Federal Home Loan Bank of San Francisco - FORM 10-Q - May 3, 2018

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EX-32.2 - CERTIFICATION OF THE CFO SECTION 906 - Federal Home Loan Bank of San Franciscoa201810qq1ex322.htm
EX-32.1 - CERTIFICATION OF THE PRESIDENT AND CEO SECTION 906 - Federal Home Loan Bank of San Franciscoa201810qq1ex321.htm
EX-31.2 - CERTIFICATION OF THE CFO SECTION 302 - Federal Home Loan Bank of San Franciscoa201810qq1ex312.htm
EX-31.1 - CERTIFICATION OF THE PRESIDENT AND CEO SECTION 302 - Federal Home Loan Bank of San Franciscoa201810qq1ex311.htm

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, 2018
OR
o
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    o  No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  Yes    o  No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
o
 
Accelerated filer
 
o
 
 
 
 
Non-accelerated filer
 
x  (Do not check if a smaller reporting company)
 
Smaller reporting company
 
o
 
 
 
 
 
 
 
 
 
 
 
Emerging growth company
 
o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.      o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    o  Yes    x  No
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, 2018

Class B Stock, par value $100
31,639,440



Federal Home Loan Bank of San Francisco
Form 10-Q
Index
PART I.
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 3.
 
 
 
 
 
Item 4.
 
 
 
 
 
PART II.
 
 
 
 
 
 
Item 1.
 
 
 
 
 
Item 1A.
 
 
 
 
 
Item 6.
 
 
 
 
 


PART II. OTHER INFORMATION

ITEM 1.    FINANCIAL STATEMENTS
 
Federal Home Loan Bank of San Francisco
Statements of Condition
(Unaudited)
(In millions-except par value)
March 31,
2018

 
December 31,
2017

Assets:
 
 
 
Cash and due from banks
$
15

 
$
31

Interest-bearing deposits
1,070

 
1,115

Securities purchased under agreements to resell
6,250

 
11,750

Federal funds sold
13,950

 
11,028

Trading securities(a)
913

 
1,164

Available-for-sale (AFS) securities(a)
3,686

 
3,833

Held-to-maturity (HTM) securities (fair values were $13,948 and $14,704, respectively)(a)
13,963

 
14,680

Advances (includes $6,637 and $6,431 at fair value under the fair value option, respectively)
66,642

 
77,382

Mortgage loans held for portfolio, net of allowance for credit losses of $0 and $0, respectively
2,376

 
2,076

Accrued interest receivable
138

 
119

Premises, software, and equipment, net
25

 
29

Derivative assets, net
102

 
83

Other assets
95

 
95

Total Assets
$
109,225

 
$
123,385

Liabilities:
 
 
 
Deposits
$
257

 
$
281

Consolidated obligations:
 
 
 
Bonds (includes $1,315 and $949 at fair value under the fair value option, respectively)
74,297

 
85,063

Discount notes
27,203

 
30,440

Total consolidated obligations
101,500

 
115,503

Mandatorily redeemable capital stock
309

 
309

Accrued interest payable
123

 
116

Affordable Housing Program (AHP) payable
199

 
204

Derivative liabilities, net
3

 
1

Other liabilities
158

 
165

Total Liabilities
102,549

 
116,579

Commitments and Contingencies (Note 17)



Capital:
 
 
 
Capital stock—Class B—Putable ($100 par value) issued and outstanding:
 
 
 
31 shares and 32 shares, respectively
3,068

 
3,243

Unrestricted retained earnings
2,681

 
2,670

Restricted retained earnings
592

 
575

Total Retained Earnings
3,273

 
3,245

Accumulated other comprehensive income/(loss) (AOCI)
335

 
318

Total Capital
6,676

 
6,806

Total Liabilities and Capital
$
109,225

 
$
123,385


(a)
At March 31, 2018, and December 31, 2017, none of these securities were pledged as collateral that may be repledged.

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

3


Federal Home Loan Bank of San Francisco
Statements of Income
(Unaudited)
 
Three Months Ended March 31,
(In millions)
2018

 
2017

Interest Income:
 
 
 
Advances
$
369

 
$
153

Interest-bearing deposits
4

 
1

Securities purchased under agreements to resell
9

 
1

Federal funds sold
51

 
19

Trading securities
4

 
4

AFS securities
57

 
61

HTM securities
81

 
67

Mortgage loans held for portfolio
21

 
9

Total Interest Income
596

 
315

Interest Expense:
 
 
 
Consolidated obligations:
 
 
 
Bonds
307

 
116

Discount notes
134

 
54

Deposits
1

 
—

Mandatorily redeemable capital stock
6

 
11

Total Interest Expense
448

 
181

Net Interest Income
148

 
134

Provision for/(reversal of) credit losses on mortgage loans
—

 
—

Net Interest Income After Mortgage Loan Loss Provision
148

 
134

Other Income/(Loss):
 
 
 
Total other-than-temporary impairment (OTTI) loss
(3
)
 
(1
)
Net amount of OTTI loss reclassified to/(from) AOCI
2

 
(2
)
Net OTTI loss, credit-related
(1
)
 
(3
)
Net gain/(loss) on trading securities
(1
)
 
1

Net gain/(loss) on advances and consolidated obligation bonds held under fair value option
(41
)
 
(1
)
Net gain/(loss) on derivatives and hedging activities
31

 
(9
)
Gains on litigation settlements, net
—

 
119

Other
4

 
5

Total Other Income/(Loss)
(8
)
 
112

Other Expense:
 
 
 
Compensation and benefits
21

 
19

Other operating expense
14

 
14

Federal Housing Finance Agency
1

 
2

Office of Finance
2

 
1

Quality Jobs Fund expense
10

 
40

Other, net
1

 
4

Total Other Expense
49

 
80

Income/(Loss) Before Assessment
91

 
166

AHP Assessment
10

 
18

Net Income/(Loss)
$
81

 
$
148


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

4


Federal Home Loan Bank of San Francisco
Statements of Comprehensive Income
(Unaudited)
 
Three Months Ended March 31,
(In millions)
2018

 
2017

Net Income/(Loss)
$
81

 
$
148

Other Comprehensive Income/(Loss):
 
 
 
Net change in pension and postretirement benefits
1

 
—

Net non-credit-related OTTI gain/(loss) on AFS securities:
 
 
 
Net change in fair value of other-than-temporarily impaired securities
17

 
29

Net amount of OTTI loss reclassified to/(from) other income/(loss)
(2
)
 
2

Total net non-credit-related OTTI gain/(loss) on AFS securities
15

 
31

Net non-credit-related OTTI gain/(loss) on HTM securities:
 
 
 
Accretion of non-credit-related OTTI loss
1

 
1

Total net non-credit-related OTTI gain/(loss) on HTM securities
1

 
1

Total other comprehensive income/(loss)
17

 
32

Total Comprehensive Income/(Loss)
$
98

 
$
180


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

5


Federal Home Loan Bank of San Francisco
Statements of Capital Accounts
(Unaudited)
 
Capital Stock
Class B—Putable
 
Retained Earnings
 
 
 
Total
Capital

(In millions)
Shares

 
Par Value

 
Restricted

 
Unrestricted

 
Total

 
AOCI

 
Balance, December 31, 2016
24

 
$
2,370

 
$
2,168

 
$
888

 
$
3,056

 
$
111

 
$
5,537

Comprehensive income/(loss)
 
 
 
 
132

 
16

 
148

 
32

 
180

Issuance of capital stock
1

 
83

 
 
 
 
 
 
 
 
 
83

Repurchase of capital stock
(2
)
 
(173
)
 
 
 
 
 
 
 
 
 
(173
)
Cash dividends paid on capital stock (9.08%)
 
 
 
 
 
 
(54
)
 
(54
)
 
 
 
(54
)
Balance, March 31, 2017
23

 
$
2,280

 
$
2,300

 
$
850

 
$
3,150

 
$
143

 
$
5,573

Balance, December 31, 2017
32

 
$
3,243

 
$
575

 
$
2,670

 
$
3,245

 
$
318

 
$
6,806

Comprehensive income/(loss)


 


 
17

 
64

 
81

 
17

 
98

Issuance of capital stock
3

 
253

 

 

 
 
 

 
253

Repurchase of capital stock
(4
)
 
(428
)
 

 

 
 
 

 
(428
)
Cash dividends paid on capital stock (7.00%)

 


 

 
(53
)
 
(53
)
 

 
(53
)
Balance, March 31, 2018
31

 
$
3,068

 
$
592

 
$
2,681

 
$
3,273

 
$
335

 
$
6,676


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

6


Federal Home Loan Bank of San Francisco
Statements of Cash Flows
(Unaudited)
 
Three Months Ended March 31,
(In millions)
2018

 
2017

Cash Flows from Operating Activities:
 
 
 
Net Income/(Loss)
$
81

 
$
148

Adjustments to reconcile net income/(loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization
4

 
(17
)
Change in net fair value of trading securities
1

 
(1
)
Change in net fair value adjustment on advances and consolidated obligation bonds held under the fair value option
41

 
1

Change in net derivatives and hedging activities
141

 
(13
)
Net OTTI loss, credit-related
1

 
3

Net change in:
 
 
 
Accrued interest receivable
(20
)
 
15

Other assets
—

 
10

Accrued interest payable
8

 
26

Other liabilities
(16
)
 
(5
)
Total adjustments
160

 
19

Net cash provided by/(used in) operating activities
241

 
167

Cash Flows from Investing Activities:
 
 
 
Net change in:
 
 
 
Interest-bearing deposits
(99
)
 
(9
)
Securities purchased under agreements to resell
5,500

 
4,000

Federal funds sold
(2,922
)
 
(5,878
)
Premises, software, and equipment
—

 
(1
)
Trading securities:
 
 
 
Proceeds from maturities of long-term
250

 
601

AFS securities:
 
 
 
Proceeds from maturities of long-term
183

 
245

HTM securities:
 
 
 
Net (increase)/decrease in short-term
500

 
650

Proceeds from maturities of long-term
652

 
731

Purchases of long-term
(433
)
 
(368
)
Advances:
 
 
 
Repaid
525,362

 
332,485

Originated
(514,739
)
 
(331,705
)
Mortgage loans held for portfolio:
 
 
 
Principal collected
72

 
30

Purchases
(369
)
 
(166
)
Proceeds from sales of foreclosed assets
—

 
2

Net cash provided by/(used in) investing activities
13,957

 
617

 


7


Federal Home Loan Bank of San Francisco
Statements of Cash Flows (continued)
(Unaudited)
 
Three Months Ended March 31,
(In millions)
2018

 
2017

Cash Flows from Financing Activities:
 
 
 
Net change in deposits and other financing activities
(14
)
 
3

Borrowings from other FHLBanks
—

 
(1,345
)
Net proceeds from issuance of consolidated obligations:
 
 
 
Bonds
17,046

 
12,320

Discount notes
37,299

 
41,735

Payments for matured and retired consolidated obligations:
 

 
Bonds
(27,760
)

(13,043
)
Discount notes
(40,557
)

(40,217
)
Proceeds from issuance of capital stock
253


83

Payments for repurchase/redemption of mandatorily redeemable capital stock
—


(54
)
Payments for repurchase of capital stock
(428
)
 
(173
)
Cash dividends paid
(53
)

(54
)
Net cash provided by/(used in) financing activities
(14,214
)

(745
)
Net increase/(decrease) in cash and due from banks
(16
)

39

Cash and due from banks at beginning of the period
31

 
2

Cash and due from banks at end of the period
$
15


$
41

Supplemental Disclosures:
 
 
 
Interest paid
$
416

 
$
168

AHP payments
16

 
10


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

8

Federal Home Loan Bank of San Francisco
Notes to Financial Statements
(Unaudited)





(Dollars in millions except per share amounts)

Note 1 — Basis of Presentation

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 the Bank, 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, 2018. 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, 2017 (2017 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 may affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of income, expenses, gains, and losses during the reporting period. The most significant of these estimates include estimating the allowance for credit losses on the advances and mortgage loan portfolios; accounting for derivatives; estimating fair values of investments classified as trading and available-for-sale, derivatives and associated hedged items carried at fair value in accordance with the accounting for derivative instruments and associated hedging activities, and financial instruments carried at fair value under the fair value option, and accounting for other-than-temporary impairment (OTTI) for investment securities; and estimating the prepayment speeds on mortgage-backed securities (MBS) and mortgage loans for the accounting of amortization of premiums and accretion of discounts on MBS and mortgage loans. Actual results could differ significantly from these estimates.

Financial Instruments Meeting Netting Requirements. The Bank presents certain financial instruments, including derivative instruments and securities purchased under agreements to resell, on a net basis when they have a legal right of offset and all other requirements for netting are met (collectively referred to as the netting requirements). The Bank has elected to offset its derivative asset and liability positions, as well as cash collateral received or pledged, when the netting requirements are met. The Bank did not have any offsetting liabilities related to its securities purchased under agreements to resell for the periods presented.

The net exposure for these financial instruments can change on a daily basis; therefore, there may be a delay between the time this exposure change is identified and additional collateral is requested, and the time this collateral is received or pledged. Likewise, there may be a delay for excess collateral to be returned. For derivative instruments that meet the netting requirements, any excess cash collateral received or pledged is recognized as a derivative liability or derivative asset. Additional information regarding these agreements is provided in Note 15 – Derivatives and Hedging Activities. Based on the fair value of the related collateral held, the securities purchased under agreements to resell were fully collateralized for the periods presented.

Derivatives. All derivatives are recognized on the Statements of Condition at their fair values and are reported as either derivative assets or derivative liabilities, net of cash collateral, including initial and certain variation margin, and accrued interest received from or pledged to clearing agents and/or counterparties. The fair values of derivatives are netted by clearing agent and/or counterparty when the netting requirements have been met. If these netted amounts are positive, they are classified as an asset, and if negative, they are classified as a liability. Cash flows associated with derivatives are reflected as cash flows from operating activities on the Statements of Cash Flows unless the derivative meets the criteria to be a financing derivative.

The Bank uses the clearinghouse, London Clearing House (LCH) Ltd, for all cleared derivative transactions. Effective January 16, 2018, LCH Ltd made certain amendments to its rulebook, changing the legal characterization

9

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



of variation margin payments to be daily settlement payments, rather than collateral. Initial margin continues to be considered cash collateral.

Variable Interest Entities. The Bank’s investments in variable interest entities (VIEs) are limited to private-label residential mortgage-backed securities (PLRMBS). On an ongoing basis, the Bank performs a quarterly evaluation to determine whether it is the primary beneficiary in any VIE. The Bank evaluated its investments in VIEs as of March 31, 2018, to determine whether it is a primary beneficiary of any of these investments. The primary beneficiary is required to consolidate a VIE. The Bank determined that consolidation accounting is not required because the Bank is not the primary beneficiary of these VIEs for the periods presented. The Bank does not have the power to significantly affect the economic performance of any of these investments because it does not act as a key decision maker nor does it have the unilateral ability to replace a key decision maker. In addition, the Bank does not design, sponsor, transfer, service, or provide credit or liquidity support in any of its investments in VIEs. The Bank’s maximum loss exposure for these investments is limited to the carrying value.

Descriptions of the Bank’s significant accounting policies are included in “Item 8. Financial Statements and Supplementary Data – Note 1 – Summary of Significant Accounting Policies” in the Bank’s 2017 Form 10-K. Other changes to these policies as of March 31, 2018, are discussed in Note 2 – Recently Issued and Adopted Accounting Guidance.

Note 2 — Recently Issued and Adopted Accounting Guidance

Targeted Improvements to Accounting for Hedging Activities. On August 28, 2017, the Financial Accounting Standards Board (FASB) issued amended guidance to improve the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements. This guidance requires that, for fair value hedges, the entire change in the fair value of the hedging instrument included in the assessment of hedge effectiveness be presented in the same income statement line that is used to present the earnings effect of the hedged item. For cash flow hedges, the entire change in the fair value of the hedging instrument included in the assessment of hedge effectiveness must be recorded in other comprehensive income. In addition, the amendments include certain targeted improvements to the assessment of hedge effectiveness and permit, among other things, the following:
•
Measurement of the change in fair value of the hedged item on the basis of the benchmark rate component of the contractual coupon cash flows determined at hedge inception.
•
Measurement of the hedged item in a partial-term fair value hedge of interest rate risk by assuming the hedged item has a term that reflects only the designated cash flows being hedged.
•
Consideration only of how changes in the benchmark interest rate affect a decision to settle a prepayable instrument before its scheduled maturity in calculating the change in the fair value of the hedged item attributable to interest rate risk.
•
For a cash flow hedge of interest rate risk of a variable-rate financial instrument, an entity could designate as the hedged risk the variability in cash flows attributable to the contractually specified interest rate.

This guidance becomes effective for the Bank for interim and annual periods beginning on January 1, 2019, and early adoption is permitted. The amended presentation and disclosure guidance is required only prospectively. The Bank does not intend to adopt this guidance early. The Bank is in the process of evaluating this guidance, and its effect on the Bank’s financial condition, results of operations, cash flows, and financial statement disclosures has not yet been determined.

Premium Amortization on Purchased Callable Debt Securities. On March 30, 2017, the FASB issued amended guidance to shorten the amortization period for certain purchased callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. This guidance affects all entities that hold investments in callable debt securities that have an amortized cost basis in excess of the amount that is repayable by the issuer at the earliest call date (that is, at a premium). This guidance is

10

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



effective for the Bank for interim and annual periods beginning on January 1, 2019, and early adoption is permitted. This guidance should be applied using a modified retrospective method through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The adoption of this guidance is not expected to have any effect on the Bank’s financial condition, results of operations, or cash flows.

Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. On March 10, 2017, the FASB issued amended guidance to improve the presentation of net periodic pension cost and net periodic postretirement benefit cost. The amendments require that employer disaggregate the service cost component from the other components of net benefit cost. The amendments also provide explicit guidance on how to present the service cost component and the other components of net benefit cost in the Statements of Income. This guidance became effective for the Bank for interim and annual periods beginning on January 1, 2018, and was adopted retrospectively for the presentation of the service cost component and the other components of net periodic pension cost and net periodic postretirement benefit cost in the Statements of Income. The adoption of this guidance did not have a material effect on the Bank’s financial condition, results of operations, cash flows, or financial statement disclosures.

Classification of Certain Cash Receipts and Cash Payments. On August 26, 2016, the FASB issued amendments to clarify guidance on the classification of certain cash receipts and payments in the Statements of Cash Flows. This guidance is intended to reduce existing diversity in practice in how certain cash receipts and cash payments are presented and classified on the Statements of Cash Flows. This guidance became effective for the Bank for interim and annual periods beginning on January 1, 2018. The adoption of this guidance did not have any effect on the Bank’s financial condition, results of operations, or cash flows.

Measurement of Credit Losses on Financial Instruments. On June 16, 2016, the FASB issued amended guidance for the accounting for credit losses on financial instruments. The amendments require entities to measure expected credit losses based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate under the circumstances. In addition, under the new guidance, a financial asset, or a group of financial assets, is required to be measured at its amortized cost to be presented at the net amount expected to be collected over the contractual term of the financial assets. Among other things, the guidance also requires:
•
The Statement of Income to reflect the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period.
•
The entities to determine the allowance for credit losses for purchased financial assets with a more-than-insignificant amount of credit deterioration since origination that are measured at amortized cost basis in a similar manner to other financial assets measured at amortized cost basis. The initial allowance for credit losses is required to be added to the purchase price.
•
Credit losses relating to available-for-sale debt securities to be recorded through an allowance for credit losses. The amendments limit the allowance for credit losses to the amount by which fair value is below amortized cost.
•
Public entities to further disaggregate the current disclosure of credit quality indicators in relation to the amortized cost of financing receivables by the year of origination (i.e., vintage).

The guidance is effective for the Bank for interim and annual periods beginning on January 1, 2020. Early application is permitted as of the interim and annual reporting periods beginning after December 15, 2018. The guidance should be applied using a modified-retrospective approach, through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. In addition, the entities are required to use a prospective transition approach for purchased financial assets with a more-than-insignificant amount of credit deterioration since origination and for debt securities for which an other-than-temporary impairment had been recognized before the effective date. The Bank does not intend to adopt the guidance early. The Bank is in the process of evaluating this guidance and expects the adoption of the guidance may

11

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



result in an increase in the allowance for credit losses given the requirement to assess losses for the entire estimated life of the financial asset, including an allowance for debt securities. The effect on the Bank’s financial condition, results of operations, and cash flows will depend on the composition of financial assets held by the Bank at the adoption date, as well as on economic conditions and forecasts at that time.

Recognition of Lease Assets and Lease Liabilities. On February 25, 2016, the FASB issued guidance that requires recognition of lease assets and lease liabilities on the Statements of Condition and disclosure of key information about leasing arrangements. In particular, this guidance requires a lessee of operating or finance leases to recognize on the Statements of Condition a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. However, for leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election not to recognize lease assets and lease liabilities. Under previous U.S. GAAP, a lessee was not required to recognize lease assets and lease liabilities arising from operating leases on the Statements of Condition. While this guidance does not fundamentally change lessor accounting, some changes have been made to align that guidance with the lessee guidance and other areas within U.S. GAAP.

The guidance becomes effective for the Bank for the interim and annual periods beginning on January 1, 2019, and early application is permitted. The guidance requires lessors and lessees to recognize and measure leases at the beginning of the earliest period presented in the financial statements using a modified retrospective approach. The Bank does not intend to adopt this guidance early. Upon adoption, the Bank expects to report higher assets and liabilities as a result of recording right-of-use assets and lease liabilities for its existing leases on the Statements of Condition. The Bank is in the process of evaluating this guidance, but its effect on the Bank’s financial condition, results of operations, and cash flows is not expected to be material.

Recognition and Measurement of Financial Assets and Financial Liabilities. On January 5, 2016, the FASB issued amended guidance on certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. This guidance includes, but is not limited to, the following:
•
Requires equity investments (with certain exceptions) to be measured at fair value with changes in fair value recognized in net income;
•
Requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments;
•
Requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the Statement of Condition or in the accompanying notes to the financial statements;
•
Eliminates the requirement for public entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the Statement of Condition.

The guidance became effective for the Bank for the interim and annual periods beginning on January 1, 2018. While the adoption of this guidance affected the Bank’s disclosures, the requirement to present the instrument-specific credit risk in other comprehensive income did not have any effect on the Bank’s financial condition, results of operations, or cash flows.

Revenue from Contracts with Customers. On May 28, 2014, the FASB issued guidance on revenue from contracts with customers. This guidance applies to all contracts with customers except those that are within the scope of certain other standards, such as financial instruments, certain guarantees, insurance contracts, and lease contracts. This guidance became effective for the Bank for the interim and annual periods beginning on January 1, 2018. Given that the majority of the Bank's financial instruments and other contractual rights that generate revenue are covered by other U.S. GAAP, the adoption of this guidance did not have any effect on the Bank's financial condition, results of operations, or cash flows.


12

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



Note 3 — Trading Securities

The estimated fair value of trading securities as of March 31, 2018, and December 31, 2017, was as follows:

 
March 31, 2018

 
December 31, 2017

Government-Sponsored Enterprises (GSEs) – Federal Farm Credit Bank (FFCB) bonds
$
907

 
$
1,158

MBS – Other U.S. obligations – Ginnie Mae
6

 
6

Total
$
913

 
$
1,164


The net unrealized gain/(loss) on trading securities was $(1) and $1 for the three months ended March 31, 2018 and 2017, respectively. These amounts represent the changes in the fair value of the securities during the reported periods.

Note 4 — Available-for-Sale Securities

Available-for-sale (AFS) securities by major security type as of March 31, 2018, and December 31, 2017, were as follows:
 
March 31, 2018
 
 
 
 
 
 
 
 
 
  
Amortized
Cost(1)

 
OTTI
Recognized in
AOCI

 
Gross
Unrealized
Gains

 
Gross
Unrealized
Losses

 
Estimated Fair Value

PLRMBS:
 
 
 
 
 
 
 
 
 
Prime
$
313

 
$
—

 
$
27

 
$
—

 
$
340

Alt-A, option ARM
681

 
(6
)
 
131

 
—

 
806

Alt-A, other
2,340

 
(18
)
 
218

 
—

 
2,540

Total
$
3,334

 
$
(24
)
 
$
376

 
$
—

 
$
3,686


December 31, 2017
 
 
 
 
 
 
 
 
 
 
Amortized
Cost(1)

 
OTTI
Recognized in
AOCI

 
Gross
Unrealized
Gains

 
Gross
Unrealized
Losses

 
Estimated Fair Value

PLRMBS:
 
 
 
 
 
 
 
 
 
Prime
$
335

 
$
—

 
$
29

 
$
—

 
$
364

Alt-A, option ARM
714

 
(10
)
 
130

 
—

 
834

Alt-A, other
2,447

 
(23
)
 
211

 
—

 
2,635

Total
$
3,496

 
$
(33
)
 
$
370

 
$
—

 
$
3,833


(1)
Amortized cost includes unpaid principal balance, unamortized premiums and discounts, and previous OTTI recognized in earnings.

Expected maturities of PLRMBS will differ from contractual maturities because borrowers generally have the right to prepay the underlying obligations without prepayment fees.

At March 31, 2018, the amortized cost of the Bank’s PLRMBS classified as AFS included credit-related OTTI of $770. At December 31, 2017, the amortized cost of the Bank’s PLRMBS classified as AFS included credit-related OTTI of $801.

The following table summarizes the AFS securities with unrealized losses as of March 31, 2018, and December 31, 2017. 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. Total unrealized losses in the following table will not agree to total gross unrealized losses in the table above. The unrealized losses in the following table also include non-credit-

13

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



related OTTI losses recognized in AOCI. For OTTI analysis of AFS securities, see Note 6 – Other-Than-Temporary Impairment Analysis.

March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
  
Less Than 12 Months
 
12 Months or More
 
Total
  
Estimated
Fair Value

 
Unrealized
Losses

 
Estimated
Fair Value

 
Unrealized
Losses

 
Estimated
Fair Value

 
Unrealized
Losses

PLRMBS:
 
 
 
 
 
 
 
 
 
 
 
Prime
$
2

 
$
—

 
$
9

 
$
—

 
$
11

 
$
—

Alt-A, option ARM
—

 
—

 
143

 
6

 
143

 
6

Alt-A, other
17

 
—

 
294

 
18

 
311

 
18

Total
$
19

 
$
—

 
$
446

 
$
24

 
$
465

 
$
24

December 31, 2017
 
 
 
 
 
 
Less Than 12 Months
 
12 Months or More
 
Total
 
Estimated
Fair Value

 
Unrealized
Losses

 
Estimated
Fair Value

 
Unrealized
Losses

 
Estimated
Fair Value

 
Unrealized
Losses

PLRMBS:
 
 
 
 
 
 
 
 
 
 
 
Prime
$
—

 
$
—

 
$
11

 
$
—

 
$
11

 
$
—

Alt-A, option ARM
—

 
—

 
144

 
10

 
144

 
10

Alt-A, other
5

 
—

 
356

 
23

 
361

 
23

Total
$
5

 
$
—

 
$
511

 
$
33

 
$
516

 
$
33


As indicated in the tables above, as of March 31, 2018, the Bank’s investments classified as AFS had unrealized losses related to PLRMBS, which were primarily due to illiquidity in the PLRMBS market and market expectations of the credit performance of loan collateral underlying these securities, which caused these assets to be valued at discounts to their amortized cost.

See Note 6 – Other-Than-Temporary Impairment Analysis for information on the transfers of securities between the AFS portfolio and the HTM portfolio.


