Portfolio

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

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

 

      March 31, 2010     December 31, 2009  

Fixed rate medium-term mortgage loans

   $ 874      $ 927   

Fixed rate long-term mortgage loans

     2,056        2,130   

Subtotal

     2,930        3,057   

Net unamortized discounts

     (19     (18

Mortgage loans held for portfolio

     2,911        3,039   

Less: Allowance for credit losses

     (2     (2

Total mortgage loans held for portfolio, net

   $ 2,909      $ 3,037   

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

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

For taking on the credit enhancement obligation, the Bank pays the participating member or any successor a credit enhancement fee, which is calculated on the remaining unpaid principal balance of the mortgage loans. The Bank records credit enhancement fees as a reduction to interest income. In the first quarter of 2010 and 2009, the Bank reduced net interest income for credit enhancement fees totaling $1 and $1, respectively.

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

Concentration of Mortgage Loans

March 31, 2010

 

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

JPMorgan Chase Bank, National Association

   $ 2,301    79   18,096    73

OneWest Bank, FSB

     387    13      4,750    19   

Subtotal

     2,688    92      22,846    92   

Others

     242    8      2,009    8   

Total

   $ 2,930    100   24,855    100

December 31, 2009

 

          
Name of Institution    Mortgage
Loan Balances
Outstanding
  

Percentage of Total
Mortgage

Loan Balances
Outstanding

    Number of
Mortgage
Loans
Outstanding
   Percentage of
Total Number
of Mortgage Loans
Outstanding
 

JPMorgan Chase Bank, National Association

   $ 2,391    78   18,613    73

OneWest Bank, FSB

     409    13      4,893    19   

Subtotal

     2,800    91      23,506    92   

Others

     257    9      2,109    8   

Total

   $ 3,057    100   25,615    100

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

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

 

     March 31, 2010    December 31, 2009
Days Past Due    Number
of Loans
  

Mortgage

Loan Balance

   Number
of Loans
  

Mortgage

Loan Balance

Between 30 and 59 days

   260    $ 29    243    $ 29

Between 60 and 89 days

   73      9    81      10

90 days or more

   213      27    177      22

Total

   546    $ 65    501    $ 61

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

At March 31, 2010, the Bank had 546 loans that were 30 days or more delinquent totaling $65, of which 213 loans totaling $27 were classified as nonaccrual or impaired. For 123 of these loans, totaling $15, the loan was in foreclosure or the borrower of the loan was in bankruptcy. At December 31, 2009, the Bank had 501 loans that were 30 days or more delinquent totaling $61, of which 177 loans totaling $22 were classified as nonaccrual or impaired. For 103 of these loans, totaling $11, the loan was in foreclosure or the borrower of the loan was in bankruptcy.

The Bank’s average recorded investment in impaired loans totaled $24 for the first quarter of 2010 and $11 for the first quarter of 2009. The Bank did not recognize any interest income for impaired loans in the first quarter of 2010 and 2009.

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

 

     Three Months Ended
     March 31, 2010     March 31, 2009
 

Balance, beginning of the period

   $ 2.0      $ 1.0

Charge-offs – transferred to real estate owned

     (0.4    

Recoveries

           

Provision for credit losses

     0.4        0.1
 

Balance, end of the period

   $ 2.0      $ 1.1
 

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

At March 31, 2010, the Bank’s other assets included $3 of real estate owned resulting from foreclosure of 31 mortgage loans held by the Bank. At December 31, 2009, the Bank’s other assets included $3 of real estate owned resulting from foreclosure of 26 mortgage loans held by the Bank.

Note 7 – Consolidated Obligations

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

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

 

24


Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

     March 31, 2010     December 31, 2009  
Contractual Maturity    Amount
Outstanding
   

Weighted

Average

Interest Rate

    Amount
Outstanding
   

Weighted

Average

Interest Rate

 
   

Within 1 year

   $ 50,373      1.83   $ 75,865      1.29

After 1 year through 2 years

     44,268      1.88        42,745      2.40   

After 2 years through 3 years

     13,762      1.99        11,589      2.12   

After 3 years through 4 years

     11,315      3.81        12,855      3.86   

After 4 years through 5 years

     4,102      3.28        5,308      3.11   

After 5 years

     10,629      4.26        11,561      4.38   

Index amortizing notes

     6      4.61        6      4.61   
               

Total par amount

     134,455      2.26     159,929      2.14
                

Unamortized premiums/(discounts)

     234          251     

Valuation adjustments for hedging activities

     1,922          1,926     

Fair value option valuation adjustments

     (23       (53  
               

Total

   $ 136,588        $ 162,053     
               

The Bank’s participation in consolidated obligation bonds outstanding includes callable bonds of $27,607 at March 31, 2010, and $32,185 at December 31, 2009. Contemporaneous with the issuance of a callable bond for which the Bank is the primary obligor, the Bank routinely enters into an interest rate swap (in which the Bank pays a variable rate and receives a fixed rate) with a call feature that mirrors the call option embedded in the bond (a sold callable swap). The Bank had notional amounts of interest rate exchange agreements hedging callable bonds of $24,280 at March 31, 2010, and $25,530 at December 31, 2009. The combined sold callable swap and callable bond enable the Bank to meet its funding needs at costs not otherwise directly attainable solely through the issuance of non-callable debt, while effectively converting the Bank’s net payment to an adjustable rate.

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

 

      March 31, 2010    December 31, 2009

Par amount of consolidated obligation bonds:

     

Non-callable

   $ 106,848    $ 127,744

Callable

     27,607      32,185

Total par amount

   $ 134,455    $ 159,929

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

 

Earlier of Contractual

Maturity or Next Call Date

   March 31, 2010    December 31, 2009

Within 1 year

   $ 73,460    $ 103,215

After 1 year through 2 years

     39,883      36,750

After 2 years through 3 years

     8,157      5,494

After 3 years through 4 years

     7,955      9,480

After 4 years through 5 years

     658      593

After 5 years

     4,336      4,391

Index amortizing notes

     6      6

Total par amount

   $ 134,455    $ 159,929

Consolidated obligation discount notes are consolidated obligations issued to raise short-term funds; discount notes have original maturities up to one year. These notes are issued at less than their face amount and redeemed at par value when they mature. The Bank’s participation in consolidated obligation discount notes, all of which are due within one year, was as follows:

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

     March 31, 2010     December 31, 2009  
     Amount
Outstanding
    Weighted
Average
Interest Rate
    Amount
Outstanding
    Weighted
Average
Interest Rate
 
   

Par amount

   $ 24,769      0.18   $ 18,257      0.35

Unamortized discounts

     (5       (11  
               

Total

   $ 24,764        $ 18,246     
               

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

 

      March 31, 2010    December 31, 2009

Par amount of consolidated obligations:

     

Bonds:

     

Fixed rate

   $ 91,230    $ 98,619

Adjustable rate

     31,915      49,244

Step-up

     9,439      10,433

Step-down

     500      350

Fixed rate that converts to adjustable rate

     983      915

Adjustable rate that converts to fixed rate

     285      250

Range bonds

     97      112

Index amortizing notes

     6      6

Total bonds, par

     134,455      159,929

Discount notes, par

     24,769      18,257

Total consolidated obligations, par

   $ 159,224    $ 178,186

Note 8 – Capital

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

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

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

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Regulatory Capital Requirements

 

     March 31, 2010     December 31, 2009  
       Required        Actual        Required        Actual   

Risk-based capital

   $ 5,610      $ 14,745      $ 6,207      $ 14,657   

Total regulatory capital

   $ 6,954      $ 14,745      $ 7,714      $ 14,657   

Total regulatory capital ratio

     4.00     8.48     4.00     7.60

Leverage capital

   $ 8,693      $ 22,117      $ 9,643      $ 21,984   

Leverage ratio

     5.00     12.72     5.00     11.40

The Bank’s total regulatory capital ratio increased to 8.48% at March 31, 2010, from 7.60% at December 31, 2009, primarily because of increased excess capital stock resulting from the decline in advances outstanding, coupled with the Bank’s decision not to repurchase excess capital stock, as noted below.

Mandatorily Redeemable Capital Stock. The Bank had mandatorily redeemable capital stock totaling $4,858 at March 31, 2010, and $4,843 at December 31, 2009. The change in mandatorily redeemable capital stock for the three months ended March 31, 2010 and 2009, was as follows:

 

     Three Months Ended  
     March 31, 2010     March 31, 2009  
      Number of
Institutions
   Amount     Number of
Institutions
   Amount  

Balance at the beginning of the period

   42    $ 4,843      30    $ 3,747   

Reclassified from/(to) capital during the period:

          

Merger with or acquisition by nonmember institution

   1           1        

Termination of membership

   2      18      2      16   

Acquired by/transferred to members(1)(2)

                  (618

Redemption of mandatorily redeemable capital stock

        (3          

Balance at the end of the period

   45    $ 4,858      33    $ 3,145   

 

(1) During 2008, JPMorgan Chase Bank, National Association, a nonmember, assumed Washington Mutual Bank’s outstanding Bank advances and acquired the associated Bank capital stock. The Bank reclassified the capital stock transferred to JPMorgan Chase Bank, National Association, totaling $3,208, to mandatorily redeemable capital stock (a liability). JPMorgan Bank and Trust Company, National Association, an affiliate of JPMorgan Chase Bank, National Association, became a member of the Bank. During the first quarter of 2009, the Bank allowed the transfer of excess stock totaling $300 from JPMorgan Chase Bank, National Association, to JPMorgan Bank and Trust Company, National Association, to enable JPMorgan Bank and Trust Company, National Association, to satisfy its activity-based stock requirement. The capital stock transferred is no longer classified as mandatorily redeemable capital stock (a liability). However, the capital stock remaining with JPMorgan Chase Bank, National Association, totaling $2,695, remains classified as mandatorily redeemable capital stock (a liability).

 

(2) On March 19, 2009, OneWest Bank, FSB, became a member of the Bank, assumed the outstanding advances of IndyMac Federal Bank, FSB, a nonmember, and acquired the associated Bank capital stock totaling $318. Bank capital stock acquired by OneWest Bank, FSB, is no longer classified as mandatorily redeemable capital stock (a liability). However, the capital stock remaining with IndyMac Federal Bank, FSB, totaling $49, remains classified as mandatorily redeemable capital stock (a liability).

Cash dividends on mandatorily redeemable capital stock in the amount of $3 were recorded as interest expense for the three months ended March 31, 2010. There were no dividends on mandatorily redeemable capital stock recorded as interest expense for the three months ended March 31, 2009.

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

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

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Contractual Redemption Period    March 31, 2010    December 31, 2009

Within 1 year

   $ 26    $ 3

After 1 year through 2 years

     44      63

After 2 years through 3 years

     86      91

After 3 years through 4 years

     2,970      2,955

After 4 years through 5 years

     1,732      1,731

Total

   $ 4,858    $ 4,843

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

Retained Earnings Related to Valuation Adjustments – In accordance with the Retained Earnings and Dividend Policy, the Bank retains in restricted retained earnings any cumulative net gains in earnings (net of applicable assessments) resulting from gains or losses on derivatives and associated hedged items and financial instruments carried at fair value (valuation adjustments). As the cumulative net gains are reversed by periodic net losses and settlements of contractual interest cash flows, the amount of cumulative net gains decreases. The amount of retained earnings required by this provision of the policy is therefore decreased, and that portion of the previously restricted retained earnings becomes unrestricted and may be made available for dividends. Retained earnings restricted in accordance with these provisions totaled $140 at March 31, 2010, and $181 at December 31, 2009. In accordance with this provision, the amount decreased by $41 in the first quarter of 2010 as a result of net unrealized losses resulting from valuation adjustments during this period.

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

The Board of Directors has set the targeted amount of restricted retained earnings at $1,800. The retained earnings restricted in accordance with this provision of the Retained Earnings and Dividend Policy totaled $1,186 at March 31, 2010, and $1,058 at December 31, 2009.

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

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

On April 29, 2010, the Bank’s Board of Directors declared a cash dividend for the first quarter of 2010 at an annualized dividend rate of 0.26%. The Bank recorded the first quarter dividend on April 29, 2010, the day it was declared by the Board of Directors. The Bank expects to pay the first quarter dividend (including dividends on mandatorily redeemable capital stock), which will total $9, on or about May 13, 2010. The Bank did not pay a dividend for the first quarter of 2009.

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

The Bank expects to pay the first quarter 2010 dividend in cash rather than stock form to comply with Finance Agency rules, which do not permit the Bank to pay dividends in the form of capital stock if the Bank’s excess stock (defined as any stock holdings in excess of a member’s minimum capital stock requirement, as established by the Bank’s capital plan) exceeds 1% of its total assets. As of March 31, 2010, the Bank’s excess capital stock totaled $7,368, or 4.24% of total assets.

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

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

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

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

Although the Bank did not repurchase excess capital stock in the first quarter of 2010, the five-year redemption period for $3 in mandatorily redeemable capital stock expired in the first quarter of 2010, and the Bank redeemed the stock at its $100 par value on the relevant expiration dates.

On April 29, 2010, the Bank announced that it plans to repurchase up to $500 in excess capital stock on May 14, 2010. The amount of excess capital stock to be repurchased from any shareholder will be based on the shareholder’s pro rata ownership share of total capital stock outstanding as of the repurchase date, up to the amount of the shareholder’s excess capital stock.

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

Excess capital stock totaled $7,368 as of March 31, 2010, which included surplus capital stock of $6,782.

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

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

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Concentration of Capital Stock

Including Mandatorily Redeemable Capital Stock

 

     March 31, 2010     December 31, 2009  
Name of Institution    Capital Stock
Outstanding
  

Percentage

of Total
Capital Stock
Outstanding

    Capital Stock
Outstanding
  

Percentage

of Total
Capital Stock
Outstanding

 

Citibank, N.A.

   $ 3,877    29   $ 3,877    29

JPMorgan Chase Bank, National Association

     2,695    20        2,695    20   

Wells Fargo Bank, N.A.

     1,567    12        1,567    12   

Subtotal

     8,139    61        8,139    61   

Others

     5,280    39        5,279    39   

Total

   $ 13,419    100   $ 13,418    100

Note 9 – Segment Information

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

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

The following table presents the Bank’s adjusted net interest income by operating segment and reconciles total adjusted net interest income to (loss)/income before assessments for the three months ended March 31, 2010 and 2009.

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Reconciliation of Adjusted Net Interest Income and Income Before Assessments

 

     Advances-
Related
Business
   Mortgage-
Related
Business(1)
   Adjusted
Net
Interest
Income
   Amortization  of
Deferred
Gains/(Losses)(2)
    Net Interest
Income/
(Expense)  on
Economic
Hedges(3)
    Interest
Expense on
Mandatorily
Redeemable
Capital
Stock(4)
   Net
Interest
Income
   Other
(Loss)/
Income
    Other
Expense
   Income
Before
Assessments
 

Three months ended:

                          

March 31, 2010

   $ 138    $ 138    $ 276    $ (20   $ (64   $ 3    $ 357    $ (195   $ 36    $ 126

March 31, 2009

     204      136      340      (9     (85          434      (236     31      167

 

(1) Does not include credit-related OTTI charges of $60 and $88 for the three months ended March 31, 2010 and 2009, respectively.

 

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

 

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

 

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

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

Total Assets

 

      Advances-
Related Business
   Mortgage-
Related Business
   Total
Assets

March 31, 2010

   $ 144,303    $ 29,548    $ 173,851

December 31, 2009

     161,406      31,456      192,862

Note 10 – Derivatives and Hedging Activities

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

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

Interest Rate Swaps – An interest rate swap is an agreement between two entities to exchange cash flows in the future. The agreement sets the dates on which the cash flows will be paid and the manner in which the cash flows will be calculated. One of the simplest forms of an interest rate swap involves the promise by one party to pay cash flows equivalent to the interest on a notional principal amount at a predetermined fixed rate for a

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

given period of time. In return for this promise, this party receives cash flows equivalent to the interest on the same notional principal amount at a variable rate index for the same period of time. The variable rate received or paid by the Bank in most interest rate exchange agreements is the London Inter-Bank Offered Rate (LIBOR).

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

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

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

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

Intermediation – As an additional service to its members, the Bank enters into offsetting interest rate exchange agreements, acting as an intermediary between exactly offsetting derivatives transactions with members and other counterparties. This intermediation allows members indirect access to the derivatives market. Derivatives in which the Bank is an intermediary may also arise when the Bank enters into derivatives to offset the economic effect of other derivatives that are no longer designated to advances, investments, or consolidated obligations. The offsetting derivatives used in intermediary activities do not receive hedge accounting treatment and are separately marked to market through earnings. The net result of the accounting for these derivatives does not significantly affect the operating results of the Bank. These amounts are recorded in other income and presented as “Net (loss)/gain on derivatives and hedging activities.”

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

The notional principal of the interest rate exchange agreements associated with derivatives with members and offsetting derivatives with other counterparties was $716 at March 31, 2010, and $616 at December 31, 2009. The Bank did not have any interest rate exchange agreements outstanding at March 31, 2010, and December 31, 2009, that were used to offset the economic effect of other derivatives that were no longer designated to advances, investments, or consolidated obligations.

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

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

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

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

The Bank executes callable swaps and purchases swaptions in conjunction with the issuance of certain consolidated obligations to create funding equivalent to fixed rate callable bonds. Although these derivatives are economic hedges against the prepayment risk of specific loan pools and are referenced to individual liabilities, they do not receive either fair value or cash flow hedge accounting treatment. The derivatives are

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

marked to market through earnings and are presented as “Net (loss)/gain on derivatives and hedging activities.”

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

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

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

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

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

Credit Risk – The Bank is subject to credit risk as a result of the risk of nonperformance by counterparties to the derivative agreements. All of the Bank’s derivative agreements contain master netting provisions to help mitigate the credit risk exposure to each counterparty. The Bank manages counterparty credit risk through credit analyses and collateral requirements and by following the requirements of the Bank’s risk management policies and credit guidelines. Based on the master netting provisions in each agreement, credit analyses, and

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

the collateral requirements in place with each counterparty, the Bank does not expect to incur any credit losses on derivative agreements.

The notional amount of an interest rate exchange agreement serves as a basis for calculating periodic interest payments or cash flows and is not a measure of the amount of credit risk from that transaction. The Bank had notional amounts outstanding of $212,127 and $235,014 at March 31, 2010, and December 31, 2009, respectively. The notional amount does not represent the exposure to credit loss. The amount potentially subject to credit loss is the estimated cost of replacing an interest rate exchange agreement that has a net positive market value if the counterparty defaults; this amount is substantially less than the notional amount.

Maximum credit risk is defined as the estimated cost of replacing all interest rate exchange agreements the Bank has transacted with counterparties where the Bank is in a net favorable position (has a net unrealized gain) if the counterparties all defaulted and the related collateral proved to be of no value to the Bank. At March 31, 2010, the Bank’s maximum credit risk, as defined above, was estimated at $1,919, including $440 of net accrued interest and fees receivable. At December 31, 2009, the Bank’s maximum credit risk was estimated at $1,827, including $399 of net accrued interest and fees receivable. Accrued interest and fees receivable and payable and the legal right to offset assets and liabilities by counterparty (under which amounts recognized for individual transactions may be offset against amounts recognized for other derivatives transactions with the same counterparty) are considered in determining the maximum credit risk. The Bank held cash, investment grade securities, and mortgage loans valued at $1,922 and $1,868 as collateral from counterparties as of March 31, 2010, and December 31, 2009, respectively. This collateral has not been sold or repledged . A significant number of the Bank’s interest rate exchange agreements are transacted with financial institutions such as major banks and highly rated derivatives dealers. Some of these financial institutions or their broker-dealer affiliates buy, sell, and distribute consolidated obligations. Assets pledged as collateral by the Bank to these counterparties are more fully discussed in Note 12 to the Financial Statements.

Certain of the Bank’s derivatives agreements contain provisions that link the Bank’s credit rating from each of the major credit rating agencies to various rights and obligations. In several of the Bank’s derivatives agreements, if the Bank’s debt rating falls below A, the Bank’s counterparty would have the right, but not the obligation, to terminate all of its outstanding derivatives transactions with the Bank. In addition, the amount of collateral that the Bank is required to deliver to a counterparty depends on the Bank’s credit rating. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a net derivative liability position (before cash collateral and related accrued interest) at March 31, 2010, was $97, for which the Bank had posted collateral of $40 in the normal course of business. If the credit rating of the Bank’s debt had been lowered to AAA/AA, then the Bank would have been required to deliver up to an additional $21 of collateral to its derivatives counterparties at March 31, 2010. The Bank’s credit ratings continue to be AAA/AAA.

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

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

Fair Values of Derivative Instruments

 

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

Derivatives designated as hedging instruments:

              

Interest rate swaps

   $ 101,419    $ 2,442      $ 578      $ 104,211    $ 2,476      $ 699   
                
Total      101,419      2,442        578        104,211      2,476        699   
                

Derivatives not designated as hedging instruments:

              

Interest rate swaps

     108,913      601        622        129,108      684        756   

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

     1,795      13        22        1,695      16        22   
                

Total

     110,708      614        644        130,803      700        778   
                

Total derivatives before netting and collateral adjustments

   $ 212,127      3,056        1,222      $ 235,014      3,176        1,477   
                      

Netting adjustments by counterparty

        (1,137     (1,137        (1,349     (1,349

Cash collateral and related accrued interest

        (1,390     25           (1,375     77   
                      

Total collateral and netting adjustments(1)

        (2,527     (1,112        (2,724     (1,272
                      

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

      $ 529      $ 110         $ 452      $ 205   
                      

 

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

The following table presents the components of net (loss)/gain on derivatives and hedging activities as presented in the Statements of Income for the three months ended March 31, 2010 and 2009.

 

     Three Months Ended  
     March 31,
2010
    March 31,
2009
 
       Gain/(Loss)        Gain/(Loss)   

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

    

Interest rate swaps

   $ 4      $ 16   

Total net gain related to fair value hedge ineffectiveness

     4        16   

Derivatives not designated as hedging instruments:

    

Economic hedges:

    

Interest rate swaps

     26        101   

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

     (2     2   

Net interest settlements

     (64     (85

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

     (40     18   

Net (loss)/gain on derivatives and hedging activities

   $ (36   $ 34   

The following table presents, by type of hedged item, the gains and losses on derivatives and the related hedged items in fair value hedging relationships and the impact of those derivatives on the Bank’s net interest income for the three months ended March 31, 2010 and 2009.

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

     Three Months Ended  
     March 31, 2010     March 31, 2009  
Hedged Item Type   

Gain/

(Loss) on
Derivative

  

Gain/

(Loss) on
Hedged
Item

   

Net Fair

Value Hedge
Ineffectiveness

    Effect of
Derivatives
on Net
Interest
Income(1)
   

Gain/

(Loss) on
Derivative

   

Gain/

(Loss) on
Hedged
Item

   

Net Fair

Value Hedge
Ineffectiveness

    Effect of
Derivatives
on Net
Interest
Income(1)
 
   

Advances

   $ 38    $ (39   $ (1   $ (168   $ 132      $ (168   $ (36   $ (191

Consolidated obligation bonds

     8      (3     5        511        (403     455        52        490   
   

Total

   $ 46    $ (42   $ 4      $ 343      $ (271   $ 287      $ 16      $ 299   
   

 

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

For the three months ended March 31, 2010 and 2009, there were no reclassifications from other comprehensive income/(loss) into earnings as a result of the discontinuance of cash flow hedges because the original forecasted transactions occurred by the end of the originally specified time period or within a two-month period thereafter.