14

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



Note 5 — Held-to-Maturity Securities

The Bank classifies the following securities as HTM because the Bank has the positive intent and ability to hold these securities to maturity:
 
March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
  
Amortized
Cost(1)

 
OTTI
Recognized
in AOCI(1)

 
Carrying
Value(1)

 
Gross
Unrecognized
Holding
Gains

 
Gross
Unrecognized
Holding
Losses

 
Estimated
Fair Value

Housing finance agency bonds:
 
 
 
 
 
 
 
 
 
 
 
California Housing Finance Agency (CalHFA) bonds
$
179

 
$
—

 
$
179

 
$
—

 
$
(7
)
 
$
172

MBS:
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations – single-family:
 
 
 
 
 
 
 
 
 
 
 
Ginnie Mae
714

 
—

 
714

 
—

 
(9
)
 
705

GSEs – single-family:
 
 
 
 
 
 
 
 
 
 
 
Freddie Mac
1,901

 
—

 
1,901

 
8

 
(28
)
 
1,881

Fannie Mae
3,395

 
—

 
3,395

 
26

 
(17
)
 
3,404

Subtotal GSEs – single-family
5,296

 
—

 
5,296

 
34

 
(45
)
 
5,285

GSEs – multifamily:
 
 
 
 
 
 
 
 
 
 
 
Freddie Mac
4,904

 
—

 
4,904

 
5

 
(1
)
 
4,908

Fannie Mae
2,108

 
—

 
2,108

 
1

 
(1
)
 
2,108

Subtotal GSEs – multifamily
7,012

 
—

 
7,012

 
6

 
(2
)
 
7,016

Subtotal GSEs
12,308

 
—

 
12,308

 
40

 
(47
)
 
12,301

PLRMBS:
 
 
 
 
 
 
 
 
 
 
 
Prime
481

 
—

 
481

 
5

 
(5
)
 
481

Alt-A, other
286

 
(5
)
 
281

 
10

 
(2
)
 
289

Subtotal PLRMBS
767

 
(5
)
 
762

 
15

 
(7
)
 
770

Total MBS
13,789

 
(5
)
 
13,784

 
55

 
(63
)
 
13,776

Total
$
13,968

 
$
(5
)
 
$
13,963

 
$
55

 
$
(70
)
 
$
13,948

 

15

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
  
Amortized
Cost(1)

 
OTTI
Recognized
in AOCI(1)

 
Carrying
Value(1)

 
Gross
Unrecognized
Holding
Gains

 
Gross
Unrecognized
Holding
Losses

 
Estimated
Fair Value

Certificates of deposit
$
500

 
$
—

 
$
500

 
$
—

 
$
—

 
$
500

Housing finance agency bonds:
 
 
 
 
 
 
 
 
 
 
 
California Housing Finance Agency (CalHFA) bonds
187

 
—

 
187

 
—

 
(9
)
 
178

MBS:
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations – single-family:
 
 
 
 
 
 
 
 
 
 
 
Ginnie Mae
751

 
—

 
751

 
1

 
(1
)
 
751

GSEs – single-family:
 
 
 
 
 
 
 
 
 
 
 
Freddie Mac
2,039

 
—

 
2,039

 
12

 
(15
)
 
2,036

Fannie Mae
3,600

 
—

 
3,600

 
34

 
(8
)
 
3,626

Subtotal GSEs – single-family
5,639

 
—

 
5,639

 
46

 
(23
)
 
5,662

GSEs – multifamily:
 
 
 
 
 
 
 
 
 
 
 
Freddie Mac
4,651

 
—

 
4,651

 
6

 
(6
)
 
4,651

Fannie Mae
2,131

 
—

 
2,131

 
2

 
—

 
2,133

Subtotal GSEs – multifamily
6,782

 
—

 
6,782

 
8

 
(6
)
 
6,784

Subtotal GSEs
12,421

 
—

 
12,421

 
54

 
(29
)
 
12,446

PLRMBS:
 
 
 
 
 
 
 
 
 
 
 
Prime
521

 
—

 
521

 
5

 
(6
)
 
520

Alt-A, other
306

 
(6
)
 
300

 
11

 
(2
)
 
309

Subtotal PLRMBS
827

 
(6
)
 
821

 
16

 
(8
)
 
829

Total MBS
13,999

 
(6
)
 
13,993

 
71

 
(38
)
 
14,026

Total
$
14,686


$
(6
)

$
14,680


$
71


$
(47
)

$
14,704


(1)
Amortized cost includes unpaid principal balance, unamortized premiums and discounts, and previous OTTI recognized in earnings. The carrying value of HTM securities represents amortized cost after adjustment for non-credit-related OTTI recognized in AOCI.

At March 31, 2018, the amortized cost of the Bank’s MBS classified as HTM included premiums of $18, discounts of $23, and credit-related OTTI of $7. At December 31, 2017, the amortized cost of the Bank’s MBS classified as HTM included premiums of $19, discounts of $24, and credit-related OTTI of $7.

The following tables summarize the HTM securities with unrealized losses as of March 31, 2018, and December 31, 2017. 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. Total unrealized losses in the following table will not agree to the total gross unrecognized holding losses in the table above. The unrealized losses in the following table also include non-credit-related OTTI losses recognized in AOCI. For OTTI analysis of HTM securities, see Note 6 – Other-Than-Temporary Impairment Analysis.


16

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
 
Less Than 12 Months
 
12 Months or More
 
Total
 
Estimated
Fair Value

 
Unrealized
Losses

 
Estimated
Fair Value

 
Unrealized
Losses

 
Estimated
Fair Value

 
Unrealized
Losses

Housing finance agency bonds:
 
 
 
 
 
 
 
 
 
 
 
CalHFA bonds
$
—

 
$
—

 
$
148

 
$
7

 
$
148

 
$
7

MBS:
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations – single-family:
 
 
 
 
 
 
 
 
 
 
 
Ginnie Mae
614

 
9

 
—

 
—

 
614

 
9

GSEs – single-family:
 
 
 
 
 
 
 
 
 
 
 
Freddie Mac
1,098

 
19

 
300

 
9

 
1,398

 
28

Fannie Mae
883

 
12

 
191

 
5

 
1,074

 
17

Subtotal GSEs – single-family
1,981

 
31

 
491

 
14

 
2,472

 
45

GSEs – multifamily:
 
 
 
 
 
 
 
 
 
 
 
Freddie Mac
1,483

 
1

 
—

 
—

 
1,483

 
1

Fannie Mae
1,118

 
1

 
—

 
—

 
1,118

 
1

Subtotal GSEs – multifamily
2,601

 
2

 
—

 
—

 
2,601

 
2

Subtotal GSEs
4,582

 
33

 
491

 
14

 
5,073

 
47

PLRMBS:
 
 
 
 
 
 
 
 
 
 
 
Prime
14

 
—

 
167

 
5

 
181

 
5

Alt-A, other
40

 
—

 
164

 
7

 
204

 
7

Subtotal PLRMBS
54

 
—

 
331

 
12

 
385

 
12

Total MBS
5,250

 
42

 
822

 
26

 
6,072

 
68

Total
$
5,250

 
$
42

 
$
970

 
$
33

 
$
6,220

 
$
75

 
December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
Less Than 12 Months
 
12 Months or More
 
Total
 
Estimated
Fair Value

 
Unrealized
Losses

 
Estimated
Fair Value

 
Unrealized
Losses

 
Estimated
Fair Value

 
Unrealized
Losses

Housing finance agency bonds:
 
 
 
 
 
 
 
 
 
 
 
CalHFA bonds
$
—

 
$
—

 
$
178

 
$
9

 
$
178

 
$
9

MBS:
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations – single-family:
 
 
 
 
 
 
 
 
 
 
 
Ginnie Mae
406

 
1

 
—

 
—

 
406

 
1

GSEs – single-family:
 
 
 
 
 
 
 
 
 
 
 
Freddie Mac
895

 
9

 
323

 
6

 
1,218

 
15

Fannie Mae
702

 
4

 
205

 
4

 
907

 
8

Subtotal GSEs – single-family
1,597

 
13

 
528

 
10

 
2,125

 
23

GSEs – multifamily:
 
 
 
 
 
 
 
 
 
 
 
Freddie Mac
1,058

 
6

 
—

 
—

 
1,058

 
6

Fannie Mae
456

 
—

 
—

 
—

 
456

 
—

Subtotal GSEs – multifamily
1,514

 
6

 
—

 
—

 
1,514

 
6

Subtotal GSEs
3,111

 
19

 
528

 
10

 
3,639

 
29

PLRMBS:
 
 
 
 
 
 
 
 
 
 
 
Prime
2

 
—

 
202

 
6

 
204

 
6

Alt-A, other
15

 
—

 
191

 
8

 
206

 
8

Subtotal PLRMBS
17

 
—

 
393

 
14

 
410

 
14

Total MBS
3,534

 
20

 
921

 
24

 
4,455

 
44

Total
$
3,534

 
$
20

 
$
1,099

 
$
33

 
$
4,633

 
$
53



17

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



As indicated in the tables above, the Bank’s investments classified as HTM had unrealized losses on CalHFA bonds and MBS. The unrealized losses associated with the CalHFA bonds were mainly due to an illiquid market, credit concerns regarding the underlying mortgage collateral, and credit concerns regarding the monoline insurance providers, causing these investments to be valued at a discount to their acquisition cost. For its agency MBS, the Bank expects to recover the entire amortized cost basis of these securities because the Bank 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. The unrealized losses associated with the PLRMBS were primarily due to illiquidity in the PLRMBS market and market expectations of the credit performance of loan collateral underlying these securities, which caused these assets to be valued at discounts to their amortized cost.

Redemption Terms. The amortized cost, carrying value, and estimated fair value of non-MBS securities by contractual maturity (based on contractual final principal payment) and of MBS as of March 31, 2018, and December 31, 2017, are shown below. Expected maturities of MBS will differ from contractual maturities because borrowers generally have the right to prepay the underlying obligations without prepayment fees.

March 31, 2018
 
 
 
 
 
Year of Contractual Maturity
Amortized
Cost(1)

 
Carrying
Value(1)

 
Estimated
Fair Value

HTM securities other than MBS:
 
 
 
 
 
Due after 1 year through 5 years
$
4

  
$
4

  
$
4

Due after 10 years
175

 
175

 
168

Subtotal
179

 
179

 
172

MBS
13,789

 
13,784

 
13,776

Total
$
13,968

 
$
13,963

 
$
13,948

 
December 31, 2017
 
 
 
 
 
Year of Contractual Maturity
Amortized
Cost(1)

 
Carrying
Value(1)

 
Estimated
Fair Value

HTM securities other than MBS:
 
 
 
 
 
Due in 1 year or less
$
500

 
$
500

 
$
500

Due after 5 years through 10 years
12

 
12

 
12

Due after 10 years
175

 
175

 
166

Subtotal
687

 
687

 
678

MBS
13,999

 
13,993

 
14,026

Total
$
14,686

 
$
14,680

 
$
14,704


(1)
Amortized cost includes unpaid principal balance, unamortized premiums and discounts, and previous OTTI recognized in earnings. The carrying value of HTM securities represents amortized cost after adjustment for non-credit-related OTTI recognized in AOCI.

See Note 6 – Other-Than-Temporary Impairment Analysis for information on the transfers of securities between the AFS portfolio and the HTM portfolio.

Note 6 — Other-Than-Temporary Impairment Analysis

On a quarterly basis, the Bank evaluates its individual AFS and HTM 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 debt 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 statement of condition date. For securities in an unrealized loss position that do not meet either 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

18

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



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.

PLRMBS. A significant input to the Bank’s cash flow analysis of its PLRMBS is the forecast of future housing price changes. The OTTI Governance Committee of the Federal Home Loan Banks (FHLBanks) developed a short-term housing price forecast with projected changes ranging from a decrease of 7.0% to an increase of 12.0% over the 12-month period beginning January 1, 2018. For the vast majority of markets, the projected short-term housing price changes range from an increase of 1.0% to an increase of 6.0%. Thereafter, a unique path is projected for each geographic area based on an internally developed framework derived from historical data.

For all the PLRMBS in its AFS and HTM portfolios, 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.

For securities determined to be other-than-temporarily impaired as of March 31, 2018 (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 during the first quarter of March 31, 2018, and the related current credit enhancement for the Bank.

March 31, 2018
 
 
 
 
 
 
 
 
Significant Inputs for Other-Than-Temporarily Impaired PLRMBS
 
Current
 
Prepayment Rates
 
Default Rates
 
Loss Severities
 
Credit Enhancement
Year of Securitization
Weighted Average % (1)
 
Weighted Average % (1)
 
Weighted Average % (1)
 
Weighted Average % (1)
Alt-A, other
 
 
 
 
 
 
 
2007
9.2
 
30.7
 
42.0
 
0.8
2005
14.0
 
17.1
 
34.7
 
0.1
2004 and earlier
16.2
 
7.0
 
31.7
 
9.9
Total Alt-A, other
10.2
 
28.0
 
40.6
 
0.9
Total
10.2
 
28.0
 
40.6
 
0.9

(1)
Weighted average percentage is based on unpaid principal balance.

Credit enhancement is defined as the percentage of subordinated tranches, excess spread, 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 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.

The following table presents the credit-related OTTI, which is recognized in earnings, for the three months ended March 31, 2018 and 2017.

19

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



 
Three Months Ended
 
March 31, 2018

 
March 31, 2017

Balance, beginning of the period
$
1,129

 
$
1,183

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

 
3

Accretion of yield adjustments resulting from improvement of expected cash flows that are recognized over the remaining life of the securities(2)
(17
)
 
(17
)
Balance, end of the period
$
1,113

 
$
1,169


(1)
For the three months ended March 31, 2018 and 2017, “securities for which OTTI was previously recognized” represents all securities that were also other-than-temporarily impaired prior to January 1, 2018 and 2017, respectively.
(2)
The total net accretion/(amortization) associated with other-than-temporarily impaired PLRMBS (amount recognized in interest income) totaled $22 and $23 for the three months ended March 31, 2018 and 2017, respectively.

Changes in circumstances may cause the Bank to change its intent to hold a certain security to maturity without calling into question its intent to hold other debt securities to maturity in the future. The sale or transfer of an HTM security because of certain changes in circumstances, such as evidence of significant deterioration in the issuers’ creditworthiness, is not considered to be inconsistent with its original classification. In addition, other events that are isolated, nonrecurring, or unusual for the Bank that could not have been reasonably anticipated may cause the Bank to sell or transfer an HTM security without necessarily calling into question its intent to hold other debt securities to maturity.

In general, the Bank elects to transfer any PLRMBS that incurred a credit-related OTTI charge during the applicable period from the Bank’s held-to-maturity portfolio to its available-for-sale portfolio at their fair values. The Bank recognized an OTTI credit loss on these held-to-maturity PLRMBS, which the Bank believes is evidence of a significant decline in the issuers’ creditworthiness. The decline in the issuers’ creditworthiness is the basis for the transfers to the available-for-sale portfolio. These transfers allow the Bank the option to sell these securities prior to maturity in view of changes in interest rates, changes in prepayment risk, or other factors, while recognizing the Bank’s intent to hold these securities for an indefinite period of time. The Bank does not intend to sell its other-than-temporarily impaired securities 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 did not transfer any PLRMBS from its HTM portfolio to its AFS portfolio during the three months ended March 31, 2018 and 2017.

The following tables present the Bank’s AFS and HTM PLRMBS that incurred OTTI losses anytime during the life of the securities at March 31, 2018, and December 31, 2017, by loan collateral type:

March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available-for-Sale Securities
 
Held-to-Maturity Securities
 
Unpaid
Principal
Balance

 
Amortized
Cost

 
Estimated
Fair Value

 
Unpaid
Principal
Balance

 
Amortized
Cost

 
Carrying
Value

 
Estimated
Fair Value

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:
 
 
 
 
 
 
 
 
 
 
 
 
 
Prime
$
379

 
$
313

 
$
340

 
$
—

 
$
—

 
$
—

 
$
—

Alt-A, option ARM
908

 
681

 
806

 
—

 
—

 
—

 
—

Alt-A, other
2,805

 
2,340

 
2,540

 
60

 
56

 
51

 
60

Total
$
4,092

 
$
3,334

 
$
3,686

 
$
60

 
$
56

 
$
51

 
$
60



20

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available-for-Sale Securities
 
Held-to-Maturity Securities
 
Unpaid
Principal
Balance

 
Amortized
Cost

 
Estimated
Fair Value

 
Unpaid
Principal
Balance

 
Amortized
Cost

 
Carrying
Value

 
Estimated
Fair Value

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:
 
 
 
 
 
 
 
 
 
 
 
 
 
Prime
$
405

 
$
335

 
$
364

 
$
—

 
$
—

 
$
—

 
$
—

Alt-A, option ARM
953

 
714

 
834

 
—

 
—

 
—

 
—

Alt-A, other
2,927

 
2,447

 
2,635

 
64

 
59

 
53

 
63

Total
$
4,285

 
$
3,496

 
$
3,833

 
$
64

 
$
59

 
$
53

 
$
63


For the Bank’s PLRMBS that were not other-than-temporarily impaired as of March 31, 2018, the Bank has experienced net unrealized losses primarily because of illiquidity in the PLRMBS market and market expectations of the credit performance of loan collateral underlying these securities, which caused these assets to be valued at discounts to their amortized cost. The Bank does not intend to sell these securities, it is not more likely than not that the Bank will be required to sell these securities before its anticipated recovery of the remaining amortized cost basis, and the Bank expects to recover the entire amortized cost basis of these securities. As a result, the Bank determined that, as of March 31, 2018, all of the gross unrealized losses on these PLRMBS are temporary. 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.

All Other Available-for-Sale and Held-to-Maturity Investments. For the Bank’s investments in housing finance agency bonds, which were issued by CalHFA, the gross unrealized losses were mainly due to an illiquid market, credit concerns regarding the underlying mortgage collateral, and credit concerns regarding the monoline insurance providers, causing these investments to be valued at a discount to their acquisition cost. The Bank independently modeled cash flows for the underlying collateral, using assumptions for default rates and loss severity that a market participant would deem reasonable, and concluded that the available credit support within the CalHFA structure more than offset the projected underlying collateral losses. The Bank determined that, as of March 31, 2018, all of the gross unrealized losses on the bonds are temporary because the underlying collateral and credit enhancements were sufficient to protect the Bank from losses. As a result, the Bank expects to recover the entire amortized cost basis of these securities.

For its agency MBS, the Bank expects to recover the entire amortized cost basis of these securities because the Bank 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. As a result, the Bank determined that, as of March 31, 2018, all of the gross unrealized losses on its agency MBS are temporary.

Note 7 — Advances

The Bank offers a wide range of fixed and adjustable rate advance products with different maturities, interest rates, payment characteristics, and option features. Fixed rate advances generally have maturities ranging from one day to 30 years. Adjustable rate advances generally have maturities ranging from less than 30 days to 10 years, with the interest rates resetting periodically at a fixed spread to LIBOR or to another specified index.

Redemption Terms. The Bank had advances outstanding, excluding overdrawn demand deposit accounts, at interest rates ranging from 0.79% to 8.57% at March 31, 2018, and 0.79% to 8.57% at December 31, 2017, as summarized below.

21

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



 
March 31, 2018
 
December 31, 2017
Contractual Maturity
Amount
Outstanding

 
Weighted
Average
Interest Rate

 
Amount
Outstanding

 
Weighted
Average
Interest Rate

Within 1 year
$
35,322

 
1.74
%
 
$
46,403

 
1.46
%
After 1 year through 2 years
16,205

 
1.91

 
16,287

 
1.61

After 2 years through 3 years
7,960

 
2.16

 
5,423

 
1.73

After 3 years through 4 years
4,722

 
1.95

 
6,719

 
1.69

After 4 years through 5 years
1,733

 
2.22

 
1,741

 
2.10

After 5 years
921

 
3.19

 
913

 
3.13

Total par value
66,863

 
1.88
%
 
77,486

 
1.57
%
Valuation adjustments for hedging activities
(155
)
 
 
 
(88
)
 
 
Valuation adjustments under fair value option
(66
)
 
 
 
(16
)
 
 
Total
$
66,642

 
 
 
$
77,382

 
 

Many of the Bank’s advances are prepayable at the borrower’s option. However, when advances are prepaid, the borrower is generally charged a prepayment fee intended to make the Bank financially indifferent to the prepayment. In addition, for certain advances with partial prepayment symmetry, 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. The Bank had advances with partial prepayment symmetry outstanding totaling $4,999 at March 31, 2018, and $4,619 at December 31, 2017. Some advances may be repaid on pertinent call dates without prepayment fees (callable advances). The Bank had callable advances outstanding totaling $16,961 at March 31, 2018, and $18,373 at December 31, 2017.

The following table summarizes advances at March 31, 2018, and December 31, 2017, by the earlier of the year of contractual maturity or next call date for callable advances. There were no putable advances at March 31, 2018, or December 31, 2017.
 
 
Earlier of Contractual
Maturity or Next Call Date
 
March 31, 2018

 
December 31, 2017

Within 1 year
$
40,633

 
$
52,624

After 1 year through 2 years
15,485

 
12,593

After 2 years through 3 years
6,410

 
7,973

After 3 years through 4 years
1,723

 
1,719

After 4 years through 5 years
1,727

 
1,729

After 5 years
885

 
848

Total par value
$
66,863

 
$
77,486


Credit and Concentration Risk. The following tables present the concentration in advances to the top five borrowers and their affiliates at March 31, 2018 and 2017. The tables also present the interest income from these advances before the impact of interest rate exchange agreements associated with these advances for the three months ended March 31, 2018 and 2017.


22

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



 
March 31, 2018
 
Three Months Ended
March 31, 2018
Name of Borrower
Advances
Outstanding

 
Percentage of
Total
Advances
Outstanding

 
Interest
Income from
Advances(1)

 
Percentage of
Total Interest
Income from
Advances

MUFG Union Bank, National Association
$
11,900

 
18
%
 
$
44

 
12
%
JPMorgan Chase Bank, National Association(2)
9,362

 
14

 
50

 
14

First Republic Bank
8,500

 
13

 
35

 
9

Bank of the West
7,159

 
10

 
29

 
8

Wells Fargo Financial National Bank
4,000

 
6

 
17

 
5

     Subtotal
40,921

 
61

 
175

 
48

Others
25,942

 
39

 
191

 
52

Total par value
$
66,863

 
100
%
 
$
366

 
100
%

 
March 31, 2017
 
Three Months Ended
March 31, 2017
Name of Borrower
Advances
Outstanding

 
Percentage of
Total
Advances
Outstanding

 
Interest
Income from
Advances(1)

 
Percentage of
Total Interest
Income from
Advances

JPMorgan Chase Bank, National Association(2)
$
14,806

 
30
%
 
$
41

 
25
%
Bank of the West
6,655

 
14

 
14

 
9

First Republic Bank
5,900

 
12

 
21

 
13

CIT Bank, N.A.
2,411

 
5

 
7

 
5

Star One Credit Union
2,046

 
4

 
7

 
4

     Subtotal
31,818

 
65

 
90

 
56

Others
17,259

 
35

 
71

 
44

Total par value
$
49,077

 
100
%
 
$
161

 
100
%

(1)
Interest income amounts exclude the interest effect of interest rate exchange agreements with derivative 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.
(2)
Nonmember institution.

The Bank held a security interest in collateral from each of the top five advances borrowers and their affiliates sufficient to support their respective advances outstanding, and the Bank does not expect to incur any credit losses on these advances.

For information related to the Bank’s credit risk on advances and allowance methodology for credit losses, see Note 9 – Allowance for Credit Losses.

Interest Rate Payment Terms. Interest rate payment terms for advances at March 31, 2018, and December 31, 2017, are detailed below:

23

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



  
March 31, 2018

 
December 31, 2017

Par value of advances:
 
 
 
Fixed rate:
 
 
 
Due within 1 year
$
19,690

 
$
31,767

Due after 1 year
15,088

 
13,022

Total fixed rate
34,778

 
44,789

Adjustable rate:
 
 
 
Due within 1 year
15,633

 
14,636

Due after 1 year
16,452

 
18,061

Total adjustable rate
32,085

 
32,697

Total par value
$
66,863

 
$
77,486


The Bank may use derivatives to adjust the repricing and options characteristics of advances to more closely match the characteristics of the Bank’s funding liabilities. In general, whenever a member executes a fixed or 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 in the advance. The combination of the advance and the interest rate exchange agreement effectively creates a variable rate asset. This type of hedge relationship receives fair value option accounting treatment. In addition, for certain advances for which the Bank has elected the fair value option, the Bank will simultaneously execute an interest rate exchange agreement with terms that economically offset the terms of the advance. However, this type of hedge is treated as an economic hedge because these combinations generally do not meet the requirements for fair value hedge accounting treatment. For more information, see Note 15 – Derivatives and Hedging Activities and Note 16 – Fair Value.

The Bank did not have any advances with embedded features that met the requirements to separate the embedded feature from the host contract and designate the embedded feature as a stand-alone derivative at March 31, 2018, or December 31, 2017. The Bank has generally elected to account for certain advances with embedded features under the fair value option, and these advances are carried at fair value on the Statements of Condition. For more information, see Note 16 – Fair Value.

Note 8 — Mortgage Loans Held for Portfolio

Under the Mortgage Partnership Finance® (MPF®) Program, the Bank may purchase from members, for its own portfolio, conventional conforming fixed rate mortgage loans under the MPF Original product and mortgage loans insured by the Federal Housing Administration (FHA) or guaranteed by the Department of Veterans Affairs (VA) under the MPF Government product. (“Mortgage Partnership Finance,” “MPF,” and “MPF Xtra” are registered trademarks of the FHLBank of Chicago.) In addition, the Bank may facilitate the purchase of conforming fixed rate mortgage loans from members for concurrent sale to Fannie Mae under the MPF Xtra® product; of jumbo fixed rate mortgage loans for concurrent sale to Redwood Residential Acquisition Corporation, a subsidiary of Redwood Trust, Inc., a real estate investment trust, under the MPF Direct product; and of government-insured or government-guaranteed mortgage loans that will be packaged into securities backed by the mortgage loans and guaranteed by Ginnie Mae under the MPF Government MBS product. When members sell mortgage loans under the MPF Xtra, MPF Direct, and MPF Government MBS products, the loans are sold to a third-party investor and are not recorded on the Bank’s Statements of Condition. As of March 31, 2018, the Bank had approved 25 members as participating financial institutions since renewing its participation in the MPF Program in 2013.

From May 2002 through October 2006, the Bank purchased conventional conforming fixed rate mortgage loans from its participating financial institutions under the MPF Original and MPF Plus products. 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.


24

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



The following table presents information as of March 31, 2018, and December 31, 2017, on mortgage loans, all of which are secured by one- to four-unit residential properties and single-unit second homes.

  
March 31, 2018

 
December 31, 2017

Fixed rate medium-term mortgage loans
$
24

 
$
32

Fixed rate long-term mortgage loans
2,272

 
1,973

Subtotal
2,296

 
2,005

Unamortized premiums
85

 
76

Unamortized discounts
(5
)
 
(5
)
Mortgage loans held for portfolio
2,376

 
2,076

Less: Allowance for credit losses
—

 
—

Total mortgage loans held for portfolio, net
$
2,376

 
$
2,076


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 information related to the Bank’s credit risk on mortgage loans and allowance methodology for credit losses, see Note 9 – Allowance for Credit Losses.

Note 9 — Allowance for Credit Losses

The Bank has established an allowance methodology for each of its portfolio segments: advances, letters of credit, and other extensions of credit, collectively referred to as “credit products,” mortgage loans held for portfolio, term securities purchased under agreements to resell, and term Federal funds sold. For more information on these portfolio segments, see “Item 8. Financial Statements and Supplementary Data – Note 10 – Allowance for Credit Losses” in the Bank’s 2017 Form 10-K.

Credit Products. The Bank manages its credit exposure related to credit products through an integrated approach that generally provides for a credit limit to be established for each borrower, includes an ongoing review of each borrower’s financial condition, and is coupled with conservative collateral and lending policies to limit the risk of loss while taking into account borrowers’ needs for a reliable funding source. At March 31, 2018, and December 31, 2017, none of the Bank’s credit products were past due, on nonaccrual status, or considered impaired. There were no troubled debt restructurings related to credit products during the three months ended March 31, 2018, or during 2017.

Based on the collateral pledged as security for advances, the Bank’s credit analyses of borrowers’ financial condition, and the Bank’s credit extension and collateral policies as of March 31, 2018, the Bank expects to collect all amounts due according to the contractual terms. Therefore, no allowance for losses on credit products was deemed necessary by the Bank. The Bank has never experienced any credit losses on its credit products.

No member institutions were placed into receivership during the first three months of 2018 or from April 1 to April 30, 2018.

Mortgage Loans Held for Portfolio. The following table presents information on delinquent mortgage loans as of March 31, 2018, and December 31, 2017.


25

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



 
March 31, 2018

 
December 31, 2017

 
Recorded
Investment(1)

 
Recorded
Investment(1)

30 – 59 days delinquent
$
8

 
$
8

60 – 89 days delinquent
2

 
2

90 days or more delinquent
11

 
12

Total past due
21

 
22

Total current loans
2,368

 
2,065

Total mortgage loans
$
2,389

 
$
2,087

In process of foreclosure, included above(2)
$
2

 
$
3

Nonaccrual loans
$
11

 
$
12

Loans past due 90 days or more and still accruing interest
$
—

 
$
—

Serious delinquencies as a percentage of total mortgage loans outstanding(3)
0.46
%
 
0.59
%

(1)
The recorded investment in a loan is the unpaid principal balance of the loan, adjusted for accrued interest, net deferred loan fees or costs, unamortized premiums or discounts, and direct write-downs. The recorded investment is not net of any valuation allowance.
(2)
Includes loans for which the servicer has reported a decision to foreclose or to pursue a similar alternative, such as deed-in-lieu. Loans in process of foreclosure are included in past due or current loans depending on their delinquency status.
(3)
Represents loans that are 90 days or more past due or in the process of foreclosure as a percentage of the recorded investment of total mortgage loans outstanding.

The amounts of charge-offs and recoveries of allowance for credit losses on the mortgage loan portfolio were de minimis during the three months ended March 31, 2018 and 2017.

The allowance for credit losses and recorded investment by impairment methodology for individually and collectively evaluated impaired loans are as follows:
(In millions)
March 31, 2018

 
December 31, 2017

Allowance for credit losses, end of the period:
 
 
 
Individually evaluated for impairment
$
—

 
$
—

Collectively evaluated for impairment
—

 
—

Total allowance for credit losses
$
—

 
$
—

Recorded investment, end of the period:
 
 
 
Individually evaluated for impairment
$
8

 
$
9

Collectively evaluated for impairment
2,381

 
2,078

Total recorded investment
$
2,389

 
$
2,087


The recorded investment, unpaid principal balance, and related allowance of impaired loans individually evaluated for impairment are as follows:
 
March 31, 2018
 
December 31, 2017
 
Recorded Investment

 
Unpaid Principal Balance

 
Related Allowance

 
Recorded Investment

 
Unpaid Principal Balance

 
Related Allowance

With no related allowance
$
8

 
$
8

 
$
—

 
$
9

 
$
9

 
$
—

With an allowance
—

 
—

 
—

 
—

 
—

 
—

Total
$
8

 
$
8

 
$
—

 
$
9

 
$
9

 
$
—


The average recorded investment on impaired loans individually evaluated for impairment is as follows:

26

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



 
Three Months Ended
 
March 31, 2018

 
March 31, 2017

With no related allowance
$
9

 
$
11

With an allowance
—

 
—

Total
$
9

 
$
11


The Bank and any participating financial institution share in the credit risk of the loans sold by that institution as specified in a master agreement. Loans purchased under the MPF Program generally had a credit risk exposure at the time of purchase that, as determined by the MPF Program methodology, would be expected from an equivalent investment rated AA if purchased prior to April 2017, or rated BBB if purchased since April 2017, taking into consideration the credit risk sharing structure mandated by the Finance Agency’s acquired member assets (AMA) regulation. The MPF Program structures potential credit losses on conventional MPF loans into layers with respect to each pool of loans purchased by the Bank under a single master commitment, as follows:

1.
The first layer of protection against loss is the liquidation value of the real property securing the loan.
2.
The next layer of protection comes from the primary mortgage insurance that is required for loans with a loan-to-value ratio greater than 80%, if still in place.
3.
Losses that exceed the liquidation value of the real property and any primary mortgage insurance, up to an agreed-upon amount called the first loss account for each master commitment, are incurred by the Bank.
4.
Losses in excess of the first loss account for each master commitment, up to an agreed-upon amount called the credit enhancement amount, are covered by the participating financial institution’s credit enhancement obligation at the time losses are incurred.
5.
Losses in excess of the first loss account and the participating financial institution’s remaining credit enhancement for the master commitment, if any, are incurred by the Bank.

Allowance for Credit Losses on MPF Loans – The Bank evaluates the allowance for credit losses on MPF mortgage loans based on two components. The first component applies to each individual loan that is specifically identified as impaired. The Bank evaluates the exposure on these loans by considering the first layer of loss protection (the liquidation value of the real property securing the loan) and the availability and collectability of credit enhancements under the terms of each master commitment and records a provision for credit losses. For this component, the Bank had no allowance for credit losses for MPF Original and MPF Plus loans as of March 31, 2018, and a de minimis allowance for credit losses for MPF Original and MPF Plus loans as of December 31, 2017.

The second component applies to loans that are not specifically identified as impaired and is based on the Bank’s estimate of probable credit losses on those loans as of the financial statement date. The Bank evaluates the credit loss exposure on a loan pool basis considering various observable data, such as delinquency statistics, past performance, current performance, loan portfolio characteristics, collateral valuations, industry data, and prevailing economic conditions. The Bank also considers the availability and collectability of credit enhancements from participating financial institutions or from mortgage insurers under the terms of each master commitment. For this component, the Bank established an allowance for credit losses for MPF Original and MPF Plus loans totaling de minimis amounts as of March 31, 2018, and December 31, 2017.

Troubled Debt Restructurings – Troubled debt restructuring (TDR) is considered to have occurred when a concession is granted to the debtor for economic or legal reasons related to the debtor’s financial difficulties and that concession would not have been considered otherwise. An MPF loan considered a TDR is individually evaluated for impairment when determining its related allowance for credit losses. Credit loss is measured by factoring in expected cash flow shortfalls incurred as of the reporting date as well as the economic loss attributable to delaying the original contractual principal and interest due dates, if applicable. The recorded investment of the Bank's nonperforming MPF loans classified as TDRs totaled $3 as of March 31, 2018, and $3 as of December 31, 2017.


27

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



Term Federal Funds Sold. The Bank invests in Federal funds sold with counterparties that are considered by the Bank to be of investment quality, and these investments are evaluated for purposes of an allowance for credit losses only if the investment is not paid when due. All investments in Federal funds sold as of March 31, 2018, and December 31, 2017, were repaid or are expected to be repaid according to the contractual terms.

Note 10 — Deposits

The Bank maintains demand deposit accounts that are directly related to the extension of credit to members and offers short-term deposit programs to members and qualifying nonmembers. In addition, a member that services mortgage loans may deposit in the Bank funds collected in connection with the mortgage loans, pending disbursement of these funds to the owners of the mortgage loans. The Bank classifies these types of deposits as non-interest-bearing deposits.

Deposits as of March 31, 2018, and December 31, 2017, were as follows:
 
March 31, 2018

 
December 31, 2017

Interest-bearing deposits:
 
 
 
Demand and overnight
$
236

 
$
263

Total interest-bearing deposits
236

 
263

Non-interest-bearing deposits
21

 
18

Total
$
257

 
$
281


Interest Rate Payment Terms. Deposits classified as demand, overnight, and other pay interest based on a daily interest rate. Term deposits pay interest based on a fixed rate determined at the issuance of the deposit. Interest rate payment terms for deposits at March 31, 2018, and December 31, 2017, are detailed in the following table:

 
March 31, 2018
 
December 31, 2017
 
Amount
Outstanding

 
Weighted
Average
Interest Rate

 
Amount
Outstanding

 
Weighted
Average
Interest Rate

Interest-bearing deposit – Adjustable rate
$
236

 
1.35
%
 
$
263

 
1.10
%
Non-interest-bearing deposits
21

 
 
 
18

 
 
Total
$
257

 
 
 
$
281

 
 

Note 11 — 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 “Item 8. Financial Statements and Supplementary Data – Note 20 – Commitments and Contingencies” in the Bank’s 2017 Form 10-K. In connection with each issuance of consolidated obligations, 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 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, 2018, and December 31, 2017.


28

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



 
March 31, 2018
 
December 31, 2017
Contractual Maturity
Amount
Outstanding

 
Weighted
Average
Interest Rate

 
Amount
Outstanding

 
Weighted
Average
Interest Rate

Within 1 year
$
60,733

 
1.62
%
 
$
69,734

 
1.33
%
After 1 year through 2 years
4,341

 
1.60

 
6,461

 
1.42

After 2 years through 3 years
3,591

 
1.82

 
2,785

 
1.74

After 3 years through 4 years
1,610

 
1.86

 
2,058

 
1.78

After 4 years through 5 years
1,939

 
2.19

 
1,994

 
2.15

After 5 years
2,181

 
2.85

 
2,076

 
2.80

Total par value
74,395

 
1.69
%
 
85,108

 
1.41
%
Unamortized premiums
7

 
 
 
9

 
 
Unamortized discounts
(11
)
 
 
 
(11
)
 
 
Valuation adjustments for hedging activities
(80
)
 
 
 
(37
)
 
 
Fair value option valuation adjustments
(14
)
 
 
 
(6
)
 
 
Total
$
74,297

 
 
 
$
85,063

 
 

The Bank’s participation in consolidated obligation bonds outstanding includes callable bonds of $10,460 at March 31, 2018, and $9,612 at December 31, 2017. When a callable bond for which the Bank is the primary obligor is issued, the Bank may simultaneously enter 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 $7,000 at March 31, 2018, and $6,406 at December 31, 2017. The combined sold callable swaps and callable bonds 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 at March 31, 2018, and December 31, 2017, was as follows:  
  
March 31, 2018

 
December 31, 2017

Par value of consolidated obligation bonds:
 
 
 
Non-callable
$
63,935

 
$
75,496

Callable
10,460

 
9,612

Total par value
$
74,395

 
$
85,108


The following is a summary of the Bank’s participation in consolidated obligation bonds outstanding at March 31, 2018, and December 31, 2017, by the earlier of the year of contractual maturity or next call date.
 
Earlier of Contractual
Maturity or Next Call Date
March 31, 2018

 
December 31, 2017

Within 1 year
$
70,123

 
$
78,606

After 1 year through 2 years
3,201

 
5,326

After 2 years through 3 years
915

 
935

After 3 years through 4 years
5

 
85

After 4 years through 5 years
90

 
55

After 5 years
61

 
101

Total par value
$
74,395

 
$
85,108



29

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



Consolidated obligation discount notes are consolidated obligations issued to raise short-term funds. These notes are issued at less than their face value 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:

 
March 31, 2018
 
December 31, 2017
 
Amount
Outstanding

 
Weighted Average
Interest Rate (1)

 
Amount
Outstanding

 
Weighted Average
Interest Rate (1)

Par value
$
27,248

 
1.49
%
 
$
30,494

 
1.24
%
Unamortized discounts
(45
)
 
 
 
(54
)
 
 
Total
$
27,203

 
 
 
$
30,440

 
 

(1)
Represents yield to maturity excluding concession fees.

Interest Rate Payment Terms. Interest rate payment terms for consolidated obligations at March 31, 2018, and December 31, 2017, are detailed in the following table. For information on the general terms and types of consolidated obligations outstanding, see “Item 8. Financial Statements and Supplementary Data – Note 12 – Consolidated Obligations” in the Bank’s 2017 Form 10-K.
  
March 31, 2018

 
December 31, 2017

Par value of consolidated obligations:
 
 
 
Bonds:
 
 
 
Fixed rate
$
18,323

 
$
17,967

Adjustable rate
54,834

 
66,276

Step-up
938

 
565

Step-down
200

 
200

Range bonds
100

 
100

Total bonds, par value
74,395

 
85,108

Discount notes, par value
27,248

 
30,494

Total consolidated obligations, par value
$
101,643

 
$
115,602


The Bank did not have any bonds with embedded features that met the requirements to separate the embedded feature from the host contract and designate the embedded feature as a stand-alone derivative at March 31, 2018, or December 31, 2017. The Bank has generally elected to account for certain bonds with embedded features under the fair value option, and these bonds are carried at fair value on the Statements of Condition. For more information, see Note 16 – Fair Value.


30

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



Note 12 — Accumulated Other Comprehensive Income/(Loss)

The following table summarizes the changes in AOCI for the three months ended March 31, 2018 and 2017:

 
Net Non-Credit-Related OTTI Loss on AFS Securities

 
Net Non-Credit-Related OTTI Loss on HTM Securities

 
Pension and Postretirement Benefits

 
Total
AOCI

Balance, December 31, 2016
$
136

 
$
(9
)
 
$
(16
)
 
$
111

Other comprehensive income/(loss) before reclassifications:
 
 
 
 
 
 
 
Net change in fair value
29

 
 
 
 
 
29

Accretion of non-credit-related OTTI loss
 
 
1

 
 
 
1

Reclassification from other comprehensive income/(loss) to net income/(loss):
 
 
 
 
 
 
 
Non-credit-related OTTI to credit-related OTTI
2

 


 
 
 
2

Net current period other comprehensive income/(loss)
31

 
1

 
—

 
32

Balance, March 31, 2017
$
167

 
$
(8
)
 
$
(16
)
 
$
143

 
 
 
 
 
 
 
 
Balance, December 31, 2017
$
337

 
$
(6
)
 
$
(13
)
 
$
318

Other comprehensive income/(loss) before reclassifications:
 
 
 
 
 
 
 
Net change in pension and postretirement benefits
 
 
 
 
1

 
1

Non-credit-related OTTI loss
(2
)
 


 
 
 
(2
)
Net change in fair value
17

 
 
 
 
 
17

Accretion of non-credit-related OTTI loss
 
 
1

 
 
 
1

Net current period other comprehensive income/(loss)
15

 
1

 
1

 
17

Balance, March 31, 2018
$
352

 
$
(5
)
 
$
(12
)
 
$
335


Note 13 — 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 Bank’s minimum capital stock requirement for shareholders 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 that is greater than or equal to its risk-based capital requirement. Because the Bank issues only Class B stock, regulatory capital and permanent capital for the Bank are both composed of retained earnings and Class B stock, including mandatorily redeemable capital stock (which 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.

The risk-based capital requirement is 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 requirement as defined.


31

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



As of March 31, 2018, and December 31, 2017, the Bank was in compliance with these capital rules and requirements as shown in the following table.
 
March 31, 2018
 
December 31, 2017
 
Required

 
Actual

 
Required

 
Actual

Risk-based capital
$
2,045

 
$
6,650

 
$
2,023

 
$
6,797

Total regulatory capital
$
4,369

 
$
6,650

 
$
4,935

 
$
6,797

Total regulatory capital ratio
4.00
%
 
6.09
%
 
4.00
%
 
5.51
%
Leverage capital
$
5,461

 
$
9,975

 
$
6,169

 
$
10,195

Leverage ratio
5.00
%
 
9.13
%
 
5.00
%
 
8.26
%

Mandatorily Redeemable Capital Stock. The Bank had mandatorily redeemable capital stock totaling $309 outstanding to six institutions at March 31, 2018, and $309 outstanding to seven institutions at December 31, 2017. The change in mandatorily redeemable capital stock for the three months ended March 31, 2018 and 2017, was as follows:
 
Three Months Ended
 
March 31, 2018

 
March 31, 2017

Balance at the beginning of the period
$
309

 
$
457

Redemption of mandatorily redeemable capital stock
—

 
(54
)
Balance at the end of the period
$
309

 
$
403


Cash dividends on mandatorily redeemable capital stock were recorded as interest expense in the amount of $6 and $11 for the three months ended March 31, 2018 and 2017, respectively.

The Bank’s mandatorily redeemable capital stock is discussed more fully in “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital” in the Bank’s 2017 Form 10-K.

The following table presents mandatorily redeemable capital stock amounts by contractual redemption period at March 31, 2018, and December 31, 2017.

Contractual Redemption Period
March 31, 2018

 
December 31, 2017

After 1 year through 2 years
$
1

 
$
—

After 2 years through 3 years
305

 
306

Past contractual redemption date because of remaining activity(1)
3

 
3

Total
$
309

 
$
309


(1)
Represents mandatorily redeemable capital stock that is past the end of the contractual redemption period because of outstanding activity.

Excess Stock Repurchase, Retained Earnings, and Dividend Framework. By Finance Agency regulation, dividends may be paid only out of current net earnings or previously retained earnings. As required by the Finance Agency, the Bank’s Excess Stock Repurchase, Retained Earnings, and Dividend Framework (Framework) summarizes the Bank’s capital management principles and objectives, as well as its policies and practices, with respect to retained earnings, dividend payments, and the repurchase of excess capital stock. The Bank may be restricted from paying dividends if the Bank 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 obligations 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 Finance Agency regulations.


32

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



The Bank’s Board of Directors reviews the Framework at least annually and may amend the Framework from time to time. In January 2017, the Framework was amended and approved by the Bank’s Board of Directors to include a dividend philosophy to endeavor to pay a quarterly dividend at an annualized rate between 5% and 7%, which was considered by the Bank’s Board of Directors beginning with the Bank’s second quarter 2017 dividend declaration. The decision to declare any dividend and the dividend rate are at the discretion of the Bank’s Board of Directors, which may choose to follow the dividend philosophy as guidance in the dividend declaration.

The Bank’s Risk Management Policy limits the payment of dividends if the ratio of the Bank’s estimated market value of total capital to par value of capital stock falls below certain levels. If this ratio at the end of any quarter is less than 100% but greater than or equal to 70%, any dividend would be limited to an annualized rate no greater than the daily average of the three-month LIBOR for the applicable quarter (subject to certain conditions), and if this ratio is less than 70%, the Bank would be restricted from paying a dividend. The ratio of the Bank’s estimated market value of total capital to par value of capital stock was 214% as of March 31, 2018.

In addition, the Bank monitors the condition of its PLRMBS portfolio, the ratio of the Bank’s estimated market value of total capital to par value of capital stock, its overall financial performance and retained earnings, developments in the mortgage and credit markets, and other relevant information as the basis for determining the payment of dividends and the repurchase of excess capital stock each quarter.

Retained Earnings – The following tables summarize the activity related to retained earnings for the three months ended March 31, 2018 and 2017:
 
 
 
Restricted Retained Earnings Related to:
 
 
 
Unrestricted Retained Earnings

 
Valuation Adjustments

 
Other

 
Joint Capital Enhancement Agreement

 
Total Restricted Retained Earnings

 
Total Retained Earnings

Balance, December 31, 2016
$
888

 
$
18

 
$
1,650

 
$
500

 
$
2,168

 
$
3,056

Net income
16

 
2

 
100

 
30

 
132

 
148

Cash dividends on capital stock
(54
)
 
 
 
 
 
 
 


 
(54
)
Balance, March 31, 2017
$
850

 
$
20

 
$
1,750

 
$
530

 
$
2,300

 
$
3,150

 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2017
$
2,670

 
$
—

 
$
—

 
$
575

 
$
575

 
$
3,245

Net income
64

 
—

 
—

 
17

 
17

 
81

Cash dividends on capital stock
(53
)
 
 
 
 
 
 
 


 
(53
)
Balance, March 31, 2018
$
2,681

 
$
—

 
$
—

 
$
592

 
$
592

 
$
3,273


The Bank’s Framework assesses the level and adequacy of retained earnings and establishes amounts to be retained in restricted retained earnings, which are not made available in the current dividend period, and maintains an amount of total retained earnings at least equal to its required retained earnings as described in the Framework. Prior to July 2017, the Bank’s Framework had three categories of restricted retained earnings: Valuation Adjustments, Other (which represented a targeted amount), and the Joint Capital Enhancement (JCE Agreement). Under the Framework, the Bank’s required amount of restricted retained earnings was determined using the Bank’s retained earnings methodology. As determined using the Bank’s methodology, from July 2015 to January 2017, the Bank’s restricted retained earnings requirement was $2,000, and from January 2017 to July 2017, the Bank’s restricted retained earnings requirement was $2,300.

In July 2017, the Bank’s Board of Directors approved the transfer of all amounts classified as restricted retained earnings, other than the amounts related to the JCE Agreement, to unrestricted retained earnings. As a conforming change related to the transfer, the Bank’s Board of Directors amended the Framework to eliminate two of the categories of restricted retained earnings (Valuation Adjustments and Other) and approved revisions to the Bank’s retained earnings methodology to provide for a required level of total retained earnings of $2,300 for loss protection, capital compliance, and business growth. In January 2018, the methodology was further revised to

33

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



provide a required level of total retained earnings of $2,500. The Bank satisfies its retained earnings requirement with both restricted retained earnings (i.e., amounts related to the JCE Agreement) and unrestricted retained earnings.

For more information on restricted retained earnings and the Bank’s Framework, see “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital” in the Bank’s 2017 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 or not 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.

In addition, Finance Agency rules do not permit the Bank to pay dividends in the form of capital stock if its excess capital stock exceeds 1% of its total assets. Excess capital stock is defined as the aggregate of the capital stock held by each shareholder in excess of its minimum capital stock requirement, as established by the Bank’s capital plan. As of March 31, 2018, the Bank’s excess capital stock totaled $566, or 0.52% of total assets.

In the first quarter of 2018, the Bank paid dividends at an annualized rate of 7.00%, totaling $59, including $53 in dividends on capital stock and $6 in dividends on mandatorily redeemable capital stock. In the first quarter of 2017, the Bank paid dividends at an annualized rate of 9.08%, totaling $65, including $54 in dividends on capital stock and $11 in dividends on mandatorily redeemable capital stock.

For the periods referenced above, the Bank paid dividends in cash. Dividends on capital stock are recognized as dividends on the Statements of Capital Accounts, and dividends on mandatorily redeemable capital stock are recognized as interest expense on the Statements of Income.

On April 26, 2018, the Bank’s Board of Directors declared a cash dividend on the capital stock outstanding during the first quarter of 2018 at an annualized rate of 7.00%, totaling $63, including $58 in dividends on capital stock and $5 in dividends on mandatorily redeemable capital stock. The Bank recorded the dividend on April 26, 2018. The Bank expects to pay the dividend on May 14, 2018. Dividends on mandatorily redeemable capital stock will be recognized as interest expense in the second quarter of 2018.

Excess Capital Stock – The Bank may repurchase some or all of a shareholder’s excess capital stock, including any excess mandatorily redeemable capital stock, at the Bank’s discretion, subject to certain statutory and regulatory requirements. The Bank must give the shareholder 15 days’ written notice; however, the shareholder may waive this notice period. The Bank may also repurchase all of a member’s excess capital stock at a member’s request, at the Bank’s discretion, subject to certain statutory and regulatory requirements. A shareholder’s excess capital stock is defined as any capital stock holdings in excess of the shareholder’s minimum capital stock requirement, as established by the Bank’s capital plan. The Bank repurchased $428 and $173 in excess capital stock during the first quarter of 2018 and 2017, respectively.

The Bank is required to redeem any mandatorily redeemable capital stock that is in excess of a former member’s minimum stock requirement on or after the expiration of the five-year redemption date. During the first quarter of 2018 and 2017, the Bank redeemed a de minimis amount and $54, respectively, in mandatorily redeemable capital stock, for which the five-year redemption period had expired, at its $100 par value. The stock was redeemed on the scheduled redemption dates or, for stock that was not excess stock on its scheduled redemption date because of outstanding activity with the Bank, on the first available repurchase date after the stock was no longer required to support outstanding activity with the Bank.


34

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



On April 9, 2018, the Bank’s Board of Directors revised the Framework to change the Bank’s practice of repurchasing the surplus capital stock of all members and the excess capital stock of all former members from a quarterly schedule to a daily schedule. Surplus capital stock is defined as any stock holdings in excess of 115% of a member’s minimum stock requirement. Effective April 24, 2018, the Bank began calculating the amount of stock to be repurchased each business day based on the shareholder’s capital stock outstanding after all stock transactions are completed for the day, ensuring that each member and former member will continue to meet its minimum capital stock requirement after the repurchase. In accordance with the revised Framework, the Bank repurchased $363 of excess capital stock on April 24, 2018. The Bank may change this practice at any time. All repurchases of capital stock are at the Bank’s discretion, subject to certain statutory and regulatory requirements and to the Bank’s Risk Management Policy, Capital Plan, and Excess Stock Repurchase, Retained Earnings, and Dividend Framework.

Excess capital stock totaled $566 as of March 31, 2018, which included surplus capital stock of $328. Excess capital stock totaled $493 as of December 31, 2017, which included surplus capital stock of $317.

For more information on excess capital stock, see “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital” in the Bank’s 2017 Form 10-K.

Concentration. No institution held 10% or more of the Bank’s outstanding capital stock, including mandatorily redeemable capital stock, as of March 31, 2018. Charles Schwab Bank, a member institution, held $405, or 11%, of the Bank’s outstanding capital stock, including mandatorily redeemable capital stock, as of December 31, 2017, and $233, or 7%, as of March 31, 2018.

Note 14 — Segment Information

The Bank uses an analysis of financial results based on the financial components 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 determine financial management strategies related to the operations of these two business segments. For purposes of segment reporting, adjusted net interest income includes income and expense associated with net settlements from economic hedges that are recorded in “Net gain/(loss) on derivatives and hedging activities” in other income and excludes interest expense that is recorded in “Mandatorily redeemable capital stock.” Other key financial information, such as any credit-related OTTI losses on the Bank’s PLRMBS, other expenses, and assessments, is not included in the segment reporting analysis, but is incorporated into the Bank’s overall assessment of financial performance.

For more information on these operating segments, see “Item 8. Financial Statements and Supplementary Data – Note 17 – Segment Information” in the Bank’s 2017 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 income before the AHP assessment for the three months ended March 31, 2018 and 2017.

35

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



 
Advances-
Related
Business

 
Mortgage-
Related
Business(1)

 
Adjusted
Net
Interest
Income

 
Amortization
of Basis
Adjustments(2)

 

Income/(Expense)
on Economic
Hedges(3)

 
Interest
Expense on
Mandatorily
Redeemable
Capital
Stock(4)

 
Net
Interest
Income After Mortgage Loan Loss Provision

 
Other
Income/
(Loss)

 
Other
Expense

 
Income
Before AHP
Assessment

Three months ended:
March 31, 2018
$
78

 
$
75

 
$
153

 
$
(1
)
 
$
—

 
$
6

 
$
148

 
$
(8
)
 
$
49

 
$
91

March 31, 2017
48

 
83

 
131

 
(2
)
 
(12
)
 
11

 
134

 
112

 
80

 
166


(1)
The mortgage-related business includes total accretion or amortization associated with other-than-temporarily impaired PLRMBS, which are recognized in interest income, totaled $22 and $23 for the three months ended March 31, 2018 and 2017, respectively. The mortgage-related business does not include credit-related OTTI losses of $1 and $3 for the three months ended March 31, 2018 and 2017, respectively.
(2)
Represents amortization of amounts deferred for adjusted net interest income purposes only.
(3)
The Bank includes income and expense associated with net settlements from 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 gain/(loss) 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, 2018, and December 31, 2017.
  
Advances-
Related Business

 
Mortgage-
Related Business

 
Total
Assets

March 31, 2018
$
89,322

 
$
19,903

 
$
109,225

December 31, 2017
103,426

 
19,959

 
123,385


Note 15 — Derivatives and Hedging Activities

General. The Bank may enter into interest rate swaps (including callable, putable, and basis swaps); and cap and floor 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 or the issuance of consolidated obligation bonds to create variable rate structures. The interest rate exchange agreements are generally executed at the same time the advances and bonds are transacted and generally have the same maturity dates as the related advances and bonds. The Bank transacts most of its derivatives with large banks and major broker-dealers. Some of these banks and broker-dealers or their affiliates buy, sell, and distribute consolidated obligations. Derivatives may be either uncleared or cleared. In an uncleared derivative transaction, the Bank’s counterparty is the executing bank or broker-dealer. In a cleared derivative transaction, the Bank may execute the transaction either directly with the executing bank or broker-dealer or on a swap execution facility, but in either case, the Bank’s counterparty is a derivatives clearing organization or clearinghouse once the derivative transaction has been accepted for clearing. The Bank is not a derivatives dealer and does not trade derivatives for short-term profit.

Additional uses of interest rate exchange agreements include: (i) offsetting embedded features in assets and liabilities, (ii) hedging anticipated issuance of debt, (iii) matching against consolidated obligation discount notes or bonds to create the equivalent of callable or non-callable fixed rate debt, (iv) modifying the repricing frequency of assets and liabilities, (v) matching against certain advances and consolidated obligations for which the Bank elected the fair value option, and (vi) exactly offsetting other derivatives cleared at a derivatives clearing organization. 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 or (ii) an economic hedge of assets, liabilities, or other derivatives.

The Bank primarily uses the following derivative instruments:

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

36

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



time. In return for this promise, the party receives cash flows equivalent to the interest on the same notional principal amount at a variable rate for the same period of time. The variable rate received or paid by the Bank in most interest rate exchange agreements is either indexed to LIBOR or to the overnight index swap rate.

Interest Rate Caps and Floors – In a cap agreement, additional cash flow is generated if the price or interest rate of an underlying variable rate rises above a certain threshold (or cap) price. In a floor agreement, additional cash flow is generated if the price or interest rate of an underlying variable rate falls below a certain threshold (or floor) price. Caps and floors may be used in conjunction with assets or liabilities. In general, 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 at inception all relationships between derivatives designated as hedging instruments and hedged items, its risk management objectives and strategies for undertaking various hedge transactions, and its method of assessing hedge effectiveness. Derivatives designated as fair value hedges may be transacted to hedge: (i) assets and liabilities on the Statement of Condition, (ii) firm commitments, or (iii) forecasted transactions. The Bank also formally assesses (both at hedge inception and on an ongoing basis) whether the hedging derivatives have been effective in offsetting changes in the fair value of hedged items attributable to the hedged risk and whether those derivatives may be expected to remain effective hedges 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 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) it determines that designating the derivative as a hedging instrument is no longer appropriate; or (vi) it decides to use the derivative to offset changes in the fair value of other derivatives or instruments carried at fair value.