As of March 31, 2010, the amount of unrecognized net losses on derivative instruments accumulated in other comprehensive income expected to be reclassified to earnings during the next 12 months was immaterial. The maximum length of time over which the Bank is hedging its exposure to the variability in future cash flows for forecasted transactions, excluding those forecasted transactions related to the payment of variable interest on existing financial instruments, is less than three months.

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

 

     March 31, 2010     December 31, 2009  
Type of Derivative and Hedge Classification    Notional
Amount of
Derivatives
  

Estimated

Fair Value

    Notional
Amount of
Derivatives
  

Estimated

Fair Value

 
   

Interest rate swaps:

          

Fair value

   $ 101,419    $ 1,436      $ 104,211    $ 1,392   

Economic

     108,913      (46     129,108      (78

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

          

Economic

     1,795      (8     1,695      (6
   

Total

   $ 212,127    $ 1,382      $ 235,014    $ 1,308   
   

Total derivatives excluding accrued interest

      $ 1,382         $ 1,308   

Accrued interest, net

        452           391   

Cash collateral held from counterparties – liabilities(1)

        (1,415        (1,452
   

Net derivative balances

      $ 419         $ 247   
   

Derivative assets

      $ 529         $ 452   

Derivative liabilities

        (110        (205
   

Net derivative balances

      $ 419         $ 247   
   

 

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

Embedded derivatives are bifurcated, and their estimated fair values are accounted for in accordance with the accounting for derivative instruments and hedging activities. The estimated fair values of the embedded derivatives are included as valuation adjustments to the host contract and are not included in the table above.

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

The estimated fair values of these embedded derivatives were immaterial as of March 31, 2010, and December 31, 2009.

Note 11 – Fair Values

Fair Value Measurement. Fair value measurement guidance defines fair value, establishes a framework for measuring fair value under U.S. GAAP, and expands disclosures about fair value measurements. The Bank adopted the fair value measurement guidance on January 1, 2008. This guidance applies whenever other accounting pronouncements require or permit assets or liabilities to be measured at fair value. The Bank uses fair value measurements to record fair value adjustments for certain financial assets and liabilities and to determine fair value disclosures.

Fair value is defined as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. Fair value is a market-based measurement, and the price used to measure fair value is an exit price considered from the perspective of the market participant that holds the asset or owes the liability.

This guidance establishes a three-level fair value hierarchy that prioritizes the inputs into the valuation techniques used to measure fair value. The fair value hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are as follows:

 

   

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

 

   

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

 

   

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

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

In general, fair values are based on quoted or market list prices in the principal market when they are available. If listed prices or quotes are not available, fair values are based on dealer prices and prices of similar instruments. If dealer prices and prices of similar instruments are not available, fair value is based on internally developed models that use primarily market-based or independently sourced inputs, including interest rate yield curves and option volatilities. Adjustments may be made to fair value measurements to ensure that financial instruments are recorded at fair value.

The following assets and liabilities, including those for which the Bank has elected the fair value option, are carried at fair value on the Statements of Condition as of March 31, 2010:

 

   

Trading securities

 

   

Available-for-sale securities

 

   

Certain advances

 

   

Derivative assets and liabilities

 

   

Certain consolidated obligation bonds

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

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

March 31, 2010

 

     Fair Value Measurement Using:    Netting      
      Level 1    Level 2    Level 3    Adjustments(1)     Total

Assets:

             

Trading securities:

             

GSEs:

             

Fannie Mae

   $    $ 7    $    $      $ 7

Other U.S. obligations:

             

Ginnie Mae

          22                  22

Total trading securities

          29                  29

Available-for-sale securities (TLGP)

          1,929                  1,929

Advances(2)

          18,602                  18,602

Derivative assets (interest-rate related)

          3,056           (2,527     529

Total assets

   $    $ 23,616    $    $ (2,527   $ 21,089

Liabilities:

             

Consolidated obligation bonds(3)

   $    $ 24,865    $    $      $ 24,865

Derivative liabilities (interest-rate related)

          1,222           (1,112     110

Total liabilities

   $    $ 26,087    $    $ (1,112   $ 24,975

December 31, 2009

 

     Fair Value Measurement Using:    Netting      
      Level 1    Level 2    Level 3    Adjustments(1)     Total

Assets:

             

Trading securities:

             

GSEs:

             

Fannie Mae

   $    $ 8    $    $      $ 8

Other U.S. obligations:

             

Ginnie Mae

          23                  23

Total trading securities

          31                  31

Available-for-sale securities (TLGP)

          1,931                  1,931

Advances(2)

          22,952                  22,952

Derivative assets (interest-rate related)

          3,176           (2,724     452

Total assets

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

Liabilities:

             

Consolidated obligation bonds(3)

   $    $ 38,173    $    $      $ 38,173

Derivative liabilities (interest-rate related)

          1,477           (1,272     205

Total liabilities

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

 

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

 

(2) Includes $17,459 and $21,616 of advances recorded under the fair value option at March 31, 2010, and December 31, 2009, respectively, and $1,143 and $1,336 of advances recorded at fair value in accordance with the accounting for derivative instruments and hedging activities at March 31, 2010, and December 31, 2009, respectively.

 

(3) Includes $24,241 and $37,022 of consolidated obligation bonds recorded under the fair value option at March 31, 2010, and December 31, 2009, respectively, and $624 and $1,151 of consolidated obligation bonds recorded at fair value in accordance with the accounting for derivatives instruments and hedging activities at March 31, 2010, and December 31, 2009, respectively.

For instruments carried at fair value, the Bank reviews the fair value hierarchy classifications on a quarterly basis. Changes in the observability of the valuation attributes may result in a reclassification of certain

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

financial assets or liabilities. Such reclassifications are reported as transfers in/out at fair value in the quarter in which the changes occur. For the periods presented, the Bank did not have any reclassifications for transfers in/out of the fair value hierarchy levels.

Valuation Methodologies and Significant Inputs for Assets and Liabilities Measured at Fair Value on a Recurring Basis. The following valuation methodologies and significant inputs were applied to all of the assets and liabilities carried at fair value, whether as a result of certain accounting requirements or election of the fair value option.

Trading Securities – The Bank’s trading securities portfolio currently consists of agency residential MBS investments collateralized by residential mortgages. These securities are recorded at fair value on a recurring basis. In 2008, fair value measurement was based on pricing models or other model-based valuation techniques, such as the present value of future cash flows adjusted for the security’s credit rating, prepayment assumptions, and other factors such as credit loss assumptions. In an effort to achieve consistency among all the FHLBanks in applying a fair value methodology, the FHLBanks formed the MBS Pricing Governance Committee with the responsibility for developing a fair value methodology that all FHLBanks could adopt. Under the methodology approved by the MBS Pricing Governance Committee and adopted by the Bank, the Bank’s valuation technique incorporates prices for all MBS from up to four specific third-party vendors. These pricing vendors use methods that generally employ, but are not limited to, trading input (recent trade information, dealer quotations, evaluation of benchmark securities), calculated input (reverse engineered model input factors such as benchmark yields, prepayments speeds), evaluation models, and asset type groupings/matrix pricing. Depending on the number of prices received for each security, the Bank selects a median or average price as determined by the methodology. The methodology also incorporates variance thresholds to assist in identifying median or average prices that may require further review. In certain limited instances (for example, when prices are outside of variance thresholds or the third-party services do not provide a price), the Bank will obtain a price from securities dealers or internally model a price that is deemed appropriate after consideration of the relevant facts and circumstances that a market participant would consider. Prices for agency residential MBS held in common with other FHLBanks are reviewed with those FHLBanks for consistency. As of March 31, 2010, substantially all of the Bank’s MBS holdings were priced using this valuation technique. Because quoted prices are not available for these securities, the Bank has primarily relied on the pricing vendors’ use of market-observable inputs and model-based valuation techniques for the fair value measurements, and the Bank classifies these investments as Level 2 within the valuation hierarchy.

The contractual interest income on the trading securities is recorded as part of net interest income on the Statements of Income. The remaining changes in the fair values of the trading securities are included in the other income section on the Statements of Income.

Available-for-Sale Securities – The Bank’s available-for-sale securities portfolio currently consists of corporate debentures issued under the TLGP, which are guaranteed by the FDIC and backed by the full faith and credit of the U.S. government. These securities are recorded at fair value on a recurring basis. In determining the estimated fair value, the Bank requests prices from four specific third-party vendors. Depending on the number of prices received for each security, the Bank selects a median or average price as determined by the methodology. The methodology also incorporates variance thresholds to assist in identifying median or average prices that may require further review. The Bank has relied on the pricing vendors’ valuation methodology, which includes quoted prices or observable inputs from an active market for similar assets, and the Bank considers these to be Level 2 inputs.

Advances – Certain advances either elected for the fair value option or accounted for in a qualifying full fair value hedging relationship are recorded at fair value on a recurring basis. Because quoted prices are not available for advances, the fair values are measured using model-based valuation techniques (such as the

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

present value of future cash flows), creditworthiness of members, advance collateral types, prepayment assumptions, and other factors, such as credit loss assumptions, as necessary.

Because no principal market exists for the sale of advances, the Bank has defined the most advantageous market as a hypothetical market in which an advance sale could occur with a hypothetical financial institution. The Bank’s primary inputs for measuring the fair value of advances are market-based consolidated obligation yield curve (CO Curve) inputs obtained from the Office of Finance and provided to the Bank. The CO Curve is then adjusted to reflect the rates on replacement advances with similar terms and collateral. These spread adjustments are not market-observable and are evaluated for significance in the overall fair value measurement and fair value hierarchy level of the advance. As of March 31, 2010, the spread adjustment to the CO Curve ranged from 1 to 16 basis points for advances carried at fair value. The Bank obtains market-observable inputs from derivatives dealers for complex advances. These inputs may include volatility assumptions, which are market-based expectations of future interest rate volatility implied from current market prices for similar options (swaptions volatilities). Pursuant to the Finance Agency’s advances regulation, advances with an original term to maturity or repricing period greater than six months generally require a prepayment fee sufficient to make the Bank financially indifferent to the borrower’s decision to prepay the advances, and the Bank has determined that no adjustment is required to the fair value measurement of advances for prepayment fees. The inputs used in the Bank’s fair value measurement of these advances are primarily market-observable, and the Bank classifies these advances as Level 2 within the valuation hierarchy.

The contractual interest income on advances is recorded as part of net interest income on the Statements of Income. The remaining changes in fair values of the advances are included in the other income section on the Statements of Income.

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

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

The inputs used in the Bank’s fair value measurement of these derivative instruments are primarily market-observable, and the Bank classifies these derivatives as Level 2 within the valuation hierarchy. The fair values are netted by counterparty pursuant to the provisions of the Bank’s master derivatives agreements. If these netted amounts are positive, they are classified as an asset and, if negative, as a liability.

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

The Bank records all derivative instruments on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in net gain/(loss) on derivatives and hedging activities or other comprehensive income, depending on whether or not a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. The gains and losses on derivative instruments that are reported in other comprehensive income are recognized as earnings in the periods in which earnings are affected by the variability of the cash flows of the hedged item. The difference between the gains or losses on derivatives and on the related hedged items that qualify for fair value hedge accounting represents hedge ineffectiveness and is recognized in net gain/(loss) on derivatives and hedging activities. Changes in the fair value of a derivative instrument that does not qualify as a hedge of an asset or liability for asset and liability management purposes (economic hedge) are also recorded each period in net gain/(loss) on derivatives and hedging activities. For additional information, see Note 10 to the Financial Statements.

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

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

The inputs used in the Bank’s fair value measurement of these consolidated obligation bonds are primarily market-observable, and the Bank generally classifies these consolidated obligation bonds as Level 2 within the valuation hierarchy. For complex transactions, market-observable inputs may not be available and the inputs are evaluated to determine whether they may result in a Level 3 classification in the fair value hierarchy.

The contractual interest expense on the consolidated obligation bonds is recorded as net interest income on the Statements of Income. The remaining changes in fair values of the consolidated obligation bonds are included in the other income section on the Statements of Income.

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

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

March 31, 2010

 

      Fair Value Measurement Using:
      Level 1    Level 2    Level 3

Assets:

        

Held-to-maturity securities – PLRMBS

   $    $    $ 1,178

PLRMBS with a carrying value of $1,370 were written down to their fair value of $1,178.

December 31, 2009

 

      Fair Value Measurement Using:
      Level 1    Level 2    Level 3

Assets:

        

Held-to-maturity securities – PLRMBS

   $    $    $ 1,880

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

To determine the estimated fair value of PLRMBS prior to September 30, 2009, the Bank used a weighting of its internal price (based on valuation models using market-based inputs obtained from broker-dealer data and price indications) and the price from an external pricing service to determine the estimated fair value that the Bank believed market participants would use to purchase the PLRMBS. The divergence among prices obtained from third-party broker/dealers and pricing services, which were derived from third parties’ proprietary models, led the Bank to conclude that the prices received were reflective of significant unobservable inputs. Because of the significant unobservable inputs used by the pricing services, the Bank considered these to be Level 3 inputs.

Beginning with the quarter ended September 30, 2009, the Bank changed the methodology used to estimate the fair value of PLRMBS. In an effort to achieve consistency among all the FHLBanks in applying a fair value methodology, the FHLBanks formed the MBS Pricing Governance Committee with the responsibility for developing a fair value methodology that all FHLBanks could adopt. Under the methodology approved by the MBS Pricing Governance Committee and adopted by the Bank, the Bank requests prices for all MBS from four specific third-party vendors. These pricing vendors use methods that generally employ, but are not limited to, trading input (recent trade information, dealer quotations, evaluation of benchmark securities), calculated input (reverse engineered model input factors such as benchmark yields, prepayments speeds), evaluation models, and asset type groupings/matrix pricing. Depending on the number of prices received for each security, the Bank selects a median or average price as determined by the methodology. The methodology also incorporates variance thresholds to assist in identifying median or average prices that may require further review. In certain limited instances (for example, when prices are outside of variance thresholds or the third-party services do not provide a price), the Bank will obtain a price from securities dealers or internally model a price that is deemed appropriate after consideration of the relevant facts and circumstances that a market participant would consider. Prices for PLRMBS held in common with other FHLBanks are reviewed with those FHLBanks for consistency. In adopting this common methodology, the Bank remains responsible for the selection and application of its fair value methodology and the reasonableness of assumptions and inputs used.

As of March 31, 2010, the Bank employed the fair value methodology described above, and four vendor prices were received for substantially all of the Bank’s MBS holdings. Substantially all of those prices fell within the specified thresholds, providing additional support for the Bank’s conclusion that the final computed prices are reasonable estimates of fair value. Based on the current lack of significant market activity for PLRMBS, the

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

non-recurring fair value measurements for such securities as of December 31, 2009, and March 31, 2010, fell within Level 3 of the fair value hierarchy.

Fair Value Option. The fair value option permits an entity to elect fair value as an alternative measurement for selected financial assets, financial liabilities, unrecognized firm commitments, and written loan commitments not previously carried at fair value. The Bank elected the fair value option for certain financial instruments on January 1, 2008, as follows.

 

   

Adjustable rate credit advances with embedded options

 

   

Callable fixed rate credit advances

 

   

Putable fixed rate credit advances

 

   

Putable fixed rate credit advances with embedded options

 

   

Fixed rate credit advances with partial prepayment symmetry

 

   

Callable or non-callable capped floater consolidated obligation bonds

 

   

Convertible consolidated obligation bonds

 

   

Floating or fixed rate range accrual consolidated obligation bonds

 

   

Ratchet consolidated obligation bonds

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

 

   

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

 

   

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

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

 

   

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

 

   

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

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

The fair value option requires entities to display the fair value of those assets and liabilities for which the entity has chosen to use fair value on the face of the balance sheet. Under the fair value option, fair value is used for both the initial and subsequent measurement of the designated assets, liabilities, and commitments, with the changes in fair value recognized in other income and presented as “Net loss on advances and consolidated obligation bonds held at fair value.”

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

The following table summarizes the activity related to financial assets and liabilities for which the Bank elected the fair value option during the three months ended March 31, 2010 and 2009:

 

     Three Months Ended  
     March 31, 2010     March 31, 2009  
     Advances     Consolidated
Obligation Bonds
    Advances     Consolidated
Obligation Bonds
 
   

Balance, beginning of the period

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

New transactions elected for fair value option

     73        7,751        43        13,660   

Maturities and terminations

     (4,134     (20,562     (2,735     (7,671

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

     (80     20        (191     (8

Change in accrued interest

     (16     10        (14     (5
   

Balance, end of the period

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

For advances and consolidated obligations recorded under the fair value option, the estimated impact of changes in credit risk for the three months ended March 31, 2010 and 2009, was immaterial.

The following table presents the changes in fair value included in the Statements of Income for each item for which the fair value option has been elected for the three months ended March 31, 2010 and 2009:

 

     Three Months Ended  
     March 31, 2010     March 31, 2009  
      Interest
Income on
Advances
   Interest
Expense on
Consolidated
Obligation
Bonds
    Net Gain/
(Loss) on
Advances and
Consolidated
Obligation
Bonds Held
at Fair Value
    Total Changes
in Fair Value
Included in
Current Period
Earnings
    Interest
Income on
Advances
   Interest
Expense on
Consolidated
Obligation
Bonds
    Net Gain/
(Loss) on
Advances and
Consolidated
Obligation
Bonds Held
at Fair Value
    Total Changes
in Fair Value
Included in
Current Period
Earnings
 

Advances

   $ 166    $      $ (80   $ 86      $ 319    $      $ (191   $ 128   

Consolidated obligation bonds

          (61     (20     (81          (46     8        (38

Total

   $ 166    $ (61   $ (100   $ 5      $ 319    $ (46   $ (183   $ 90   

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

 

     At March 31, 2010     At December 31, 2009  
      Principal Balance    Fair Value    Fair Value
Over/(Under)
Principal Balance
    Principal Balance    Fair Value    Fair Value
Over/(Under)
Principal Balance
 

Advances(1)

   $ 16,943    $ 17,459    $ 516      $ 21,000    $ 21,616    $ 616   

Consolidated obligation bonds

     24,264      24,241      (23     37,075      37,022      (53

 

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

Estimated Fair Values. The tables show the estimated fair values of the Bank’s financial instruments at March 31, 2010, and December 31, 2009. These estimates are based on pertinent information available to the

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Bank as of March 31, 2010, and December 31, 2009. Although the Bank uses its best judgment in estimating the fair value of these financial instruments, there are inherent limitations in any estimation technique or valuation methodology. For example, because an active secondary market does not exist for a portion of the Bank’s financial instruments, in certain cases fair values are not subject to precise quantification or verification and may change as economic and market factors, and evaluation of those factors, change. Therefore, these estimated fair values are not necessarily indicative of the amounts that would be realized in current market transactions, although they do reflect the Bank’s judgment of how market participants would estimate fair values. The fair value summary tables do not represent an estimate of the overall market value of the Bank as a going concern, which would take into account future business opportunities.

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

The assumptions used in estimating the fair values of the Bank’s financial instruments are discussed below.

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

Federal Funds Sold – The estimated fair value of these instruments has been determined based on quoted prices or by calculating the present value of expected cash flows for the instruments excluding accrued interest. The discount rates used in these calculations are the replacement rates for comparable instruments with similar terms.

Trading and Available-for-Sale Securities – The estimated fair value of trading securities is measured as described in “Fair Value Measurement – Trading Securities” above and the estimated fair value of available-for-sale securities is measured as described in “Fair Value Measurement – Available-for-Sale Securities” above.

Held-to-Maturity Securities – The estimated fair value of held-to-maturity MBS is measured as described in “Nonrecurring Fair Value Measurements” above. The estimated fair value of all other instruments is determined based on each security’s quoted price, or prices obtained from pricing services, excluding accrued interest, as of the last business day of the period, or when quoted prices are not available, the estimated fair value is determined by calculating the present value of expected cash flows, excluding interest, using market-observable inputs as of the last business day of the period, or by using industry standard analytical models and certain actual and estimated market information. The discount rates used in these calculations are the replacement rates for comparable instruments with similar terms.

Advances – The estimated fair value of these instruments is measured as described in “Fair Value Measurement – Advances” above.

Mortgage Loans Held for Portfolio – The estimated fair value for mortgage loans represents modeled prices based on observable market spreads for agency passthrough MBS adjusted for differences in credit, coupon, average loan rate, and seasoning. Market prices are highly dependent on the underlying prepayment assumptions. Changes in the prepayment speeds often have a material effect on the fair value estimates.

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

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

Derivative Assets and Liabilities – The estimated fair value of these instruments is measured as described in “Fair Value Measurement – Derivative Assets and Derivative Liabilities” above.

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

Consolidated Obligations – The estimated fair value of these instruments is measured as described in “Fair Value Measurement – Consolidated Obligation Bonds” above.

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

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

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Fair Value of Financial Instruments

 

     March 31, 2010    December 31, 2009
     

Carrying

Value

  

Estimated

Fair Value

   Carrying
Value
  

Estimated

Fair Value

Assets

           

Cash and due from banks

   $ 2,942    $ 2,942    $ 8,280    $ 8,280

Federal funds sold

     17,839      17,839      8,164      8,164

Trading securities

     29      29      31      31

Available-for-sale securities

     1,929      1,929      1,931      1,931

Held-to-maturity securities

     34,586      33,923      36,880      35,682

Advances (includes $17,459 and $21,616 at fair value under the fair value option, respectively)

     112,139      112,310      133,559      133,778

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

     2,909      3,008      3,037      3,117

Accrued interest receivable

     220      220      355      355

Derivative assets(1)

     529      529      452      452

Liabilities

           

Deposits

     131      131      224      224

Consolidated obligations:

           

Bonds (includes $24,241 and $37,022 at fair value under the fair value option, respectively)

     136,588      136,744      162,053      162,220

Discount notes

     24,764      24,765      18,246      18,254

Mandatorily redeemable capital stock

     4,858      4,858      4,843      4,843

Accrued interest payable

     705      705      754      754

Derivative liabilities(1)

     110      110      205      205

Other

           

Standby letters of credit

     26      26      27      27

 

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

As of March 31, 2010, the Bank’s investment in held-to-maturity securities had net unrecognized holding losses totaling $663. These net unrecognized holding losses were primarily in MBS and were primarily due to illiquidity in the MBS market, uncertainty about the future condition of the housing and mortgage markets and the economy, and continued deterioration in the credit performance of loan collateral underlying these securities, which caused these assets to be valued at significant discounts to their acquisition cost. For more information, see Note 4 to the Financial Statements.

As of December 31, 2009, the Bank’s investment in held-to-maturity securities had net unrecognized holding losses totaling $1,198. These net unrecognized holding losses were primarily in MBS and were primarily due to illiquidity in the 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. For more information, see Note 6 to the Financial Statements in the Bank’s 2009 Form 10-K.