The Bank may have the following types of hedged items:

Investments – The Bank may invest in U.S. Treasury and agency obligations, agency MBS, and the taxable portion of highly rated state or local housing finance agency obligations. In the past, the Bank has also invested in PLRMBS rated AAA at the time of acquisition. 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. The Bank may execute callable swaps in conjunction with the issuance of certain liabilities to create funding that is economically 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. Investment securities may be classified as trading, AFS, or HTM.

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 range of advances 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 options characteristics of advances to more closely match the characteristics of the Bank’s funding liabilities. In general, whenever a member executes a fixed or variable rate advance with embedded options, the Bank will simultaneously execute an interest rate exchange

37

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



agreement with terms that offset the terms and embedded options in the advance. The combination of the advance and the interest rate exchange agreement effectively creates a variable rate asset.

In addition, for certain advances for which the Bank has elected the fair value option, the Bank will simultaneously execute an interest rate exchange agreement with terms that economically offset the terms of the advance.

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 mortgage loans with lower-yielding assets and the Bank’s higher funding costs are not reduced accordingly.

The Bank executes callable swaps in conjunction with the issuance of certain consolidated obligations to create funding that is economically 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.

Consolidated Obligations – Consolidated obligation bonds may be structured to meet the Bank’s or the 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 are issued, the Bank simultaneously executes 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 an adjustable rate bond alone. These transactions generally receive fair value hedge accounting treatment.

When the Bank issues consolidated obligation discount notes, it may also simultaneously enter into an interest rate exchange agreement to convert the fixed rate discount note to an adjustable rate discount note. This type of hedge is treated as an economic hedge.

In addition, when certain consolidated obligation bonds for which the Bank has elected the fair value option are issued, the Bank simultaneously executes an interest rate exchange agreement with terms that economically offset the terms of the consolidated obligation bond. However, this type of hedge is treated as an economic hedge because these combinations do not meet the requirements for fair value hedge accounting treatment.

Offsetting Derivatives – The Bank enters into derivatives to offset the economic effect of other derivatives that are no longer designated to advances, investments, or consolidated obligations. Offsetting derivatives 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.

The notional principal of the interest rate exchange agreements associated with offsetting derivatives with other counterparties was $24 and $14, at March 31, 2018, and December 31, 2017, respectively.

The notional amount of an interest rate exchange agreement serves as a factor in determining periodic interest payments or cash flows received and paid. However, the notional amount of derivatives represents neither the actual amounts exchanged nor the overall exposure of the Bank to credit risk and market risk. The risks of derivatives can be measured meaningfully on a portfolio basis by taking into account the counterparties, the types of derivatives, the items being hedged, and any offsets between the derivatives and the items being hedged.


38

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



The following table summarizes the notional amount and fair value of derivative instruments, including the effect of netting adjustments and cash collateral as of March 31, 2018, and December 31, 2017. For purposes of this disclosure, the derivative values include the fair value of derivatives and related accrued interest.

 
March 31, 2018
 
December 31, 2017
 
Notional
Amount of
Derivatives

 
Derivative
Assets

 
Derivative
Liabilities

 
Notional
Amount of
Derivatives

 
Derivative
Assets

 
Derivative
Liabilities

Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
$
30,008

 
$
7

 
$
41

 
$
24,270

 
$
92

 
$
27

Total
30,008

 
7

 
41

 
24,270

 
92

 
27

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
45,445

 
69

 
65

 
73,760

 
81

 
57

Interest rate caps and floors
1,563

 
3

 
—

 
1,563

 
1

 
1

Mortgage delivery commitments
11

 
—

 
—

 
16

 
—

 
—

Total
47,019

 
72

 
65

 
75,339

 
82

 
58

Total derivatives before netting and collateral adjustments
$
77,027

 
79

 
106

 
$
99,609

 
174

 
85

Netting adjustments and cash collateral(1)
 
 
23

 
(103
)
 
 
 
(91
)
 
(84
)
Total derivative assets and total derivative liabilities
 
 
$
102

 
$
3

 
 
 
$
83

 
$
1


(1)
Amounts represent the application of the netting requirements that allow the Bank to settle positive and negative positions, and also cash collateral and related accrued interest held or placed with the same clearing agents and/or counterparty. Cash collateral posted and related accrued interest was $155 and $10 at March 31, 2018, and December 31, 2017, respectively. Cash collateral received and related accrued interest was $29 and $18 at March 31, 2018, and December 31, 2017, respectively.

The following table presents the components of net gain/(loss) on derivatives and hedging activities as presented in the Statements of Income for the three months ended March 31, 2018 and 2017.
 
Three Months Ended
 
March 31, 2018

 
March 31, 2017

 
Gain/(Loss)

 
Gain/(Loss)

Derivatives designated as hedging instruments:
 
 
 
Interest rate swaps
$
2

 
$
—

Total net gain/(loss) related to fair value hedge ineffectiveness
2

 
—

Derivatives not designated as hedging instruments:
 
 
 
Economic hedges:
 
 
 
Interest rate swaps
24

 
2

Interest rate caps and floors
2

 
(2
)
Net settlements
—

 
(12
)
Mortgage delivery commitments
4

 
3

Total net gain/(loss) related to derivatives not designated as hedging instruments
30

 
(9
)
Other(1)
(1
)
 
—

Net gain/(loss) on derivatives and hedging activities
$
31

 
$
(9
)

(1)
Consists of price alignment amount on derivatives for which variation margin is characterized as a daily settled contract.

The following tables present, 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, 2018 and 2017.

39

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)




 
Three Months Ended
 
March 31, 2018
 
March 31, 2017
Hedged Item Type
Gain/(Loss)
on Derivatives

 
Gain /(Loss) on Hedged Item

 
Net Fair
Value Hedge
Ineffectiveness

 
Effect of
Derivatives on
Net Interest Income(1)

 
Gain/(Loss)
on Derivatives

 
Gain /(Loss) on Hedged Item

 
Net Fair
Value Hedge
Ineffectiveness

 
Effect of
Derivatives on
Net Interest Income(1)

Advances
$
70

 
$
(67
)
 
$
3

 
$
3

 
$
14

 
$
(14
)
 
$
—

 
$
(9
)
Consolidated obligation bonds
(44
)
 
43

 
(1
)
 
1

 
(11
)
 
11

 
—

 
9

Total
$
26

 
$
(24
)
 
$
2

 
$
4

 
$
3

 
$
(3
)
 
$
—

 
$
—


(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.    

Credit Risk – The Bank is subject to credit risk as a result of potential nonperformance by counterparties to the interest rate exchange agreements. All of the Bank’s agreements governing uncleared derivative transactions 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, credit guidelines, and Finance Agency and other regulations. The Bank also requires credit support agreements on all uncleared derivatives.

For cleared derivatives, the clearinghouse is the Bank’s counterparty. The requirement that the Bank post initial and variation margin through a clearing agent, to the clearinghouse, exposes the Bank to institutional credit risk in the event that the clearing agent or the clearinghouse fails to meet its obligations. The use of cleared derivatives, however, mitigates the Bank’s overall credit risk exposure because a central counterparty is substituted for individual counterparties. Variation margin and initial margin are posted for changes in the value and risk profile of cleared derivatives. The Bank has analyzed the enforceability of offsetting rights applicable to its cleared derivative transactions and determined that the exercise of those offsetting rights by a non-defaulting party under these transactions should be upheld under applicable bankruptcy law and Commodity Futures Trading Commission rules in the event of a clearinghouse or clearing agent insolvency and under applicable clearinghouse rules upon a non-insolvency-based event of default of the clearinghouse or clearing agent. Based on this analysis, the Bank presents a net derivative receivable or payable for all of its transactions through a particular clearing agent with a particular clearinghouse.

Based on the Bank’s credit analyses and the collateral requirements, the Bank does not expect to incur any credit losses on its derivative transactions.

The Bank’s agreements for uncleared derivative transactions contain provisions that link the Bank’s credit rating from Moody’s Investors Service and S&P Global Ratings to various rights and obligations. Certain of these derivative agreements provide that, if the Bank’s long-term debt rating falls below a specified rating (ranging from A3/A- to Baa3/BBB-), the Bank’s counterparty would have the right, but not the obligation, to terminate all of its outstanding derivative transactions with the Bank; the Bank’s agreements with its clearing agents for cleared derivative transactions have similar provisions with respect to the debt rating of FHLBank System consolidated bonds. If this occurs, the Bank may choose to enter into replacement hedges, either by transferring the existing transactions to another counterparty or entering into new replacement transactions, based on prevailing market rates. The aggregate fair value of all uncleared 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, 2018, was $56, for which the Bank had posted cash collateral of $53 in the ordinary course of business.

The Bank may present derivative instruments, related cash collateral received or pledged, and associated accrued interest by clearing agent or by counterparty when the netting requirements have been met.


40

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



The following table presents separately the fair value of derivative assets and derivative liabilities that have met the netting requirements, including the related collateral received from or pledged to counterparties as of March 31, 2018, and December 31, 2017.

 
March 31, 2018
 
December 31, 2017
 
Derivative Instruments Meeting Netting Requirements
 
 
 
Derivative Instruments Meeting Netting Requirements
 
 
 
Amount Recognized
 
Gross Amount of Netting Adjustments and Cash Collateral
 
Total Derivative Assets and Total Derivative Liabilities
 
Amount Recognized
 
Gross Amount of Netting Adjustments and Cash Collateral
 
Total Derivative Assets and Total Derivative Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Derivative Assets
 
 
 
 
 
 
 
 
 
 
 
Uncleared
$
75

 
$
(72
)
 
$
3

 
$
35

 
$
(33
)
 
$
2

Cleared
4

 
95

 
99

 
139

 
(58
)
 
81

Total
 
 
 
 
$
102

 
 
 
 
 
$
83

Derivative Liabilities
 
 
 
 
 
 
 
 
 
 
 
Uncleared
$
100

 
$
(97
)
 
$
3

 
$
29

 
$
(28
)
 
$
1

Cleared
6

 
(6
)
 
—

 
56

 
(56
)
 
—

Total
 
 
 
 
$
3

 
 
 
 
 
$
1


Note 16 — Fair Value

The following fair value amounts have been determined by the Bank using available market information and the Bank’s best judgment of appropriate valuation methods. These estimates are based on pertinent information available to the Bank at March 31, 2018, and December 31, 2017. 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 cannot be precisely quantified or verified and may change as economic and market factors and evaluation of those factors change. The Bank continues to refine its valuation methodologies as markets and products develop and the pricing for certain products becomes more or less transparent. While the Bank believes that its valuation methodologies are appropriate and consistent with those of other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a materially different estimate of fair value as of the reporting date. U.S. GAAP defines fair value 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 (i.e., an exit price). Therefore, the 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 as to how a market participant would estimate the fair values. The fair value summary table does not represent an estimate of the overall market value of the Bank as a going concern, which would take into account future business opportunities and the net profitability of total assets and liabilities.

The following tables present the carrying value, the estimated fair value, and the fair value hierarchy level of the Bank’s financial instruments at March 31, 2018, and December 31, 2017. The Bank records trading securities, AFS securities, derivative assets, derivative liabilities, certain advances, certain consolidated obligations, and certain other assets at fair value on a recurring basis, and on occasion certain mortgage loans held for portfolio and certain other assets at fair value on a nonrecurring basis. The Bank records all other financial assets and liabilities at amortized cost. Refer to the following tables for further details about the financial assets and liabilities held at fair value on either a recurring or non-recurring basis.


41

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



 
March 31, 2018
  
Carrying
Value

 
Estimated Fair Value

 
Level 1

 
Level 2

 
Level 3

 
Netting Adjustments and Cash Collateral(1)

Assets
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
$
15

 
$
15


$
15


$
—

 
$
—

 
$
—

Interest-bearing deposits
1,070

 
1,070

 
1,070

 
—

 
—

 
—

Securities purchased under agreements to resell
6,250

 
6,250

 
—

 
6,250

 
—

 
—

Federal funds sold
13,950

 
13,952

 
—

 
13,952

 
—

 
—

Trading securities
913

 
913

 
—

 
913

 
—

 
—

AFS securities
3,686

 
3,686

 
—

 
—

 
3,686

 
—

HTM securities
13,963

 
13,948

 
—

 
13,005

 
943

 
—

Advances
66,642

 
66,689

 
—

 
66,689

 
—

 
—

Mortgage loans held for portfolio, net of allowance for credit losses on mortgage loans
2,376

 
2,323

 
—

 
2,323

 
—

 
—

Accrued interest receivable
138

 
138

 
—

 
138

 
—

 
—

Derivative assets, net(1)
102

 
102

 
—

 
79

 
—

 
23

Other assets(2)
9

 
9

 
9

 
—

 
—

 
—

Liabilities
 
 
 
 
 
 
 
 
 
 
 
Deposits
257

 
257

 
—

 
257

 
—

 
—

Consolidated obligations:
 
 
 
 
 
 
 
 
 
 
 
Bonds
74,297

 
74,088

 
—

 
74,088

 
—

 
—

Discount notes
27,203

 
27,197

 
—

 
27,197

 
—

 
—

Total consolidated obligations
101,500

 
101,285

 
—

 
101,285

 
—

 
—

Mandatorily redeemable capital stock
309

 
309


309


—

 
—

 
—

Accrued interest payable
123


123


—


123

 
—

 
—

Derivative liabilities, net(1)
3

 
3

 
—

 
106

 
—

 
(103
)
Other
 
 
 
 
 
 
 
 
 
 
 
Standby letters of credit
20

 
20


—


20

 
—

 
—



42

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



 
December 31, 2017
 
Carrying
Value

 
Estimated Fair Value

 
Level 1

 
Level 2

 
Level 3

 
Netting Adjustments and Cash Collateral(1)

Assets
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
$
31

 
$
31

 
$
31

 
$
—

 
$
—

 
$
—

Interest-bearing deposits
1,115

 
1,115

 
1,115

 
—

 
—

 
—

Securities purchased under agreements to resell
11,750

 
11,750

 
—

 
11,750

 
—

 
—

Federal funds sold
11,028

 
11,029

 
—

 
11,029

 
—

 
—

Trading securities
1,164

 
1,164

 
—

 
1,164

 
—

 
—

AFS securities
3,833

 
3,833

 
—

 
—

 
3,833

 
—

HTM securities
14,680

 
14,704

 
—

 
13,697

 
1,007

 
—

Advances
77,382

 
77,437

 
—

 
77,437

 
—

 
—

Mortgage loans held for portfolio, net of allowance for credit losses on mortgage loans
2,076

 
2,075

 
—

 
2,075

 
—

 
—

Accrued interest receivable
119

 
119

 
—

 
119

 
—

 
—

Derivative assets, net(1)
83

 
83

 
—

 
174

 
—

 
(91
)
Other assets(2)
9

 
9

 
9

 
—

 
—

 
—

Liabilities
 
 


 
 
 
 
 
 
 
 
Deposits
281

 
281

 
—

 
281

 
—

 
—

Consolidated obligations:
 
 


 
 
 
 
 
 
 
 
Bonds
85,063

 
84,938

 
—

 
84,938

 
—

 
—

Discount notes
30,440

 
30,437

 
—

 
30,437

 
—

 
—

Total consolidated obligations
115,503

 
115,375

 
—

 
115,375

 
—

 
—

Mandatorily redeemable capital stock
309

 
309

 
309

 
—

 
—

 
—

Accrued interest payable
116

 
116

 
—

 
116

 
—

 
—

Derivative liabilities, net(1)
1

 
1

 
—

 
85

 
—

 
(84
)
Other
 
 


 
 
 
 
 
 
 
 
Standby letters of credit
19

 
19

 
—

 
19

 
—

 
—


(1)
Amounts represent the application of the netting requirements that allow the Bank to settle positive and negative positions, and also cash collateral and related accrued interest held or placed with the same clearing agents and/or counterparty.
(2)
Represents publicly traded mutual funds held in a grantor trust.

Fair Value Hierarchy. The fair value hierarchy is used to prioritize the fair value methodologies and valuation techniques as well as the inputs to the valuation techniques used to measure fair value for assets and liabilities carried at fair value on the Statements of Condition. The inputs are evaluated and an overall level for the fair value measurement is determined. This overall level is an indication of market observability of the fair value measurement for the asset or liability. The fair value hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). An entity must disclose the level within the fair value hierarchy in which the measurements are classified for all financial assets and liabilities measured on a recurring or non-recurring basis.

The application of the fair value hierarchy to the Bank’s financial assets and financial liabilities that are carried at fair value either on a recurring or non-recurring basis is as follows:
•
Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in an active market that the reporting entity can access on the measurement date.
•
Level 2 – Inputs other than quoted prices within Level 1 that are observable inputs for the asset or liability, either directly or indirectly. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability. Level 2 inputs include the following: (1) quoted prices for similar assets or liabilities in active markets; (2) quoted prices for identical or similar

43

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



assets or liabilities in markets that are not active; (3) inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates and yield curves that are observable at commonly quoted intervals, and implied volatilities); and (4) inputs that are derived principally from or corroborated by observable market data by correlation or other means.
•
Level 3 – Unobservable inputs for the asset or liability.

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

The following assets and liabilities, including those for which the Bank has elected the fair value option, are carried at fair value on the Statements of Condition as of March 31, 2018:
•
Trading securities
•
AFS securities
•
Certain advances
•
Derivative assets and liabilities
•
Certain consolidated obligation bonds
•
Certain other assets

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 inputs may result in a reclassification of certain assets or liabilities. Such reclassifications are reported as transfers in or out as of the beginning of the quarter in which the changes occur. For the periods presented, the Bank did not have any reclassifications for transfers in or out of the fair value hierarchy levels.

Summary of Valuation Methodologies and Primary Inputs.

The valuation methodologies and primary inputs used to develop the measurement of fair value for assets and liabilities that are measured at fair value on a recurring or nonrecurring basis in the Statements of Condition are listed below.

Investment Securities – MBS – To value its MBS, the Bank obtains prices from multiple designated third-party pricing vendors when available. The pricing vendors use various proprietary models to price these securities. The inputs to those models are derived from various sources including, but not limited to: benchmark yields, reported trades, dealer estimates, issuer spreads, prices on benchmark securities, bids, offers, and other market-related data. Since many securities do not trade on a daily basis, the pricing vendors use available information as applicable, such as benchmark yield curves, benchmarking of like securities, sector groupings, and matrix pricing, to determine the prices for individual securities. Each pricing vendor has an established challenge process in place for all security valuations, which facilitates resolution of price discrepancies identified by the Bank.

At least annually, the Bank conducts reviews of the multiple pricing vendors to update and confirm its understanding of the vendors’ pricing processes, methodologies, and control procedures.

The Bank’s valuation technique for estimating the fair values of its MBS first requires the establishment of a median vendor price for each security. If three prices are received, the middle price is the median price; if two prices are received, the average of the two prices is the median price; and if one price is received, it is the median price (and also the default fair value) subject to additional validation. All vendor prices that are within a specified tolerance threshold of the median price are included in the cluster of vendor prices that are averaged to establish a default fair value. All vendor prices that are outside the threshold (outliers) are subject to further analysis including, but not limited to, comparison to prices provided by an additional third-party valuation service, prices for similar securities and/or dealer estimates, or use of internal model prices, which are deemed to be reflective of all relevant facts and circumstances that a market participant would consider. Such analysis is also applied in those limited instances where no third-party vendor price or only one third-party vendor price is available in order to arrive at an

44

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



estimated fair value. If an outlier (or some other price identified in the analysis) is determined to be a better estimate of fair value, then the outlier (or the other price, as appropriate) is used as the fair value rather than the default fair value. If, instead, the analysis confirms that an outlier is (or outliers are) not representative of fair value and the default fair value is the best estimate, then the default fair value is used as the fair value.

If all vendor prices received for a security are outside the tolerance threshold level of the median price, then there is no default fair value, and the fair value is determined by an evaluation of all outlier prices (or the other prices, as appropriate) as described above.

As of March 31, 2018, multiple vendor prices were received for most of the Bank’s MBS, and the fair value estimates for most of those securities were determined in accordance with the Bank’s valuation technique based on these vendor prices. Based on the Bank’s reviews of the pricing methods employed by the third-party pricing vendors and the relative lack of dispersion among the vendor prices (or, in those instances in which there were outliers, the Bank’s additional analyses), the Bank believes that its fair value estimates are reasonable and that the fair value measurements are classified appropriately in the fair value hierarchy. Based on limited market liquidity for PLRMBS, the fair value measurements for these securities were classified as Level 3 within the fair value hierarchy.

Investment Securities – FFCB Bonds – The Bank estimates the fair values of these securities using the methodology described above for Investment Securities – MBS.

Advances Recorded Under the Fair Value Option – Because quoted prices are not available for advances, the fair values are measured using model-based valuation techniques (such as calculating the present value of future cash flows and reducing the amount for accrued interest receivable).

The Bank’s primary inputs for measuring the fair value of advances recorded under the fair value option are market-based consolidated obligation yield curve (CO Curve) inputs obtained from the Office of Finance. The CO Curve is then adjusted to reflect the rates on replacement advances with similar terms and collateral. These spread adjustments are not market-observable and are evaluated for significance in the overall fair value measurement and the fair value hierarchy level of the advance. The Bank obtains market-observable inputs for complex advances recorded under the fair value option. These inputs may include volatility assumptions, which are market-based expectations of future interest rate volatility implied from current market prices for similar options (swaption volatility and volatility skew). The discount rates used in these calculations are the replacement advance rates for advances with similar terms. Pursuant to the Finance Agency’s advances regulation, advances with an original term to maturity or repricing period greater than six months generally require a prepayment fee sufficient to make the Bank financially indifferent to the borrower’s decision to prepay the advances. The Bank determined that no adjustment is required to the fair value measurement of advances for prepayment fees. In addition, the Bank did not adjust its fair value measurement of advances recorded under the fair value option for creditworthiness primarily because advances were fully collateralized.

Other Assets – The estimated fair value of grantor trust assets is based on quoted market prices.

Derivative Assets and Liabilities – In general, derivative instruments transacted and held by the Bank for risk management activities are traded in over-the-counter markets where quoted market prices are not readily available. These derivatives are interest rate-related. For these derivatives, the Bank measures fair value using internally developed discounted cash flow models that use market-observable inputs, such as the overnight index swap (OIS) curve and volatility assumptions, which are market-based expectations of future interest rate volatility implied from current market prices for similar options (swaption volatility and volatility skew), adjusted for counterparty credit risk, as necessary.

The Bank is subject to credit risk because of the risk of potential nonperformance by its derivative counterparties. To mitigate this risk, the Bank executes uncleared derivative transactions only with highly rated derivative dealers

45

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



and major banks (derivative dealer counterparties) that meet the Bank’s eligibility criteria. In addition, the Bank has entered into master netting agreements and bilateral credit support agreements with all active derivative dealer counterparties that provide for delivery of collateral at specified levels 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 derivative dealer counterparty is either (i) limited to an absolute dollar credit exposure limit according to the counterparty’s long-term debt or deposit credit rating, as determined by rating agencies or (ii) set at zero (subject to a minimum transfer amount). The Bank clears its cleared derivative transactions only through clearing agents that meet the Bank’s eligibility requirements, and the Bank’s credit exposure to the clearinghouse is secured by variation margin received from the clearinghouse. All credit exposure from derivative transactions entered into by the Bank with member counterparties that are not derivative dealers must be fully secured by eligible collateral. The Bank evaluated the potential for the fair value of the instruments to be affected by counterparty credit risk and determined that no adjustments to the overall fair value measurements were required.

The fair values of the derivative assets and liabilities include accrued interest receivable/payable and cash collateral remitted to/received from counterparties. The estimated fair values of the accrued interest receivable/payable and cash collateral approximate their carrying values because of their short-term nature. The fair values of derivatives that met the netting requirements are presented on a net basis. If these netted amounts are positive, they are classified as an asset and, if negative, they are classified as a liability.

Consolidated Obligations Recorded Under the Fair Value Option – 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 input for measuring the fair value of consolidated obligation bonds is a market-based CO Curve obtained from the Office of Finance. The Office of Finance constructs the CO Curve using the Treasury yield curve as a base curve, which is adjusted by indicative consolidated obligation spreads obtained from market-observable sources. These market indications are generally derived from pricing indications from dealers, historical pricing relationships, and market activity for similar liabilities, such as recent GSE issuances or secondary market activity. For consolidated obligation bonds with embedded options, the Bank also obtains market-observable inputs, such as volatility assumptions, which are market-based expectations of future interest rate volatility implied from current market prices for similar options (swaption volatility and volatility skew).

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 and the creditworthiness of the other 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 recorded under the fair value option have been significantly affected during the reporting period by changes in the instrument-specific credit risk.

Subjectivity of Estimates Related to Fair Values of Financial Instruments. Estimates of the fair value of financial assets and liabilities using the methodologies described above are 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.


46

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



Fair Value Measurements. The tables below present the fair value of assets and liabilities, which are recorded on a recurring or nonrecurring basis at March 31, 2018, and December 31, 2017, by level within the fair value hierarchy.

March 31, 2018
 
 
 
 
 
 
 
 
 
 
Fair Value Measurement Using:
 
Netting

 
 
 
Level 1

 
Level 2

 
Level 3

 
Adjustments(1)

 
Total

Recurring fair value measurements – Assets:
 
 
 
 
 
 
 
 
 
Trading securities:
 
 
 
 
 
 
 
 
 
GSEs – FFCB bonds
$
—

 
$
907

 
$
—

 
$
—

 
$
907

MBS:
 
 
 
 
 
 
 
 
 
Other U.S. obligations – Ginnie Mae
—

 
6

 
—

 
—

 
6

Total trading securities
—

 
913

 
—

 
—

 
913

AFS securities:
 
 
 
 
 
 
 
 
 
PLRMBS
—

 
—

 
3,686

 
—

 
3,686

Total AFS securities
—

 
—

 
3,686

 
—

 
3,686

Advances(2)
—

 
6,637

 
—

 
—

 
6,637

Derivative assets, net: interest rate-related
—

 
79

 
—

 
23

 
102

Other assets
9

 
—

 
—

 
—

 
9

Total recurring fair value measurements – Assets
$
9

 
$
7,629

 
$
3,686

 
$
23

 
$
11,347

Recurring fair value measurements – Liabilities:
 
 
 
 
 
 
 
 
 
Consolidated obligation bonds(3)
$
—

 
$
1,315

 
$
—

 
$
—

 
$
1,315

Derivative liabilities, net: interest rate-related
—

 
106

 
—

 
(103
)
 
3

Total recurring fair value measurements – Liabilities
$
—

 
$
1,421

 
$
—

 
$
(103
)
 
$
1,318

Nonrecurring fair value measurements – Assets:(4)
 
 
 
 
 
 
 
 
 
Impaired mortgage loans held for portfolio
$
—

 
$
—

 
$
2

 
$
—

 
$
2

Total nonrecurring fair value measurements – Assets
$
—

 
$
—

 
$
2

 
$
—

 
$
2



47

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



December 31, 2017
 
 
 
 
 
 
 
 
 
 
Fair Value Measurement Using:
 
Netting

 
 
 
Level 1

 
Level 2

 
Level 3

 
Adjustments(1)

 
Total

Recurring fair value measurements – Assets:
 
 
 
 
 
 
 
 
 
Trading securities:
 
 
 
 
 
 
 
 
 
GSEs – FFCB bonds
$
—

 
$
1,158

 
$
—

 
$
—

 
$
1,158

MBS:
 
 
 
 
 
 
 
 
 
Other U.S. obligations – Ginnie Mae
—

 
6

 
—

 
—

 
6

Total trading securities
—

 
1,164

 
—

 
—

 
1,164

AFS securities:
 
 
 
 
 
 
 
 
 
PLRMBS
—

 
—

 
3,833

 
—

 
3,833

Total AFS securities
—

 
—

 
3,833

 
—

 
3,833

Advances(2)
—

 
6,431

 
—

 
—

 
6,431

Derivative assets, net: interest rate-related
—

 
174

 
—

 
(91
)
 
83

Other assets
9

 
—

 
—

 
—

 
9

Total recurring fair value measurements – Assets
$
9

 
$
7,769

 
$
3,833

 
$
(91
)
 
$
11,520

Recurring fair value measurements – Liabilities:
 
 
 
 
 
 
 
 
 
Consolidated obligation bonds(3)
$
—

 
$
949

 
$
—

 
$
—

 
$
949

Derivative liabilities, net: interest rate-related
—

 
85

 
—

 
(84
)
 
1

Total recurring fair value measurements – Liabilities
$
—

 
$
1,034

 
$
—

 
$
(84
)
 
$
950

Nonrecurring fair value measurements – Assets:(4)
 
 
 
 
 
 
 
 
 
Impaired mortgage loans held for portfolio
$
—

 
$
—

 
$
3

 
$
—

 
$
3

Total nonrecurring fair value measurements – Assets
$
—

 
$
—

 
$
3

 
$
—

 
$
3


(1)
Amounts represent the application of the netting requirements that allow the Bank to settle positive and negative positions, and also cash collateral and related accrued interest held or placed by the Bank, with the same clearing agents and/or counterparty.
(2)
Represents advances recorded under the fair value option at March 31, 2018, and December 31, 2017.
(3)
Represents consolidated obligation bonds recorded under the fair value option at March 31, 2018, and December 31, 2017.
(4)
The fair value information presented is as of the date the fair value adjustment was recorded during the three months ended March 31, 2018, and the year ended December 31, 2017.