Note 12 – Commitments and Contingencies

As provided by the FHLBank Act or regulations governing the operations of the FHLBanks, all FHLBanks have joint and several liability for all FHLBank consolidated obligations, which are backed only by the financial resources of the FHLBanks. The joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor. The Bank has never been asked or required to repay the

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

principal or interest on any consolidated obligation on behalf of another FHLBank, and as of March 31, 2010, and through the filing date of this report, does not believe that is probable that it will be asked to do so. The par amount of the outstanding consolidated obligations of all 12 FHLBanks was $870,928 at March 31, 2010, and $930,617 at December 31, 2009. The par value of the Bank’s participation in consolidated obligations was $159,224 at March 31, 2010, and $178,186 at December 31, 2009. For more information on the joint and several liability regulation, see Note 18 to the Financial Statements in the Bank’s 2009 Form 10-K.

Commitments that legally obligate the Bank for additional advances totaled $500 at March 31, 2010, and $32 at December 31, 2009. Advance commitments are generally for periods up to 12 months. Standby letters of credit are generally issued for a fee on behalf of members to support their obligations to third parties. A standby letter of credit is a financing agreement between the Bank and its member. If the Bank is required to make payment for a beneficiary’s drawing under a letter of credit, the amount is charged to the member’s demand deposit account with the Bank. The Bank’s outstanding standby letters of credit at March 31, 2010, and December 31, 2009, were as follows:

 

      March 31, 2010    December 31, 2009

Outstanding notional

   $5,220    $5,269

Original terms

   19 days to 10 years    23 days to 10 years

Final expiration year

   2020    2019

The value of the guarantees related to standby letters of credit is recorded in other liabilities and amounted to $26 at March 31, 2010, and $27 at December 31, 2009. Based on management’s credit analyses of members’ financial condition and collateral requirements, no allowance for losses is deemed necessary by management on these advance commitments and letters of credit. Advances funded under these advance commitments and letters of credit are fully collateralized at the time of funding or issuance (see Note 5 to the Financial Statements). The estimated fair value of advance commitments and letters of credit was immaterial to the balance sheet as of March 31, 2010, and December 31, 2009.

The Bank executes interest rate exchange agreements with major banks and derivatives entities affiliated with broker-dealers that have, or are supported by, guarantees from related entities that have long-term credit ratings equivalent to single-A or better from both Standard & Poor’s and Moody’s. The Bank also executes interest rate exchange agreements with its members. The Bank enters into master agreements with netting provisions with all counterparties and into bilateral security agreements with all active derivatives dealer counterparties. All member counterparty master agreements, excluding those with derivatives dealers, are subject to the terms of the Bank’s Advances and Security Agreement with members, and all member counterparties (except for those that are derivatives dealers) must fully collateralize the Bank’s net credit exposure. As of March 31, 2010, the Bank had pledged as collateral securities with a carrying value of $40, all of which could be sold or repledged, to counterparties that have market risk exposure from the Bank related to derivatives. As of December 31, 2009, the Bank had pledged as collateral securities with a carrying value of $40, all of which could be sold or repledged, to counterparties that had market risk exposure from the Bank related to derivatives.

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

At March 31, 2010, the Bank had committed to the issuance of $1,816 in consolidated obligation bonds, of which $1,771 were hedged with associated interest rate swaps. At December 31, 2009, the Bank had committed to the issuance of $1,090 in consolidated obligation bonds, of which $1,000 were hedged with associated interest rate swaps.

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

The Bank entered into interest rate exchange agreements that had traded but not yet settled with notional amounts totaling $2,416 at March 31, 2010, and $1,110 at December 31, 2009.

Other commitments and contingencies are discussed in Notes 5, 6, 7, 8, and 10 to the Financial Statements.

Note 13 – Transactions with Certain Members, Certain Nonmembers, and Other FHLBanks

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

 

      March 31, 2010    December 31, 2009

Assets:

     

Cash and due from banks

   $ 2    $

Federal funds sold

     1,758     

Held-to-maturity securities(1)

     2,415      2,638

Advances

     65,155      87,701

Mortgage loans held for portfolio

     2,301      2,391

Accrued interest receivable

     55      150

Derivative assets

     934      956

Total

   $ 72,620    $ 93,836

Liabilities:

     

Deposits

   $ 944    $ 993

Mandatorily redeemable capital stock

     4,311      4,311

Total

   $ 5,255    $ 5,304

Notional amount of derivatives

   $ 59,005    $ 55,152

Standby letters of credit

     3,838      3,885

 

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

 

     Three Months Ended  
     March 31, 2010     March 31, 2009  
   

Interest Income:

    

Held-to-maturity securities

   $ 26      $ 44   

Advances(1)

     170        724   

Mortgage loans held for portfolio

     29        35   
   

Total

   $ 225      $ 803   
   

Interest Expense:

    

Mandatorily redeemable capital stock

   $ 3      $   

Consolidated obligations(1)

     (185     (144
   

Total

   $ (182   $ (144
   

Other Income/(Loss):

    

Net loss on derivatives and hedging activities

   $ 3      $ (73

Other income

     1        1   
   

Total

   $ 4      $ (72
   

 

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

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

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

Note 14 – Subsequent Events

The Bank has evaluated events subsequent to March 31, 2010, until the time of the Form 10-Q filing with the SEC, and no material subsequent events were identified, other than those discussed below.

On April 29, 2010, the Bank announced that it plans to repurchase up to $500 in excess capital stock on May 14, 2010. The amount of excess capital stock to be repurchased from any shareholder will be based on the shareholder’s pro rata ownership share of total capital stock outstanding as of the repurchase date, up to the amount of the shareholder’s excess capital stock.

On April 29, 2010, the Bank’s Board of Directors declared a cash dividend for the first quarter of 2010 at an annualized dividend rate of 0.26%. The Bank recorded the first quarter dividend on April 29, 2010, the day it was declared by the Board of Directors. The Bank expects to pay the first quarter dividend (including dividends on mandatorily redeemable capital stock), which will total $9, on or about May 13, 2010. The Bank expects to pay the dividend in cash rather than stock form to comply with Finance Agency rules.

 

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

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

 

   

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

 

   

the volatility of market prices, rates, and indices;

 

   

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

 

   

changes in the Bank’s capital structure;

 

   

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

 

   

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

 

   

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

 

   

changes in the demand by Bank members for Bank advances;

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

the ability of the Bank to introduce new products and services to meet market demand and to manage successfully the risks associated with new products and services;

 

   

the ability of each of the other FHLBanks to repay the principal and interest on consolidated obligations for which it is the primary obligor and with respect to which the Bank has joint and several liability;

 

   

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

 

   

the timing and volume of market activity.

 

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

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

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

Quarterly Overview

The U.S. economy and financial markets continued a moderate recovery during the first quarter of 2010, although the strength and sustainability of this trend remain uncertain. Some improvement in both new and used home sales, partially in response to Federal tax credits, has been noted, but housing markets remain burdened by the prospect of continuing delinquencies and foreclosures. Housing prices still face downward pressure in many markets, although some markets are beginning to stabilize, depending on local conditions. Challenging real estate market conditions continued to affect the Bank’s business and results of operations as well as our members’ operations during the quarter.

Net income for the first quarter of 2010 fell $30 million, or 24%, to $93 million from $123 million in the first quarter of 2009. The decrease primarily reflected a decline in net interest income and an increase in net losses associated with derivatives, hedged items, and financial instruments carried at fair value, partially offset by a decrease in other-than-temporary impairment (OTTI) charges on some of the private-label residential mortgage-backed securities (PLRMBS) in the Bank’s held-to-maturity securities portfolio.

Net interest income for the first quarter of 2010 fell $77 million, or 18%, to $357 million from $434 million for the first quarter of 2009. The decrease in net interest income was primarily driven by a significant decline in advances. In addition, net interest income for the first quarter of 2010 reflected a lower net interest spread on advances, as favorably priced short-term debt issued in the fourth quarter of 2008 matured by yearend 2009. Net interest income on economically hedged assets and liabilities, which is generally offset by net interest expense on derivative instruments used in economic hedges (reflected in other income), was also lower in the first quarter of 2010 relative to the year-earlier period. The effect of these factors on net interest income was partially offset by higher net interest spreads on the mortgage portfolio and other investments.

Other income for the first quarter of 2010 was a net loss of $195 million, compared to a net loss of $236 million for the first quarter of 2009. Net interest expense on derivative instruments used in economic hedges, which was generally offset by net interest income on the economically hedged assets and liabilities, totaled $64 million in the first quarter of 2010, compared to $85 million in the first quarter of 2009. In addition, the losses in other income for the first quarter of 2010 reflected a credit-related OTTI charge of $60 million on certain PLRMBS, compared to a credit-related OTTI charge of $88 million in the prior year period, and a net loss of $72 million associated with derivatives, hedged items, and financial instruments carried at fair value, compared to a net loss of $63 million in the year-earlier period.

 

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The $72 million net loss associated with derivatives, hedged items, and financial instruments carried at fair value for the first quarter of 2010 increased relative to the $63 million net loss for the first quarter of 2009. This increase was primarily driven by larger reversals of prior period gains and changes in interest rates and swaption volatilities. Net gains and losses on these financial instruments are primarily a matter of timing and will generally reverse through changes in future valuations and settlements of contractual interest cash flows over the remaining contractual terms to maturity, or by the exercised call or put dates. As of March 31, 2010, the Bank had a cumulative net gain of $140 million associated with derivatives, hedged items, and financial instruments carried at fair value.

The credit-related OTTI charges of $60 million for the first quarter of 2010 represent additional projected credit losses on the loan collateral underlying some of 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 supporting the Bank’s PLRMBS and revises the assumptions in its collateral loss projection models based on more recent information, as necessary. The increases in projected collateral loss rates in the Bank’s OTTI analysis in the first quarter of 2010 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 lower forecasted housing prices and greater-than-expected deterioration in the credit quality of the loan collateral.

The non-credit-related OTTI charges on the affected PLRMBS recorded in other comprehensive income were $132 million for the first quarter of 2010 and $1.1 billion for the first quarter of 2009. For each security, the amount of the non-credit-related impairment is accreted prospectively, based on the amount and timing of future estimated cash flows, over the remaining life of the security as an increase in the carrying value of the security, with no effect on earnings unless the security is subsequently sold or there are additional decreases in the cash flows expected to be collected. The Bank does not intend to sell these securities and it is not more likely than not that the Bank will be required to sell these securities before its anticipated recovery of the remaining amortized cost basis. At March 31, 2010, the estimated weighted average life of the affected securities was approximately four years.

Additional information about investments and OTTI charges associated with the Bank’s PLRMBS is provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – Investments” and in Note 4 to the Financial Statements. Additional information about the Bank’s PLRMBS is also provided in “Part II. Item 1. Legal Proceedings.”

On April 29, 2010, the Bank’s Board of Directors declared a cash dividend for the first quarter of 2010 at an annualized rate of 0.26%. The Bank recorded the first quarter dividend on April 29, 2010, the day it was declared by the Board of Directors. The Bank expects to pay the dividend (including dividends on mandatorily redeemable capital stock), which will total $9 million, on or about May 13, 2010. The Bank expects to pay the dividend in cash rather than stock form to comply with Finance Agency rules, which do not permit the Bank to pay dividends in the form of capital stock if the Bank’s excess capital stock exceeds 1% of its total assets. As of March 31, 2010, the Bank’s excess capital stock totaled $7.4 billion, or 4% of total assets.

As of March 31, 2010, the Bank was in compliance with all of its regulatory capital requirements. The Bank’s total regulatory capital ratio was 8.48%, exceeding the 4.00% requirement. The Bank had $14.7 billion in regulatory capital, exceeding its risk-based capital requirement of $5.6 billion.

 

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In light of the Bank’s strengthened regulatory capital position, the Bank plans to repurchase up to $500 million in excess capital stock on May 14, 2010. The amount of excess capital stock to be repurchased from any shareholder will be based on the shareholder’s pro rata ownership share of total capital stock outstanding as of the repurchase date, up to the amount of the shareholder’s excess capital stock.

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

During the first quarter of 2010, total assets decreased $19.0 billion, or 10%, to $173.9 billion at March 31, 2010, from $192.9 billion at December 31, 2009. Total advances declined $21.5 billion, or 16%, to $112.1 billion at March 31, 2010, from $133.6 billion at December 31, 2009. The continued decline in member advance demand reflected general economic conditions. Members also had ample deposits and access to a number of other funding options, including a variety of government lending programs. Held-to-maturity securities decreased to $34.6 billion at March 31, 2010, from $36.9 billion at December 31, 2009, primarily because of principal payments, prepayments, and maturities in the MBS portfolio and OTTI charges recognized on the PLRMBS. In addition, the Bank did not purchase any MBS during the first quarter of 2010. Cash and due from banks decreased to $2.9 billion at March 31, 2010, from $8.3 billion at December 31, 2009. The decrease was primarily offset by an increase in Federal funds sold. During the first quarter of 2010, Federal funds sold increased $9.6 billion, to $17.8 billion at March 31, 2010, from $8.2 billion at December 31, 2009.

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

Four member institutions were placed into receivership or liquidation during the first quarter of 2010. All of these institutions had advances outstanding at the time they were placed into receivership or liquidation. The advances outstanding to these four institutions were either repaid prior to March 31, 2010, or assumed by other institutions, and no losses were incurred by the Bank. The Bank capital stock held by three of the four institutions totaling $18 million was classified as mandatory redeemable capital stock (a liability). The capital stock of the other institution was transferred to another member institution.

From April 1, 2010, to April 30, 2010, two member institutions were placed into receivership. The outstanding advances and capital stock of one institution were assumed by a member institution. The advances outstanding to the other institution were assumed by another member institution, however the Bank capital stock totaling $9 million was not acquired by the member institution and was classified as mandatorily redeemable capital stock (a liability).

 

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Financial Highlights

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

Financial Highlights

(Unaudited)

 

(Dollars in millions)   

March 31,

2010

   

December 31,

2009

   

September 30,

2009

   

June 30,

2009

   

March 31,

2009

 
   

Selected Balance Sheet Items at Quarter End

          

Total Assets

   $ 173,851      $ 192,862      $ 211,212      $ 238,924      $ 270,287   

Advances

     112,139        133,559        154,962        174,732        203,904   

Mortgage Loans Held for Portfolio, Net

     2,909        3,037        3,172        3,357        3,586   

Investments(1)

     54,383        47,006        45,943        58,933        59,601   

Consolidated Obligations:(2)

          

Bonds

     136,588        162,053        154,869        176,200        189,382   

Discount Notes

     24,764        18,246        43,901        49,009        66,239   

Mandatorily Redeemable Capital Stock

     4,858        4,843        3,159        3,165        3,145   

Capital Stock – Class B – Putable

     8,561        8,575        10,244        10,253        10,238   

Retained Earnings

     1,326        1,239        1,065        1,172        869   

Accumulated Other Comprehensive Loss

     (3,501     (3,584     (3,601     (2,717     (1,615

Total Capital

     6,386        6,230        7,708        8,708        9,492   

Selected Operating Results for the Quarter

          

Net Interest Income

   $ 357      $ 406      $ 458      $ 484      $ 434   

Provision for Credit Losses on Mortgage Loans

                          1          

Other Loss

     (195     (130     (543     (39     (236

Other Expense

     36        39        31        31        31   

Assessments

     33        63        (31     110        44   
   

Net Income/(Loss)

   $ 93      $ 174      $ (85   $ 303      $ 123   
   

Selected Other Data for the Quarter

          

Net Interest Margin(3)(4)

     0.78     0.79     0.80     0.76     0.59

Operating Expenses as a Percent of Average Assets

     0.06        0.06        0.05        0.04        0.03   

Return on Average Assets

     0.20        0.34        (0.15     0.47        0.17   

Return on Average Equity

     5.96        10.30        (3.84     12.49        4.95   

Annualized Dividend Rate(5)(6)

     0.26        0.27               0.84          

Dividend Payout Ratio(7)

     5.92        3.57               7.08          

Selected Other Data at Quarter End

          

Regulatory Capital Ratio(8)

     8.48        7.60        6.85        6.11        5.27   

Average Equity to Average Assets Ratio

     3.41        3.29        3.88        3.77        3.34   

Duration Gap (in months)

     4        4        4        2        4   
   

 

(1) Investments consist of Federal funds sold, trading securities, available-for-sale securities, held-to-maturity securities, securities purchased under agreements to resell, and loans to other Federal Home Loan Banks (FHLBanks).
(2) As provided by the FHLBank Act or regulations governing the operations of the FHLBanks, all of the FHLBanks have joint and several liability for FHLBank consolidated obligations, which are backed only by the financial resources of the FHLBanks. The joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor. The Bank has never been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank, and as of March 31, 2010, and through the filing date of this report, does not believe that it is probable that it will be asked to do so. The par amount of the outstanding consolidated obligations of all 12 FHLBanks at the dates indicated was as follows:
      Par amount

March 31, 2010

   $ 870,928

December 31, 2009

     930,617

September 30, 2009

     973,579

June 30, 2009

     1,055,863

March 31, 2009

     1,135,379

 

(3) Net interest margin is net interest income (annualized) divided by average interest-earning assets.
(4) For the purpose of calculating the net interest margin, on a retroactive basis, the Bank included in interest-earning assets fair value adjustments resulting from hedging relationships and fair value option adjustments. The Bank made this change to achieve consistency among all the FHLBanks in reporting interest-earning assets. This change did not materially affect average interest-earning assets and had no effect on reported assets, net interest income, or net income. Prior to this change, the net interest margins for the three months ended March 31, June 30, September 30, and December 31, 2009, were reported as 0.60%, 0.77%, 0.81% and 0.80%, respectively. For more information see First Quarter of 2010 Compared to First Quarter of 2009 – Average Balance Sheets below.
(5) On April 29, 2010, the Bank’s Board of Directors declared a cash dividend for the first quarter of 2010 at an annualized dividend rate of 0.26%. The Bank will record and pay the first quarter dividend during the second quarter of 2010.
(6) On February 22, 2010, the Bank’s Board of Directors declared a cash dividend for the fourth quarter of 2009, which was recorded and paid during the first quarter of 2010. On July 30, 2009, the Bank’s Board of Directors declared a cash dividend for the second quarter of 2009, which was recorded and paid during the third quarter of 2009.
(7) This ratio is calculated as dividends per share divided by net income per share.
(8) This ratio is calculated as regulatory capital divided by total assets. Regulatory capital includes mandatorily redeemable capital stock (which is classified as a liability) and excludes accumulated other comprehensive income.

 

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Results of Operations

The primary source of Bank earnings is net interest income, which is the interest earned on advances, mortgage loans, and investments, less interest paid on consolidated obligations, deposits, and other borrowings. The following Average Balance Sheets table presents average balances of earning asset categories and the sources that fund those earning assets (liabilities and capital) for the three months ended March 31, 2010 and 2009, together with the related interest income and expense. It also presents the average rates on total earning assets and the average costs of total funding sources. The Change in Net Interest Income table details the changes in interest income and interest expense for the first quarter of 2010 compared to the first quarter of 2009. Changes in both volume and interest rates influence changes in net interest income and the net interest margin.

 

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First Quarter of 2010 Compared to First Quarter of 2009

Average Balance Sheets

 

     Three Months Ended  
     March 31, 2010     March 31, 2009  
(Dollars in millions)    Average
Balance
    Interest
Income/
Expense
   Average
Rate
    Average
Balance
    Interest
Income/
Expense
   Average
Rate
 
   

Assets

              

Interest-earning assets:

              

Federal funds sold

   $ 14,641      $ 5    0.14   $ 15,767      $ 7    0.18

Trading securities:

              

MBS

     29           4.16        35           4.92   

Available-for-sale securities:

              

Other investments

     1,934        1    0.23                    

Held-to-maturity securities:

              

MBS

     30,447        283    3.77        38,734        422    4.42   

Other investments

     10,103        5    0.20        13,292        13    0.40   

Mortgage loans held for portfolio, net

     2,969        36    4.92        3,661        43    4.76   

Advances(1)(2)

     125,062        332    1.08        224,179        1,065    1.93   

Deposits with other FHLBanks

     2           0.01                    

Loans to other FHLBanks

     13           0.09        314           0.10   
                                  

Total interest-earning assets

     185,200        662    1.45        295,982        1,550    2.12   

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

     102                  5,831             
                                  

Total Assets

   $ 185,302      $ 662    1.45   $ 301,813      $ 1,550    2.08
   

Liabilities and Capital

              

Interest-bearing liabilities:

              

Consolidated obligations:

              

Bonds(1)(2)

   $ 147,769      $ 289    0.79   $ 204,181      $ 860    1.71

Discount notes

     23,152        13    0.23        78,567        256    1.32   

Deposits(3)

     1,719                  2,621           0.06   

Borrowings from other FHLBanks

     1           0.13        5           0.25   

Mandatorily redeemable capital stock

     4,850        3    0.27        3,559             

Other borrowings

     2           0.10        19           0.07   
                                  

Total interest-bearing liabilities

     177,493        305    0.70        288,952        1,116    1.57   

Other liabilities(2)(3)(4)

     1,498                  2,787             
                                  

Total Liabilities

     178,991        305    0.69        291,739        1,116    1.55   

Total Capital

     6,311                  10,074             
                                  

Total Liabilities and Capital

   $ 185,302      $ 305    0.67   $ 301,813      $ 1,116    1.50
   

Net Interest Income

     $ 357        $ 434   
                      

Net Interest Spread(2)(6)

        0.75        0.55
                      

Net Interest Margin(2)(7)

        0.78        0.59
                      

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

     104.34          102.43     
                          

Total Average Assets/Regulatory Capital Ratio(8)

     16.6          22.1     
                          

 

(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 $168 million and $191 million for the first quarter of 2010 and 2009, respectively. Interest expense on consolidated obligation bonds includes net interest income on interest rate exchange agreements of $511 million and $490 million for the first quarter of 2010 and 2009, respectively.

(2) For the purpose of calculating the net interest margin, on a retroactive basis, the Bank included in interest-earning assets and interest-bearing liabilities fair value adjustments resulting from hedging relationships and fair value option adjustments that had been included in other assets and other liabilities prior to the first quarter of 2010. The Bank made these changes to achieve consistency among all the FHLBanks in reporting interest-earning assets and interest-bearing liabilities. These changes did not materially affect average rates, net interest spread, or net interest margin, and had no effect on reported assets, liabilities, net interest income or net income.
(3) Average balances do not reflect the effect of reclassifications of cash collateral.
(4) Includes forward settling transactions and valuation adjustments for certain cash items.
(5) Includes OTTI charges on held-to-maturity securities related to all other factors.
(6) Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities.
(7) Net interest margin is net interest income (annualized) divided by average interest-earning assets.
(8) For this purpose, regulatory capital includes mandatorily redeemable capital stock and excludes other comprehensive income.

 

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Change in Net Interest Income: Rate/Volume Analysis

Three Months Ended March 31, 2010, Compared to Three Months Ended March 31, 2009

 

    

Increase/
(Decrease)

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

Interest-earning assets:

      

Federal funds sold

   $ (2   $      $ (2

Trading securities:

      

MBS

                     

Available-for-sale securities:

      

Other investments

     1        1          

Held-to-maturity securities:

      

MBS

     (139     (82     (57

Other investments

     (8     (3     (5

Mortgage loans held for portfolio

     (7     (8     1   

Advances(2)

     (733     (367     (366
   

Total interest-earning assets

     (888     (459     (429
   

Interest-bearing liabilities:

      

Consolidated obligations:

      

Bonds(2)

     (571     (194     (377

Discount notes

     (243     (112     (131

Deposits

                     

Mandatorily redeemable capital stock

     3               3   
   

Total interest-bearing liabilities

     (811     (306     (505
   

Net interest income

   $ (77   $ (153   $ 76   
   

 

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

 

(2)

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

Net Interest Income

Net interest income in the first quarter of 2010 was $357 million, an 18% decrease from $434 million in the first quarter of 2009. This decrease was driven primarily by the following:

 

   

Interest income on non-MBS investments decreased $9 million in the first quarter of 2010 compared to the first quarter of 2009. The decrease consisted of a $7 million decrease attributable to lower average yields on non-MBS investments and a $2 million decrease attributable to an 8% decrease in average non-MBS investment balances.

 

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Interest income from the mortgage portfolio decreased $146 million in the first quarter of 2010 compared to the first quarter of 2009. The decrease consisted of a $57 million decrease attributable to lower average yields on MBS investments, an $82 million decrease attributable to a 21% decrease in average MBS outstanding, an $8 million decrease attributable to a 19% decrease in average mortgage loans outstanding, and a $1 million increase attributable to higher average yields on mortgage loans outstanding. Interest income from the mortgage portfolio includes the impact of cumulative retrospective adjustments for the amortization of net purchase discounts from the acquisition dates of the MBS and mortgage loans, which decreased interest income by $11 million in the first quarter of 2010 and increased interest income by $9 million in the first quarter of 2009. This decrease was primarily due to slower projected prepayment speeds during the first quarter of 2010.

 

   

Interest income from advances decreased $733 million in the first quarter of 2010 compared to the first quarter of 2009. The decrease consisted of a $366 million decrease attributable to lower average yields and a $367 million decrease attributable to a 44% decrease in average advances outstanding, reflecting lower member demand during the first quarter of 2010 relative to the first quarter of 2009. In addition, members and nonmember borrowers prepaid $6.4 billion of advances in the first quarter of 2010 compared to $2.7 billion in the first quarter of 2009. As a result of these advance prepayments, interest income was increased by net prepayment fees of $11 million in the first quarter of 2010 and $2 million in the first quarter of 2009. The increase in advances prepayments in the first quarter of 2010 reflected members’ reduced liquidity needs.

 

   

Interest expense on consolidated obligations (bonds and discount notes) decreased $814 million in the first quarter of 2010 compared to the first quarter of 2009. The decrease consisted of a $508 million decrease attributable to lower interest rates on consolidated obligations and a $306 million 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.

The net interest margin was 78 basis points for the first quarter of 2010, 19 basis points higher than the net interest margin for the first quarter of 2009, which was 59 basis points. The net interest spread was 75 basis points for the first quarter of 2010, 20 basis points higher than the net interest spread for the first quarter of 2009, which was 55 basis points. These improvements were primarily due to a higher net interest spread on the mortgage portfolio resulting from the favorable impact of lower interest rates. 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.

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

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

 

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Other Loss

The following table presents the components of “Other Loss” for the three months ended March 31, 2010 and 2009.

 

     Three Months Ended  
        
(In millions)    March 31, 2010     March 31, 2009  
   

Other Loss:

    

Net gain on trading securities

   $      $ 1   

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

     (192     (1,156

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

     132        1,068   
   

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

     (60     (88

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

     (100     (183

Net (loss)/gain on derivatives and hedging activities

     (36     34   

Other

     1          
   

Total Other Loss

   $ (195   $ (236
   

Net Other-Than-Temporary Impairment Loss on Held-to-Maturity Securities – The Bank recognized a $60 million credit-related OTTI charge on PLRMBS during the first quarter of 2010, compared to an $88 million credit-related OTTI charge on PLRMBS during the first quarter of 2009. Additional information about the OTTI charge is provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – Investments” and in Note 4 to the Financial Statements.

Net Loss on Advances and Consolidated Obligation Bonds Held at Fair Value – The following table presents the net loss on advances and consolidated obligation bonds held at fair value for the three months ended March 31, 2010 and 2009.

 

     Three Months Ended  
        
(In millions)    March 31, 2010     March 31, 2009  
   

Advances

   $ (80   $ (191

Consolidated obligation bonds

     (20     8   
   

Total

   $ (100   $ (183
   

For the first quarter of 2010, the unrealized net fair value losses on advances were primarily driven by advances with a maturity of less than six months where interest rates increased relative to the actual coupon rates on the Bank’s advances, partially offset by gains resulting from the decreased swaption volatilities used in pricing fair value option putable advances during the first quarter of 2010. The unrealized net fair value losses on consolidated obligation bonds were primarily driven by the decreased long-term interest rate environment relative to the actual coupon rates on the consolidated obligation bonds and lower swaption volatilities used in pricing fair value option callable bonds during the first quarter of 2010.

For the first quarter of 2009, the unrealized net fair value losses on advances were primarily driven by the increased long-term interest rate environment relative to the actual coupon rates on the Bank’s advances, partially offset by gains resulting from the decreased swaption volatilities used in pricing fair value option putable advances during the first quarter of 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 the first quarter of 2009.

 

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

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

Three Months Ended March 31, 2010, Compared to Three Months Ended March 31, 2009

 

(In millions)   March 31, 2010     March 31, 2009  
    Gain/(Loss)    

Net Interest
Income/

(Expense) on

   

Total

    Gain/(Loss)    

Net Interest
Income/

(Expense) on

       
Hedged Item   Fair Value
Hedges, Net
    Economic
Hedges
    Economic
Hedges
      Fair Value
Hedges, Net
    Economic
Hedges
    Economic
Hedges
    Total  
   

Advances:

               

Elected for fair value option

  $      $ 61      $ (146   $ (85   $      $ 133      $ (149   $ (16

Not elected for fair value option

    (1     1        (14     (14     (36     42        (47     (41

Consolidated obligations:

               

Elected for fair value option

           24        54        78               42        (80     (38

Not elected for fair value option

    5        (62     42        (15     52        (114     191        129   
   

Total

  $ 4      $ 24      $ (64   $ (36   $ 16      $ 103      $ (85   $ 34   
   

During the first quarter of 2010, net losses on derivatives and hedging activities totaled $36 million compared to net gains of $34 million in the first quarter of 2009. These amounts included net interest expense on derivative instruments used in economic hedges of $64 million in the first quarter of 2010, compared to net interest expense on derivative instruments used in economic hedges of $85 million in the first quarter of 2009. The decrease in net interest expense was primarily due to the impact of lower interest rates throughout the first quarter of 2010 on the floating leg of the interest rate swaps.

Excluding the $64 million impact from net interest expense on derivative instruments used in economic hedges, net gains for the first quarter of 2010 totaled $28 million as detailed above. The $28 million in net gains were primarily attributable to a decrease in interest rates and a decrease in swaption volatilities during the first quarter of 2010.

Excluding the $85 million impact from net interest expense on derivative instruments used in economic hedges, net gains for the first quarter of 2009 totaled $119 million as detailed above. The $119 million in net gains were primarily attributable to a decrease in interest rates and a decrease in swaption volatilities during the first quarter of 2009.

The gains or losses on derivatives and associated hedged items and financial instruments carried at fair value (valuation adjustments) during the first quarter of 2010 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 these valuation adjustments. The effects of these valuation adjustments may lead to significant volatility in future earnings, including earnings available for dividends.

 

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Return on Average Equity

Return on average equity (ROE) was 5.96% (annualized) for the first quarter of 2010, an increase of 101 basis points from the first quarter of 2009. This increase reflected the decline in average equity, which decreased 38%, to $6.3 billion in the first quarter of 2010 from $10.1 billion in the first quarter of 2009, partially offset by the decrease in net income in the first quarter of 2010.

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 March 31, 2010, advances maturing within five years totaled $104.2 billion, significantly in excess of the $0.1 billion of member deposits on that date. At December 31, 2009, advances maturing within five years totaled $125.2 billion, also significantly in excess of the $0.2 billion of member deposits on that date. In addition, as of March 31, 2010, and December 31, 2009, the Bank’s estimated total sources of funds obtainable from liquidity investments, repurchase agreement borrowings collateralized by the Bank’s marketable securities, and advance repayments would have allowed the Bank to meet its liquidity needs for more than 90 days without access to the consolidated obligations markets.

Retained Earnings Related to Valuation Adjustments – In accordance with the Bank’s Retained Earnings and Dividend Policy, the Bank retains in restricted retained earnings any cumulative net gains in earnings (net of applicable assessments) resulting from valuation adjustments. As the cumulative net gains are reversed by periodic net losses and settlements of contractual interest cash flows, the amount of the cumulative net gains decreases. The amount of retained earnings required by this provision of the policy is therefore decreased, and that portion of the previously restricted retained earnings becomes unrestricted and may be made available for dividends. The retained earnings restricted in accordance with this provision of the Bank’s Retained Earnings and Dividend Policy totaled $140 million at March 31, 2010, and $181 million at December 31, 2009.

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

 

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The Board of Directors has set the targeted amount of restricted retained earnings at $1.8 billion. The retained earnings restricted in accordance with this provision of the Retained Earnings and Dividend Policy totaled $1.2 billion at March 31, 2010, and $1.1 billion at December 31, 2009.

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

Dividends – On April 29, 2010, the Bank’s Board of Directors declared a cash dividend for the first quarter of 2010 at an annualized rate of 0.26%. The Bank recorded the first quarter dividend on April 29, 2010, the day it was declared by the Board of Directors. The Bank expects to pay the first quarter dividend (including dividends on mandatorily redeemable capital stock), which will total $9 million, on or about May 13, 2010. The Bank did not pay a dividend for the first quarter of 2009.

The Bank expects to pay the first quarter 2010 dividend in cash rather than stock form to comply with Finance Agency rules, which do not permit the Bank to pay dividends in the form of capital stock if the Bank’s excess stock exceeds 1% of its total assets. As of March 31, 2010, the Bank’s excess capital stock totaled $7.4 billion, or 4% of total assets.

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

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

Financial Condition

Total assets were $173.9 billion at March 31, 2010, a 10% decrease from $192.9 billion at December 31, 2009, primarily as a result of decline in advances, which decreased by $21.5 billion or 16%, to $112.1 billion at March 31, 2010, from $133.6 billion at December 31, 2009. In addition to the decline in advances, cash and due from banks decreased to $2.9 billion at March 31, 2010, from $8.3 billion at December 31, 2009, and held-to-maturity securities decreased to $34.6 billion at March 31, 2010, from $36.9 billion at December 31, 2009, while Federal funds sold increased to $17.8 billion at March 31, 2010, from $8.2 billion at December 31, 2009. Average total assets were $185.3 billion for the first quarter of 2010, a 39% decrease compared to $301.8 billion for the first quarter of 2009. Average advances were $125.1 billion for the first quarter of 2010, a 44% decrease from $224.2 billion in the first quarter of 2009.

The continued decline in member advance demand reflected general economic conditions. Members also had ample deposits and access to a number of other funding options, including a variety of government lending programs. Held-to-maturity securities decreased primarily because of principal payments, prepayments, and maturities in the MBS portfolio and OTTI charges recognized on the PLRMBS. In addition, the Bank did not purchase any MBS during the first quarter of 2010. The decrease in cash and due from banks was primarily offset by an increase in Federal funds sold.

Advances outstanding at March 31, 2010, included unrealized gains of $996 billion, of which $480 million represented unrealized gains on advances hedged in accordance with the accounting for derivative instruments and hedging activities and $516 million represented unrealized gains on economically hedged advances that are carried at fair value in accordance with the fair value option. Advances outstanding at December 31, 2009, included unrealized gains of $1.1 billion, of which $524 million represented unrealized

 

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

Total liabilities were $167.5 billion at March 31, 2010, a 10% decrease from $186.6 billion at December 31, 2009, reflecting decreases in consolidated obligations outstanding from $180.3 billion at December 31, 2009, to $161.4 billion at March 31, 2010. The decrease in consolidated obligations outstanding paralleled the decrease in assets during the first quarter of 2010. Average total liabilities were $179.0 billion for the first quarter of 2010, a 39% decrease compared to $291.7 billion for the first quarter of 2009. The decrease in average liabilities reflects decreases in average consolidated obligations, paralleling the decline in average assets. Average consolidated obligations were $170.9 billion in the first quarter of 2010 and $282.7 billion in the first quarter of 2009.

Consolidated obligations outstanding at March 31, 2010, 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 $23 million on economically hedged consolidated obligation bonds that are carried at fair value in accordance with the fair value option. Consolidated obligations outstanding at December 31, 2009, included unrealized losses of $1.9 billion on consolidated obligation bonds hedged in accordance with the accounting for derivative instruments and hedging activities and unrealized gains of $53 million on economically hedged consolidated obligation bonds that are carried at fair value in accordance with the fair value option. The overall increase in the unrealized losses on the hedged consolidated obligation bonds and the consolidated obligation bonds carried at fair value from December 31, 2009, to March 31, 2010, was primarily attributable to the reversal of prior period gains.

As provided by the FHLBank Act or regulations governing the operations of the FHLBanks, all FHLBanks have joint and several liability for all FHLBank consolidated obligations. The joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor. The Bank has never been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank, and as of March 31, 2010, and through the filing date of this report, does not believe that it is probable that it will be asked to do so. The par amount of the outstanding consolidated obligations of all 12 FHLBanks was $870.9 billion at March 31, 2010, and $930.6 billion at December 31, 2009.

As of March 31, 2010, Standard & Poor’s Rating Services (Standard & Poor’s) rated the FHLBanks’ consolidated obligations AAA/A-1+, and Moody’s Investors Service (Moody’s) rated them Aaa/P-1. As of March 31, 2010, 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 March 31, 2010, Moody’s continued to assign all the FHLBanks a long-term credit rating of Aaa. Changes in the long-term credit ratings of individual FHLBanks do not necessarily affect the credit rating of the consolidated obligations issued on behalf of the FHLBanks. Rating agencies may change a rating from time to time because of various factors, including operating results or actions taken, business developments, or changes in their opinion regarding, among other factors, the general outlook for a particular industry or the economy.

The Bank evaluated the publicly disclosed FHLBank regulatory actions and long-term credit ratings of other FHLBanks as of March 31, 2010, and as of each period end presented, and determined that they have not materially increased the likelihood that the Bank will be required to repay any principal or interest associated with consolidated obligations for which the Bank is not the primary obligor.

 

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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 expense associated with economic hedges that are recorded in “Net (loss)/gain on derivatives and hedging activities” in other income and excludes interest expense that is recorded in “Mandatorily redeemable capital stock.” Other key financial information, such as any OTTI loss on the Bank’s held-to-maturity PLRMBS, other expenses, and assessments, are not included in the segment reporting analysis, but are incorporated into management’s overall assessment of financial performance. For a reconciliation of the Bank’s operating segment adjusted net interest income to the Bank’s total net interest income, see Note 9 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 $144.3 billion (83% of total assets) at March 31, 2010, from $161.4 billion (84% of total assets) at December 31, 2009, representing a decrease of $17.1 billion, or 11%. 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 is derived primarily from the difference, or spread, between the yield on advances and non-MBS investments and the cost of the consolidated obligations funding these assets, including the cash flows from associated interest rate exchange agreements.

Adjusted net interest income for this segment was $138 million in the first quarter of 2010, a decrease of $66 million, or 32%, compared to $204 million in the first quarter of 2009. The decline was primarily attributable to a significant decrease in advance balances and a lower net interest spread on advances, as the favorably priced short-term debt issued in the fourth quarter of 2008 matured by yearend 2009. In addition, adjusted net interest income for the first quarter of 2010 reflected a lower yield on capital because of the lower interest rate environment during the first quarter of 2010. Members and nonmember borrowers prepaid $6.4 billion of advances in the first quarter of 2010 compared to $2.7 billion in the first quarter of 2009. As a result of these advances prepayments, interest income was increased by net prepayment fees of $11 million in the first quarter of 2010 and $2 million in the first quarter of 2009. The increase in advances prepayments in the first quarter of 2010 reflected members’ reduced liquidity needs, as described below.

Adjusted net interest income for this segment represented 50% and 60% of total adjusted net interest income for the first quarter of 2010 and 2009, respectively. The decrease was 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 by $21.2 billion, or 16%, to $111.1 billion at March 31, 2010, from $132.3 billion at December 31, 2009. The decrease reflects a $6.3 billion decrease in fixed rate advances, a $14.3 billion decrease in adjustable rate advances, and a $0.6 billion decrease in daily variable rate advances.

 

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Advances outstanding to the Bank’s four largest borrowers totaled $72.4 billion at March 31, 2010, a net decrease of $18.8 billion from $91.2 billion at December 31, 2009. The decrease was primarily attributable to lower advance borrowings by three of the four largest borrowers. The remaining $2.4 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, 35 institutions increased their advances during the first quarter of 2009, while 132 institutions decreased their advances.

Average advances were $125.1 billion in the first quarter of 2010, a 44% decrease from $224.2 billion in the first quarter of 2009. The decline in member advance demand reflected general economic conditions. Members also had ample deposits and access to a number of other funding options, including a variety of government lending programs.

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

Advances Portfolio by Product Type

 

(In millions)    March 31, 2010    December 31, 2009

Standard advances:

     

Adjustable – London Inter-Bank Offered Rate (LIBOR)

   $ 46,660    $ 60,993

Adjustable – other indices

     288      288

Fixed

     46,404      48,606

Daily variable rate

     882      1,496

Subtotal

     94,234      111,383

Customized advances:

     

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

     1,125      1,125

Fixed – amortizing

     447      485

Fixed with PPS(1)

     11,732      15,688

Fixed with caps and PPS(1)

     200      200

Fixed – callable at member’s option

     12      19

Fixed – putable at Bank’s option

     2,836      2,910

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

     468      503

Subtotal

     16,820      20,930

Total par value

     111,054      132,313

Hedging valuation adjustments

     480      524

Fair value option valuation adjustments

     516      616

Net unamortized premiums

     89      106

Total

   $ 112,139    $ 133,559

 

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

Non-MBS Investments – The Bank’s non-MBS investment portfolio consists of financial instruments that are used primarily to facilitate the Bank’s role as a cost-effective provider of credit and liquidity to members. These investments are also used as a source of liquidity to meet the Bank’s financial obligations on a timely basis, which may supplement or reduce earnings. The Bank’s total non-MBS investment portfolio was $28.5 billion as of March 31, 2010, an increase of $9.7 billion, or 52%, from $18.8 billion as of December 31, 2009, primarily due to an increase in Federal funds sold.

Cash and Due from Banks – Cash and due from banks decreased to $2.9 billion at March 31, 2010, from $8.3 billion at December 31, 2009. The decrease was primarily in cash held at the Federal Reserve Bank of San Francisco, reflecting an increase in the availability of high quality non-MBS investments.

 

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Borrowings – Consistent with the decrease in advances, total liabilities (primarily consolidated obligations) funding the advances-related business decreased $17.3 billion, or 11%, from $155.2 billion at December 31, 2009, to $137.9 billion at March 31, 2010. For further information and discussion of the Bank’s joint and several liability for FHLBank consolidated obligations, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition.”

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

At March 31, 2010, the notional amount of interest rate exchange agreements associated with the advances-related business totaled $196.9 billion, of which $51.5 billion were hedging advances, $144.7 billion were hedging consolidated obligations, and $0.7 billion were interest rate exchange agreements that the Bank entered into as an intermediary between exactly offsetting derivatives transactions with members and other counterparties. At December 31, 2009, the notional amount of interest rate exchange agreements associated with the advances-related business totaled $220.8 billion, of which $53.7 billion were hedging advances, $166.5 billion were hedging consolidated obligations, and $0.6 billion were interest rate exchange agreements that the Bank entered into as an intermediary between exactly offsetting derivatives transactions with members and other counterparties. The hedges associated with advances and consolidated obligations were primarily used to convert the fixed rate cash flows and non-LIBOR-indexed cash flows of the advances and consolidated obligations to adjustable rate LIBOR-indexed cash flows or to manage the interest rate sensitivity and net repricing gaps of assets, liabilities, and interest rate exchange agreements.

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

Since December 16, 2008, the Federal Open Market Committee has not changed the target Federal funds rate. During the first quarter of 2010, yields on long-term U.S. Treasury securities declined slightly due to reduced investor inflation expectations. Since December 31, 2008, 3-month LIBOR declined from 1.43% to 0.29% 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    March 31, 2010     December 31, 2009     March 31, 2009     December 31, 2008  

Federal Reserve target rate for overnight Federal funds

   0-0.25   0-0.25   0-0.25   0-0.25

3-month Treasury bill

   0.16      0.06      0.21      0.13   

3-month LIBOR

   0.29      0.25      1.19      1.43   

2-year Treasury note

   1.02      1.14      0.80      0.77   

5-year Treasury note

   2.54      2.68      1.67      1.55   

 

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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 the first quarters of 2010 and 2009. Federal Reserve purchases of GSE debt coupled with strong investor demand for longer-term GSE debt resulted in lowered borrowing costs for FHLBank System consolidated obligation bonds relative to LIBOR compared to a year ago. For short-term debt in the first quarter of 2010, the Bank experienced a higher cost on discount notes relative to LIBOR compared to a year ago. The higher relative cost reflected the decrease in LIBOR and the reduced demand for short-term GSE debt in 2010 compared to 2009.

 

     Spread to LIBOR of Average Cost of
Consolidated Obligations  for the
Three Months Ended
(In basis points)    March 31, 2010    March 31, 2009
 

Consolidated obligation bonds

   –14.9    –7.8

Consolidated obligation discount notes (one month and greater)

   –13.7    –70.2

At March 31, 2010, the Bank had $106.3 billion of swapped non-callable bonds and $24.3 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, 2009, the Bank had $130.7 billion of swapped non-callable bonds and $25.4 billion of swapped callable bonds that primarily funded advances and non-MBS investments. These swapped non-callable and callable bonds combined represented 96% of the Bank’s total consolidated obligation bonds outstanding.

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

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

At March 31, 2010, assets associated with this segment were $29.5 billion (17% of total assets), a decrease of $2.0 billion, or 6%, from $31.5 billion at December 31, 2009 (16% of total assets). The MBS portfolio decreased $2.3 billion to $25.9 billion at March 31, 2010, from $28.2 billion at December 31, 2009, and mortgage loan balances decreased $0.1 billion to $2.9 billion at March 31, 2010, from $3.0 billion at December 31, 2009. In the first quarter of 2010, average MBS investments were $30.5 billion, a decrease of $8.3 billion compared to $38.8 billion in the first quarter of 2009. Average mortgage loans were $3.0 billion in the first quarter of 2010, a decrease of $0.7 billion from $3.7 billion in the first quarter of 2009. The decrease was primarily due to principal payments, prepayments, and maturities in the MBS portfolio and OTTI charges recognized on the PLRMBS. In addition, the Bank did not purchase any MBS during the first quarter of 2010.