The following tables present a reconciliation of the Bank’s AFS PLRMBS that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2018 and 2017.
 
Three Months Ended
 
March 31, 2018

 
March 31, 2017

Balance, beginning of the period
$
3,833

 
$
4,489

Total gain/(loss) realized and unrealized included in:
 
 
 
Interest income
22

 
22

Net OTTI loss, credit-related
(1
)
 
(3
)
Unrealized gain/(loss) of other-than-temporarily impaired securities included in AOCI
17

 
29

Net amount of OTTI loss reclassified to/(from) other income/(loss)
(2
)
 
2

Settlements
(183
)
 
(245
)
Balance, end of the period
$
3,686

 
$
4,294

Total amount of gain/(loss) for the period included in earnings attributable to the change in unrealized gains/losses relating to assets and liabilities still held at the end of the period
$
21

 
$
20


Fair Value Option. The fair value option provides an entity with an irrevocable option to elect fair value as an alternative measurement for selected financial assets, financial liabilities, unrecognized firm commitments, and written loan commitments not previously carried at fair value. It requires an entity to display the fair value of those

48

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



assets and liabilities for which the entity has chosen to use fair value on the face of the Statements of Condition. Fair value is used for both the initial and subsequent measurement of the designated assets, liabilities, and commitments, with the changes in fair value recognized in net income. Interest income and interest expense on advances and consolidated bonds carried at fair value are recognized solely on the contractual amount of interest due or unpaid. Any transaction fees or costs are immediately recognized in non-interest income or non-interest expense.

For more information on the Bank’s election of the fair value option, see “Item 8. Financial Statements and Supplementary Data – Note 19 – Fair Values” in the Bank’s 2017 Form 10-K.

The Bank has elected the fair value option for certain financial instruments to assist in mitigating potential earnings volatility that can arise from economic hedging relationships in which the carrying value of the hedged item is not adjusted for changes in fair value. The potential earnings volatility associated with using fair value only for the derivative is the Bank’s primary reason for electing the fair value option for financial assets and liabilities that do not qualify for hedge accounting or that have not previously met or may be at risk for not meeting the hedge effectiveness requirements.

The following tables summarize the activity related to financial assets and liabilities for which the Bank elected the fair value option during the three months ended March 31, 2018 and 2017:
 
Three Months Ended
 
March 31, 2018
 
March 31, 2017
 
Advances

 
Consolidated
Obligation Bonds

 
Advances

 
Consolidated
Obligation Bonds

Balance, beginning of the period
$
6,431

 
$
949

 
$
3,719

 
$
1,507

New transactions elected for fair value option
1,222

 
374

 
288

 
740

Maturities and terminations
(968
)
 
—

 
(192
)
 
(15
)
Net gain/(loss) from changes in fair value recognized in earnings
(49
)
 
(8
)
 
1

 
2

Change in accrued interest
1

 
—

 
—

 
2

Balance, end of the period
$
6,637

 
$
1,315

 
$
3,816

 
$
2,236


For instruments for which the fair value option has been elected, the related contractual interest income and contractual interest expense are recorded as part of net interest income on the Statements of Income. The remaining changes in fair value for instruments for which the fair value option has been elected are recorded as net gains/ (losses) on financial instruments held under the fair value option in the Statements of Income, except for changes in fair value related to instrument-specific credit risk which are recorded in AOCI on the Statements of Condition. For advances and consolidated obligations recorded under the fair value option, the Bank determined that none of the remaining changes in fair value were related to instrument-specific credit risk for the three months ended March 31, 2018 and 2017. In determining that there has been no change in instrument-specific credit risk period to period, the Bank primarily considered the following factors:
•
The Bank is a federally chartered GSE, and as a result of this status, the consolidated obligations have historically received the same credit ratings as the government bond credit rating of the United States, even though they are not obligations of the United States and are not guaranteed by the United States.
•
The Bank is jointly and severally liable with the other FHLBanks for the payment of principal and interest on all consolidated obligations of each of the FHLBanks.

The following table presents the difference between the aggregate remaining contractual principal balance outstanding and aggregate fair value of advances and consolidated obligation bonds for which the Bank elected the fair value option at March 31, 2018, and December 31, 2017:


49

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



 
March 31, 2018
 
December 31, 2017
 
Principal Balance

 
Fair Value

 
Fair Value
Over/(Under)
Principal Balance

 
Principal Balance

 
Fair Value

 
Fair Value
Over/(Under)
Principal Balance

Advances(1)
$
6,703

 
$
6,637

 
$
(66
)
 
$
6,447

 
$
6,431

 
$
(16
)
Consolidated obligation bonds
1,329

 
1,315

 
(14
)
 
955

 
949

 
(6
)

(1)
At March 31, 2018, and December 31, 2017, none of these advances were 90 days or more past due or had been placed on nonaccrual status.

Note 17 — 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 regulations provide a general framework for addressing the possibility that an FHLBank may be unable to repay the consolidated obligations for which it is the primary obligor. 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, 2018, 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 value of the outstanding consolidated obligations of the FHLBanks was $1,019,229 at March 31, 2018, and $1,034,260 at December 31, 2017. The par value of the Bank’s participation in consolidated obligations was $101,643 at March 31, 2018, and $115,602 at December 31, 2017. For more information on the joint and several liability regulation, see “Item 8. Financial Statements and Supplementary Data – Note 20 – Commitments and Contingencies” in the Bank’s 2017 Form 10-K.

Off-balance sheet commitments as of March 31, 2018, and December 31, 2017, were as follows:
 
March 31, 2018
 
December 31, 2017
 
Expire Within
One Year

 
Expire After
One Year

 
Total

 
Expire Within
One Year

 
Expire After
One Year

 
Total

Standby letters of credit outstanding
$
12,323

 
$
3,997

 
$
16,320

 
$
12,910

 
$
3,240

 
$
16,150

Commitments to fund additional advances
18

 
—

 
18

 
1

 
—

 
1

Commitments to issue consolidated obligation discount notes, par
—

 
—

 
—

 
134

 
—

 
134

Commitments to issue consolidated obligation bonds, par
15

 
—

 
15

 
595

 
—

 
595

Commitments to purchase mortgage loans
11

 
—

 
11

 
16

 
—

 
16


Standby letters of credit are generally issued for a fee on behalf of members to support their obligations to third parties. If the Bank is required to make a payment for a beneficiary’s drawing under a letter of credit, the amount is immediately due and payable by the member to the Bank and is charged to the member’s demand deposit account with the Bank. The original terms of these standby letters of credit range from 14 days to 15 years, including a final expiration in 2033. The Bank monitors the creditworthiness of members that have standby letters of credit. The value of the Bank’s obligations related to standby letters of credit is recorded in other liabilities and amounted to $20 at March 31, 2018, and $19 at December 31, 2017. Standby letters of credit are fully collateralized at the time of issuance. Based on the Bank’s credit analyses of members’ financial condition and collateral requirements, the Bank deemed it unnecessary to record any additional liability on the letters of credit outstanding as of March 31, 2018, and December 31, 2017.

Commitments to fund advances totaled $18 at March 31, 2018, and $1 at December 31, 2017. Advances funded under advance commitments are fully collateralized at the time of funding (see Note 9 – Allowance for Credit Losses). Based on the Bank’s credit analyses of members’ financial condition and collateral requirements, the Bank

50

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



deemed it unnecessary to record any additional liability on the advance commitments outstanding as of March 31, 2018, and December 31, 2017.

The Bank may enter into commitments that unconditionally obligate it to purchase mortgage loans from its members. Commitments are generally for periods not exceeding P60D days. Delivery commitments are recorded at fair value as derivative assets or derivative liabilities in the Statements of Condition.

The Bank executes over-the-counter uncleared interest rate exchange agreements with major banks and derivative entities affiliated with broker-dealers and has executed uncleared interest rate exchange agreements in the past with the Bank’s members. The Bank enters into master agreements with netting provisions and into bilateral credit support agreements with all active derivative dealer counterparties. All member counterparty master agreements, excluding those with derivative 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 derivative dealers) must fully collateralize the Bank’s net credit exposure. For cleared derivatives, the clearinghouse is the Bank’s counterparty, and the Bank has clearing agreements with clearing agents that provide for delivery of initial margin to, and exchange of variation margin with, the clearinghouse. See Note 15 – Derivatives and Hedging Activities for additional information about the Bank’s pledged collateral and other credit-risk-related contingent features.

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

Note 18 — Transactions with Certain Members, Certain Nonmembers, and Other FHLBanks

Transactions with Members and Nonmembers. The following tables set forth information at the dates and for the periods indicated with respect to transactions with members that have an officer or director serving on the Bank’s Board of Directors.
  
March 31, 2018

 
December 31, 2017

Assets:
 
 
 
Advances
$
3,641

 
$
3,072

Mortgage loans held for portfolio
12

 
13

Accrued interest receivable
6

 
5

Liabilities:
 
 
 
Deposits
$
12

 
$
3

Capital:
 
 
 
Capital Stock
$
131

 
$
126


 
Three Months Ended
 
March 31, 2018

 
March 31, 2017

Interest Income:
 
 
 
Advances
$
14

 
$
9


All transactions with members, nonmembers, and their affiliates are entered into in the ordinary course of business. As of March 31, 2018, and December 31, 2017, no shareholder owned more than 10% of the total voting interests in the Bank because of the statutory limit on members' voting rights. For more information on transactions with members and nonmembers, see “Item 8. Financial Statements and Supplementary Data – Note 21 – Transactions with Certain Members, Certain Nonmembers, and Other FHLBanks” in the Bank’s 2017 Form 10-K.


51

Federal Home Loan Bank of San Francisco
Notes to Financial Statements (continued)



Transactions with Other FHLBanks. The Bank may occasionally enter into transactions with other FHLBanks. These transactions are summarized below.

Deposits with other FHLBanks. The Bank may, from time to time, maintain deposits with other FHLBanks. Deposits with other FHLBanks totaled de minimis amounts at March 31, 2018, and December 31, 2017, which were recorded in the Statements of Condition in the Cash and due from banks line item.

Overnight Funds. The Bank may borrow or lend unsecured overnight funds from or to other FHLBanks. All such transactions are at current market rates. Interest income and interest expense related to these transactions with other FHLBanks are included in other interest income and interest expense from other borrowings in the Statements of Income. Balances outstanding at period end with other FHLBanks, if any, are identified in the Bank’s financial statements. During the three months ended March 31, 2018, the Bank extended overnight loans to other FHLBanks for $100. There were no overnight loans extended to other FHLBanks during the three months ended March 31, 2017. During the three months ended March 31, 2018 and 2017, the Bank borrowed $1,500 and $10, respectively, from other FHLBanks. The impact to net interest income related to these transactions was de minimis during both periods in this report.

MPF Mortgage Loans. The Bank pays a transaction services fee to the FHLBank of Chicago for its participation in the MPF program. This fee is assessed monthly and is based on the amount of mortgage loans in which the Bank invested and which remain outstanding on its Statements of Condition. For the three months ended March 31, 2018 and 2017, the Bank recorded $1 and a de minimis amount, respectively, in MPF transaction services fee expense to the FHLBank of Chicago, which was recorded in the Statements of Income as other expense.

In addition, the Bank receives a counterparty fee from the FHLBank of Chicago for facilitating the sale of loans under the MPF program. For the three months ended March 31, 2018 and 2017, the Bank recorded a de minimis amount in MPF counterparty fee income from the FHLBank of Chicago, which was recorded in the Statements of Income as other income.

Consolidated Obligations. The Bank may, from time to time, transfer to or assume from another FHLBank the outstanding primary liability for FHLBank consolidated obligations. During the three months ended March 31, 2018 and 2017, the Bank did not transfer any debt to other FHLBanks or assume any debt from other FHLBanks.

Transactions with the Office of Finance. The Bank’s proportionate share of the cost of operating the Office of Finance is identified in the Statements of Income.

Note 19 — Subsequent Events

On April 9, 2018, the Bank’s Board of Directors revised the Framework to change the Bank’s practice of repurchasing the surplus capital stock of all members and the excess capital stock of all former members from a quarterly schedule to a daily schedule. Effective April 24, 2018, the Bank began calculating the amount of stock to be repurchased each business day based on the shareholder’s capital stock outstanding after all stock transactions are completed for the day, ensuring that each member and former member will continue to meet its minimum capital stock requirement after the repurchase. In accordance with the revised Framework, the Bank repurchased $363 of excess capital stock on April 24, 2018. The Bank may change this practice at any time. All repurchases of capital stock are at the Bank’s discretion, subject to certain statutory and regulatory requirements and to the Bank’s Risk Management Policy, Capital Plan, and Excess Stock Repurchase, Retained Earnings, and Dividend Framework.
There were no other material subsequent events identified, subsequent to March 31, 2018, until the time of the Form 10-Q filing with the Securities and Exchange Commission.



52


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 (FHLBank 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, among others, gains and losses on derivatives, plans to pay dividends and repurchase excess capital stock, future other-than-temporary impairment losses, future classification of securities, 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;
•
the timing and volume of market activity;
•
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 the impact of any government-sponsored enterprises (GSE) legislative reforms, 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 changes in other statutes or regulations applicable to the FHLBanks;
•
changes in the Bank’s capital structure and composition;
•
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;
•
the soundness of other financial institutions, including Bank members, nonmember borrowers, other counterparties, and the other FHLBanks;
•
changes in Bank members’ demand 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 derivative counterparties;
•
changes in the fair value and economic value of, impairments of, and risks associated with the Bank’s investments in mortgage loans and mortgage-backed securities (MBS) or other assets and the related credit enhancement protections;
•
changes in the Bank’s ability or intent to hold MBS and mortgage loans to maturity;
•
competitive forces, including the availability of other sources of funding for Bank members;
•
the willingness of the Bank’s members to do business with the Bank;
•
changes in investor demand for consolidated obligations (including the terms of consolidated obligations) and/or the terms of interest rate exchange or similar agreements;
•
the impact of any changes and developments in FHLBank System-wide debt issuance and governance practices;
•
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;
•
changes in key Bank personnel;
•
technology changes and enhancements, and the Bank’s ability to develop and support technology and information systems sufficient to manage the risks of the Bank’s business effectively; and
•
changes in the FHLBanks’ long-term credit ratings.

Readers of this report should not rely solely on the forward-looking statements and should consider all risks and uncertainties addressed throughout this report, as well as those discussed under “Item 1A. Risk Factors” in the
Bank’s Annual Report on Form 10-K for the year ended December 31, 2017 (2017 Form 10-K).

53


Quarterly Overview

The Bank serves eligible financial institutions in Arizona, California and Nevada, the three states that make up the Eleventh District of the FHLBank System. The Bank’s primary business is providing competitively priced, collateralized loans, known as advances, to its member institutions and certain qualifying housing associates. The Bank's principal source of funds is debt issued in the capital markets. All 11 FHLBanks issue debt in the form of consolidated obligations through the Office of Finance as their agent, and all 11 FHLBanks are jointly and severally liable for the repayment of all consolidated obligations.

The Bank experienced strong earnings in the first quarter of 2018. Net income for the quarter was $81 million, compared with net income of $148 million for the first quarter of 2017. The $67 million decrease in net income relative to the prior-year period primarily reflected a decline in other income, primarily related to net gains on settlements related to the Bank’s private-label residential mortgage-backed securities (PLRMBS). In the first quarter of 2017, the Bank recognized gains on settlements of $119 million (after netting certain legal fees and expenses) relating to the Bank's PLRMBS litigation. This reduction in net income was partially offset by a $30 million decrease in the expense associated with voluntary charitable contributions for the Quality Jobs Fund, from $40 million in the first quarter of 2017 to $10 million in the first quarter of 2018. In addition, net interest income related to higher average balances of interest-earning assets increased by $14 million in the first quarter of 2018 compared to the prior-year period.

Retained earnings grew to $3.3 billion at March 31, 2018, from $3.2 billion at December 31, 2017, and the Bank paid dividends at an annualized rate of 7.00%, totaling $59 million, including $53 million in dividends on capital stock and $6 million in dividends on mandatorily redeemable capital stock during the first quarter of 2018.

Total assets decreased $14.2 billion during the first quarter of 2018, to $109.2 billion at March 31, 2018, from $123.4 billion at December 31, 2017. Total advances decreased $10.8 billion, to $66.6 billion at March 31, 2018, from $77.4 billion at December 31, 2017. In addition, investments decreased $3.8 billion, to $39.8 billion at March 31, 2018, from $43.6 billion at December 31, 2017, primarily reflecting a decrease of $5.5 billion in securities purchased under agreements to resell, partially offset by an increase of $2.9 billion in Federal funds sold.

Accumulated other comprehensive income increased by $17 million during the first quarter of 2018, to $335 million at March 31, 2018, from $318 million at December 31, 2017, primarily as a result of improvement in the fair value of PLRMBS classified as available-for-sale.

On April 26, 2018, the Bank’s Board of Directors declared a quarterly cash dividend on the capital stock outstanding during the first quarter of 2018 at an annualized rate of 7.00%. The dividend will total $63 million, including $5 million in dividends on mandatorily redeemable capital stock that will be reflected as interest expense in the second quarter of 2018. The Bank recorded the dividend on April 26, 2018, and expects to pay the dividend on or about May 14, 2018.

As of March 31, 2018, the Bank was in compliance with all of its regulatory capital requirements. The Bank’s total regulatory capital ratio was 6.1%, exceeding the 4.0% requirement. The Bank had $6.7 billion in permanent capital, exceeding its risk-based capital requirement of $2.0 billion.

On April 9, 2018, the Bank’s Board of Directors revised the Bank’s Excess Stock Repurchase, Retained Earnings, and Dividend Framework (Framework) to change the Bank’s practice of repurchasing the surplus capital stock of all members and the excess capital stock of all former members from a quarterly schedule to a daily schedule. Surplus capital stock is defined as any stock holdings in excess of 115% of a member’s minimum stock requirement. Effective April 24, 2018, the Bank began calculating the amount of stock to be repurchased each business day based on the shareholder’s capital stock outstanding after all stock transactions are completed for the day, ensuring that each member and former member will continue to meet its minimum capital stock requirement after the repurchase. In accordance with the revised Framework, the Bank repurchased $363 million of excess capital stock on April 24, 2018. The Bank may change this practice at any time. All repurchases of capital stock are at the Bank’s discretion,

54


subject to certain statutory and regulatory requirements and to the Bank’s Risk Management Policy, Capital Plan, and Excess Stock Repurchase, Retained Earnings, and Dividend Framework.

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


55


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,
2018

 
December 31,
2017

 
September 30,
2017

 
June 30,
2017

 
March 31,
2017

Selected Balance Sheet Items at Quarter End
 
 
 
 
 
 
 
 
 
Total Assets
$
109,225

 
$
123,385

 
$
109,503

 
$
101,923

 
$
91,290

Advances
66,642

 
77,382

 
61,629

 
55,179

 
49,052

Mortgage Loans Held for Portfolio, Net
2,376

 
2,076

 
1,774

 
1,383

 
966

Investments(1)
39,832

 
43,570

 
45,775

 
45,035

 
40,983

Consolidated Obligations:(2)
 
 
 
 
 
 
 
 
 
Bonds
74,297

 
85,063

 
72,266

 
60,966

 
49,493

Discount Notes
27,203

 
30,440

 
29,902

 
33,335

 
35,028

Mandatorily Redeemable Capital Stock
309

 
309

 
342

 
404

 
403

Capital Stock —Class B —Putable
3,068

 
3,243

 
2,815

 
2,687

 
2,280

Unrestricted Retained Earnings
2,681

 
2,670

 
2,664

 
872

 
850

Restricted Retained Earnings
592

 
575

 
562

 
2,317

 
2,300

Accumulated Other Comprehensive Income/(Loss) (AOCI)
335

 
318

 
308

 
227

 
143

Total Capital
6,676

 
6,806

 
6,349

 
6,103

 
5,573

Selected Operating Results for the Quarter
 
 
 
 
 
 
 
 
 
Net Interest Income
$
148

 
$
143

 
$
146

 
$
144

 
$
134

Provision for/(Reversal of) Credit Losses on Mortgage Loans
—

 
—

 
—

 
—

 
—

Other Income/(Loss)
(8
)
 
(14
)
 
(4
)
 
(16
)
 
112

Other Expense
49

 
54

 
51

 
39

 
80

Affordable Housing Program Assessment
10

 
8

 
10

 
9

 
18

Net Income/(Loss)
$
81

 
$
67

 
$
81

 
$
80

 
$
148

Selected Other Data for the Quarter
 
 
 
 
 
 
 
 
 
Net Interest Margin(3)
0.47
%
 
0.49
%
 
0.55
%
 
0.59
%
 
0.58
%
Operating Expenses as a Percent of Average Assets
0.11

 
0.14

 
0.14

 
0.15

 
0.14

Return on Average Assets
0.26

 
0.23

 
0.30

 
0.33

 
0.63

Return on Average Equity
4.74

 
4.02

 
5.19

 
5.56

 
10.59

Annualized Dividend Rate
7.00

 
7.00

 
7.00

 
7.00

 
9.08

Dividend Payout Ratio(4)
65.67

 
72.32

 
53.39

 
51.21

 
36.45

Average Equity to Average Assets Ratio
5.40

 
5.64

 
5.84

 
5.87

 
5.97

Selected Other Data at Quarter End
 
 
 
 
 
 
 
 
 
Regulatory Capital Ratio(5)
6.09

 
5.51

 
5.83

 
6.16

 
6.39

Duration Gap (in months)
1

 
1

 
1

 
1

 
1


(1)
Investments consist of interest-bearing deposits, securities purchased under agreements to resell, Federal funds sold, trading securities, available-for-sale securities, and held-to-maturity securities.
(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 Federal Housing Finance Agency (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, 2018, 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 value of the outstanding consolidated obligations of all FHLBanks at the dates indicated was as follows:


56


 
Par Value
(In millions)

March 31, 2018
$
1,019,229

December 31, 2017
1,034,260

September 30, 2017
1,028,710

June 30, 2017
1,011,526

March 31, 2017
959,280


(3)
Net interest margin is net interest income (annualized) divided by average interest-earning assets.
(4)
This ratio is calculated as dividends per share divided by net income per share.
(5)
This ratio is calculated as regulatory capital divided by total assets. Regulatory capital includes retained earnings, Class B capital stock, and mandatorily redeemable capital stock (which is classified as a liability), but excludes AOCI.

Results of Operations

Net Interest Income. The primary source of the Bank’s earnings is net interest income, which is the interest earned on advances, mortgage loans, and investments. This includes net accretion of related income, which is a result of improvement in expected cash flows on certain other-than-temporarily-impaired PLRMBS, less interest paid on consolidated obligations, deposits, mandatorily redeemable capital stock, and other borrowings. The Average Balance Sheets table that follows presents the average balances of interest-earning asset categories and the sources that funded those interest-earning assets (liabilities and capital) for the three months ended March 31, 2018 and 2017, together with the related interest income and expense. It also presents the average rates on total interest-earning assets and the average costs of total funding sources.


57


First Quarter of 2018 Compared to First Quarter of 2017

Average Balance Sheets
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended
 
March 31, 2018
 
March 31, 2017
(Dollars in millions)
Average
Balance

 
Interest
Income/
Expense

 
Average
Rate

 
Average
Balance

 
Interest
Income/
Expense

 
Average
Rate

Assets
 
 
 
 
 
 
 
 
 
 
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
1,152

 
$
4

 
1.54
%
 
$
582

 
$
1

 
0.70
%
Securities purchased under agreements to resell
2,362

 
9

 
1.48

 
911

 
1

 
0.57

Federal funds sold
13,852

 
51

 
1.51

 
10,477

 
19

 
0.75

Trading securities:
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities (MBS)
6

 
—

 
2.69

 
8

 
—

 
2.10

Other investments
916

 
4

 
1.79

 
1,616

 
4

 
0.97

Available-for-sale (AFS) securities:(1)
 
 
 
 
 
 
 
 
 
 
 
MBS(2)
3,399

 
57

 
6.78

 
4,219

 
61

 
5.85

Held-to-maturity (HTM) securities:(1)
 
 
 
 
 
 
 
 
 
 
 
MBS
13,732

 
79

 
2.32

 
12,056

 
64

 
2.14

Other investments
438

 
2

 
1.66

 
1,215

 
3

 
1.03

Mortgage loans held for portfolio
2,247

 
21

 
3.80

 
898

 
9

 
4.18

Advances(3)
89,082

 
369

 
1.68

 
62,174

 
153

 
1.00

Loans to other FHLBanks
1

 
—

 
1.37

 
—

 
—

 
—

Total interest-earning assets
127,187

 
596

 
1.90

 
94,156

 
315

 
1.36

Other assets(4)(5)
895

 
—

 
 
 
795

 
—

 
 
Total Assets
$
128,082

 
$
596

 
 
 
$
94,951

 
$
315

 
 
Liabilities and Capital
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Consolidated obligations:
 
 
 
 
 
 
 
 
 
 
 
Bonds(3)
$
81,313

 
$
307

 
1.53
%
 
$
49,657

 
$
116

 
0.95
%
Discount notes
38,621

 
134

 
1.41

 
38,327

 
54

 
0.57

Deposits and other borrowings
307

 
1

 
1.27

 
224

 
—

 
0.42

Mandatorily redeemable capital stock
309

 
6

 
7.52

 
448

 
11

 
9.72

Borrowings from other FHLBanks
17

 
—

 
1.66

 
30

 
—

 
0.52

Total interest-bearing liabilities
120,567

 
448

 
1.51

 
88,686

 
181

 
0.83

Other liabilities(4)
601

 
—

 
 
 
594

 
—

 
 
Total Liabilities
121,168

 
448

 
 
 
89,280

 
181

 
 
Total Capital
6,914

 
—

 
 
 
5,671

 
—

 
 
Total Liabilities and Capital
$
128,082

 
$
448

 
 
 
$
94,951

 
$
181

 
 
Net Interest Income
 
 
$
148

 
 
 
 
 
$
134

 
 
Net Interest Spread(6)
 
 
 
 
0.39
%
 
 
 
 
 
0.53
%
Net Interest Margin(7)
 
 
 
 
0.47
%
 
 
 
 
 
0.58
%
Interest-earning Assets/Interest-bearing Liabilities
105.49
%
 
 
 
 
 
106.17
%
 
 
 
 

(1)
The average balances of AFS securities and HTM securities are reflected at amortized cost. As a result, the average rates do not reflect changes in fair value or non-credit-related OTTI losses.
(2)
Interest income on AFS securities includes accretion of yield adjustments on other-than-temporarily impaired PLRMBS (resulting from improvement in expected cash flows) totaling $17 million and $17 million for the three months ended March 31, 2018 and 2017, respectively.
(3)
Interest income/expense and average rates include the effect of associated interest rate exchange agreements, as follows:

58


 
Three Months Ended
 
March 31, 2018
 
March 31, 2017
(In millions)
(Amortization)/
Accretion of
Hedging
Activities

 
Net Interest
Settlements

 
Total Net Interest
Income/(Expense)

 
(Amortization)/
Accretion of
Hedging
Activities

 
Net Interest
Settlements

 
Total Net Interest
Income/(Expense)

Advances
$
—

 
$
3

 
$
3

 
$
—

 
$
(9
)
 
$
(9
)
Consolidated obligation bonds
—

 
1

 
1

 
—

 
9

 
9


(4)
Includes forward settling transactions and valuation adjustments for certain cash items.
(5)
Includes non-credit-related OTTI losses on AFS and HTM securities.
(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.

Net interest income in the first quarter of 2018 was $148 million, a 10% increase from $134 million in the first quarter of 2017. The following table details the changes in interest income and interest expense for the first quarter of 2018 compared to the first quarter of 2017. Changes in both volume and interest rates influence changes in net interest income, net interest spread, and net interest margin.