 

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Adjusted net interest income for this segment was $138 million in the first quarter of 2010, an increase of $2 million, or 1%, from $136 million in the first quarter of 2009. The increase for the first quarter of 2010 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, which 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 represented 50% and 40% of total adjusted net interest income for the first quarter of 2010 and 2009, respectively.

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

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

 

(In millions)    March 31, 2010     December 31, 2009  
   

MPF Plus

   $ 2,687      $ 2,800   

Original MPF

     243        257   
   

Subtotal

     2,930        3,057   

Net unamortized discounts

     (19     (18
   

Mortgage loans held for portfolio

     2,911        3,039   

Less: Allowance for credit losses

     (2     (2
   

Mortgage loans held for portfolio, net

   $ 2,909      $ 3,037   
   

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 March 31, 2010, and $2 million at December 31, 2009. For more information on how the Bank determines its estimated allowance for credit losses on mortgage loans, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates – Allowance for Credit Losses – Mortgage Loans Acquired Under the MPF Program” in the Bank’s 2009 Form 10-K.

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

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

 

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

Mortgage

Loan Balance

   Number
of Loans
  

Mortgage

Loan Balance

Between 30 and 59 days

   260    $ 29    243    $ 29

Between 60 and 89 days

   73      9    81      10

90 days or more

   213      27    177      22

Total

   546    $ 65    501    $ 61

At March 31, 2010, the Bank had 546 loans that were 30 days or more delinquent totaling $65 million, of which 213 loans totaling $27 million were classified as nonaccrual or impaired. For 123 of these loans, totaling $15 million, the loan was in foreclosure or the borrower of the loan was in bankruptcy. 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 or the borrower of the loan was in bankruptcy.

At March 31, 2010, the Bank’s other assets included $3 million of real estate owned resulting from the foreclosure of 31 mortgage loans held by the Bank. 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.

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 $25.9 billion, or 176% of Bank capital (as determined in accordance with regulations governing the operations of the FHLBanks), at March 31, 2010, compared to $28.2 billion, or 193% of Bank capital, at December 31, 2009. During the first quarter of 2010, the Bank’s MBS portfolio decreased primarily because of principal payments, prepayments, and maturities in the MBS portfolio and OTTI charges recognized on the PLRMBS. In addition, the Bank did not purchase any MBS during the first quarter of 2010. For a discussion of the composition of the Bank’s MBS portfolio and the Bank’s OTTI analysis of that portfolio, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Investments.”

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

Borrowings – Total consolidated obligations funding the mortgage-related business decreased $2.0 billion, or 6%, to $29.5 billion at March 31, 2010, from $31.5 billion at December 31, 2009, paralleling the decrease in mortgage portfolio assets. For further information and discussion of the Bank’s joint and several liability for FHLBank consolidated obligations, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition.”

At March 31, 2010, the notional amount of interest rate exchange agreements associated with the mortgage-related business totaled $15.2 billion, almost all of which hedged or was associated with consolidated obligations funding the mortgage portfolio.

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

 

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Interest Rate Exchange Agreements

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

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

 

(In millions)                   
              Notional Amount
Hedging Instrument    Hedging Strategy    Accounting
Designation
  March 31,
2010
   December 31,
2009

Hedged Item: Advances

                      
Pay fixed, receive floating interest rate swap    Fixed rate advance converted to a LIBOR floating rate    Fair Value Hedge   $ 31,099    $ 28,859
Basis swap    Adjustable rate advance converted to a LIBOR floating rate    Economic  Hedge(1)     2,000      2,000
Receive fixed, pay floating interest rate swap    LIBOR floating rate advance converted to a fixed rate    Economic  Hedge(1)     150      150
Basis swap    Floating rate advance converted to another floating rate index to reduce interest rate sensitivity and repricing gaps    Economic  Hedge(1)     158      158
Pay fixed, receive floating interest rate swap    Fixed rate advance converted to a LIBOR floating rate    Economic  Hedge(1)     1,292      1,708
Pay fixed, receive floating interest rate swap; swap may be callable at the Bank’s option or putable at the counterparty’s option    Fixed rate advance (with or without an embedded cap) converted to a LIBOR floating rate; advance and swap may be callable or putable; matched to advance accounted for under the fair value option    Economic  Hedge(1)     15,660      19,717
Interest rate cap, floor, corridor, and/or collar    Interest rate cap, floor, corridor, and/or collar embedded in an adjustable rate advance; matched to advance accounted for under the fair value option    Economic  Hedge(1)     1,125      1,125

Subtotal Economic Hedges(1)

         20,385      24,858
Total               51,484      53,717

Hedged Item: Non-Callable Bonds

                 
Receive fixed or structured, pay floating interest rate swap    Fixed rate or structured rate non-callable bond converted to a LIBOR floating rate    Fair Value Hedge     58,480      62,317
Receive fixed or structured, pay floating interest rate swap    Fixed rate or structured rate non-callable bond converted to a LIBOR floating rate    Economic  Hedge(1)     13,205      23,034

 

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(In millions)                    
               Notional Amount
Hedging Instrument    Hedging Strategy    Accounting
Designation
   March 31,
2010
   December 31,
2009
Receive fixed or structured, pay floating interest rate swap    Fixed rate or structured rate non-callable bond converted to a LIBOR floating rate; matched to non-callable bond accounted for under the fair value option    Economic Hedge(1)    35    505
Basis swap    Non-LIBOR floating rate non-callable bond converted to a LIBOR floating rate; matched to non-callable bond accounted for under the fair value option    Economic Hedge(1)    15,000    28,130
Basis swap    Floating rate non-callable bond converted to another floating rate index to reduce interest rate sensitivity and repricing gaps    Economic Hedge(1)    27,826    24,261
Pay fixed, receive floating interest rate swap    Floating rate bond converted to fixed rate non-callable debt that offsets the interest rate risk of mortgage assets    Economic Hedge(1)    3,495    2,980

Subtotal Economic Hedges(1)

        59,561    78,910
Total              118,041    141,227

Hedged Item: Callable Bonds

              
Receive fixed or structured, pay floating interest rate swap with an option to call at the counterparty’s option    Fixed or structured rate callable bond converted to a LIBOR floating rate; swap is callable    Fair Value Hedge    11,840    13,035
Pay fixed, receive floating interest rate swap with an option to call at the counterparty’s option    Fixed rate callable bond converted to a LIBOR floating rate; swap is callable    Economic Hedge(1)       110
Receive fixed or structured, pay floating interest rate swap with an option to call at the counterparty’s option    Fixed or structured rate callable bond converted to a LIBOR floating rate; swap is callable    Economic Hedge(1)    2,635    3,280
Receive fixed or structured, pay floating interest rate swap with an option to call at the counterparty’s option    Fixed or structured rate callable bond converted to a LIBOR floating rate; swap is callable; matched to callable bond accounted for under the fair value option    Economic Hedge(1)    9,805    9,105

Subtotal Economic Hedges(1)

        12,440    12,495
Total              24,280    25,530

Hedged Item: Discount Notes

              
Pay fixed, receive floating callable interest rate swap    Discount note converted to fixed rate callable debt that offsets the prepayment risk of mortgage assets    Economic Hedge(1)    2,297    1,685
Basis swap or receive fixed, pay floating interest rate swap    Discount note converted to one-month LIBOR or other short-term floating rate to hedge repricing gaps    Economic Hedge(1)    15,057    12,231
Pay fixed, receive floating non-callable interest rate swap    Discount note converted to fixed rate non-callable debt that offsets the interest rate risk of mortgage assets    Economic Hedge(1)    245   
Total              17,599    13,916

Hedged Item: Trading Securities

              
Pay MBS rate, receive floating interest rate swap    MBS rate converted to a LIBOR floating rate    Economic Hedge(1)    7    8

 

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(In millions)                    
               Notional Amount
Hedging Instrument    Hedging Strategy    Accounting
Designation
   March 31,
2010
   December 31,
2009

Hedged Item: Intermediary Positions

                  
Pay fixed, receive floating interest rate swap, and receive fixed, pay floating interest rate swap    Interest rate swaps executed with members offset by executing interest rate swaps with derivatives dealer counterparties    Economic Hedge(1)      46      46
Interest rate cap/floor    Stand-alone interest rate cap and/or floor executed with a member offset by executing an interest rate cap and/or floor with derivatives dealer counterparties    Economic Hedge(1)      670      570
Total                716      616

Total Notional Amount

        $ 212,127    $ 235,014

 

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

At March 31, 2010, the total notional amount of interest rate exchange agreements outstanding was $212.1 billion, compared with $235.0 billion at December 31, 2009. The $22.9 billion decrease in the notional amount of derivatives during the first quarter of 2010 was primarily due to a net $24.4 billion decrease in interest rate exchange agreements hedging consolidated obligation bonds and a net $2.2 billion decrease in interest rate exchange agreements hedging the market risk of fixed rate advances, partially offset by a net $3.7 billion increase in interest rate exchange agreements hedging consolidated obligation discount notes. The decrease in interest rate exchange agreements hedging consolidated obligation bonds reflected decreased use of interest rate exchange agreements that effectively converted the repricing frequency from three months to one month, and is consistent with the decline in the amount of bonds outstanding at March 31, 2010, relative to December 31, 2009. By category, the Bank experienced large changes in the levels of interest rate exchange agreements, which reflected the January 1, 2008, transition of certain hedging instruments from a fair value hedge classification under the accounting for derivative instruments and hedging activities to an economic hedge classification under the fair value option. The notional amount serves as a basis for calculating periodic interest payments or cash flows received and paid.

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

 

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

Fair value hedges:

            

Advances

   $ 31,099    $ (480   $ 480      $    $   

Non-callable bonds

     58,480      1,855        (1,864          (9

Callable bonds

     11,840      61        (58          3   
   

Subtotal

     101,419      1,436        (1,442          (6
   

Not qualifying for hedge accounting (economic hedges):

            

Advances

     20,385      (495            446      (49

Non-callable bonds

     59,511      402               5      407   

Non-callable bonds with embedded derivatives

     50      1                    1   

Callable bonds

     12,440      1               55      56   

Discount notes

     17,599      37                    37   

MBS – trading

     7                           

Intermediated

     716                           
   

Subtotal

     110,708      (54            506      452   
   

Total excluding accrued interest

     212,127      1,382        (1,442     506      446   

Accrued interest

          452        (515     33      (30
   

Total

   $ 212,127    $ 1,834      $ (1,957   $ 539    $ 416   
   

 

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(In millions)                              
December 31, 2009                              
     Notional
Amount
   Fair Value of
Derivatives
    Unrealized
Gain/(Loss)
on Hedged
Items
    Financial
Instruments
Carried at
Fair Value
    Difference  
   

Fair value hedges:

           

Advances

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

Non-callable bonds

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

Callable bonds

     13,035      32        (32              
   

Subtotal

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

Not qualifying for hedge accounting (economic hedges):

           

Advances

     24,858      (560            529        (31

Non-callable bonds

     78,826      457               (20     437   

Non-callable bonds with embedded derivatives

     84      1                      1   

Callable bonds

     12,495      (41            100        59   

Discount notes

     13,916      60                      60   

MBS – trading

     8      (1                   (1

Intermediated

     616                             
   

Subtotal

     130,803      (84            609        525   
   

Total excluding accrued interest

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

Accrued interest

          391        (395     60        56   
   

Total

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

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

Because the periodic and cumulative net gains or losses on the Bank’s derivatives, hedged instruments, and certain assets and liabilities that are carried at fair value are primarily a matter of timing, the net gains or losses will generally reverse through changes in future valuations and settlements of contractual interest cash flows over the remaining contractual term to maturity, call date, or put date of the hedged financial instruments, associated interest rate exchange agreements, and financial instruments carried at fair value. However, the Bank may have instances in which the financial instruments or hedging relationships are terminated prior to maturity or prior to the call or put date. Terminating the financial instruments or hedging 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 hedging and fair value option valuation adjustments during the first quarter of 2010 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 offset the impact of these valuation adjustments. The effects of these valuation adjustments may lead to significant volatility in future earnings, including earnings available for dividends.

 

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

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

Concentration of Derivatives Counterparties

 

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

JPMorgan Chase Bank, National Association

   AA    $ 31,931    15   $ 34,297    15

BNP Paribas

   AA      26,984    13        25,388    11   

Deutsche Bank AG

   A      26,413    13        36,257    15   

Barclays Bank PLC

   AA      26,109    12        35,060    15   

Citibank, N.A.

   A      22,187    10        16,554    7   
   

Subtotal

        133,624    63        147,556    63   

Others

   At least A      78,503    37        87,458    37   
   

Total

      $ 212,127    100   $ 235,014    100
   

 

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

Liquidity and Capital Resources

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

The Federal Reserve concluded its program to purchase GSE debt on March 31, 2010. During the first quarter of 2010, the Federal Reserve purchased $12 billion in agency term obligations, including $3 billion in FHLBank consolidated obligation bonds. As of March 31, 2010, the Federal Reserve had purchased a total of $172 billion of GSE debt, including $38 billion in FHLBank consolidated obligation bonds. During the first quarter of 2010, the FHLBanks issued $8 billion in global bonds and over $205 billion in auctioned discount notes. The combination of declining FHLBank funding needs, Federal Reserve purchases of FHLBank direct obligations, and a monthly debt issuance calendar for global bonds has generally improved the FHLBanks’ ability to issue debt at reasonable costs relative to the year-earlier period.

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 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

 

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liquidity, through short-term investments, in an amount at least equal to its anticipated cash outflows under two different scenarios. One scenario assumes that the FHLBank cannot access the capital markets for a targeted period of 15 days and that during that time members do not renew any maturing, prepaid, and called advances. The second scenario assumes that the FHLBank cannot access the capital markets for a targeted period of five days and that during that period the Bank will automatically renew maturing and called advances for all members except very large, highly rated members.

The Bank has a regulatory contingency liquidity requirement to maintain at least five 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 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 the first three months of 2010 and during 2009. On a daily basis, the Bank models its cash commitments and expected cash flows for the next 90 days to determine its projected liquidity position.

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

 

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Principal Financial Obligations Due and Funds Available for Selected Periods

 

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

Obligations due:

           

Commitments for new advances

   $ 500    $ 500    $ 32    $ 32

Demand deposits

     1,510      1,510      1,647      1,647

Maturing member term deposits

     13      36      16      28

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

     4,650      36,039      7,830      52,493
 

Subtotal obligations

     6,673      38,085      9,525      54,200
 

Sources of available funds:

           

Maturing investments

     14,282      25,500      9,185      15,774

Cash at Federal Reserve Bank of San Francisco

     2,940      2,940      8,280      8,280

Proceeds from scheduled settlements of discount notes and bonds

     376      1,816      30      1,090

Maturing advances and scheduled prepayments

     1,833      15,128      4,762      36,134
 

Subtotal sources

     19,431      45,384      22,257      61,278
 

Net funds available

     12,758      7,299      12,732      7,078
 

Additional contingent sources of funds:(1)

           

Estimated borrowing capacity of securities available for repurchase agreement borrowings:

           

MBS

          19,555           19,457

Housing finance agency bonds

                   

Marketable money market investments

     4,798           3,339     

TLGP investments

     2,185      2,185      2,186      2,186
 

Subtotal contingent sources

     6,983      21,740      5,525      21,643
 

Total contingent funds available

   $ 19,741    $ 29,039    $ 18,257    $ 28,721
 

 

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

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

Capital

Total capital as of March 31, 2010, was $6.4 billion, a 3% increase from $6.2 billion as of December 31, 2009. The increase was primarily due to a $93 million increase in retained earnings and an $83 million decrease in impairment loss related to all other factors recorded in other comprehensive income in the first quarter of 2010 on the Bank’s PLRMBS, partially offset by the transfer of $18 million in capital stock to mandatorily redeemable capital stock (a liability) because of two membership terminations during the quarter.

 

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

The following table shows the Bank’s compliance with the Finance Agency’s capital requirements at March 31, 2010, and December 31, 2009. During the first quarter of 2010, the Bank’s required risk-based capital decreased from $6.2 billion at December 31, 2009, to $5.6 billion at March 31, 2010. The decrease was due to lower market risk capital requirements, reflecting the improvement in the Bank’s market value of capital relative to its book value of capital.

Regulatory Capital Requirements

 

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

Risk-based capital

   $ 5,610      $ 14,745      $ 6,207      $ 14,657   

Total regulatory capital

   $ 6,954      $ 14,745      $ 7,714      $ 14,657   

Total capital-to-assets ratio

     4.00     8.48     4.00     7.60

Leverage capital

   $ 8,693      $ 22,117      $ 9,643      $ 21,984   

Leverage ratio

     5.00     12.72     5.00     11.40

The Bank’s total regulatory capital ratio increased to 8.48% at March 31, 2010, from 7.60% at December 31, 2009, primarily because of increased excess capital stock resulting from the decline in advances outstanding, coupled with the Bank’s decision not to repurchase excess capital stock in 2009 and the first quarter of 2010.

In light of the Bank’s strengthened regulatory capital position, the Bank plans to repurchase up to $500 million in excess capital stock on May 14, 2010. The amount of excess capital stock to be repurchased from any shareholder will be based on the shareholder’s pro rata ownership share of total capital stock outstanding as of the repurchase date, up to the amount of the shareholder’s excess capital stock.

The Bank’s capital requirements are more fully discussed in the Bank’s 2009 Form 10-K in Note 13 to the Financial Statements and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources – Capital.”

Risk Management

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

 

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

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

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

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

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

 

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Member and Nonmember Credit Outstanding and Collateral Borrowing Capacity

by Credit Quality Rating

 

(Dollars in millions)

 

March 31, 2010

  

  

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

Member or Nonmember

Credit Quality Rating

   Number    Number    Credit
Outstanding(1)
   Total    Used  
   

1-3

   55    38    $ 9,399    $ 14,290    66

4-6

   205    145      101,372      205,178    49   

7-10

   150    105      5,508      11,353    49   
    

Total

   410    288    $ 116,279    $ 230,821    50
   
December 31, 2009   
     All Members and
Nonmembers
   Members and Nonmembers with Credit Outstanding  
                    Collateral Borrowing  Capacity(2)  

Member or Nonmember

Credit Quality Rating

   Number    Number    Credit
Outstanding(1)
   Total    Used  
   

1-3

   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
   

 

  (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)

March 31, 2010

 

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

Collateral
Borrowing

Capacity(2)

 

0% - 10%

   21    $ 12,524    $ 13,011

11% - 25%

   26      15,607      18,340

26% - 50%

   74      65,144      118,392

More than 50%

   167      23,004      81,078
 

Total

   288    $ 116,279    $ 230,821
 

December 31, 2009

 

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

Collateral
Borrowing

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
 

 

  (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.

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 March 31, 2010, the borrowing capacities assigned to U.S. Treasury securities and most agency securities ranged from 95% to 99.5% of their market value. The borrowing capacities assigned to private-label MBS, which must be rated AAA or AA when initially pledged, generally ranged from 50% to 85% of their market value, depending on the underlying collateral (residential mortgages, home equity loans, or commercial real estate). None of the MBS pledged as collateral were labeled as subprime.

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

 

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Composition of Securities Collateral Pledged

by Members and by Nonmembers with Credit Outstanding

(In millions)

 

      March 31, 2010    December 31, 2009
Securities Type with Current Credit Ratings    Current Par    Borrowing
Capacity
   Current Par    Borrowing
Capacity
 

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

   $ 1,232    $ 1,230    $ 1,284    $ 1,280

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

     5,937      5,892      7,366      7,298

Agency pools and collateralized mortgage obligations

     21,804      21,318      23,348      22,738

PLRMBS – publicly registered AAA-rated senior tranches

     470      324      535      379

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

     1           1     

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

     59      47      89      68

PLRMBS – publicly registered AA-rated senior tranches

     78      34      197      84

PLRMBS – publicly registered A-rated senior tranches

     170      26      189      30

PLRMBS – publicly registered BBB-rated senior tranches

     177      21      185      21

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

     1      1      2      1

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

     16      3      16      3

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

               13      8

Term deposits with the FHLBank of San Francisco

     36      36      29      29
 

Total

   $ 29,981    $ 28,932    $ 33,254    $ 31,939
 

With respect to loan collateral, most members may choose to pledge loan collateral using a specific identification method or a blanket lien method. Members pledging under the specific identification method must provide a detailed listing of all the loans pledged to the Bank on a monthly or quarterly basis. Under the blanket lien method, a member generally pledges 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.

 

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As of March 31, 2010, 70% of the loan collateral pledged to the Bank was pledged by 38 institutions under specific identification, 22% was pledged by 187 institutions under blanket lien with detailed reporting, and 8% was pledged by 114 institutions under blanket lien with summary reporting.

As of March 31, 2010, the Bank’s maximum borrowing capacities for loan collateral ranged from 20% to 95% of the unpaid principal balance. For example, the maximum borrowing capacities for collateral pledged under blanket lien with detailed reporting were as follows: 95% for first lien residential mortgage loans, 66% for multifamily mortgage loans, 58% for commercial mortgage loans, 50% for small business, small farm, and small agribusiness loans, and 20% for second lien residential mortgage loans. The highest borrowing capacities are available to members that pledge under blanket lien with detailed reporting because the detailed loan information allows the Bank to assess the value of the collateral more precisely and because additional collateral is pledged under the blanket lien that may not receive borrowing capacity but may be liquidated to repay advances in the event of default. The Bank may review and change the maximum borrowing capacity for any type of loan collateral at any time.

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

Composition of Loan Collateral Pledged

by Members and by Nonmembers with Credit Outstanding

(In millions)

 

      March 31, 2010    December 31, 2009
Loan Type   

Unpaid Principal

Balance

  

Borrowing

Capacity

  

Unpaid Principal

Balance

  

Borrowing

Capacity

 

First lien residential mortgage loans

   $ 199,441    $ 118,718    $ 203,874    $ 117,511

Second lien residential mortgage loans and home equity lines of credit

     77,446      14,400      81,562      17,468

Multifamily mortgage loans

     37,045      21,857      37,011      21,216

Commercial mortgage loans

     57,735      30,042      58,783      30,550

Loan participations

     24,742      15,958      21,389      12,097

Small business, small farm, and small agribusiness loans

     3,191      606      3,422      672

Other

     1,040      309      1,055      314
 

Total

   $ 400,640    $ 201,890    $ 407,096    $ 199,828
 

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 March 31, 2010, and December 31, 2009, the amount of these loans totaled $47 billion and $38 billion, respectively. The Bank reviews and assigns borrowing capacities to subprime mortgage loans as it does for all other types of loan collateral, taking into account the known credit attributes in assigning the appropriate secondary market discounts. In addition, members with concentrations in nontraditional and subprime mortgage loans are subject to more frequent analysis to assess the credit quality and value of the loans. All advances, including those made to members pledging subprime mortgage loans, are required to be fully collateralized.

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

The Bank monitors its investments for substantive changes in relevant market conditions and any declines in fair value. For securities in an unrealized loss position because of factors other than movements in interest rates, such as widening of mortgage asset spreads, the Bank considers whether it expects to recover the entire

 

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amortized cost basis of the security by comparing the best estimate of the present value of the cash flows expected to be collected from the security with the amortized cost basis of the security. If the Bank’s best estimate of the present value of the cash flows expected to be collected is less than the amortized cost basis, the difference is considered the credit loss.

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

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

Investment Credit Exposure

(In millions)

March 31, 2010

 

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

Federal funds sold

   $    $ 12,578    $ 5,261    $    $    $    $    $    $    $ 17,839

Trading securities:

                             

MBS:

                             

Other U.S. obligations:

                             

Ginnie Mae

     22                                              22

GSEs:

                             

Fannie Mae

     7                                              7
 

Total trading securities

     29                                              29
 

Available-for-sale securities:

                             

TLGP(2)

     1,929                                              1,929

Held-to-maturity securities:

                             

Interest-bearing deposits

          3,011      3,150                                    6,161

Commercial paper(3)

          1,500                                         1,500

Housing finance agency bonds

     26      732                                         758

TLGP(2)

     303                                              303

MBS:

                             

Other U.S. obligations:

                             

Ginnie Mae

     15                                              15

GSEs:

                             

Freddie Mac

     2,554                                              2,554

Fannie Mae

     7,831                                              7,831

Other:

                             

PLRMBS

     2,558      1,567      1,875      2,389      1,661      1,351      2,985      1,017      61      15,464
 

Total held-to-maturity securities

     13,287      6,810      5,025      2,389      1,661      1,351      2,985      1,017      61      34,586
 

Total investments

   $ 15,245    $ 19,388    $ 10,286    $ 2,389    $ 1,661    $ 1,351    $ 2,985    $ 1,017    $ 61    $ 54,383
 

 

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Investment Credit Exposure

(In millions)

December 31, 2009

 

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

Federal funds sold

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

Trading securities:

                             

MBS:

                             

Other U.S. obligations:

                             

Ginnie Mae

     23                                              23

GSEs:

                             

Fannie Mae

     8                                              8
 

Total trading securities

     31                                              31
 

Available-for-sale securities:

                             

TLGP(2)

     1,931                                              1,931

Held-to-maturity securities:

                             

Interest-bearing deposits

          2,340      4,170                                    6,510

Commercial paper(3)

          1,000      100                                    1,100

Housing finance agency bonds

     28      741                                         769

TLGP(2)

     304                                              304

MBS:

                             

Other U.S. obligations:

                             

Ginnie Mae

     16                                              16

GSEs:

                             

Freddie Mac

     3,423                                              3,423

Fannie Mae

     8,467                                              8,467

Other:

                             

PLRMBS

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

Total held-to-maturity securities

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

Total investments

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

 

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

 

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

 

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

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

The Bank invests in short-term unsecured Federal funds sold, negotiable certificates of deposit (interest-bearing deposits), and commercial paper with member and nonmember counterparties. The Bank has determined that, as of March 31, 2010, all of the gross unrealized losses on its short-term unsecured Federal funds sold, interest-bearing deposits, and commercial paper are temporary because the gross unrealized losses were caused by movements in interest rates and not by the deterioration of the issuers’ creditworthiness; the short-term unsecured Federal funds sold, interest-bearing deposits, and commercial paper were all with issuers that had credit ratings of at least A at March 31, 2010; and all of the securities had maturity dates within 45 days of March 31, 2010. As a result, the Bank expects to recover the entire amortized cost basis of these securities.

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

 

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bonds held by the Bank are issued by the California Housing Finance Agency (CalHFA) and insured by either Ambac Assurance Corporation (Ambac), MBIA Insurance Corporation (MBIA), or Assured Guaranty Municipal Corporation (formerly Financial Security Assurance Incorporated). At March 31, 2010, all of the bonds were rated at least AA by Moody’s or Standard & Poor’s. On April 2, 2010, and April 19, 2010, Standard & Poor’s and Moody’s, respectively, downgraded $529 million of the Bank’s CalHFA bonds to A because of concerns over rising delinquencies and foreclosures and concerns over the credit profile of the California Housing Loan Insurance Fund, which provides primary mortgage insurance on approximately 41% of the underlying loans. As of April 30, 2010, all of the A-rated housing finance agency bonds issued by CalHFA and insured by Ambac or MBIA were on negative watch according to Moody’s or Standard & Poor’s.

At March 31, 2010, the Bank’s investments in housing finance agency bonds had gross unrealized losses totaling $142 million. These gross unrealized losses were mainly due to an illiquid market, causing these investments to be valued at a discount to their acquisition cost. In addition, the Bank independently modeled cash flows for the underlying collateral, using assumptions for default rates and loss severity that management deemed reasonable, and concluded that the available credit support within the CalHFA structure more than offset the projected underlying collateral losses. The Bank has determined that, as of March 31, 2010, all of the gross unrealized losses on its 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 A at March 31, 2010 (based on the lowest of Moody’s or Standard & Poor’s ratings). As a result, the Bank expects to recover the entire amortized cost basis of these securities.

The Bank invests in corporate debentures issued under the TLGP, which are guaranteed by the FDIC and backed by the full faith and credit of the U.S. government. The Bank expects to recover the entire amortized cost basis of these securities because it determined that the strength of the guarantees and the direct support from the U.S. government is sufficient to protect the Bank from losses based on current expectations. As a result, the Bank has determined that, as of March 31 2010, all of the gross unrealized losses on its TLGP investments are temporary.

The Bank’s investments also include agency residential MBS, which are backed by Fannie Mae, Freddie Mac, or Ginnie Mae, and PLRMBS, some of which were issued by and/or purchased from members, former members, or their respective affiliates. At March 31, 2010, PLRMBS representing 46% of the amortized cost of the Bank’s MBS portfolio were labeled Alt-A by the issuer. Alt-A MBS are generally collateralized by mortgage loans that are considered less risky than subprime loans but more risky than prime loans. These loans are generally made to borrowers who have sufficient credit ratings to qualify for a conforming mortgage loan but the loans may not meet standard guidelines for documentation requirements, property type, or loan-to-value ratios. In addition, the property securing the loan may be non-owner-occupied.

As of March 31, 2010, the Bank’s investment in MBS classified as held-to-maturity had gross unrealized losses totaling $5.0 billion, most of which were related to PLRMBS. These gross unrealized losses were primarily due to illiquidity in the MBS market, uncertainty about the future condition of the housing and mortgage markets and the economy, and continued deterioration in the credit performance of loan collateral underlying these securities, causing these assets to be valued at significant discounts to their acquisition cost.

For its agency residential MBS, the Bank expects to recover the entire amortized cost basis of these securities because it determined that the strength of the issuers’ guarantees through direct obligations or support from

 

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the U.S. government is sufficient to protect the Bank from losses based on current expectations. As a result, the Bank has determined that, as of March 31, 2010, all of the gross unrealized losses on its agency residential MBS are temporary.

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

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

To assess whether it expects to recover the entire amortized cost basis of its PLRMBS, the Bank performed a cash flow analysis for all of its PLRMBS as of March 31, 2010. In performing the cash flow analysis for each security, the Bank used two third-party models. The first model considers borrower characteristics and the particular attributes of the loans underlying the Bank’s securities, in conjunction with assumptions about future changes in home prices, interest rates, and other assumptions, to project prepayments, default rates, and loss severities. A significant input to the first model is the forecast of future housing price changes for the relevant states and core-based statistical areas (CBSAs) based on an assessment of the relevant housing markets. CBSA refers collectively to metropolitan and micropolitan statistical areas as defined by the United States Office of Management and Budget. As currently defined, a CBSA must contain at least one urban area of 10,000 or more people. The Bank’s housing price forecast as of March 31, 2010, assumed CBSA-level current-to-trough home price declines ranging from 0% to 12% over the 6- to 12-month periods beginning January 1, 2010 (average price decline during this time period equaled 5%). 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

 

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reduced to zero. The projected cash flows are based on a number of assumptions and expectations, and the results of these models can vary significantly with changes in assumptions and expectations. The scenario of cash flows determined based on the model approach described above reflects a best-estimate scenario and includes a base case current-to-trough housing price forecast and a base case housing price recovery path.

In addition to the cash flow analysis of the Bank’s PLRMBS under a base case (best estimate) housing price scenario, a cash flow analysis was also performed based on a housing price scenario that is more adverse than the base case (adverse case housing price scenario). The adverse case housing price scenario was based on a projection of housing prices that was 5 percentage points lower at the trough compared to the base case scenario, had a flatter recovery path, and had housing prices increase at a long-term annual rate of 3% compared to 4% in the base case. Under the adverse case housing price scenario, current-to-trough housing price declines were projected to range from 5% to 17% over the 6- to 12-month periods beginning January 1, 2010. Thereafter, home prices were projected to increase 0% in the first year, 1% in the second year, 2% in the third and fourth year, and 3% in each subsequent year.

The following table shows the base case scenario and what the OTTI charges would have been under the more stressful housing price scenario at March 31, 2010:

 

     Three Months Ended March 31, 2010
     Housing Price Scenario
     Base Case    Adverse Case
(Dollars in millions)    Number of
Securities
   Unpaid
Principal
Balance
   OTTI Related
to Credit Loss
   OTTI
Related to
All Other
Factors
   Number of
Securities
   Unpaid
Principal
Balance
   OTTI Related
to Credit Loss
   OTTI
Related to
All Other
Factors
 

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

                       

Prime

   7    $ 719    $ 6    $ 53    11    $ 1,433    $ 50    $ 14

Alt-A

   73      6,748      54      79    133      10,277      371      126
 

Total

   80    $ 7,467    $ 60    $ 132    144    $ 11,710    $ 421    $ 140
 

The Bank uses models in projecting the cash flows for all PLRMBS for its analysis of OTTI. The projected cash flows are based on a number of assumptions and expectations, and the results of these models can vary significantly with changes in assumptions and expectations.

For more information on the Bank’s OTTI analysis and reviews, see Note 4 to the Financial Statements.

The following table presents the ratings of the Bank’s PLRMBS investments as of March 31, 2010, by year of issuance.

 

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Unpaid Principal Balance of PLRMBS by Year of Issuance and Credit Rating

March 31, 2010

(In millions)

 

     Unpaid Principal Balance
     Credit Rating(1)     
Year of Issuance    AAA    AA    A    BBB    BB    B    CCC    CC    C    Total
 

Prime

                             

2004 and earlier

   $ 1,951    $ 676    $ 372    $ 92    $    $ 24    $    $    $    $ 3,115

2005

     105      55      122                                    282

2006

     237           281      217      69      34      107                945

2007

               23           98           298      510           929

2008

                    42                259      75           376
 

Total Prime

     2,293      731      798      351      167      58      664      585           5,647
 

Alt-A

                             

2004 and earlier

     243      616      632      92           44                     1,627

2005

     21      272      524      1,666      973      636      1,532      98           5,722

2006

                    106      296      41      800      515           1,758

2007

                         834      1,375      1,874      425      108      4,616

2008

                    289                               289
 

Total Alt-A

     264      888      1,156      2,153      2,103      2,096      4,206      1,038      108      14,012
 

Total par amount

   $ 2,557    $ 1,619    $ 1,954    $ 2,504    $ 2,270    $ 2,154    $ 4,870    $ 1,623    $ 108    $ 19,659
 

 

(1)

The credit ratings used by the Bank are based on the lowest of Moody’s, Standard & Poor’s, or comparable Fitch ratings. Credit ratings of BB and lower are below investment grade.

The following table presents the ratings of the Bank’s total portfolio of other-than-temporarily impaired PLRMBS at March 31, 2010, by year of issuance.

Unpaid Principal Balance of Other-Than-Temporarily Impaired PLRMBS

by Year of Issuance and Credit Rating

March 31, 2010

(In millions)

 

     Unpaid Principal Balance
     Credit Rating(1)     
Year of Issuance    AA    A    BBB    BB    B    CCC    CC    C    Total
 

Prime

                          

2004 and earlier

   $    $    $    $    $ 24    $    $    $    $ 24

2005

          53                                    53

2006

                         34      107                141

2007

                              298      510           808

2008

                              259      75           334
 

Total Prime

          53                58      664      585           1,360
 

Alt-A

                          

2004 and earlier

          139      57           44                     240

2005

     168      217      353      731      363      1,532      98           3,462

2006

               106      258      41      800      515           1,720

2007

                    596      1,375      1,697      425      108      4,201
 

Total Alt-A

     168      356      516      1,585      1,823      4,029      1,038      108      9,623
 

Total par amount

   $ 168    $ 409    $ 516    $ 1,585    $ 1,881    $ 4,693    $ 1,623    $ 108    $ 10,983
 

 

(1) The credit ratings used by the Bank are based on the lowest of Moody’s, Standard & Poor’s, or comparable Fitch ratings. Credit ratings of BB and lower are below investment grade.

 

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For the Bank’s PLRMBS, the following table shows the amortized cost, estimated fair value, OTTI charges, performance of the underlying collateral based on the classification at the time of origination, and credit enhancement statistics by type of collateral and year of issuance. Credit enhancement is defined as the percentage of subordinated tranches and over-collateralization, if any, in a security structure that will absorb losses before the Bank will experience a loss on the security. The credit enhancement figures include the additional credit enhancement required by the Bank (above the amounts required for an AAA rating by the credit rating agencies) for selected securities starting in late 2004, and for all securities starting in late 2005. The calculated original, average, and current credit enhancement amounts represent the dollar-weighted averages of all the MBS in each category shown.

PLRMBS Credit Characteristics

March 31, 2010

(Dollars in millions)

 

                For the Three Months Ended
March 31, 2010
  Underlying Collateral Performance and
Credit Enhancement Statistics
 
Year of Issuance   Amortized
Cost
  Gross
Unrealized
Losses
  Estimated
Fair
Value
  OTTI
Related to
Credit
Loss
  OTTI
Related to
All Other
Factors
    Total
OTTI
 

Weighted-
Average

60+ Days

Collateral
Delinquency
Rate

    Original
Weighted
Average
Credit
Support
    Current
Weighted
Average
Credit
Support
    Minimum
Current
Credit
Support
 
   

Prime

                   

2004 and earlier

  $ 3,117   $ 288   $ 2,831   $   $ 4      $ 4   6.41   4.02   8.55   4.09

2005

    281     50     236                  13.70      11.78      16.73      6.72   

2006

    927     71     859     1     (1       8.95      9.28      9.90      6.73   

2007

    879     347     580     1     53        54   21.61      23.00      21.10      7.28   

2008

    369     91     304     4     (3     1   24.41      30.00      31.09      31.09   
         

Total Prime

    5,573     847     4,810     6     53        59   10.90      10.14      12.75      4.09   
         

Alt-A

                   

2004 and earlier

    1,639     262     1,380     1     13        14   13.83      7.92      16.55      8.75   

2005

    5,525     1,641     4,055     13     76        89   20.79      14.04      16.92      5.65   

2006

    1,568     472     1,209     14     5        19   33.25      22.62      20.58      9.59   

2007

    4,362     1,664     2,932     26     (15     11   33.53      32.94      31.82      9.51   

2008

    289     72     217                  17.55      31.80      32.97      32.97   
         

Total Alt-A

    13,383     4,111     9,793     54     79        133   25.67      21.00      22.58      5.65   
         

Total

  $ 18,956   $ 4,958   $ 14,603   $ 60   $ 132      $ 192   21.43   17.88   19.75   4.09
   

The following table presents the weighted average delinquency of the collateral underlying the Bank’s PLRMBS by collateral type based on the classification at the time of origination and current credit rating.

 

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Credit Ratings of PLRMBS as of March 31, 2010

 

(Dollars in millions)    Unpaid
Principal
Balance
   Amortized
Cost
   Carrying
Value
   Gross
Unrealized
Losses
   Weighted-
Average
60+ Days
Collateral
Delinquency
Rate
 
   

Prime

              

AAA-rated

   $ 2,293    $ 2,291    $ 2,291    $ 165    4.61   

AA-rated

     731      731      731      98    9.97   

A-rated

     798      791      782      101    10.25   

BBB-rated

     351      349      349      30    11.07   

BB-rated

     167      166      166      25    4.70   

B-rated

     58      58      51      7    17.59   

CCC-rated

     664      643      395      248    22.98   

CC-rated

     585      544      371      173    24.89   
    

Total Prime

   $ 5,647    $ 5,573    $ 5,136    $ 847    10.90
   

Alt-A

              

AAA-rated

   $ 264    $ 266    $ 266    $ 37    13.99

AA-rated

     888      893      836      179    14.66   

A-rated

     1,156      1,160      1,093      227    14.27   

BBB-rated

     2,153      2,155      2,039      528    17.51   

BB-rated

     2,103      2,030      1,495      697    25.68   

B-rated

     2,096      2,004      1,301      783    30.30   

CCC-rated

     4,206      3,874      2,590      1,365    31.04   

CC-rated

     1,038      899      647      253    37.15   

C-rated

     108      102      61      42    20.70   
    

Total Alt-A

   $ 14,012    $ 13,383    $ 10,328    $ 4,111    25.67
   

Unpaid Principal Balance of PLRMBS by Collateral Type Classified at Origination

 

     March 31, 2010    December 31, 2009
(In millions)    Fixed Rate    Adjustable
Rate
   Total    Fixed Rate    Adjustable
Rate
   Total
 

PLRMBS:

                 

Prime

   $ 2,778    $ 2,869    $ 5,647    $ 3,083    $ 2,983    $ 6,066

Alt-A

     6,890      7,122      14,012      7,544      6,890      14,434
 

Total

   $ 9,668    $ 9,991    $ 19,659    $ 10,627    $ 9,873    $ 20,500
 

PLRMBS in a Loss Position

at March 31, 2010, and Credit Ratings as of April 30, 2010

(Dollars in millions)

 

     March 31, 2010     April 30, 2010  

PLRMBS

backed by

loans

classified at

origination as:

   Unpaid
Principal
Balance
   Amortized
Cost
   Carrying
Value
   Gross
Unrealized
Losses
  

Weighted-
Average

60+ Days
Collateral
Delinquency
Rate

    %
Rated
AAA
    %
Rated
AAA
    % Rated
Investment
Grade
    % Rated
Below
Investment
Grade
    % on
Watchlist
 
   

Prime

   $ 5,401    $ 5,329    $ 4,891    $ 847    11.30   37.90   37.30   69.39   30.61   44.88

Alt-A

     14,012      13,383      10,329      4,111    25.67      1.88      1.88      23.33      76.67      32.56   
              

Total

   $ 19,413    $ 18,712    $ 15,220    $ 4,958    21.68   11.90   11.74   36.15   63.85   35.99
   

 

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The following table presents the fair value of the Bank’s PLRMBS as a percentage of the unpaid principal balance by collateral type and year of securitization.

Fair Value of PLRMBS as a Percentage of Unpaid Principal Balance by Year of Securitization

    
Collateral Type at Origination and Year of Securitization   

March 31,

2010

   

December 31,

2009

   

September 30,

2009

   

June 30,

2009

   

March 31,

2009

 
   

Prime

          

2004 and earlier

   90.87   89.57   89.79   85.02   80.49

2005

   83.73      82.15      78.16      70.43      63.61   

2006

   90.88      85.40      85.95      80.03      73.38   

2007

   62.44      67.64      62.69      64.78      63.10   

2008

   80.87      77.59      74.55      80.25      72.77   

Weighted average of all Prime

   85.17   84.23   83.41   80.14   75.50
   

Alt-A

          

2004 and earlier

   84.79   82.56   81.27   72.98   72.24

2005

   70.87      69.34      67.55      64.85      60.84   

2006

   68.76      66.74      64.48      58.69      57.38   

2007

   63.53      60.96      59.48      56.36      55.19   

2008

   75.21      51.17      49.16      58.72      66.20   

Weighted average of all Alt-A

   69.89   67.41   65.73   62.14   60.07

Weighted average of all PLRMBS

   74.28   72.39   71.09   67.80   65.13
   

The following table summarizes rating agency downgrade actions on PLRMBS that occurred from April 1, 2010, to April 30, 2010. The credit ratings used by the Bank are based on the lowest of Moody’s, Standard & Poor’s, or comparable Fitch ratings.

PLRMBS Downgraded from April 1, 2010, to April 30, 2010

Dollar amounts as of March 31, 2010

 

     To A    To BB    To B    To CCC    To CC    Total
(In millions)    Carrying
Value
   Fair
Value
   Carrying
Value
   Fair
Value
   Carrying
Value
   Fair
Value
   Carrying
Value
   Fair
Value
   Carrying
Value
   Fair
Value
   Carrying
Value
   Fair
Value
 

PLRMBS:

                                   

Downgrade from AAA

   $ 31    $ 31    $    $    $    $    $    $    $    $    $ 31    $ 31

Downgrade from AA

                         83      70                          83      70

Downgrade from A

               69      67      126      98      212      161                407      326

Downgrade from BBB

               108      81      418      306      436      353                962      740

Downgrade from BB

                                   295      277      89      61      384      338

Downgrade from B

                                   391      344                391      344
 

Total

   $ 31    $ 31    $ 177    $ 148    $ 627    $ 474    $ 1,334    $ 1,135    $ 89    $ 61    $ 2,258    $ 1,849
 

The securities that were downgraded from April 1, 2010, to April 30, 2010, were included in the Bank’s OTTI analysis performed as of March 31, 2010, and no additional OTTI charges were required as a result of these downgrades.

 

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The Bank believes that, as of March 31, 2010, the gross unrealized losses on the remaining PLRMBS that did not have an OTTI charge are primarily due to unusually wide mortgage-asset spreads, generally resulting from an illiquid market, which caused these assets to be valued at significant discounts to their acquisition costs. The Bank does not intend to sell these securities, it is not more likely than not that the Bank will be required to sell these securities before its anticipated recovery of the remaining amortized cost basis, and the Bank expects to recover the entire amortized cost basis of these securities. As a result, the Bank had determined that, as of March 31, 2010, all of the gross unrealized losses on these securities are temporary. The Bank will continue to monitor and analyze the performance of these securities to assess the likelihood of the recovery of the entire amortized cost basis of these securities as of each balance sheet date.

If conditions in the housing and mortgage markets and general business and economic conditions remain stressed or deteriorate further, the fair value of MBS may decline further and the Bank may experience OTTI of additional PLRMBS in future periods, as well as further impairment of PLRMBS that were identified as other-than-temporarily impaired as of March 31, 2010. Additional future OTTI credit charges could adversely affect the Bank’s earnings and retained earnings and its ability to pay dividends and repurchase capital stock. The Bank cannot predict whether it will be required to record additional OTTI charges on its PLRMBS in the future.

Federal and state government authorities, as well as private entities, such as financial institutions and the servicers of residential mortgage loans, have begun or promoted implementation of programs designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures. These loan modification programs, as well as future legislative, regulatory, or other actions, including amendments to the bankruptcy laws, that result in the modification of outstanding mortgage loans, may adversely affect the value of, and the returns on, these mortgage loans or MBS related to these mortgage loans.