Change in Net Interest Income: Rate/Volume Analysis
Three Months Ended March 31, 2018, Compared to Three Months Ended March 31, 2017
 
 
 
 
 
 
 
Increase/
(Decrease)

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

 
Average Rate

Interest-earning assets:
 
 
 
 
 
Interest-bearing deposits
$
3

 
$
1

 
$
2

Securities purchased under agreements to resell
8

 
4

 
4

Federal funds sold
32

 
8

 
24

Trading securities: Other investments
—

 
(2
)
 
2

AFS securities:
 
 
 
 
 
MBS
(4
)
 
(13
)
 
9

HTM securities:
 
 
 
 
 
MBS
15

 
9

 
6

Other investments
(1
)
 
(2
)
 
1

Mortgage loans held for portfolio
12

 
13

 
(1
)
Advances(2) 
216

 
84

 
132

Total interest-earning assets
281

 
102

 
179

Interest-bearing liabilities:
 
 
 
 
 
Consolidated obligations:
 
 
 
 
 
Bonds(2)
191

 
98

 
93

Discount notes
80

 
—

 
80

Deposits and other borrowings
1

 
—

 
1

Mandatorily redeemable capital stock
(5
)
 
(3
)
 
(2
)
Total interest-bearing liabilities
267

 
95

 
172

Net interest income
$
14

 
$
7

 
$
7


(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.

The net interest margin was 47 basis points for the first quarter of 2018, 11 basis points lower than the net interest margin for the first quarter of 2017, which was 58 basis points. The net interest spread was 39 basis points for the first quarter of 2018, 14 basis points lower than the net interest spread for the first quarter of 2017, which was 53 basis points. These decreases were primarily due to a decline in spreads on interest-earning assets.


59


For securities previously identified as other-than-temporarily impaired, the Bank updates its estimate of future estimated cash flows on a regular basis. If there is no additional impairment on the security, the yield of the security is adjusted upward on a prospective basis and accreted into interest income when there is a significant increase in the expected cash flows. As a result of improvements in the estimated cash flows of securities previously identified as other-than-temporarily impaired, the accretion of yield adjustments is likely to continue to be a positive source of net interest income in future periods.

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

Other Income/(Loss). The following table presents the components of “Other Income/(Loss)” for the three months ended March 31, 2018 and 2017.
Other Income/(Loss)
 
 
 
 
 
Three Months Ended
(In millions)
March 31, 2018

 
March 31, 2017

Other Income/(Loss):
 
 
 
Total OTTI loss
$
(3
)
 
$
(1
)
Net amount of OTTI loss reclassified to/(from) AOCI
2

 
(2
)
Net OTTI loss, credit-related
(1
)
 
(3
)
Net gain/(loss) on trading securities(1)

(1
)
 
1

Net gain/(loss) on advances and consolidated obligation bonds held under fair value option
(41
)
 
(1
)
Net gain/(loss) on derivatives and hedging activities
31

 
(9
)
Gains on litigation settlements, net
—

 
119

Other
4

 
5

Total Other Income/(Loss)
$
(8
)
 
$
112


(1)
The net gain/(loss) on trading securities that were economically hedged totaled a de minimis amount and $1 million for the three months ended March 31, 2018 and 2017, respectively.

Net Other-Than-Temporary Impairment Loss, Credit-Related – Each quarter, the Bank updates its OTTI analysis to reflect current housing market conditions, changes in anticipated housing market conditions, observed and anticipated borrower behavior, and updated information on the loans supporting the Bank’s PLRMBS.

Additional information about the OTTI loss is provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Investments” and in “Item 1. Financial Statements – Note 6 – Other-Than-Temporary Impairment Analysis.”

Net Gain/(Loss) on Advances and Consolidated Obligation Bonds Held Under Fair Value Option – The following table presents the net gain/(loss) recognized in earnings on advances and consolidated obligation bonds held under the fair value option for the three months ended March 31, 2018 and 2017.

60


 
Net Gain/(Loss) from Changes in Fair Value Recognized in Earnings
 
 
 
 
 
Three Months Ended
(In millions)
March 31, 2018

 
March 31, 2017

Advances
$
(49
)
 
$
1

Consolidated obligation bonds
8

 
(2
)
Total
$
(41
)
 
$
(1
)

Under the fair value option, the Bank elected to carry certain assets and liabilities at fair value. In general, transactions elected for the fair value option are in economic hedge relationships. Gains or losses on these transactions are generally offset by losses or gains on the derivatives that economically hedge these instruments.

The net gains/(losses) on advances and consolidated obligation bonds held under the fair value option were primarily driven by the effects of changes in market interest rates, interest rate spreads, interest rate volatility, and other market factors relative to the actual terms on the advances and consolidated obligation bonds during the period.

Additional information about advances and consolidated obligation bonds held under the fair value option is provided in “Item 1. Financial Statements – Note 16 – Fair Value.”

Net Gain/(Loss) on Derivatives and Hedging Activities – The following table shows the accounting classification of hedges and the categories of hedged items that contributed to the gains and losses on derivatives and hedged items that were recorded in “Net gain/(loss) on derivatives and hedging activities” in the first quarter of 2018 and 2017.


61


Sources of Gains/(Losses) Recorded in Net Gain/(Loss) on Derivatives and Hedging Activities
Three Months Ended March 31, 2018, Compared to Three Months Ended March 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended
(In millions)
March 31, 2018
 
March 31, 2017
 
Gain/(Loss)
 

Income/
(Expense) on

 
 
 
Gain/(Loss)
 

Income/
(Expense) on

 
 
Hedged Item
Fair Value
Hedges, Net

 
Economic
Hedges

 
Economic
Hedges

 
Total

 
Fair Value
Hedges, Net

 
Economic
Hedges

 
Economic
Hedges

 
Total

Advances:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Elected for fair value option
$
—

 
$
54

 
$
(1
)
 
$
53

 
$
—

 
$
8

 
$
(7
)
 
$
1

Not elected for fair value option
2

 
(10
)
 
1

 
(7
)
 
—

 
(1
)
 
1

 
—

Consolidated obligation bonds:
 
 
 
 
 
 
 
 

 

 

 
 
Elected for fair value option
—

 
(8
)
 
—

 
(8
)
 
—

 
1

 
1

 
2

Not elected for fair value option
—

 
(41
)
 
3

 
(38
)
 
—

 
—

 
1

 
1

Consolidated obligation discount notes:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Not elected for fair value option
—

 
29

 
(3
)
 
26

 
—

 
(6
)
 
(8
)
 
(14
)
MBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Not elected for fair value option
—

 
1

 
—

 
1

 
—

 
(2
)
 
—

 
(2
)
Non-MBS investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Not elected for fair value option
—

 
1

 
—

 
1

 
—

 
—

 
—

 
—

Mortgage delivery commitment:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Not elected for fair value option
—

 
4

 
—

 
4

 
—

 
3

 
—

 
3

Other(1)
—

 
(1
)
 
—

 
(1
)
 
—

 
—

 
—

 
—

Total
$
2

 
$
29

 
$
—

 
$
31

 
$
—

 
$
3

 
$
(12
)
 
$
(9
)

(1)
Amount in other includes the price alignment amount on derivatives for which variation margin is characterized as a daily settled contract.

During the first quarter of 2018, net gains on derivatives and hedging activities totaled $31 million compared to net losses of $9 million in the first quarter of 2017. These amounts included expense of a de minimis amount and expense of $12 million resulting from net settlements on derivative instruments used in economic hedges in the first quarter of 2018 and 2017, respectively. Excluding the impact of income or expense from net settlements on derivative instruments used in economic hedges, the net gains or losses on fair value and economic hedges were primarily associated with the effects of changes in market interest rates, interest rate spreads, interest rate volatility, and other market factors during the period.

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

Additional information about derivatives and hedging activities is provided in “Item 1. Financial Statements – Note 15 – Derivatives and Hedging Activities.”

Gains on Litigation Settlements, Net – During the first three months of 2017, gains relating to settlements with certain defendants in connection with the Bank’s PLRMBS litigation (after netting certain legal fees and expenses) totaled $119 million. The Bank had no settlement gains in the first quarter of 2018.

Other Expense. During the first quarter of 2018, other expenses totaled $49 million, compared to $80 million in the first quarter of 2017, primarily reflecting the decrease in voluntary charitable contributions made during the first quarter of 2018.

Quality Jobs Fund Expense and Other – In the first quarter of 2017, the Board of Directors approved an allocation of $100 million for the Quality Jobs Fund, a donor-advised fund established to support quality jobs growth and

62


small business expansion to be funded by the Bank in incremental amounts over the next two years. During the first quarter of 2018 and 2017, the Bank made voluntary charitable contributions of $10 million and $40 million, respectively, for the Quality Jobs Fund, as well as voluntary contributions of $1 million and $4 million, respectively, to the Affordable Housing Program (AHP) to offset the impact on the AHP assessment of the charitable contribution expense.

Return on Average Equity

Return on average equity (ROE) was 4.74% (annualized) for the first quarter of 2018, compared to 10.59% (annualized) for the first quarter of 2017. The decrease primarily reflected lower net income for the first quarter of 2018, which decreased 45%, from $148 million in the first quarter of 2017 to $81 million in the first quarter of 2018. The decrease in net income primarily reflected a gain on settlements of $119 million (after netting certain legal fees and expenses) in the prior-year period relating to the Bank's PLRMBS litigation. The Bank had no settlement gains in the first quarter of 2018. This reduction in net income was partially offset by a $30 million decrease in the expense associated with voluntary charitable contributions for the Quality Jobs Fund, from $40 million in the first quarter of 2017 to $10 million in the first quarter of 2018.

Dividends and Retained Earnings

The Bank’s Framework summarizes the Bank’s capital management principles and objectives, as well as its policies and practices with respect to restricted retained earnings, dividend payments, and the repurchase of excess capital stock. As required by the regulations governing the operations of the FHLBanks, the Framework is reviewed at least annually by the Bank’s Board of Directors. The Board of Directors may amend the Framework from time to time.

In accordance with the Framework, the Bank retains certain amounts in restricted retained earnings, which are not made available for dividends in the current dividend period, and maintains an amount of total retained earnings at least equal to its required retained earnings as described in the Framework. 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 contingent 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, 2018, advances maturing within five years totaled $65.9 billion, significantly in excess of the $257 million of member deposits on that date. At December 31, 2017, advances maturing within five years totaled $76.6 billion, significantly in excess of the $281 million of member deposits on that date.

As of March 31, 2018, and December 31, 2017, the Bank held estimated total sources of funds in an amount that would have allowed the Bank to meet its liquidity needs for more than five consecutive business days without issuing new consolidated obligations, subject to certain conditions. For more information, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Liquidity Risk” in the Bank’s 2017 Form 10-K.

Finance Agency rules do not permit the Bank to pay dividends in the form of capital stock if its excess capital stock exceeds 1% of its total assets. Excess capital stock is defined as the aggregate of the capital stock held by each shareholder in excess of its minimum capital stock requirement, as established by the Bank’s capital plan. As of March 31, 2018, the Bank’s excess capital stock totaled $566 million, or 0.52% of total assets.


63


In the first quarter of 2018, the Bank paid dividends at an annualized rate of 7.00%, totaling $59 million, including $53 million in dividends on capital stock and $6 million in dividends on mandatorily redeemable capital stock. In the first quarter of 2017, the Bank paid dividends at an annualized rate of 9.08%, totaling $65 million, including $54 million in dividends on capital stock and $11 million in dividends on mandatorily redeemable capital stock.

The Bank paid these dividends in cash. Dividends on capital stock are recognized as dividends on the Statements of Capital Accounts, and dividends on mandatorily redeemable capital stock are recognized as interest expense on the Statements of Income.

In January 2017, the Framework was amended and approved by the Bank’s Board of Directors to include a dividend philosophy to endeavor to pay a quarterly dividend at an annualized rate between 5% and 7%. The decision to declare any dividend and the dividend rate are at the discretion of the Bank’s Board of Directors, which may choose to follow the dividend philosophy as guidance in the dividend declaration. The Bank’s historical dividend rates and the dividend philosophy are not indicative of future dividend declarations. The Bank’s dividend policy may be revised or eliminated in the future and there can be no assurance as to future dividends.

On April 26, 2018, the Bank’s Board of Directors declared a cash dividend on the capital stock outstanding during the first quarter of 2018 at an annualized rate of 7.00%, totaling $63 million, including $58 million in dividends on capital stock and $5 million in dividends on mandatorily redeemable capital stock. The Bank recorded the dividend on April 26, 2018. The Bank expects to pay the dividend on May 14, 2018. Dividends on mandatorily redeemable capital stock will be recognized as interest expense in the second quarter of 2018.

The Bank’s Framework assesses the level and adequacy of retained earnings and establishes amounts to be retained in restricted retained earnings, which are not made available in the current dividend period, and maintains an amount of total retained earnings at least equal to its required retained earnings as described in the Framework. Prior to July 2017, the Bank’s Framework had three categories of restricted retained earnings: Valuation Adjustments, Other (which represented a targeted amount), and the Joint Capital Enhancement (JCE Agreement). Under the Framework, the Bank’s required amount of restricted retained earnings was determined using the Bank’s retained earnings methodology. As determined using the Bank’s methodology, from July 2015 to January 2017, the Bank’s restricted retained earnings requirement was $2,000, and from January 2017 to July 2017, the Bank’s restricted retained earnings requirement was $2,300.

In July 2017, the Bank’s Board of Directors approved the transfer of all amounts classified as restricted retained earnings, other than the amounts related to the JCE Agreement, to unrestricted retained earnings. As a conforming change related to the transfer, the Bank’s Board of Directors amended the Framework to eliminate two of the categories of restricted retained earnings (Valuation Adjustments and Other) and approved revisions to the Bank’s retained earnings methodology to provide for a required level of total retained earnings of $2,300 for loss protection, capital compliance, and business growth. In January 2018, the methodology was further revised to provide a required level of total retained earnings of $2,500. The Bank satisfies its retained earnings requirement with both restricted retained earnings (i.e., amounts related to the JCE Agreement) and unrestricted retained earnings.

Total restricted retained earnings were $592 million and $575 million as of March 31, 2018, and December 31, 2017, respectively.

The Bank will continue to monitor the condition of its PLRMBS portfolio, the ratio of the Bank’s estimated market value of total capital to par value of capital stock, its overall financial performance and retained earnings, developments in the mortgage and credit markets, and other relevant information as the basis for determining the payment of dividends in future quarters.

For more information, see “Item 1. Financial Statements – Note 13 – Capital” in this report and see “Item 1. Business – Dividends and Retained Earnings” and “Item 8. Financial Statements and Supplementary Data – Note 15

64


– Capital – Excess Stock Repurchase, Retained Earnings, and Dividend Framework.” in the Bank’s 2017 Form 10–K.

Financial Condition

Total assets were $109.2 billion at March 31, 2018, compared to $123.4 billion at December 31, 2017. Advances decreased by $10.8 billion, or 14%, to $66.6 billion at March 31, 2018, from $77.4 billion at December 31, 2017. MBS decreased by $0.3 billion, or 2%, to $17.5 billion at March 31, 2018, from $17.8 billion at December 31, 2017. Average total assets were $128.1 billion for the first quarter of 2018, a 35% increase compared to $95.0 billion for the first quarter of 2017. Average advances were $89.1 billion for the first quarter of 2018, a 43% increase from $62.2 billion for the first quarter of 2017. Average MBS were $17.1 billion for March 31, 2018, a 5% increase from $16.3 billion for March 31, 2017.

Advances outstanding at March 31, 2018, included net unrealized losses of $221 million, of which $155 million represented unrealized losses on advances hedged in accordance with the accounting for derivative instruments and hedging activities and $66 million represented unrealized losses on economically hedged advances that are carried at fair value in accordance with the fair value option. Advances outstanding at December 31, 2017, included unrealized losses of $104 million, of which $88 million represented unrealized losses on advances hedged in accordance with the accounting for derivative instruments and hedging activities and $16 million represented unrealized losses on economically hedged advances that are carried at fair value in accordance with the fair value option. The overall increase in the unrealized losses on the hedged advances and advances carried at fair value from December 31, 2017, to March 31, 2018, was primarily attributable to the effects of changes in market interest rates, interest rate spreads, interest rate volatility, and other market factors relative to the terms on the Bank’s advances during the period.

Total liabilities were $102.5 billion at March 31, 2018, a decrease of $14.1 billion from $116.6 billion at December 31, 2017, primarily reflecting a $14.0 billion decrease in consolidated obligations outstanding to $101.5 billion at March 31, 2018, from $115.5 billion at December 31, 2017. Average total liabilities were $121.2 billion for the first quarter of 2018, a 36% increase compared to $89.3 billion for the first quarter of 2017. Average consolidated obligations were $119.9 billion for the first quarter of 2018 and $88.0 billion for the first quarter of 2017.

Consolidated obligations outstanding at March 31, 2018, included unrealized gains of $80 million on consolidated obligation bonds hedged in accordance with the accounting for derivative instruments and hedging activities and unrealized gains of $14 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, 2017, included unrealized gains of $37 million on consolidated obligation bonds hedged in accordance with the accounting for derivative instruments and hedging activities and unrealized gains of $6 million on economically hedged consolidated obligation bonds that are carried at fair value in accordance with the fair value option. The increase in the net unrealized gains on the hedged consolidated obligation bonds and on the consolidated obligation bonds carried at fair value from December 31, 2017, to March 31, 2018, were primarily attributable to the effects of changes in market interest rates, interest rate spreads, interest rate volatility, and other market factors relative to the actual terms on the Bank's consolidated obligation bonds during the period.

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, 2018, 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 value of the outstanding consolidated obligations of the FHLBanks was $1,019.2 billion at March 31, 2018, and $1,034.3 billion at December 31, 2017.


65


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 or withdraw 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 does not believe, as of the date of this report, that it is probable 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.

Segment Information

The Bank uses an analysis of financial results based on the financial components 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 determine financial management strategies related to the operations of these two business segments. For purposes of segment reporting, adjusted net interest income includes income and expense associated with net settlements from economic hedges that are recorded in “Net gain/(loss) on derivatives and hedging activities” in other income and excludes interest expense that is recorded in “Mandatorily redeemable capital stock.” Other key financial information, such as any credit-related OTTI losses on the Bank’s PLRMBS, other expenses, and assessments, is not included in the segment reporting analysis, but is incorporated into the Bank’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 “Item 1. Financial Statements – Note 14 – Segment Information.”

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. Assets associated with this segment decreased $14.1 billion to $89.3 billion (82% of total assets) at March 31, 2018, from $103.4 billion (84% of total assets) at December 31, 2017.

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 net settlements from associated interest rate exchange agreements, and from earnings on capital.

Adjusted net interest income for this segment was $78 million in the first quarter of 2018, an increase of $30 million, or 63%, compared to $48 million in the first quarter of 2017. The increase was primarily due to an improvement in spreads and higher balances on advances-related assets, partially offset by lower earnings from non-MBS investments.

Adjusted net interest income for this segment represented 51% and 37% of total adjusted net interest income for the first quarter of 2018 and 2017, respectively.

Advances – The par value of advances outstanding decreased by $10.6 billion, or 14%, to $66.9 billion at March 31, 2018, from $77.5 billion at December 31, 2017. Average advances outstanding were $89.1 billion in the first quarter of 2018, a 43% increase from $62.2 billion in the first quarter of 2017. Outstanding balances of advances may significantly increase and decrease from period to period because of a member’s liquidity and financial strategies.

As of March 31, 2018, advances outstanding to the Bank’s top five borrowers and their affiliates decreased by $7.5 billion, and advances outstanding to the Bank’s other borrowers decreased by $3.1 billion. Advances to the top five borrowers decreased to $40.9 billion at March 31, 2018, from $48.4 billion at December 31, 2017. (See “Item 1. Financial Statements – Note 7 – Advances – Credit and Concentration Risk” for further information.)

The $10.6 billion decrease in advances outstanding primarily reflected a $10.0 billion decrease in fixed rate advances and a $0.8 billion decrease in variable rate advances, partially offset by a $0.2 billion increase in adjustable rate advances.

66



The components of the advances portfolio at March 31, 2018, and December 31, 2017, are presented in the following table.
Advances Portfolio by Product Type
 
 
 
 
 
 
 
 
 
March 31, 2018
 
December 31, 2017
(Dollar in millions)
Par Value

 
Percentage of Total Par Value

 
Par Value

 
Percentage of Total Par Value

Adjustable – LIBOR
$
8,057

 
12
%
 
$
6,957

 
9
%
Adjustable – LIBOR, callable at borrower’s option
15,620

 
23

 
16,495

 
21

Adjustable – LIBOR, with caps and/or floors and PPS(1)
83

 
—

 
83

 
—

Adjustable – Other Indices
1

 
—

 
2

 
—

Subtotal adjustable rate advances
23,761

 
35

 
23,537

 
30

Fixed
28,355

 
43

 
38,242

 
50

Fixed – amortizing
205

 
—

 
210

 
—

Fixed – with PPS(1)
4,401

 
7

 
4,035

 
5

Fixed – with caps and PPS(1)
475

 
1

 
425

 
1

Fixed – callable at borrower’s option
1,302

 
2

 
1,802

 
2

Fixed – callable at borrower’s option with PPS(1)
40

 
—

 
75

 
—

Subtotal fixed rate advances
34,778

 
53

 
44,789

 
58

Daily variable rate
8,324

 
12

 
9,160

 
12

Total par value
$
66,863

 
100
%
 
$
77,486

 
100
%

(1)
Partial prepayment symmetry (PPS) is a product feature under which 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.

For a discussion of advances credit risk, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – Advances.”

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 and to support the operations of the Bank. The Bank’s total non-MBS investment portfolio was $22.3 billion and $25.7 billion as of March 31, 2018, and December 31, 2017, respectively. The decrease in the total size of the non-MBS investment portfolio reflects lower balances of securities purchased under agreements to resell, agency securities, and certificates of deposit, partially offset by higher balances of Federal funds sold.

Interest rate payment terms for non-MBS investments classified as HTM at March 31, 2018, and December 31, 2017, are detailed in the following table:
Non-MBS Investments: Interest Rate Payment Terms
 
 
 
 
(In millions)
March 31, 2018

 
December 31, 2017

Amortized cost of HTM securities other than MBS:
 
 
 
Fixed rate
$
—


$
500

Adjustable rate
179


187

Total
$
179


$
687


Borrowings – Total liabilities (primarily consolidated obligations) funding the advances-related business decreased to $82.6 billion at March 31, 2018, from $96.6 billion at December 31, 2017. For further information and

67


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” and “Item 1. Financial Statements – Note 17 – Commitments and Contingencies.”

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. 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, 2018, the notional amount of interest rate exchange agreements associated with the advances-related business totaled $72.8 billion, of which $33.3 billion were hedging advances, $39.0 billion were hedging consolidated obligations, and $0.5 billion were economically hedging trading securities. At December 31, 2017, the notional amount of interest rate exchange agreements associated with the advances-related business totaled $95.5 billion, of which $44.3 billion were hedging advances, $50.4 billion were hedging consolidated obligations, $0.8 billion were economically hedging trading securities, and $14 million were offsetting derivatives. The hedges associated with advances and consolidated obligations were primarily used to convert the fixed rate cash flows of the advances and consolidated obligations to adjustable rate cash flows or to manage the interest rate sensitivity and net repricing gaps of assets, liabilities, and interest rate exchange agreements.

FHLBank System consolidated obligation bonds and discount notes, along with similar debt securities issued by other GSEs such as Fannie Mae and Freddie Mac, are generally referred to as agency debt. The costs of debt issued by the FHLBanks and the other GSEs generally rise and fall with increases and decreases in general market interest rates.

The following table presents a comparison of selected market interest rates as of March 31, 2018, and December 31, 2017. All selected market interest rates increased in 2018 compared to the prior yearend.
Selected Market Interest Rates
 
 
 
 
 
 
 
 
 
 
 
 
Market Instrument
March 31, 2018
 
December 31, 2017
 
March 31, 2017
 
December 31, 2016
Federal Reserve target range for overnight Federal funds
1.50-1.75

%
 
1.25-1.50

%
 
0.75-1.00

%
 
0.50-0.75

%
3-month Treasury bill
1.71

 
 
1.36

 
 
0.75

 
 
0.50

 
3-month LIBOR
2.31

 
 
1.69

 
 
1.15

 
 
1.00

 
2-year Treasury note
2.27

 
 
1.89

 
 
1.26

 
 
1.19

 
5-year Treasury note
2.56

 
 
2.21

 
 
1.92

 
 
1.93

 

The following table presents a comparison of the average issuance cost of FHLBank System consolidated obligation bonds and discount notes converted to LIBOR-indexed liabilities through interest rate swaps in the first three months of 2018 and 2017. The average issuance cost relative to LIBOR of bonds and discount notes deteriorated in the first three months of 2018 compared to 2017.

 
Spread to LIBOR of Average Cost of
Consolidated Obligations for the Three Months Ended
(In basis points)
March 31, 2018
 
March 31, 2017
Consolidated obligation bonds
–23.5
 
–31.0
Consolidated obligation discount notes (one month and greater)
–25.7
 
–36.6


68


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,” “MPF,” and “MPF Xtra” are registered trademarks of the FHLBank 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 net settlements from associated interest rate exchange agreements.

At March 31, 2018, assets associated with this segment were $19.9 billion (18% of total assets), a decrease of $0.1 billion from $20.0 billion at December 31, 2017 (16% of total assets).

Adjusted net interest income for this segment was $75 million in the first quarter of 2018, a decrease of $8 million, or 10%, from $83 million in the first quarter of 2017. The decrease in adjusted net interest income was due to lower spreads on interest-earning assets, primarily caused by lower spreads on new investments, and lower accretion-related income, which more than offset the impact of higher average balances of MBS investments and mortgage loans.

Adjusted net interest income for this segment represented 49% and 63% of total adjusted net interest income for the first quarter of 2018 and 2017, respectively.

MBS Investments – The Bank’s MBS portfolio was $17.5 billion at March 31, 2018, compared with $17.8 billion at December 31, 2017. During the first quarter of 2018, the Bank’s MBS portfolio decreased primarily because of $0.8 billion in principal repayments, partially offset by $0.4 billion in new MBS investments. Average MBS investments were $17.1 billion in the first quarter of 2018, an increase of $0.8 billion from $16.3 billion in the first quarter of 2017. 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” and “Item 1. Financial Statements – Note 6 – Other-Than-Temporary Impairment Analysis.”

Intermediate-term and long-term fixed rate MBS investments are subject to prepayment risk, and intermediate-term and long-term adjustable rate MBS investments are also subject to interest rate cap risk. The Bank has managed these risks predominately by 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. The Bank has purchased interest rate caps to hedge some of the interest rate cap risk associated with the long-term adjustable rate MBS investments.

Interest rate payment terms for MBS securities at March 31, 2018, and December 31, 2017, are shown in the following table:
MBS Investments: Interest Rate Payment Terms
 
 
 
 
(In millions)
March 31, 2018

 
December 31, 2017

Amortized cost of MBS:
 
 
 
Passthrough securities:
 
 
 
Fixed rate
$
25

 
$
26

Adjustable rate
2,357

 
2,406

Subtotal
2,382

 
2,432

Collateralized mortgage obligations:
 
 
 
Fixed rate
4,455

 
4,738

Adjustable rate
10,286

 
10,325

Subtotal
14,741

 
15,063

Total
$
17,123

 
$
17,495



69


Certain MBS classified as fixed rate passthrough securities and fixed rate collateralized mortgage obligations have an initial fixed interest rate that subsequently converts to an adjustable interest rate on a specified date as follows:
(In millions)
March 31, 2018

 
December 31, 2017

Passthrough securities:
 
 
 
Converts after 1 year through 5 years
$
23

 
$
24

Total
$
23

 
$
24


MPF Program – Under the MPF Program, the Bank may purchase from members, for its own portfolio, conventional conforming fixed rate mortgage loans under the MPF Original product and mortgage loans insured by the Federal Housing Administration (FHA) or guaranteed by the Department of Veterans Affairs (VA) under the MPF Government product. In addition, the Bank may facilitate the purchase of conforming fixed rate mortgage loans from members for concurrent sale to Fannie Mae under the MPF Xtra product; of jumbo fixed rate mortgage loans for concurrent sale to Redwood Residential Acquisition Corporation, a subsidiary of Redwood Trust, Inc., a real estate investment trust, under the MPF Direct product; and of government-insured or government-guaranteed mortgage loans that will be packaged into securities backed by the mortgage loans and guaranteed by Ginnie Mae under the MPF Government MBS product. When members sell mortgage loans under the MPF Xtra, MPF Direct, and MPF Government MBS products, the loans are sold to a third-party investor and are not recorded on the Bank’s Statements of Condition.