Derivatives Counterparties. The Bank has also adopted credit policies and exposure limits for derivatives credit exposure. All credit exposure from derivatives transactions entered into by the Bank with member counterparties that are not derivatives dealers (including interest rate swaps, caps, floors, corridors, and collars), for which the Bank serves as an intermediary, must be fully secured by eligible collateral, and all such derivatives transactions are subject to both the Bank’s Advances and Security Agreement and a master netting agreement.

For all derivatives dealer counterparties, the Bank selects only highly rated derivatives dealers and major banks that meet the Bank’s eligibility criteria. In addition, the Bank has entered into master netting agreements and bilateral security agreements with all active derivatives dealer counterparties that provide for delivery of collateral at specified levels tied to counterparty credit ratings to limit the Bank’s net unsecured credit exposure to these counterparties.

Under these policies and agreements, the amount of unsecured credit exposure to an individual derivatives dealer counterparty is limited to the lesser of (i) a percentage of the counterparty’s capital, or (ii) an absolute dollar credit exposure limit, both according to the counterparty’s credit rating, as determined by rating agency long-term credit ratings of the counterparty’s debt securities or deposits. The following table presents the Bank’s credit exposure to its derivatives counterparties at the dates indicated.

 

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Credit Exposure to Derivatives Counterparties

(In millions)

 

March 31, 2010

           
Counterparty Credit Rating(1)    Notional
Balance
   Gross Credit
Exposure
   Collateral    Net Unsecured
Exposure

AA

   $ 91,349    $ 1,147    $ 1,132    $ 15

A(2)

     120,420      771      763      8

Subtotal

     211,769      1,918      1,895      23

Member institutions(3)

     358      1      1     

Total derivatives

   $ 212,127    $ 1,919    $ 1,896    $ 23

December 31, 2009

           
Counterparty Credit Rating(1)    Notional
Balance
   Gross Credit
Exposure
   Collateral    Net Unsecured
Exposure

AA

   $ 101,059    $ 1,129    $ 1,101    $ 28

A(2)

     133,647      698      690      8

Subtotal

     234,706      1,827      1,791      36

Member institutions(3)

     308               

Total derivatives

   $ 235,014    $ 1,827    $ 1,791    $ 36

 

(1) The credit ratings used by the Bank are based on the lowest of Moody’s, Standard & Poor’s, or comparable Fitch ratings.
(2) Includes notional amounts of derivatives contracts outstanding totaling $22.2 billion at March 31, 2010, and $16.6 billion at December 31, 2009, with Citibank, N.A., a member that is a derivatives dealer counterparty.
(3) Collateral held with respect to interest rate exchange agreements with members represents either collateral physically held by or on behalf of the Bank or collateral assigned to the Bank, as evidenced by an Advances and Security Agreement, and held by the members for the benefit of the Bank. These amounts do not include those related to Citibank, N.A., which are included in the A-rated derivatives dealer counterparty amounts above at March 31, 2010, and at December 31, 2009.

At March 31, 2010, the Bank had a total of $212.1 billion in notional amounts of derivatives contracts outstanding. Of this total:

 

   

$211.8 billion represented notional amounts of derivatives contracts outstanding with 18 derivatives dealer counterparties. Seven of these counterparties made up 79% of the total notional amount outstanding with these derivatives dealer counterparties, individually ranging from 8% to 15% of the total. The remaining counterparties each represented less than 5% of the total. Six of these counterparties, with $83.7 billion of derivatives outstanding at March 31, 2010, were affiliates of members, and one counterparty, with $22.2 billion outstanding at March 31, 2010, was a member of the Bank.

 

   

$358 million represented notional amounts of derivatives contracts with three member counterparties that are not derivatives dealers. The Bank entered into these derivatives contracts as an intermediary and entered into the same amount of exactly offsetting transactions with derivatives dealer counterparties. The Bank’s intermediation in this manner allows members indirect access to the derivatives market.

Gross credit exposure on derivatives contracts at March 31, 2010, was $1.9 billion, which consisted of:

 

   

$1.9 billion of gross credit exposure on open derivatives contracts with 14 derivatives dealer counterparties. After consideration of collateral held by the Bank, the amount of net unsecured exposure from these contracts totaled $23 million.

 

   

$1 million of gross credit exposure on open derivatives contracts, in which the Bank served as an intermediary, with one member counterparty that is not a derivatives dealer, all of which was secured with eligible collateral.

 

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At December 31, 2009, the Bank had a total of $235.0 billion in notional amounts of derivatives contracts outstanding. Of this total:

 

   

$234.7 billion represented notional amounts of derivatives contracts outstanding with 18 derivatives dealer counterparties. Seven of these counterparties made up 78% of the total notional amount outstanding with these derivatives dealer counterparties, individually ranging from 6% to 15% of the total. The remaining counterparties each represented less than 5% of the total. Six of these counterparties, with $95.9 billion of derivatives outstanding at December 31, 2009, were affiliates of members, and one counterparty, with $16.6 billion outstanding at December 31, 2009, was a member of the Bank.

 

   

$308 million represented notional amounts of derivatives contracts with three member counterparties that are not derivatives dealers. The Bank entered into these derivatives contracts as an intermediary and entered into the same amount of exactly offsetting transactions with derivatives dealer counterparties. The Bank’s intermediation in this manner allows members indirect access to the derivatives market.

Gross credit exposure on derivatives contracts at December 31, 2009, was $1.8 billion, which consisted of:

 

   

$1.8 billion of gross credit exposure on open derivatives contracts with 12 derivatives dealer counterparties. After consideration of collateral held by the Bank, the amount of net unsecured exposure from these contracts totaled $36 million.

 

   

$0.3 million of gross credit exposure on open derivatives contracts, in which the Bank served as an intermediary, with one member counterparty that is not a derivatives dealer, all of which was secured with eligible collateral.

The Bank’s gross credit exposure with derivatives dealer counterparties, representing net gain amounts due to the Bank, was $1.9 billion at March 31, 2010, and $1.8 billion at December 31, 2009. The gross credit exposure reflects the fair value of derivatives contracts, including interest amounts accrued through the reporting date, and is netted by counterparty because the Bank has the legal right to do so under its master netting agreement with each counterparty.

The Bank’s gross credit exposure increased $0.1 billion from December 31, 2009, to March 31, 2010. In general, the Bank is a net receiver of fixed interest rates and a net payer of floating interest rates under its derivatives contracts with counterparties. From December 31, 2009, to March 31, 2010, interest rates decreased, causing interest rate swaps in which the Bank is a net receiver of fixed interest rates to increase in value.

An increase or decrease in the notional amounts of derivatives contracts may not result in a corresponding increase or decrease in gross credit exposure because the fair values of derivatives contracts are generally zero at inception.

Based on the master netting arrangements, its credit analyses, and the collateral requirements in place with each counterparty, the Bank does not expect to incur any credit losses on its derivatives agreements.

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

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) requires management to make a number of judgments, estimates, and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and

 

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liabilities, if applicable, and the reported amounts of income, expenses, gains, and losses during the reporting period. Changes in these judgments, estimates, and assumptions could potentially affect the Bank’s financial position and results of operations significantly. Although management believes these judgments, estimates, and assumptions to be reasonably accurate, actual results may differ.

In the Bank’s 2009 Form 10-K, the following accounting policies and estimates were identified as critical because they require management to make subjective or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies and estimates are: estimating the allowance for credit losses on the advances and mortgage loan portfolios; accounting for derivatives; estimating fair values of investments classified as trading and other-than-temporarily impaired, derivatives and associated hedged items carried at fair value in accordance with the accounting for derivative instruments and associated hedging activities, and financial instruments carried at fair value under the fair value option; and estimating the prepayment speeds on MBS and mortgage loans for the accounting of amortization of premiums and accretion of discounts on MBS and mortgage loans.

There have been no significant changes in the judgments and assumptions made during the first three months of 2010 in applying the Bank’s critical accounting policies. In addition, these policies and the judgments, estimates, and assumptions are also described in greater detail in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” and Note 1 to the Financial Statements in the Bank’s 2009 Form 10-K and in Note 11 to the Financial Statements.

Recently Issued Accounting Standards and Interpretations

See Note 2 to the Financial Statements for a discussion of recently issued accounting standards and interpretations.

Recent Developments

Financial Reform Legislation. On December 11, 2009, the U.S. House of Representatives passed H.R. 4173, the Wall Street Reform and Consumer Protection Act (Reform Act), which, if passed by the U.S. Senate and signed into law, would, among other things: (1) create a consumer financial protection agency; (2) create an inter-agency oversight council that would identify and regulate systemically important financial institutions; (3) regulate the over-the-counter derivatives market; (4) reform the credit rating agencies; (5) provide shareholders with an advisory vote on the compensation practices of the entity in which they invest, including executive compensation and golden parachutes; and (6) create a federal insurance office that would monitor the insurance industry.

The U.S. Senate has moved its version of the bill, S. 3217, the Restoring American Financial Stability Act (Financial Stability Act), to the floor for debate and amendment. This proposed bill is generally similar to the House bill described above.

Depending on whether the Reform Act or Financial Stability Act, or a combination of both, is signed into law, and on the provisions of any legislation, the Bank’s business operations, funding costs, rights and obligations, and the manner in which the Bank carries out its housing finance mission may be affected. For example, regulations on the over-the-counter derivatives market that may be issued under the Reform Act or the proposed Financial Stability Act could materially affect the Bank’s ability to hedge its interest rate risk. In addition, the proposed Financial Stability Act has a provision that would prohibit the FHLBanks, if deemed systemically significant, from lending an amount that exceeds 25 percent of capital stock to a member financial institution. This limitation could cause a significant decrease in the aggregate amount of FHLBank advances and could increase advance rates for the FHLBanks’ member financial institutions. In addition, the proposed Financial Stability Act includes proposals that would prohibit banks, bank holding companies, and subsidiaries of either from purchasing or selling in trading accounts certain financial instruments, except for U.S., state, or local government obligations or securities issued by Ginnie Mae, Fannie Mae, or Freddie Mac. This exception does not refer to FHLBank debt and therefore it is uncertain whether this provision, as proposed, could limit investments in FHLBank debt.

 

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The Bank cannot predict whether any financial reform legislation will be enacted or what the content of the legislation or the regulations issued under the legislation would be, and therefore cannot predict the impact on the Bank or its members.

FHLBank Membership for Community Development Financial Institutions (CDFIs). On January 5, 2010, the Finance Agency published a final rule to amend its membership regulations to authorize non-federally insured CDFIs to become members of an FHLBank. The newly eligible CDFIs include community development loan funds, community development venture capital funds, and state-chartered credit unions without federal insurance. The final rule sets forth the eligibility and procedural requirements for CDFIs that want to become members of an FHLBank.

Minimum Capital. On February 8, 2010, the Finance Agency published a notice of proposed rulemaking seeking comment on a proposed rule to effect Section 1111 of the Housing Act, which amended Section 1362 of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (Safety and Soundness Act) to provide additional authority for the Finance Agency regarding minimum capital requirements for the federal housing enterprises and the FHLBanks. Among other things, the amendment to the Safety and Soundness Act authorizes the Director of the Finance Agency to establish capital levels higher than the minimum levels specified for the FHLBanks under the Bank Act and for additional capital and reserve requirements with respect to products or activities, and to temporarily increase an established minimum capital level if it determines that an increase is necessary and consistent with prudential regulation and the safe and sound operation of an FHLBank. The proposed rule is intended to implement the Director’s authority in this regard and sets forth procedures and standards for imposing a temporary increase in the minimum capital levels to address the following factors: current or anticipated declines in the value of assets, the amounts of outstanding mortgage-backed securities, and the ability to access liquidity and funding; credit, market, operational, and other risks; current or projected declines in capital; compliance with regulations, written orders, or agreements; unsafe and unsound operations or practices; housing finance market conditions; level of reserves or retained earnings; initiatives, operations, products, or practices that entail heightened risk; ratio of the market value of equity to the par value of capital stock; or any other conditions as detailed by the Director. The proposed regulation also includes procedures for periodic review and rescission of a temporarily increased minimum capital level. Comments were due April 9, 2010.

Community Development Loans for Community Financial Institutions; Secured Lending by FHLBanks to Members and Affiliates. On February 23, 2010, the Finance Agency published a notice of proposed rulemaking and request for comment on a proposed rule that would implement Section 1211 of the Housing Act, which amended the Bank Act to include secured loans for community development activities as eligible collateral for community financial institution (CFI) members and to allow the Bank to make long-term advances to CFI members for purposes of financing community development activities. The proposed rule would add new definitions and make other conforming changes in accordance with Section 1211 of the Housing Act. The proposed rule would also add a new provision deeming any form of secured lending by an FHLBank to a member of any FHLBank to be an advance and prohibiting secured extensions of credit to an affiliate of any member. The supplemental information to the proposed rule clarifies that the Finance Agency considers any kind of secured lending to a member or member affiliate, including reverse repurchase agreements, to be secured extensions of credit subject to the rule. Finally, the proposed rule would make some technical changes and transfer the advances and new business activities regulations from the Finance Board regulations to the Finance Agency regulations. Comments were due April 26, 2010.

 

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Director Compensation and Expenses. On April 5, 2010, the Finance Agency published a final rule on director compensation and expenses, which will amend the current rule to implement changes made by the Housing Act. In addition to eliminating the former statutory limitations on director compensation, the final rule authorizes the FHLBanks to pay “reasonable compensation and expenses” subject to Finance Agency oversight and authority to disapprove. Under the new rule, any Finance Agency disapproval of a Bank’s compensation plan would be applied prospectively and not affect compensation or expenses paid prior to any Finance Agency determination or order.

Director Eligibility and Elections. On April 5, 2010, the Finance Agency published a final rule that deems the redesignation of a directorship to a new state prior to the end of its term as a result of the annual designation of FHLBank directorships to be a termination of the directorship. The redesignated directorship will be filled by an election by the members of the new state. The new rule constitutes a change from the prior Finance Board rule, which deemed the redesignation to create a vacancy on the board that could be filled by an election by the remaining directors.

Board of Directors of the Federal Home Loan Bank System Office of Finance. On April 26, 2010, the Finance Agency adopted a final rule to increase the size of the Board of Directors of the Office of Finance and have it consist of the 12 FHLBank presidents and five independent directors. The final rule provides that the independent directors will serve as the audit committee of the Office of Finance and will be charged with the oversight of the Office of Finance’s preparation of accurate combined financial reports. The final rule also gives responsibilities to the audit committee to ensure that the FHLBanks adopt consistent accounting policies and procedures to the extent necessary for information submitted by the FHLBanks to the Office of Finance to be combined to create accurate and meaningful combined financial reports. If the FHLBanks are not able to agree on consistent accounting policies and procedures, the audit committee, in consultation with the Finance Agency, may require them. The Finance Agency will fill the initial independent director positions each for a term of five years, which will be staggered. By June 10, 2010, the current Board of Directors of the Office of Finance must, in consultation with the FHLBanks, agree on a slate of at least five persons and nominate such persons for consideration for appointment as independent directors by the Finance Agency. Within 45 days after the Finance Agency appoints an independent director, the Board of Directors of the Office of Finance must hold an organizational meeting, where the Board of Directors of the Office of Finance and the audit committee will be reconstituted. Once the terms of the independent directors initially appointed by the Finance Agency expire or the positions otherwise become vacant, the independent directors subsequently will be elected by a majority vote of the Board of Directors of the Office of Finance, subject to the Finance Agency’s review of, and non-objection to, each independent director.

Finance Agency Proposed Rule Regarding FHLBank Investments. On May 4, 2010, the Finance Agency issued a notice of proposed rulemaking regarding FHLBank investments. Among other things the proposed rule would incorporate the current limitations on MBS investments and derivatives activities that are applicable to an FHLBank as a matter of Finance Agency financial management policy and order (including without limitation the provision limiting the level of MBS investments to no more than 300% of an FHLBank’s capital). The proposal also requests comment on whether additional limitations on an FHLBank’s MBS investments should be adopted as part of a final regulation and whether with respect to private-label MBS investments such limitations should be based on an FHLBank’s level of retained earnings, the underlying collateral characteristics, or other criteria. Comments on the proposed rule are due July 6, 2010.

 

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Off-Balance Sheet Arrangements, Guarantees, and Other Commitments

In accordance with regulations governing the operations of the FHLBanks, each FHLBank, including the Bank, is jointly and severally liable for the FHLBank System’s consolidated obligations issued under Section 11(a) of the FHLBank Act, and in accordance with the FHLBank Act, each FHLBank, including the Bank, is jointly and severally liable for consolidated obligations issued under Section 11(c) of the FHLBank Act. The joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor.

The Bank’s joint and several contingent liability is a guarantee, but is excluded from initial recognition and measurement provisions because the joint and several obligations are mandated by the FHLBank Act or Finance Agency regulation and are not the result of arms-length transactions among the FHLBanks. The Bank has no control over the amount of the guaranty or the determination of how each FHLBank would perform under the joint and several obligations. The valuation of this contingent liability is therefore not recorded on the balance sheet of the Bank. The par amount of the outstanding consolidated obligations of all 12 FHLBanks was $870.9 billion at March 31, 2010, and $930.6 billion at December 31, 2009. The par value of the Bank’s participation in consolidated obligations was $159.2 billion at March 31, 2010, and $178.2 billion at December 31, 2009. At March 31, 2010, the Bank had committed to the issuance of $1.8 billion in consolidated obligation bonds, almost all of which were hedged with associated interest rate swaps. At December 31, 2009, the Bank had committed to the issuance of $1.1 billion in consolidated obligation bonds, of which $1.0 billion were hedged with associated interest rate swaps. For additional information on the Bank’s joint and several liability contingent obligation, see Notes 10 and 18 to the Financial Statements in the Bank’s 2009 Form 10-K.

In addition, in the ordinary course of business, the Bank engages in financial transactions that, in accordance with U.S. GAAP, are not recorded on the Bank’s balance sheet or may be recorded on the Bank’s balance sheet in amounts that are different from the full contract or notional amount of the transactions. For example, the Bank routinely enters into commitments to extend advances and issues standby letters of credit. These commitments and standby letters of credit may represent future cash requirements of the Bank, although the standby letters of credit usually expire without being drawn upon. Standby letters of credit are subject to the same underwriting and collateral requirements as advances made by the Bank. At March 31, 2010, the Bank had $0.5 billion of advance commitments and $5.2 billion in standby letters of credit outstanding. At December 31, 2009, the Bank had $32 million of advance commitments and $5.3 billion in standby letters of credit outstanding. The estimated fair values of these advance commitments and standby letters of credit were immaterial to the balance sheet at March 31, 2010, and December 31, 2009.

The Bank’s financial statements do not include a liability for future statutorily mandated payments from the Bank to Resolution Funding Corporation (REFCORP). No liability is recorded because each FHLBank must pay 20% of net earnings (after its Affordable Housing Program obligation) to REFCORP to support the payment of part of the interest on the bonds issued by the REFCORP, and each FHLBank is unable to estimate its future required payments because the payments are based on the future earnings of that FHLBank and the other FHLBanks and are not estimable under the accounting for contingencies. Accordingly, the REFCORP payments are disclosed as a long-term statutory payment requirement and, for accounting purposes, are treated, accrued, and recognized like an income tax.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Federal Home Loan Bank of San Francisco’s (Bank) market risk management objective is to maintain a relatively low exposure of the value of capital and future earnings (excluding the impact of any cumulative net gains or losses on derivatives and associated hedged items and on financial instruments carried at fair value) to changes in interest rates. This profile reflects the Bank’s objective of maintaining a conservative asset-liability mix and its commitment to providing value to its members through products and dividends without subjecting their investments in Bank capital stock to significant interest rate risk.

In May 2008, the Bank’s Board of Directors modified the market risk management objective in the Bank’s Risk Management Policy to maintaining a relatively low exposure of the net portfolio value of capital and future earnings (excluding the impact of any cumulative net gains or losses on derivatives and associated hedged items and on financial instruments carried at fair value) to changes in interest rates. See “Total Bank Market Risk” below for a discussion of the modification.

Market risk identification and measurement are primarily accomplished through market value of capital sensitivity analyses, net portfolio value of capital sensitivity analyses, and net interest income sensitivity analyses. The Risk Management Policy approved by the Bank’s Board of Directors establishes market risk policy limits and market risk measurement standards at the total Bank level. Additional guidelines approved by the Bank’s asset-liability management committee (ALCO) apply to the Bank’s two business segments, the advances-related business and the mortgage-related business. These guidelines provide limits that are monitored at the segment level and are consistent with the total Bank policy limits. Interest rate risk is managed for each business segment on a daily basis, as discussed below in “Segment Market Risk.” At least monthly, compliance with Bank policies and management guidelines is presented to the ALCO or the Board of Directors, along with a corrective action plan if applicable.

Total Bank Market Risk

Market Value of Capital Sensitivity and Net Portfolio Value of Capital Sensitivity

The Bank uses market value of capital sensitivity (the interest rate sensitivity of the net fair value of all assets, liabilities, and interest rate exchange agreements) as an important measure of the Bank’s exposure to changes in interest rates. As presented below, the Bank continues to measure, monitor, and report on market value of capital sensitivity, but no longer has a policy limit as of May 2008.

In May 2008, the Board of Directors approved a modification to the Bank’s Risk Management Policy to use net portfolio value of capital sensitivity as the primary market value metric for measuring the Bank’s exposure to changes in interest rate risk and to establish a policy limit on net portfolio value of capital sensitivity. This approach uses valuation methods that estimate the value of mortgage-backed securities (MBS) and mortgage loans in alternative interest rate environments based on valuation spreads that existed at the time the Bank acquired the MBS and mortgage loans (acquisition spreads), rather than valuation spreads implied by the current market prices of MBS and mortgage loans (market spreads). Risk metrics based on spreads existing at the time of acquisition of mortgage assets better reflect the interest rate risk of the Bank, since the Bank’s mortgage asset portfolio is primarily classified as held-to-maturity, while the use of market spreads calculated from estimates of current market prices (which include large embedded liquidity spreads) would not reflect the actual risks faced by the Bank. Because the Bank intends to and is able to hold its MBS and mortgage loans to maturity, the risks of value loss implied by current market prices of MBS and mortgage loans are not likely to be faced by the Bank. Prior to the third quarter of 2009, in the case where specific PLRMBS were classified as other-than-temporarily impaired, market spreads were used from the date of impairment for the purpose of estimating net portfolio of capital. Beginning in the third quarter of 2009, in the case of PLRMBS for which management expects loss of principal in future periods, the par amount of the other-than-temporarily impaired security is reduced by the amount of the projected principal shortfall and the asset price is calculated based on the acquisition spread. This approach directly takes into consideration the impact of

 

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projected principal (credit) losses from PLRMBS on the net portfolio value of capital, but eliminates the impact of large liquidity spreads inherent in the prior treatment of other-than-temporarily impaired securities. The Bank continues to monitor both the market value of capital sensitivity and the net portfolio value of capital sensitivity.

The Bank’s net portfolio value of capital sensitivity policy limits the potential adverse impact of an instantaneous parallel shift of a plus or minus 100-basis-point change in interest rates from current rates (base case) to no worse than –3% of the estimated net portfolio value of capital. In addition, the policy limits the potential adverse impact of an instantaneous plus or minus 100-basis-point change in interest rates measured from interest rates that are 200 basis points above or below the base case to no worse than –4% of the estimated net portfolio value of capital. The Bank’s measured net portfolio value of capital sensitivity was within the policy limit as of March 31, 2010.

To determine the Bank’s estimated risk sensitivities to interest rates for both the market value of capital sensitivity and net portfolio value of capital sensitivity, the Bank uses a third-party proprietary asset and liability system to calculate estimated net portfolio values under alternative interest rate scenarios. The system analyzes all of the Bank’s financial instruments including derivatives on a transaction-level basis using sophisticated valuation models with consistent and appropriate behavioral assumptions and current position data. The system also includes a mortgage prepayment model.

At least annually, the Bank reexamines the major assumptions and methodologies used in the model, including interest rate curves, spreads for discounting, and prepayment assumptions. The Bank also compares the prepayment assumptions in the third-party model to other sources, including actual prepayment history.

The Market Value of Capital Sensitivity table below presents the sensitivity of the market value of capital (the market value of all of the Bank’s assets, liabilities, and hedges, with mortgage assets valued using market spreads) to changes in interest rates. The table presents the estimated percentage change in the Bank’s market value of capital that would be expected to result from changes in interest rates under different interest rate scenarios, using market spread assumptions.

Market Value of Capital Sensitivity

Estimated Percentage Change in Market Value of Bank Capital

for Various Changes in Interest Rates

 

Interest Rate Scenario(1)    March 31, 2010     December 31, 2009  

+200 basis-point change above current rates

   –7.6   –9.0

+100 basis-point change above current rates

   –4.5      –5.3   

–100 basis-point change below current rates(2)

   +8.8      +12.1   

–200 basis-point change below current rates(2)

   +19.4      +21.6   

 

  (1) Instantaneous change from actual rates at dates indicated.
  (2) Interest rates for each maturity are limited to non-negative interest rates.

The Bank’s estimates of the sensitivity of the market value of capital to changes in interest rates as of March 31, 2010, show less sensitivity than the estimates as of December 31, 2009, primarily because of improved MBS asset pricing and resulting reduced MBS asset spreads. Compared to interest rates as of December 31, 2009, interest rates as of March 31, 2010, were 6 basis points lower for terms of 1 year, 25 basis points lower for terms of 5 years, and 15 basis points lower for terms of 10 years. As indicated by the table above, the market value of capital sensitivity is adversely affected when rates increase. In general, mortgage assets, including MBS, are expected to remain outstanding for a longer period of time when interest rates increase and prepayment speeds decline as a result of reduced incentives to refinance. Because most of the Bank’s MBS were purchased when mortgage asset spreads to pricing benchmarks were significantly lower than what

 

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is currently required by investors, the adverse spread difference gives rise to an embedded negative impact on the market value of MBS, which directly reduces the estimated market value of Bank capital. If interest rates increase and MBS consequently remain outstanding for a longer period of time, the adverse spread difference will exist for a longer period of time, giving rise to an even larger embedded negative market value impact than exists at current interest rate levels. This creates additional downward pressure on the measured market value of capital. As a result, the Bank’s measured market value of capital sensitivity to changes in rates is higher than it would be if it were measured based on the fundamental underlying repricing and option risks (a greater decline in the market value of capital when rates increase and a greater increase in the market value of capital when rates decrease). Based on the liquidity premium investors require for these assets and the Bank’s held-to-maturity classification, management does not believe the market value of capital sensitivity is the best indication of risk from a held-to-maturity perspective, and management has therefore developed an alternative way to measure that risk, based on estimates of the sensitivity of the net portfolio value of capital.

The Net Portfolio Value of Capital Sensitivity table below presents the sensitivity of the net portfolio value of capital (the net value of the Bank’s assets, liabilities, and hedges, with mortgage assets valued using acquisition valuation spreads) to changes in interest rates. The table presents the estimated percentage change in the Bank’s net portfolio value of capital that would be expected to result from changes in interest rates under different interest rate scenarios based on pricing mortgage assets at spreads that existed at the time of purchase rather than current market spreads. The Bank’s estimates of the net portfolio value of capital sensitivity to changes in interest rates as of March 31, 2010, show substantially the same sensitivity compared to the estimates as of December 31, 2009.

Net Portfolio Value of Capital Sensitivity

Estimated Percentage Change in Net Portfolio Value of Bank Capital

for Various Changes in Interest Rates Based on Acquisition Spreads

 

Interest Rate Scenario(1)    March 31, 2010     December 31, 2009  

+200 basis-point change above current rates

   –3.3   –4.4

+100 basis-point change above current rates

   –1.2      –1.8   

–100 basis-point change below current rates(2)

   +0.3      +0.2   

–200 basis-point change below current rates(2)

   +1.0      +0.1   

 

  (1) Instantaneous change from actual rates at dates indicated.
  (2) Interest rates for each maturity are limited to non-negative interest rates.

Potential Dividend Yield

The potential dividend yield is a measure used by the Bank to assess financial performance. The potential dividend yield is based on current period economic earnings that exclude the effects of unrealized net gains or losses resulting from the Bank’s derivatives and associated hedged items and from financial instruments carried at fair value, which will generally reverse through changes in future valuations and settlements of contractual interest cash flows over the remaining contractual terms to maturity or by the call or put date of the assets and liabilities held at fair value, hedged assets and liabilities, and derivatives. Economic earnings also exclude the interest expense on mandatorily redeemable stock.

The Bank limits the sensitivity of projected financial performance through a Board of Directors’ policy limit on projected adverse changes in the potential dividend yield. The Bank’s potential dividend yield sensitivity policy limits the potential adverse impact of an instantaneous parallel shift of a plus or minus 200-basis-point change in interest rates from current rates (base case) to no worse than –120 basis points from the base case projected potential dividend yield. In the downward shift, interest rates were limited to non-negative rates. With the indicated interest rate shifts, the potential dividend yield for the projected period March 2010 through March 2011 would be expected to decrease by 37 basis points, well within the policy limit of –120 basis points.

 

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Duration Gap

Duration gap is the difference between the estimated durations (market value sensitivity) of assets and liabilities (including the impact of interest rate exchange agreements) and reflects the extent to which estimated maturity and repricing cash flows for assets and liabilities are matched. The Bank monitors duration gap analysis at the total Bank level but does not have a policy limit. The Bank’s duration gap was four months at March 31, 2010, and four months at December 31, 2009.

Total Bank Duration Gap Analysis

 

     March 31, 2010    December 31, 2009
     

Amount

(In millions)

  

Duration Gap(1)

(In months)

  

Amount

(In millions)

   Duration Gap(1)
(In months)

Assets

   $ 173,851    9    $ 192,862    9

Liabilities

     167,465    5      186,632    5

Net

   $ 6,386    4    $ 6,230    4

 

(1) Duration gap values include the impact of interest rate exchange agreements.

The duration gap as of March 31, 2010, stayed substantially the same compared to December 31, 2009. Since duration gap is a measure of market value sensitivity, the impact of the extraordinarily wide mortgage asset spreads on duration gap is the same as described in the analysis in “Market Value of Capital Sensitivity” above. As a result of the liquidity premium investors require for these assets and the Bank’s held-to-maturity classification, management does not believe that market value-based sensitivity risk measures provide a fundamental indication of risk.

Segment Market Risk

The financial performance and interest rate risks of each business segment are managed within prescribed guidelines, which, when combined, are consistent with the policy limits for the total Bank.

Advances-Related Business

Interest rate risk arises from the advances-related business primarily through the use of member-contributed capital to fund fixed rate investments of targeted amounts and maturities. In general, advances result in very little net interest rate risk for the Bank because most fixed rate advances with original maturities greater than three months and advances with embedded options are hedged contemporaneously with an interest rate swap or option with terms offsetting the advance. The interest rate swap or option generally is maintained as a hedge for the life of the advance. These hedged advances effectively create a pool of variable rate assets, which, in combination with the strategy of raising debt swapped to variable rate liabilities, creates an advances portfolio with low net interest rate risk.

Non-MBS investments have maturities of less than three months or are variable rate investments. These investments also effectively match the interest rate risk of the Bank’s variable rate funding.

The interest rate risk in the advances-related business is primarily associated with the Bank’s strategy for investing the members’ contributed capital. The Bank’s general strategy is to invest 50% of member capital in short-term investments (maturities of 3 months or less) and 50% in intermediate-term investments (laddered portfolio of investments with maturities of up to four years). Because of the Federal Reserve’s actions to stimulate the economy, short-term interest rates are exceptionally low, resulting in lower returns on the Bank’s capital. In order to improve the return on the Bank’s capital, while not materially affecting the Bank’s risk profile, effective January 2010 the Bank temporarily modified its invested capital strategy to invest 50% of the capital currently invested in investments with maturities of 3 months or less (25% of total member capital) in a portfolio of investments with maturities of 12 to 24 months, and as those investments mature, to reinvest the capital back into short-term investments.

 

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The strategy to invest 50% of member capital in short-term assets is intended to mitigate the market value of capital risks associated with the potential repurchase or redemption of members’ excess capital stock. The strategy to invest 50% of member capital in a laddered portfolio of instruments with short to intermediate maturities is intended to take advantage of the higher earnings available from a generally positively sloped yield curve, when intermediate-term investments generally have higher yields than short-term investments. Excess capital stock primarily results from a decline in a member’s advances. Under the Bank’s capital plan, capital stock, when repurchased or redeemed, is required to be repurchased or redeemed at its par value of $100 per share, subject to certain regulatory and statutory limits.

Management updates the repricing and maturity gaps for actual asset, liability, and derivatives transactions that occur in the advances-related segment each day. Management regularly compares the targeted repricing and maturity gaps to the actual repricing and maturity gaps to identify rebalancing needs for the targeted gaps. On a weekly basis, management evaluates the projected impact of expected maturities and scheduled repricings of assets, liabilities, and interest rate exchange agreements on the interest rate risk of the advances-related segment. The analyses are prepared under base case and alternate interest rate scenarios to assess the effect of put options and call options embedded in the advances, related financing, and hedges. These analyses are also used to measure and manage potential reinvestment risk (when the remaining term of advances is shorter than the remaining term of the financing) and potential refinancing risk (when the remaining term of advances is longer than the remaining term of the financing).

Because of the short-term and variable rate nature of the assets, liabilities, and derivatives of the advances-related business, the Bank’s interest rate risk guidelines address the amounts of net assets that are expected to mature or reprice in a given period. Net market value sensitivity analysis and net interest income simulations are also used to identify and measure risk and variances to the target interest rate risk exposure in the advances-related segment.

Mortgage-Related Business

The Bank’s mortgage assets include MBS, most of which are classified as held-to-maturity and a small amount of which are classified as trading, and mortgage loans held for portfolio purchased under the MPF Program. The Bank is exposed to interest rate risk from the mortgage-related business because the principal cash flows of the mortgage assets and the liabilities that fund them are not exactly matched through time and across all possible interest rate scenarios, given the uncertainty of mortgage prepayments and the existence of interest rate caps on certain adjustable rate MBS.

The Bank purchases a mix of intermediate-term fixed rate and floating rate MBS. Generally, purchases of long-term fixed rate MBS have been relatively small; any MPF loans that have been acquired are long-term fixed rate mortgage assets. This results in a mortgage portfolio that has a diversified set of interest rate risk attributes.

The estimated market risk of the mortgage-related business is managed both at the time an individual asset is purchased and on a total portfolio level. At the time of purchase (for all significant mortgage asset acquisitions), the Bank analyzes the estimated earnings sensitivity and estimated net market value sensitivity, taking into consideration the estimated prepayment sensitivity of the mortgage assets and anticipated funding and hedging under various interest rate scenarios. The related funding and hedging transactions are executed at or close to the time of purchase of a mortgage asset.

At least monthly, management reviews the estimated market risk of the entire portfolio of mortgage assets and related funding and hedges. Rebalancing strategies to modify the estimated mortgage portfolio market risks are then considered. Periodically, management performs more in-depth analyses, which include the impacts of non-parallel shifts in the yield curve and assessments of unanticipated prepayment behavior. Based on these analyses, management may take actions to rebalance the mortgage portfolio’s estimated market risk

 

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profile. These rebalancing strategies may include entering into new funding and hedging transactions, forgoing or modifying certain funding or hedging transactions normally executed with new mortgage purchases, or terminating certain funding and hedging transactions for the mortgage asset portfolio.

The Bank manages the estimated interest rate risk associated with mortgage assets, including prepayment risk, through a combination of debt issuance and derivatives. The Bank may obtain funding through callable and non-callable FHLBank System debt and execute derivatives transactions to achieve principal cash flow patterns and market value sensitivities for the liabilities and derivatives that provide a significant offset to the interest rate and prepayment risks associated with the mortgage assets. Debt issued to finance mortgage assets may be fixed rate debt, callable fixed rate debt, or adjustable rate debt. Derivatives may be used as temporary hedges of anticipated debt issuance, temporary hedges of mortgage loan purchase commitments, or long-term hedges of debt used to finance the mortgage assets. The derivatives used to hedge the interest rate risk of fixed rate mortgage assets generally may be options to enter into interest rate swaps (swaptions) or callable and non-callable pay-fixed interest rate swaps. Derivatives used to hedge the periodic cap risks of adjustable rate mortgages may be receive-adjustable, pay-adjustable swaps with embedded caps that offset the periodic caps in the mortgage assets.

In May 2008, the Board of Directors approved a modification to the Bank’s Risk Management Policy to use net portfolio value of capital sensitivity as a primary metric for measuring the Bank’s exposure to interest rate risk and to establish a policy limit on net portfolio value of capital sensitivity. This new approach uses valuation methods that estimate the value of MBS and mortgage loans in alternative interest rate environments based on valuation spreads that existed at the time the Bank acquired the MBS and mortgage loans (acquisition spreads), rather than valuation spreads implied by the current market prices of MBS and mortgage loans (market spreads). Risk metrics based on spreads existing at the time of acquisition of mortgage assets better reflect the interest rate risk of the Bank, since the Bank’s mortgage asset portfolio is primarily classified as held-to-maturity, while the use of market spreads calculated from estimates of current market prices (which include large embedded liquidity spreads) would not reflect the actual risks faced by the Bank. Beginning in the third quarter of 2009, in the case of specific mortgage assets where management expects loss of principal in future periods, the par amount of the other-than-temporarily impaired security is reduced by the amount of the projected principal shortfall and the asset price is calculated based on the acquisition spread. This approach directly takes into consideration the impact of projected principal (credit) losses from PLRMBS on the net portfolio value of capital, but eliminates the impact of large liquidity spreads inherent in the prior treatment of other-than-temporarily impaired securities. The Bank continues to monitor both the market value of capital sensitivity and the net portfolio value of capital sensitivity attributable to the mortgage-related business.

The following table presents results of the estimated market value of capital sensitivity analysis attributable to the mortgage-related business as of March 31, 2010, and December 31, 2009.

 

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Market Value of Capital Sensitivity

Estimated Percentage Change in Market Value of Bank Capital

Attributable to the Mortgage-Related Business for Various Changes in Interest Rates

 

Interest Rate Scenario(1)    March 31, 2010     December 31, 2009  

+200 basis-point change

   –5.6   –6.2

+100 basis-point change

   –3.7      –4.0   

–100 basis-point change(2)

   +8.0      +11.1   

–200 basis-point change(2)

   +18.0      +19.8   

 

  (1) Instantaneous change from actual rates at dates indicated.
  (2) Interest rates for each maturity are limited to non-negative interest rates.

The Bank’s estimates of the sensitivity of the market value of capital to changes in interest rates as of March 31, 2010, show less sensitivity than the estimates as of December 31, 2009, primarily because of improved MBS asset pricing and resulting reduced MBS asset spreads. Compared to interest rates as of December 31, 2009, interest rates as of March 31, 2010, were 6 basis points lower for terms of 1 year, 25 basis points lower for terms of 5 years, and 15 basis points lower for terms of 10 years. As indicated by the table above, the market value of capital sensitivity is adversely affected when rates increase. In general, mortgage assets, including MBS, are expected to remain outstanding for a longer period of time when interest rates increase and prepayment speeds decline as a result of reduced incentives to refinance. Because most of the Bank’s MBS were purchased when mortgage asset spreads to pricing benchmarks were significantly lower than what is currently required by investors, the adverse spread difference gives rise to an embedded negative impact on the market value of MBS, which directly reduces the estimated market value of Bank capital. If interest rates increase and MBS consequently remain outstanding for a longer period of time, the adverse spread difference will exist for a longer period of time, giving rise to an even larger embedded negative market value impact than exists at current interest rate levels. This creates additional downward pressure on the measured market value of capital. As a result, the Bank’s measured market value of capital sensitivity to changes in rates is higher than it would be if it were measured based on the fundamental underlying repricing and option risks (a greater decline in the market value of capital when rates increase and a greater increase in the market value of capital when rates decrease). Based on the liquidity premium investors require for these assets and the Bank’s held-to-maturity classification, management does not believe the market value of capital sensitivity is the best indication of risk from a held-to-maturity perspective, and management has therefore developed an alternative way to measure that risk, based on estimates of the sensitivity of the net portfolio value of capital.

The Bank’s interest rate risk guidelines for the mortgage-related business address the net portfolio value of capital sensitivity of the assets, liabilities, and derivatives of the mortgage-related business. The following table presents the estimated percentage change in the value of Bank capital attributable to the mortgage-related business that would be expected to result from changes in interest rates under different interest rate scenarios based on pricing mortgage assets at spreads that existed at the time of purchase rather than current market spreads. The Bank’s estimates of the net portfolio value of capital sensitivity to changes in interest rates as of March 31, 2010, show substantially the same sensitivity compared to the estimates as of December 31, 2009.

 

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Net Portfolio Value of Capital Sensitivity

Estimated Percentage Change in Net Portfolio Value of Bank Capital

Attributable to the Mortgage-Related Business for Various Changes in

Interest Rates Based on Acquisition Spreads

 

Interest Rate Scenario(1)    March 31, 2010     December 31, 2009  

+200 basis-point change above current rates

   –2.0   –2.5

+100 basis-point change above current rates

   –0.7      –1.0   

–100 basis-point change below current rates(2)

   –0.8      –0.4   

–200 basis-point change below current rates(2)

   –1.9      –1.0   

 

  (1) Instantaneous change from actual rates at dates indicated.
  (2) Interest rates for each maturity are limited to non-negative interest rates.

 

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

The senior management of the Federal Home Loan Bank of San Francisco (Bank) is responsible for establishing and maintaining a system of disclosure controls and procedures designed to ensure that information required to be disclosed by the Bank in the reports filed or submitted under the Securities Exchange Act of 1934 (1934 Act) is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. The Bank’s disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Bank in the reports that it files or submits under the 1934 Act is accumulated and communicated to the Bank’s management, including its principal executive officer or officers and principal financial officer or officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the Bank’s disclosure controls and procedures, the Bank’s management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and the Bank’s management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of controls and procedures.

Management of the Bank has evaluated the effectiveness of the design and operation of its disclosure controls and procedures with the participation of the president and chief executive officer, executive vice president and chief operating officer, senior vice president and chief financial officer, and senior vice president, controller and operations officer as of the end of the quarterly period covered by this report. Based on that evaluation, the Bank’s president and chief executive officer, executive vice president and chief operating officer, senior vice president and chief financial officer, and senior vice president, controller and operations officer have concluded that the Bank’s disclosure controls and procedures were effective at a reasonable assurance level as of the end of the fiscal quarter covered by this report.

Internal Control Over Financial Reporting

During the three months ended March 31, 2010, there were no changes in the Bank’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Bank’s internal control over financial reporting.

 

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Consolidated Obligations

The Bank’s disclosure controls and procedures include controls and procedures for accumulating and communicating information in compliance with the Bank’s disclosure and financial reporting requirements relating to the joint and several liability for the consolidated obligations of other Federal Home Loan Banks (FHLBanks). Because the FHLBanks are independently managed and operated, the Bank’s management relies on information that is provided or disseminated by the Federal Housing Finance Agency (Finance Agency), the Office of Finance, and the other FHLBanks, as well as on published FHLBank credit ratings, in determining whether the joint and several liability regulation is reasonably likely to result in a direct obligation for the Bank or whether it is reasonably possible that the Bank will accrue a direct liability.

The Bank’s management also relies on the operation of the joint and several liability regulation, which is located in Section 966.9 of Title 12 of the Code of Federal Regulations. The joint and several liability regulation requires that each FHLBank file with the Finance Agency a quarterly certification that it will remain capable of making full and timely payment of all of its current obligations, including direct obligations, coming due during the next quarter. In addition, if an FHLBank cannot make such a certification or if it projects that it may be unable to meet its current obligations during the next quarter on a timely basis, it must file a notice with the Finance Agency. Under the joint and several liability regulation, the Finance Agency may order any FHLBank to make principal and interest payments on any consolidated obligations of any other FHLBank, or allocate the outstanding liability of an FHLBank among all remaining FHLBanks on a pro rata basis in proportion to each FHLBank’s participation in all consolidated obligations outstanding or on any other basis.

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

The Federal Home Loan Bank of San Francisco (Bank) may be subject to various legal proceedings arising in the normal course of business. On March 15, 2010, the Bank filed two complaints in the Superior Court of the State of California, County of San Francisco, relating to the purchase of private-label residential mortgage-backed securities. The Bank’s complaints are actions for rescission and damages and assert claims for and violations of state and federal securities laws, negligent misrepresentation, and rescission of contract. For a discussion of this litigation, see “Part I. Item 3. Legal Proceedings” in the Bank’s Annual Report on Form 10-K for the year ended December 31, 2009. After consultation with legal counsel, management is not aware of any other legal proceedings that may have a material effect on the Bank’s financial condition or results of operations or that are otherwise material to the Bank.

 

ITEM 1A. RISK FACTORS

For a discussion of risk factors, see “Part I. Item 1A. Risk Factors” in the Federal Home Loan Bank of San Francisco’s (Bank’s) Annual Report on Form 10-K for the year ended December 31, 2009 (2009 Form 10-K). There have been no material changes from the risk factors disclosed in the “Risk Factors” section of the Bank’s 2009 Form 10-K.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

 

ITEM 4. (REMOVED AND RESERVED)

 

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ITEM 5. OTHER INFORMATION

None.

 

ITEM 6. EXHIBITS

 

10.1    2010 Audit Executive Incentive Plan
31.1    Certification of the President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2    Certification of the Chief Operating Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.3    Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.4    Certification of the Controller pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1    Certification of the President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2    Certification of the Chief Operating Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.3    Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.4    Certification of the Controller pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1    Computation of Ratio of Earnings to Fixed Charges – Three Months Ended March 31, 2010

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on May 12, 2010.

 

Federal Home Loan Bank of San Francisco

/S/ STEVEN T. HONDA

Steven T. Honda

Senior Vice President and Chief Financial Officer

(Principal Financial Officer)

/S/ VERA MAYTUM

Vera Maytum

Senior Vice President, Controller and Operations Officer

(Chief Accounting Officer)

 

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