From May 2002 through October 2006, the Bank purchased conventional conforming fixed rate mortgage loans from its participating financial institutions under the MPF Original and MPF Plus products. 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.

As of March 31, 2018, all mortgage loans purchased by the Bank under the MPF Program were qualifying conventional conforming fixed rate, first lien mortgage loans with fully amortizing loan terms of up to 30 years. A conventional loan is one that is not insured by the federal government or any of its agencies. Conforming loan size, which is established annually as required by Finance Agency regulations, may not exceed the loan limits set by the Finance Agency each year. All MPF loans are secured by owner-occupied, one- to four-unit residential properties or single-unit second homes.

As of March 31, 2018, the Bank had approved 25 members as participating financial institutions since renewing its participation in the MPF Program in 2013. The Bank purchased $369 million in eligible loans under the MPF Original product during the first quarter of 2018.

Mortgage loan balances increased to $2.4 billion at March 31, 2018, from $2.1 billion at December 31, 2017, an increase of $0.3 billion. Average mortgage loans were $2.2 billion in the first quarter of 2018, an increase of $1.3 billion from $0.9 billion in the first quarter of 2017.

At March 31, 2018, and December 31, 2017, the Bank held conventional conforming fixed rate mortgage loans purchased under one of two MPF products, MPF Plus or MPF Original, which are described in greater detail in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – MPF Program.” in the Bank’s 2017 Form 10-K. Mortgage loan balances at March 31, 2018, and December 31, 2017, were as follows:


70


Mortgage Loan Balances by MPF Product Type
 
 
 
 
(In millions)
March 31, 2018

 
December 31, 2017

MPF Plus
$
250

 
$
267

MPF Original
2,046

 
1,738

Subtotal
2,296

 
2,005

Unamortized premiums
85

 
76

Unamortized discounts
(5
)
 
(5
)
Mortgage loans held for portfolio
2,376

 
2,076

Less: Allowance for credit losses
—

 
—

Mortgage loans held for portfolio, net
$
2,376

 
$
2,076


The Bank performs periodic reviews of its mortgage loan portfolio to identify probable credit losses in the portfolio and to determine the likelihood of collection on the loans in the portfolio. For more information on the Bank’s mortgage loan portfolio, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – MPF Program” and “Item 7. 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 2017 Form 10-K.

Borrowings – Total consolidated obligations funding the mortgage-related business decreased $0.1 billion to $19.9 billion at March 31, 2018, from $20.0 billion at December 31, 2017, paralleling the decrease in MBS investments. 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” and “Item 1. Financial Statements – Note 17 – Commitments and Contingencies.”

The notional amount of interest rate exchange agreements associated with the mortgage-related business totaled $4.2 billion at March 31, 2018, of which $2.7 billion were hedging or were associated with consolidated obligations funding the mortgage portfolio and $1.5 billion were associated with MBS. The notional amount of interest rate exchange agreements associated with the mortgage-related business totaled $4.1 billion at December 31, 2017, of which $2.6 billion were hedging or were associated with consolidated obligations funding the mortgage portfolio and $1.5 billion were associated with MBS.

Interest Rate Exchange Agreements

A derivative 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; interest rate cap and floor agreements; and callable and putable interest rate swaps (collectively, interest rate exchange agreements) to manage its exposure to market risks inherent in its ordinary course of business, including its 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 “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Market Risk – Interest Rate Exchange Agreements” in the Bank’s 2017 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, 2018, and December 31, 2017.


71


Interest Rate Exchange Agreements
 
 
 
 
 
 
 
 
 
(In millions)
 
 
 
 
 
Notional Amount
Hedging Instrument
 
Hedging Strategy
 
Accounting Designation
 
March 31, 2018

 
December 31, 2017

Hedged Item: Advances
 
 
 
 
 
 
 
 
Pay fixed, receive adjustable interest rate swap
 
Fixed rate advance converted to an adjustable rate
 
Fair Value Hedge
 
$
21,989

 
$
16,713

Basis swap
  
Adjustable rate advance converted to another adjustable rate index to reduce interest rate sensitivity and repricing gaps
  
Economic Hedge(1)
 
2

 
2

Received fixed, pay adjustable interest rate swap
 
Adjustable rate advance converted to a fixed rate
 
Economic Hedge(1)
 
2,047

 
1,972

Pay fixed, receive adjustable interest rate swap
 
Fixed rate advance converted to an adjustable rate
 
Economic Hedge(1)
 
2,551

 
19,401

Pay fixed, receive adjustable 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 an adjustable rate; advance and swap may be callable or putable; matched to advance accounted for under the fair value option
 
Economic Hedge(1)
 
6,618

 
6,163

Interest rate cap or floor
 
Interest rate cap or floor embedded in an adjustable rate advance; matched to advance accounted for under the fair value option
 
Economic Hedge(1)
 
83

 
83

Subtotal Economic Hedges(1)
 
 
 
 
 
11,301

 
27,621

Total
 
 
 
 
 
33,290

 
44,334

Hedged Item: Non-Callable Bonds
 
 
 
 
 
 
 
 
Receive fixed or structured, pay adjustable interest rate swap
 
Fixed rate or structured rate non-callable bond converted to an adjustable rate
 
Fair Value Hedge
 
5,649

 
5,373

Receive fixed or structured, pay adjustable interest rate swap
 
Fixed rate or structured rate non-callable bond converted to an adjustable rate
 
Economic Hedge(1)
 
1,181

 
1,106

Receive fixed or structured, pay adjustable interest rate swap
 
Fixed rate or structured rate non-callable bond converted to an adjustable rate; matched to non-callable bond accounted for under the fair value option
 
Economic Hedge(1)
 
155

 
90

Basis swap
 
Fixed rate or adjustable rate non-callable bond previously converted to an adjustable rate index, converted to another adjustable rate index to reduce interest rate sensitivity and repricing gaps
 
Economic Hedge(1)
 
6,550

 
7,050

Pay fixed, receive adjustable interest rate swap
 
Fixed rate or adjustable rate non-callable bond, which may have been previously converted to an adjustable rate, converted to fixed rate debt that offsets the interest rate risk of mortgage assets
 
Economic Hedge(1)
 
—

 
4,620

Subtotal Economic Hedges(1)
 
 
 
 
 
7,886

 
12,866

Total
 
 
 
 
 
13,535

 
18,239



72


Interest Rate Exchange Agreements (continued)
 
 
 
 
 
 
 
 
 
(In millions)
 
 
 
 
 
Notional Amount
Hedging Instrument
 
Hedging Strategy
 
Accounting Designation
 
March 31, 2018

 
December 31, 2017

Hedged Item: Callable Bonds
 
 
 
 
 
 
 
 
Receive fixed or structured, pay adjustable interest rate swap with an option to call at the counterparty’s option
 
Fixed or structured rate callable bond converted to an adjustable rate; swap is callable
 
Fair Value Hedge
 
2,370

 
2,184

Receive fixed or structured, pay adjustable interest rate swap with an option to call at the counterparty’s option
 
Fixed or structured rate callable bond converted to an adjustable rate; swap is callable
 
Economic Hedge(1)
 
3,442

 
3,357

Receive fixed or structured, pay adjustable interest rate swap with an option to call at the counterparty’s option
 
Fixed or structured rate callable bond converted to an adjustable rate; swap is callable; matched to callable bond accounted for under the fair value option
 
Economic Hedge(1)
 
1,188

 
865

Subtotal Economic Hedges(1)
 
 
 
 
 
4,630

 
4,222

Total
 
 
 
 
 
7,000

 
6,406

Hedged Item: Discount Notes
 
 
 
 
 
 
 
 
Pay fixed, receive adjustable callable interest rate swap
 
Discount note, which may have been previously converted to an adjustable rate, converted to fixed rate callable debt that offsets the prepayment risk of mortgage assets
 
Economic Hedge(1)
 
1,560

 
1,535

Basis swap or receive fixed, pay adjustable interest rate swap
 
Discount note converted to short-term adjustable rate to hedge repricing gaps
 
Economic Hedge(1)
 
19,127

 
26,435

Pay fixed, receive adjustable non-callable interest rate swap
 
Discount note, which may have been previously converted to an adjustable rate, converted to fixed rate non-callable debt that offsets the interest rate risk of mortgage assets
 
Economic Hedge(1)
 
500

 
400

Total
 
 
 
 
 
21,187

 
28,370

Hedged Item: Trading Securities
 
 
 
 
 
 
 
 
Basis swap
 
Basis swap hedging adjustable rate Federal Farm Credit Bank (FFCB) bonds
 
Economic Hedge(1)
 
500

 
750

Interest rate cap
 
Interest rate cap used to offset cap risk embedded in floating rate MBS
 
Economic Hedge(1)
 
1,480

 
1,480

Total
 
 
 
 
 
1,980

 
2,230

Hedged Item: Offsetting Derivatives
 
 
 
 
 
 
Pay fixed, receive adjustable interest rate swap and receive fixed, pay adjustable interest rate swap
 
Interest rate swap used to offset the economic effect of interest rate swap that is no longer designated to advances, investments, or consolidated obligations
 
Economic Hedge(1)
 
24

 
14

Total
 
 
 
 
 
24

 
14

Stand-Alone Derivatives
 
 
 
 
 
 
 
 
Mortgage delivery commitments
 
N/A
 
N/A
 
11

 
16

Total
 
 
 
 
 
11

 
16

Total Notional Amount
 
 
 
 
 
$
77,027

 
$
99,609


(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.

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 type of accounting treatment and product as of March 31, 2018, and December 31, 2017.


73


Interest Rate Exchange Agreements
Notional Amounts and Estimated Fair Values

 
 
 
 
 
 
 
 
 
March 31, 2018
 
 
 
 
 
 
 
 
 
(In millions)
Notional
Amount

 
Fair Value of
Derivatives

 
Unrealized
Gain/(Loss)
on Hedged
Items

 
Financial
Instruments
Carried at
Fair Value

 
Difference

Fair value hedges:
 
 
 
 
 
 
 
 
 
Advances
$
21,989

 
$
2

 
$
(155
)
 
$
—

 
$
(153
)
Non-callable bonds
5,649

 
(10
)
 
38

 
—

 
28

Callable bonds
2,370

 
(41
)
 
42

 
—

 
1

Subtotal
30,008

 
(49
)
 
(75
)
 
—

 
(124
)
Not qualifying for hedge accounting:
 
 
 
 
 
 
 
 
Advances
11,301

 
22

 
—

 
(78
)
 
(56
)
Non-callable bonds
7,886

 
(4
)
 
—

 
—

 
(4
)
Callable bonds
4,630

 
(68
)
 
—

 
17

 
(51
)
Discount notes
21,187

 
48

 
—

 
—

 
48

FFCB bonds
500

 
—

 
—

 
—

 
—

MBS
1,480

 
2

 
—

 
—

 
2

Mortgage delivery commitments
11

 
—

 
—

 
—

 
—

Offsetting derivatives
24

 
—

 
—

 
—

 
—

Subtotal
47,019

 
—

 
—

 
(61
)
 
(61
)
Total excluding accrued interest
77,027

 
(49
)
 
(75
)
 
(61
)
 
(185
)
Accrued interest
—

 
22

 
(10
)
 
10

 
22

Total
$
77,027

 
$
(27
)
 
$
(85
)
 
$
(51
)
 
$
(163
)

December 31, 2017
 
 
 
 
 
 
 
 
 
(In millions)
Notional
Amount

 
Fair Value of
Derivatives

 
Unrealized
Gain/(Loss)
on Hedged
Items

 
Financial
Instruments
Carried at
Fair Value

 
Difference

Fair value hedges:
 
 
 
 
 
 
 
 
 
Advances
$
16,713

 
$
85

 
$
(88
)
 
$
—

 
$
(3
)
Non-callable bonds
5,373

 
(23
)
 
24

 
—

 
1

Callable bonds
2,184

 
(12
)
 
13

 
—

 
1

Subtotal
24,270

 
50

 
(51
)
 
—

 
(1
)
Not qualifying for hedge accounting:
 
 
 
 
 
 
 
 
Advances
27,621

 
27

 
—

 
(28
)
 
(1
)
Non-callable bonds
12,866

 
—

 
—

 
(1
)
 
(1
)
Callable bonds
4,222

 
(29
)
 
—

 
10

 
(19
)
Discount notes
28,370

 
23

 
—

 
—

 
23

FFCB bonds
750

 
(1
)
 
—

 
—

 
(1
)
MBS
1,480

 
1

 
—

 
—

 
1

Mortgage delivery commitments
16

 
—

 
—

 
—

 
—

Offsetting derivatives
14

 
—

 
—

 
—

 
—

Subtotal
75,339

 
21

 
—

 
(19
)
 
2

Total excluding accrued interest
99,609

 
71

 
(51
)
 
(19
)
 
1

Accrued interest
—

 
18

 
(15
)
 
9

 
12

Total
$
99,609

 
$
89

 
$
(66
)
 
$
(10
)
 
$
13


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

74



Concentration Risk. The following table presents the concentration in derivatives with derivative counterparties whose outstanding notional balances represented 10% or more of the Bank’s total notional amount of derivatives outstanding as of March 31, 2018, and December 31, 2017.

Concentration of Derivative Counterparties
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in millions)
March 31, 2018
 
December 31, 2017
Derivative Counterparty
Credit  
Rating(1)  
 
Notional
Amount

 
Percentage of
Total
Notional Amount

 
Credit  
Rating(1)  
 
Notional
Amount

 
Percentage of
Total
Notional Amount

Uncleared
 
 
 
 
 
 
 
 
 
 
 
Others
At least BBB
 
$
14,561

 
19
%
 
At least BBB
 
$
13,900

 
14
%
Subtotal uncleared
 
 
14,561

 
19

 
 
 
13,900

 
14

Cleared
 
 
 
 
 
 
 
 
 
 
 
LCH Ltd(2)
 
 
 
 
 
 
 
 
 
 
 
Credit Suisse Securities (USA) LLC
A
 
34,920

 
45

 
A
 
54,371

 
55

Morgan Stanley & Co. LLC
A
 
27,535

 
36

 
A
 
31,322

 
31

Subtotal cleared
 
 
62,455

 
81

 
 
 
85,693

 
86

Total(3)
 
 
$
77,016

 
100
%
 
 
 
$
99,593

 
100
%

(1)
The credit ratings used by the Bank are based on the lower of Moody’s Investors Service (Moody’s) or S&P Global Ratings (S&P) ratings. 
(2)
London Clearing House (LCH) Ltd is the Bank’s counterparty for all of its cleared swaps. For purposes of clearing swaps with LCH Ltd, Credit Suisse Securities (USA) LLC and Morgan Stanley & Co. LLC are the Bank’s clearing agents. LCH Ltd’s parent, LCH Group Holdings Limited, was rated A+ by S&P. On May 31, 2017, S&P lowered the rating to A and withdrew the rating at LCH Group Holdings Limited’s request. LCH Ltd’s ultimate parent, London Stock Exchange Group, plc., is rated A3 by Moody’s and A- by S&P.
(3)
Total notional amount at March 31, 2018, and December 31, 2017, does not include $11 million and $16 million of mortgage delivery commitments with members, respectively.

Liquidity and Capital Resources

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

Liquidity

The Bank strives to maintain the liquidity necessary to repay maturing consolidated obligations for which it is the primary obligor, meet other obligations and commitments, and meet expected and unexpected member credit demands. The Bank monitors its financial position in order to maintain ready access to sufficient liquid funds to meet normal transaction requirements, take advantage of appropriate investment opportunities, and cover unforeseen liquidity demands.

The Bank generally manages operational, contingent, and structural liquidity risks using a portfolio of cash and short-term investments and access to the debt capital markets. In addition, the Bank maintains alternate sources of funds, detailed in its contingent liquidity plan, which also includes an explanation of how sources of funds may be allocated under stressed market conditions, such as short-term operational disruptions at the Bank or the Office of Finance or short-term disruptions in the debt capital markets. The Bank maintains short-term, high-quality money market investments and government and agency securities in amounts that may average up to three times the Bank’s capital as a primary source of funds to satisfy these requirements and objectives.


75


The Bank has a regulatory contingent liquidity requirement to maintain at least 5 business days of liquidity to enable it to meet its obligations without issuance of new consolidated obligations. In addition, the Finance Agency has established liquidity guidelines that require each FHLBank to maintain sufficient on-balance sheet liquidity in an amount at least equal to its anticipated cash outflows for two different scenarios. Both scenarios assume no new consolidated obligation issuance and no reliance on repurchase agreements and permit the sale of certain existing investments as determined by the Finance Agency. The two scenarios differ only in the treatment of maturing advances. One scenario assumes that the Bank does not renew any maturing advances. For this scenario, the Bank must have sufficient liquidity to meet its obligations for 15 calendar days. The second scenario requires the Bank to renew maturing advances for certain members based on specific criteria established by the Finance Agency. For this scenario, the Bank must have sufficient liquidity to meet its obligations for 5 calendar days.

In addition to the regulatory contingent liquidity requirement and the Finance Agency’s guidelines on contingent liquidity, the Bank models its cash commitments and expected cash flows on a daily basis to determine its projected liquidity position. If a market or operational disruption occurred that prevented the issuance of new consolidated obligations, the Bank could meet its obligations by: (i) allowing short-term liquid investments to mature, (ii) using eligible securities as collateral for repurchase agreement borrowings, and (iii) if necessary, allowing advances to mature without renewal. In addition, the Bank may be able to borrow on a short-term unsecured basis from other financial institutions (Federal funds purchased) or other FHLBanks (inter-FHLBank borrowings).

The Bank actively monitors and manages structural liquidity risks, which the Bank defines as maturity mismatches greater than 90 days for sources and uses of funds, of the advances business segment. Structural liquidity maturity mismatches are identified using maturity gap analysis and valuation sensitivity metrics that quantify the risk associated with the Bank’s structural 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 5-business-day period following March 31, 2018, and December 31, 2017.

Principal Financial Obligations Due and Funds Available for Selected Period
 
 
 
 
 
As of March 31, 2018
 
As of December 31, 2017
(In millions)
5 Business Days
 
5 Business Days
Obligations due:
 
 
 
Demand deposits
$
357

 
$
299

Discount note and bond maturities and expected exercises of bond call options
4,586

 
3,950

Subtotal obligations due
4,943

 
4,249

Sources of available funds:
 
 
 
Maturing investments
19,274

 
21,613

Available cash
12

 
27

Proceeds from scheduled settlements of discount notes and bonds
—

 
635

Maturing advances and scheduled prepayments
6,307

 
7,854

Subtotal sources of available funds
25,593

 
30,129

Net funds available
$
20,650

 
$
25,880


For more information, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources – Liquidity” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Liquidity Risk” in the Bank’s 2017 Form 10-K.


76


Regulatory Capital Requirements

The FHLBank Act and Finance Agency regulations specify that each FHLBank must meet certain minimum regulatory capital standards. The Bank must maintain: (i) total regulatory capital in an amount equal to at least 4% of its total assets, (ii) leverage capital in an amount equal to at least 5% of its total assets, and (iii) permanent capital in an amount that is greater than or equal to its risk-based capital requirement. Because the Bank issues only Class B stock, regulatory capital and permanent capital for the Bank are both composed of retained earnings and Class B stock, including mandatorily redeemable capital stock (which 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. The risk-based capital requirement is 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 following table shows the Bank’s compliance with the Finance Agency’s capital requirements at March 31, 2018, and December 31, 2017.  
Regulatory Capital Requirements
 
 
 
 
 
 
 
 
 
March 31, 2018
 
December 31, 2017
(Dollars in millions)
Required

 
Actual

 
Required

 
Actual

Risk-based capital
$
2,045

 
$
6,650

 
$
2,023

 
$
6,797

Total regulatory capital
4,369

 
6,650

 
4,935

 
6,797

Total regulatory capital ratio
4.00
%
 
6.09
%
 
4.00
%
 
5.51
%
Leverage capital
$
5,461

 
$
9,975

 
$
6,169

 
$
10,195

Leverage ratio
5.00
%
 
9.13
%
 
5.00
%
 
8.26
%

The Bank repurchased $428 million in excess capital stock during the first three months of 2018. As a result of changes in the Bank’s capital plan, both capital stock and retained earnings are required to support regulatory capital compliance.

On April 9, 2018, the Bank’s Board of Directors revised the Framework to change the Bank’s practice of repurchasing the surplus capital stock of all members and the excess capital stock of all former members from a quarterly schedule to a daily schedule. Surplus capital stock is defined as any stock holdings in excess of 115% of a member’s minimum stock requirement. Effective April 24, 2018, the Bank began calculating the amount of stock to be repurchased each business day based on the shareholder’s capital stock outstanding after all stock transactions are completed for the day, ensuring that each member and former member will continue to meet its minimum capital stock requirement after the repurchase. In accordance with the revised Framework, the Bank repurchased $363 million of excess capital stock on April 24, 2018. The Bank may change this practice at any time. All repurchases of capital stock are at the Bank’s discretion, subject to certain statutory and regulatory requirements and to the Bank’s Risk Management Policy, Capital Plan, and Excess Stock Repurchase, Retained Earnings, and Dividend Framework.

The Bank’s capital requirements are more fully discussed in “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital” in the Bank’s 2017 10-K.

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 Governance Policy that outlines the key roles and responsibilities of the Board of Directors and management and sets forth how the Bank is organized to achieve its risk management objectives, including the implementation of the Bank’s strategic objectives, risk management strategies, corporate governance, and standards of conduct. The policy also establishes the Bank’s risk governance organizational

77


structure and identifies the general roles and responsibilities of the Board of Directors and management in establishing risk management policies, procedures, and guidelines; in overseeing the enterprise risk profile; and in implementing enterprise risk management processes and business strategies. The policy establishes an independent risk oversight function to identify, assess, measure, monitor, and report on the enterprise risk profile and risk management capabilities of the Bank. For more information, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management” in the Bank’s 2017 Form 10-K.

Advances. The Bank manages the credit risk of advances and other credit products by setting the credit and collateral terms available to individual members and housing associates based on their creditworthiness and on the quality and value of the assets they pledge as collateral. The Bank also has procedures to assess the mortgage loan quality and documentation standards of institutions that pledge mortgage loan collateral. In addition, the Bank has collateral policies and restricted lending procedures in place to help manage its exposure to institutions that experience difficulty in meeting their capital requirements or other standards of creditworthiness. These credit and collateral policies balance the Bank’s dual goals of meeting the needs of members and housing associates as a reliable source of liquidity and mitigating credit risk by adjusting credit and collateral terms in view of deterioration in creditworthiness. The Bank has never experienced a credit loss on an advance.

The Bank determines the maximum amount and maximum term of the advances it will make to a member or housing associate based on the institution’s creditworthiness and eligible collateral pledged in accordance with the Bank’s credit and collateral policies and regulatory requirements. The Bank may review and change the maximum amount and maximum term at any time. The maximum amount a member or housing associate may borrow is also limited by the amount and type of collateral pledged because all advances must be fully collateralized.

To identify the credit strength of each borrower and potential borrower, other than insurance companies, community development financial institutions (CDFIs), and housing associates, the Bank assigns each member and each nonmember borrower an internal credit quality rating from one to ten, with one as the highest credit quality rating. 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 institution’s current financial position. Credit and collateral terms may be adjusted based on the results of this credit analysis.

The Bank determines the maximum amount and maximum term of the advances it will make to an insurance company based on an ongoing risk assessment that considers the member's financial and regulatory standing and other qualitative information deemed relevant by the Bank. This evaluation results in the assignment of an internal credit quality rating from one to ten, with one as the highest credit quality rating. Approved terms are designed to meet the needs of the individual member while mitigating the unique credit and collateral risks associated with insurance companies, including risks related to the resolution process for insurance companies, which is significantly different from the resolution processes established for the Bank’s insured depository members.

The Bank determines the maximum amount and maximum term of the advances it will make to a CDFI based on an ongoing risk assessment that considers information from the CDFI’s audited annual financial statements, supplemented by additional information deemed relevant by the Bank. Approved terms are designed to meet the needs of the individual member while mitigating the unique credit and collateral risks of CDFIs, which do not file quarterly regulatory financial reports and are not subject to the same inspection and regulation requirements as the Bank’s insured depository members.

The Bank determines the maximum amount and maximum term of the advances it will make to a housing associate based on an ongoing risk assessment that considers the housing associate’s financial and regulatory standing and other qualitative information deemed relevant by the Bank. Approved terms are designed to meet the needs of the individual housing associate while mitigating the unique credit and collateral risks of housing associates, which do not file quarterly regulatory financial reports and are not subject to the same inspection and regulation requirements as the Bank’s insured depository members.


78


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

In addition, the total amount of advances made available to each member or housing associate may be limited by the financing availability assigned by the Bank, which is generally expressed as a percentage of the member’s or housing associate’s assets. The amount of financing availability is generally determined by the creditworthiness of the member or housing associate.

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 the Bank’s applicable credit, collateral, and capital stock 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, 2018, and December 31, 2017. During the three months ended March 31, 2018, the Bank’s internal credit ratings stayed the same or improved for the majority of members and nonmember borrowers.
 
Member and Nonmember Credit Outstanding and Collateral Borrowing Capacity
by Credit Quality Rating
 
 
 
 
 
 
 
 
 
 
(Dollars in millions)
 
 
 
 
 
 
 
 
 
March 31, 2018
 
 
 
 
 
 
 
 
 
  
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
273

 
155

 
$
77,620

 
$
215,771

 
36
%
4-6
56

 
22

 
5,433

 
15,886

 
34

7-10
6

 
3

 
7

 
71

 
10

Subtotal
335

 
180

 
83,060

 
231,728

 
36

CDFIs
6

 
4

 
83

 
96

 
86

Housing associates
2

 
1

 
112

 
113

 
99

Total
343

 
185

 
$
83,255

 
$
231,937

 
36
%


79


December 31, 2017
 
 
 
 
 
 
 
 
 
 
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
265

 
155

 
$
84,257

 
$
240,247

 
35
%
4-6
58

 
25

 
9,255

 
22,005

 
42

7-10
4

 
1

 
—

 
25

 
—

Subtotal
327

 
181

 
93,512

 
262,277

 
36

CDFIs
6

 
4

 
78

 
99

 
79

Housing associates
2

 
1

 
107

 
112

 
96

Total
335

 
186

 
$
93,697

 
$
262,488

 
36
%
 
(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.

Member and Nonmember Credit Outstanding and Collateral Borrowing Capacity
by Unused Borrowing Capacity
 
 
 
 
 
 
(Dollars in millions)
 
 
 
 
 
March 31, 2018
 
 
 
 
 
Unused Borrowing Capacity
Number of Members and Nonmembers with
Credit Outstanding

 
Credit
Outstanding(1)

 
Collateral
Borrowing
Capacity(2)

0% – 10%
5

 
$
253

 
$
263

11% – 25%
7

 
8,447

 
10,854

26% – 50%
31

 
30,517

 
51,232

More than 50%
142

 
44,038

 
169,588

Total
185

 
$
83,255

 
$
231,937

December 31, 2017
 
 
 
 
 
Unused Borrowing Capacity
Number of Members and Nonmembers with
Credit Outstanding

 
Credit
Outstanding(1)

 
Collateral
Borrowing
Capacity(2)

0% – 10%
4

 
$
160

 
$
169

11% – 25%
4

 
553

 
672

26% – 50%
35

 
33,571

 
54,487

More than 50%
143

 
59,413

 
207,160

Total
186

 
$
93,697

 
$
262,488

 
(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.

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

Securities pledged as collateral are assigned borrowing capacities that reflect the securities’ pricing volatility and market liquidity risks. Securities are delivered to the Bank’s custodian when they are pledged. The Bank prices securities collateral on a daily basis or twice a month, depending on the availability and reliability of external pricing sources. Securities that are normally priced twice a month may be priced more frequently in volatile market conditions. The Bank benchmarks the borrowing capacities for securities collateral to the market on a periodic basis and may review and change the borrowing capacity for any security type at any time. As of March 31, 2018, the

80


borrowing capacities assigned to U.S. Treasury and agency securities ranged from 80% to 99% 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 65% to 90% of their market value, depending on the underlying collateral (residential mortgage loans, home equity loans, or commercial real estate loans), the rating, and the subordination structure of the respective securities.

The following table presents the securities collateral pledged by all members and by nonmembers with credit outstanding at March 31, 2018, and December 31, 2017.
Composition of Securities Collateral Pledged
by Members and by Nonmembers with Credit Outstanding
 
 
 
 
 
 
 
 
(In millions)
March 31, 2018
 
December 31, 2017
Securities Type with Current Credit Ratings
Current Par

 
Borrowing
Capacity

 
Current Par

 
Borrowing
Capacity

U.S. Treasury (bills, notes, bonds)
$
2,308

 
$
2,228

 
$
1,946

 
$
1,875

Agency (notes, subordinated debt, structured notes, indexed amortization notes, and Small Business Administration pools)
3,179

 
3,077

 
3,135

 
3,019

Agency pools and collateralized mortgage obligations
10,731

 
10,112

 
34,182

 
32,755

Private-label commercial MBS – publicly registered investment-grade-rated senior tranches
3

 
3

 
3

 
2

PLRMBS – private placement investment-grade-rated senior tranches
65

 
48

 
68

 
51

Municipal Bonds – investment-grade-rated
53

 
48

 
55

 
49

Total
$
16,339

 
$
15,516

 
$
39,389

 
$
37,751


With respect to loan collateral, most borrowers may choose to pledge loan collateral by specific identification or under a blanket lien. Insurance companies, CDFIs, and housing associates are required to pledge loan collateral by specific identification with monthly reporting. All other borrowers pledging by specific identification must provide a detailed listing of all the loans pledged to the Bank on a monthly basis. With a blanket lien, a borrower generally pledges the following loan types, whether or not the individual loans are eligible to receive borrowing capacity: all loans secured by real estate; all loans made for commercial, corporate, or business purposes; and all participations in these loans. Borrowers pledging under a blanket lien may provide a detailed listing of loans or may use a summary reporting method.

The Bank may require certain borrowers to deliver pledged loan collateral to the Bank for one or more reasons, including the following: the borrower is a de novo institution (chartered within the last three years), an insurance company, a CDFI, or a housing associate; the Bank is concerned about the borrower’s creditworthiness; or the Bank is concerned about the maintenance of its collateral or the priority of its security interest. With the exception of insurance companies, CDFIs, and housing associates, borrowers required to deliver loan collateral must pledge those loans under a blanket lien with detailed reporting.

As of March 31, 2018, of the loan collateral pledged to the Bank, 22% was pledged by 26 institutions by specific identification, 53% was pledged by 121 institutions under a blanket lien with detailed reporting, and 25% was pledged by 130 institutions under a blanket lien with summary reporting.

As of March 31, 2018, the Bank’s maximum borrowing capacities as a percentage of the assigned market value of mortgage loan collateral pledged under a blanket lien with detailed reporting were as follows: 90% for first lien residential mortgage loans, 88% for multifamily mortgage loans, 88% for commercial mortgage loans, and 77% for second lien residential mortgage loans. The maximum borrowing capacity for small business, small agribusiness, and small farm loans was 50% of the unpaid principal balance, although most of these loans are pledged under blanket lien with summary reporting, with a maximum borrowing capacity of 25%. The highest borrowing capacities are available to borrowers that pledge under a 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

81


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, 2018, and December 31, 2017.
 
Composition of Loan Collateral Pledged
by Members and by Nonmembers with Credit Outstanding
 
 
 
 
 
 
 
 
(In millions)
March 31, 2018
 
December 31, 2017
Loan Type
Unpaid Principal
Balance

 
Borrowing
Capacity

 
Unpaid Principal
Balance

 
Borrowing
Capacity

First lien residential mortgage loans
$
153,295

 
$
130,079

 
$
162,740

 
$
138,937

Second lien residential mortgage loans and home equity lines of credit
20,253

 
11,087

 
22,440

 
12,500

Multifamily mortgage loans
27,526

 
21,021

 
26,143

 
20,098

Commercial mortgage loans
70,637

 
49,994

 
68,703

 
48,759

Loan participations(1)
4,607

 
3,282

 
4,793

 
3,487

Small business, small farm, and small agribusiness loans
3,837

 
958

 
3,830

 
956

Other
—

 
—

 
2

 
—

Total
$
280,155

 
$
216,421

 
$
288,651

 
$
224,737


(1)
The unpaid principal balance for loan participations is 100% of the outstanding loan amount. The borrowing capacity for loan participations is based on the participated amount pledged to the Bank.

The Bank holds a security interest in subprime residential mortgage loans pledged as collateral. Subprime loans are defined as loans with a borrower FICO score of 660 or less at origination, or if the original FICO score is not available, as loans with a current borrower FICO score of 660 or less. At March 31, 2018, and December 31, 2017, the unpaid principal balance of these loans totaled $8 billion and $9 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 the pricing of the loans. All advances, including those made to borrowers pledging subprime mortgage loans, are required to be fully collateralized. The Bank limits the amount of borrowing capacity that may be supported by subprime collateral.

Investments. The Bank has adopted credit policies and exposure limits for investments that promote risk limitation, diversification, and liquidity. These policies determine eligible counterparties and 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 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 OTTI 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.

82



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

Investment Credit Exposure
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(In millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
  
Carrying Value
 
Credit Rating(1)
 
 
 
 
Investment Type
AAA

 
AA

 
A

 
BBB

 
Below Investment Grade

 
Unrated

 
Total

Non-MBS
 
 
 
 
 
 
 
 
 
 
 
 
 
Housing finance agency bonds:
 
 
 
 
 
 
 
 
 
 
 
 
 
CalHFA bonds
$
—

 
$
—

 
$
179

 
$
—

 
$
—

 
$
—

 
$
179

GSEs:
 
 
 
 
 
 
 
 
 
 
 
 
 
FFCB bonds
—

 
907

 
—

 
—

 
—

 
—

 
907

Total non-MBS
—

 
907

 
179

 
—

 
—

 
—

 
1,086

MBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations – single-family:
 
 
 
 
 
 
 
 
 
 
 
 
 
Ginnie Mae
—

 
720

 
—

 
—

 
—

 
—

 
720

GSEs – single-family:
 
 
 
 
 
 
 
 
 
 
 
 
 
Freddie Mac
—

 
1,901

 
—

 
—

 
—

 
—

 
1,901

Fannie Mae(2)
—

 
3,384

 
7

 
—

 
4

 
—

 
3,395

Subtotal
—

 
5,285

 
7

 
—

 
4

 
—

 
5,296

GSEs – multifamily:
 
 
 
 
 
 
 
 
 
 
 
 
 
Freddie Mac
—

 
4,904

 
—

 
—

 
—

 
—

 
4,904

Fannie Mae
—

 
2,108

 
—

 
—

 
—

 
—

 
2,108

Subtotal
—


7,012


—


—


—


—


7,012

Total GSEs
—

 
12,297

 
7

 
—

 
4

 
—

 
12,308

PLRMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
Prime
—

 
2

 
13

 
198

 
484

 
124

 
821

Alt-A, option ARM
—

 
—

 
—

 
—

 
806

 
—

 
806

Alt-A, other
1

 
23

 
23

 
54

 
2,350

 
370

 
2,821

Total PLRMBS
1

 
25

 
36

 
252

 
3,640

 
494

 
4,448

Total MBS
1

 
13,042

 
43

 
252

 
3,644

 
494

 
17,476

Total securities
1

 
13,949

 
222

 
252

 
3,644

 
494

 
18,562

Interest-bearing deposits
—

 
30

 
1,040

 
—

 
—

 
—

 
1,070

Securities purchased under agreements to resell
—

 
6,250

 
—

 
—

 
—

 
—

 
6,250

Federal funds sold(3)
—

 
8,550

 
5,400

 
—

 
—

 
—

 
13,950

Total investments
$
1

 
$
28,779

 
$
6,662

 
$
252

 
$
3,644

 
$
494

 
$
39,832




83


(In millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
  
Carrying Value
 
Credit Rating(1)
 
 
 
Investment Type
AAA

 
AA

 
A

 
BBB

 
Below Investment Grade

 
Unrated

 
Total

Non-MBS
 
 
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit
$
—

 
$
—

 
$
500

 
$
—

 
$
—

 
$
—

 
$
500

Housing finance agency bonds:
 
 
 
 
 
 
 
 
 
 
 
 

CalHFA bonds
—

 
—

 
187

 
—

 
—

 
—

 
187

GSEs:
 
 
 
 
 
 
 
 
 
 
 
 
 
FFCB bonds
—

 
1,158

 
—

 
—

 
—

 
—

 
1,158

Total non-MBS
—

 
1,158

 
687

 
—

 
—

 
—

 
1,845

MBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations – single-family:
 
 
 
 
 
 
 
 
 
 
 
 
 
Ginnie Mae
—

 
757

 
—

 
—

 
—

 
—

 
757

GSEs – single-family:
 
 
 
 
 
 
 
 
 
 
 
 
 
Freddie Mac
—

 
2,039

 
—

 
—

 
—

 
—

 
2,039

Fannie Mae(2)
—

 
3,588

 
7

 
—

 
5

 
—

 
3,600

Subtotal
—

 
5,627

 
7

 
—

 
5

 
—

 
5,639

GSEs – multifamily:
 
 
 
 
 
 
 
 
 
 
 
 
 
Freddie Mac
—

 
4,651

 
—

 
—

 
—

 
—

 
4,651

Fannie Mae
—

 
2,131

 
—

 
—

 
—

 
—

 
2,131

Subtotal
—

 
6,782

 
—

 
—

 
—

 
—

 
6,782

Total GSEs
—

 
12,409

 
7

 
—

 
5

 
—

 
12,421

PLRMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
Prime
—

 
—

 
12

 
200

 
642

 
31

 
885

Alt-A, option ARM
—

 
—

 
—

 
—

 
834

 
—

 
834

Alt-A, other
2

 
13

 
12

 
57

 
2,549

 
302

 
2,935

Total PLRMBS
2

 
13

 
24

 
257

 
4,025

 
333

 
4,654

Total MBS
2

 
13,179

 
31

 
257

 
4,030

 
333

 
17,832

Total securities
2

 
14,337

 
718

 
257

 
4,030

 
333

 
19,677

Interest-bearing deposits
—

 
40

 
1,075

 
—

 
—

 
—

 
1,115

Securities purchased under agreements to resell
—

 
11,750

 
—

 
—

 
—

 
—

 
11,750

Federal funds sold(3)
—

 
5,283

 
5,745

 
—

 
—

 
—

 
11,028

Total investments
$
2

 
$
31,410

 
$
7,538

 
$
257

 
$
4,030

 
$
333

 
$
43,570


(1)
Credit ratings of BB and lower are below investment grade.
(2)
The Bank has one security guaranteed by Fannie Mae but rated D by S&P because of extraordinary expenses incurred during bankruptcy of the security's sponsor.
(3)
Includes $135 million and $225 million at March 31, 2018, and December 31, 2017, respectively, in Federal funds sold to a member counterparty determined by the Bank to have an internal credit rating equivalent to an AA rating.

For all securities in its AFS and HTM portfolios, for Federal funds sold, and for securities purchased under agreements to resell, 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 interest-bearing deposits, short-term unsecured Federal funds sold, securities purchased under agreements to resell, and negotiable certificates of deposit with member and nonmember counterparties, all of which are highly rated.

The Bank actively monitors its credit exposures and the credit quality of its counterparties, including an assessment of each counterparty’s financial performance, capital adequacy, likelihood of parental or sovereign support, and the current market perceptions of the counterparties. The Bank may also consider general macroeconomic and market

84


conditions and political stability when establishing limits on unsecured investments with U.S. branches and agency offices of foreign commercial banks. As a result of deteriorating financial condition or concerns about adverse economic or market developments, the Bank may reduce limits or terms on unsecured investments or suspend a counterparty.

Finance Agency regulations limit the amount of unsecured credit that an individual FHLBank may extend to a single counterparty. This limit is calculated with reference to a percentage of either the FHLBank’s or the counterparty’s capital and to the counterparty’s overall credit rating. Under these regulations, the lesser of the FHLBank’s total regulatory capital or the counterparty’s Tier 1 capital is multiplied by a percentage specified in the regulation. The percentages used to determine the maximum amount of term extensions of unsecured credit range from 1% to 15%, depending on the counterparty’s overall credit rating. Term extensions of unsecured credit include on-balance sheet transactions, off-balance sheet commitments, and derivative transactions, but exclude overnight Federal funds sales, even if subject to a continuing contract. (See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Derivative Counterparties” for additional information related to derivatives exposure.)

Finance Agency regulations also permit the FHLBanks to extend additional unsecured credit to the same single counterparty for overnight sales of Federal funds, even if subject to a continuing contract. However, an FHLBank’s total unsecured credit to a single counterparty (total term plus additional overnight Federal funds unsecured credit) may not exceed twice the regulatory limit for term exposures (2% to 30% of the lesser of the FHLBank’s total regulatory capital or the counterparty’s Tier 1 capital, based on the counterparty’s overall credit rating). In addition, the FHLBanks are prohibited by Finance Agency regulation from investing in financial instruments issued by non-U.S. entities other than those issued by U.S. branches and agency offices of foreign commercial banks.

Under Finance Agency regulations, the total amount of unsecured credit that an FHLBank may extend to a group of affiliated counterparties for term extensions of unsecured credit and overnight Federal funds sales, combined, may not exceed 30% of the FHLBank’s total capital. These limits on affiliated counterparty groups are in addition to the limits on extensions of unsecured credit applicable to any single counterparty within the affiliated group.

The following table presents the unsecured credit exposure with counterparties by investment type at March 31, 2018, and December 31, 2017.
Unsecured Investment Credit Exposure by Investment Type
 
 
 
 
 
Carrying Value(1)

(In millions)
March 31, 2018

 
December 31, 2017

Interest-bearing deposits
$
1,070

 
$
1,115

Certificates of deposit
—

 
500

Federal funds sold
13,950

 
11,028

Total
$
15,020

 
$
12,643


(1)
Excludes unsecured investment credit exposure to U.S. government agencies and instrumentalities, government-sponsored enterprises, and supranational entities and does not include related accrued interest as of March 31, 2018, and December 31, 2017.

The following table presents the credit ratings of the unsecured investment credit exposures presented by the domicile of the counterparty or the domicile of the counterparty’s parent for U.S. branches and agency offices of foreign commercial banks, based on the lowest of the credit ratings provided by Moody’s, S&P, or comparable Fitch ratings. This table does not reflect the foreign sovereign government’s credit rating. At March 31, 2018, 57% of the carrying value of unsecured investments held by the Bank were rated AA, and 76% of the Bank’s total unsecured investments were to U.S. branches and agency offices of foreign commercial banks.


85


Ratings of Unsecured Investment Credit Exposure by Domicile of Counterparty
 
 
 
 
 
 
(In millions)
 
 
 
 
 
March 31, 2018
 
 
 
 
 
  
Carrying Value(1)
 
Credit Rating(2)
 
Domicile of Counterparty
AA

 
A

 
Total

Domestic(3)
$
1,890

 
$
1,640

 
$
3,530

U.S. subsidiaries of foreign commercial banks
—

 
—

 
—

Total domestic and U.S. subsidiaries of foreign commercial banks
1,890

 
1,640

 
3,530

U.S. branches and agency offices of foreign commercial banks:
 
 
 
 
 
Australia
2,875

 
—

 
2,875

Austria
—

 
450

 
450

Canada
—

 
1,300

 
1,300

Japan
—

 
1,100

 
1,100

Netherlands
—

 
1,000

 
1,000

Norway
—

 
400

 
400

Singapore
1,300

 
—

 
1,300

Sweden
2,515

 
—

 
2,515

Switzerland
—

 
550

 
550

Total U.S. branches and agency offices of foreign commercial banks
6,690

 
4,800

 
11,490

Total unsecured credit exposure
$
8,580

 
$
6,440

 
$
15,020


(1)
Excludes unsecured investment credit exposure to U.S. government agencies and instrumentalities, government-sponsored enterprises, and supranational entities and does not include related accrued interest as of March 31, 2018.
(2)
Does not reflect changes in ratings, outlook, or watch status occurring after March 31, 2018. These ratings represent the lowest rating available for each unsecured investment owned by the Bank, based on the ratings provided by Moody’s, S&P, or comparable Fitch ratings. The Bank’s internal rating may differ from this rating.
(3)
Includes $135 million at March 31, 2018, in Federal funds sold to a member counterparty determined by the Bank to have an internal credit rating equivalent to an AA rating.

The following table presents the contractual maturity of the Bank’s unsecured investment credit exposure by the domicile of the counterparty or the domicile of the counterparty’s parent for U.S. branches and agency offices of foreign commercial banks. At March 31, 2018, 83% of the carrying value of unsecured investments held by the Bank had overnight maturities.

86


Contractual Maturity of Unsecured Investment Credit Exposure by Domicile of Counterparty
 
 
 
 
 
 
 
 
(In millions)
 
 
 
 
 
 
 
March 31, 2018
 
 
 
 
 
 
 
  
Carrying Value(1)
Domicile of Counterparty
Overnight

 
Due 2 Days Through 30 Days

 
Due 31 Days Through 90 Days

 
Total

Domestic
$
3,530

 
$
—

 
$
—

 
$
3,530

U.S. subsidiaries of foreign commercial banks
—

 
—

 
—

 
—

Total domestic and U.S. subsidiaries of foreign commercial banks
3,530

 
—

 
—

 
3,530

U.S. branches and agency offices of foreign commercial banks:
 
 
 
 
 
 
 
Australia
2,175

 
300

 
400

 
2,875

Austria
—

 
200

 
250

 
450

Canada
1,300

 
—

 
—

 
1,300

Japan
1,100

 
—

 
—

 
1,100

Netherlands
1,000

 
—

 
—

 
1,000

Norway
400

 
—

 
—

 
400

Singapore
500

 
—

 
800

 
1,300

Sweden
2,515

 
—

 
—

 
2,515

Switzerland
—

 
—

 
550

 
550

Total U.S. branches and agency offices of foreign commercial banks
8,990

 
500

 
2,000

 
11,490

Total unsecured credit exposure
$
12,520

 
$
500

 
$
2,000

 
$
15,020


(1)
Excludes unsecured investment credit exposure to U.S. government agencies and instrumentalities, government-sponsored enterprises, and supranational entities and does not include related accrued interest as of March 31, 2018.

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. These bonds are federally taxable mortgage revenue bonds, collateralized by pools of first lien residential mortgage loans and credit-enhanced by bond insurance. The bonds held by the Bank are issued by the California Housing Finance Agency (CalHFA) and insured by either National Public Financial Guarantee (formerly MBIA Insurance Corporation), or Assured Guaranty Municipal Corporation (formerly Financial Security Assurance Incorporated). At March 31, 2018, all of the bonds were rated at least A by Moody’s or S&P.

For the Bank’s investments in housing finance agency bonds, which were issued by CalHFA, the gross unrealized losses were mainly due to an illiquid market, credit concerns regarding the underlying mortgage collateral, and credit concerns regarding the monoline insurance providers, causing these investments to be valued at a discount to their acquisition cost. The Bank independently modeled cash flows for the underlying collateral, using assumptions for default rates and loss severity that a market participant would deem reasonable, and concluded that the available credit support within the CalHFA structure more than offset the projected underlying collateral losses. The Bank determined that, as of March 31, 2018, all of the gross unrealized losses on the CalHFA bonds are temporary because the underlying collateral and credit enhancements were sufficient to protect the Bank from losses. As a result, the Bank expects to recover the entire amortized cost basis of these securities. If conditions in the housing and mortgage markets and general business and economic conditions deteriorate, the fair value of the CalHFA bonds may decline further and the Bank may experience OTTI in future periods.

The Bank’s MBS investments include PLRMBS, all of which were AAA-rated at the time of purchase, and agency residential MBS, which are backed by Fannie Mae, Freddie Mac, or Ginnie Mae. Some of the PLRMBS were issued by and/or purchased from members, former members, or their affiliates. The Bank has investment credit limits and terms for these investments that do not differ for members and nonmembers. Regulatory policy limits total MBS investments to three times the Bank’s capital at the time of purchase. At March 31, 2018, the Bank’s

87


MBS portfolio was 258% of Bank capital (as determined in accordance with regulations governing the operations of the FHLBanks). The Bank has not purchased any PLRMBS since the first quarter of 2008.

The Bank executes all MBS investments without preference to the status of the counterparty or the issuer of the investment as a nonmember, member, or affiliate of a member. When the Bank executes non-MBS investments with members, the Bank may give consideration to their secured credit availability and the Bank’s advances price levels.

At March 31, 2018, PLRMBS representing 19% of the amortized cost of the Bank’s MBS portfolio were labeled Alt-A by the issuer. These PLRMBS are generally collateralized by mortgage loans that are considered less risky than subprime loans but more risky than prime loans. These loans are generally made to borrowers with credit scores that are high enough to qualify for a prime mortgage loan, but the loans may not meet standard underwriting guidelines for documentation requirements, property type, or loan-to-value ratios.

As of March 31, 2018, the Bank’s investment in MBS had gross unrealized losses totaling $92 million, $36 million of which were related to PLRMBS. These gross unrealized losses were primarily due to illiquidity in the MBS market and market expectations of the credit performance of loan collateral underlying these securities, which caused these assets to be valued at discounts to their amortized cost.

For its agency MBS, the Bank expects to recover the entire amortized cost basis of these securities because the Bank 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. As a result, the Bank determined that, as of March 31, 2018, 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, 2018, using two third-party models. The FHLBanks’ OTTI Committee developed a short-term housing price forecast with projected changes ranging from a decrease of 7.0% to an increase of 12.0% over the 12-month period beginning January 1, 2018. For the vast majority of markets, the projected short-term housing price changes range from an increase of 1.0% to an increase of 6.0%. Thereafter, a unique path is projected for each geographic area based on an internally developed framework derived from historical data.

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 reflects a best-estimate scenario and includes a base case housing price forecast that reflects the expectations for near- and long-term housing price behavior.

In addition to evaluating its PLRMBS under a base case (or best estimate) scenario, the Bank performed a cash flow analysis for each of these securities under a more adverse housing price scenario. This more adverse scenario was primarily based on a short-term housing price forecast that was five percentage points below the base case forecast, followed by a recovery path with annual rates of housing price growth that were 33.0% lower than the base case.

The following table shows the base case scenario and what the credit-related OTTI loss would have been under the more adverse housing price scenario at March 31, 2018:

88


OTTI Analysis Under Base Case and Adverse Case Scenarios
 
 
 
 
 
 
 
 
 
 
 
 
 
Housing Price Scenario
 
Base Case
 
Adverse Case
(Dollars in millions)
Number of
Securities

 
Unpaid
Principal
Balance

 
Credit-
Related
OTTI(1)

 
Number of
Securities

 
Unpaid
Principal
Balance

 
Credit-
Related
OTTI(1)

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:
 
 
 
 
 
 
 
 
 
 
 
Alt-A, other
9

 
$
164

 
$
(1
)
 
11

 
$
192

 
$
(3
)
Total
9

 
$
164

 
$
(1
)
 
11

 
$
192

 
$
(3
)

(1)
Amounts are for the three months ended March 31, 2018.

For more information on the Bank’s OTTI analysis and reviews, see “Item 1. Financial Statements – Note 6 – Other-Than-Temporary Impairment Analysis.”

The following table presents the ratings of the Bank’s PLRMBS as of March 31, 2018, by collateral type at origination and by year of securitization.

Unpaid Principal Balance of PLRMBS by Year of Securitization and Credit Rating
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(In millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unpaid Principal Balance
 
Credit Rating(1) 
 
 
 
Collateral Type at Origination and Year of Securitization
AAA

 
AA

 
A

 
BBB

 
Below Investment Grade

 
Unrated

 
Total

Prime
 
 
 
 
 
 
 
 
 
 
 
 
 
2008
$
—

 
$
—

 
$
—

 
$
—

 
$
99

 
$
—

 
$
99

2007
—

 
—

 
—

 
—

 
123

 
140

 
263

2006
—

 
—

 
—

 
—

 
25

 
—

 
25

2005
—

 
—

 
—

 
13

 
32

 
—

 
45

2004 and earlier
—

 
2

 
14

 
184

 
225

 
2

 
427

Total Prime
—

 
2

 
14

 
197

 
504

 
142

 
859

Alt-A, option ARM
 
 
 
 
 
 
 
 
 
 
 
 
 
2007
—

 
—

 
—

 
—

 
655

 
—

 
655

2006
—

 
—

 
—

 
—

 
126

 
—

 
126

2005
—

 
—

 
—

 
—

 
127

 
—

 
127

Total Alt-A, option ARM
—

 
—

 
—

 
—

 
908

 
—

 
908

Alt-A, other
 
 
 
 
 
 
 
 
 
 
 
 
 
2008
—

 
—

 
—

 
—

 
72

 
—

 
72

2007
—

 
—

 
—

 
—

 
676

 
222

 
898

2006
—

 
—

 
—

 
—

 
240

 
133

 
373

2005
—

 
1

 
—

 
—

 
1,334

 
68

 
1,403

2004 and earlier
1

 
22

 
22

 
53

 
243

 
6

 
347

Total Alt-A, other
1

 
23

 
22

 
53

 
2,565

 
429

 
3,093

Total par value
$
1

 
$
25

 
$
36

 
$
250

 
$
3,977

 
$
571

 
$
4,860


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

89


The following table presents the ratings of the Bank’s other-than-temporarily impaired PLRMBS at March 31, 2018, by collateral type at origination and by year of securitization.
 
Unpaid Principal Balance of Other-Than-Temporarily Impaired PLRMBS
by Year of Securitization and Credit Rating
 
 
 
 
 
 
 
 
(In millions)
 
 
 
 
 
 
 
March 31, 2018
 
 
 
 
 
 
 
 
Unpaid Principal Balance
 
Credit Rating(1)
 
 
 
 
Collateral Type at Origination and Year of Securitization
AA

 
Below Investment Grade

 
Unrated

 
Total

Prime
 
 
 
 
 
 
 
2008
$
—

 
$
93

 
$
—

 
$
93

2007
—

 
91

 
140

 
231

2006
—

 
10

 
—

 
10

2005
—

 
15

 
—

 
15

2004 and earlier
2

 
28

 
—

 
30

Total Prime
2

 
237

 
140

 
379

Alt-A, option ARM
 
 
 
 
 
 
 
2007
—

 
655

 
—

 
655

2006
—

 
126

 
—

 
126

2005
—

 
127

 
—

 
127

Total Alt-A, option ARM
—

 
908

 
—

 
908

Alt-A, other
 
 
 
 
 
 
 
2008
—

 
71

 
—

 
71

2007
—

 
672

 
222

 
894

2006
—

 
240

 
133

 
373

2005
—

 
1,334

 
68

 
1,402

2004 and earlier
3

 
118

 
4

 
125

Total Alt-A, other
3

 
2,435

 
427

 
2,865

Total par value
$
5

 
$
3,580

 
$
567

 
$
4,152

 

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

For the Bank’s PLRMBS, the following table shows the amortized cost, estimated fair value, credit- and non-credit-related OTTI, 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 securitization. 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, expressed as a percentage of the underlying collateral balance. 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 weighted averages represent the dollar-weighted averages of all the PLRMBS in each category shown. The classification (prime or Alt-A) is based on the model used to run the estimated cash flows for the security, which may not necessarily be the same as the classification at the time of origination.


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PLRMBS Credit Characteristics
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Underlying Collateral Performance and
Credit Enhancement Statistics
Collateral Type at Origination and Year of Securitization
Amortized
Cost

 
Gross
Unrealized
Losses(2)

 
Estimated
Fair
Value

 
Total
OTTI(1)

 
Non-
Credit-
Related
OTTI(1)

 
Credit-
Related
OTTI(1)

 
Weighted
Average
60+ Days
Collateral
Delinquency
Rate

 
Original
Weighted
Average
Credit
Support

 
Current
Weighted
Average
Credit
Support

Prime
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2008
$
84

 
$
—

 
$
95

 
$
—

 
$
—

 
$
—

 
12.02
%
 
30.00
%
 
9.76
%
2007
219

 
(2
)
 
228

 
—

 
—

 
—

 
15.18

 
22.98

 
2.20

2006
22

 
—

 
24

 
—

 
—

 
—

 
12.00

 
12.30

 
4.34

2005
44

 
—

 
45

 
—

 
—

 
—

 
7.99

 
11.85

 
15.86

2004 and earlier
425

 
(3
)
 
429

 
—

 
—

 
—

 
7.03

 
4.53

 
14.14

Total Prime
794

 
(5
)
 
821

 
—

 
—

 
—

 
10.30

 
13.74

 
9.78

Alt-A, option ARM
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2007
539

 
(5
)
 
599

 
—

 
—

 
—

 
16.99

 
44.25

 
11.62

2006
95

 
—

 
117

 
—

 
—

 
—

 
15.15

 
44.90

 
3.50

2005
47

 
(1
)
 
90

 
—

 
—

 
—

 
15.71

 
22.81

 
5.13

Total Alt-A, option ARM
681

 
(6
)
 
806

 
—

 
—

 
—

 
16.56

 
41.34

 
9.59

Alt-A, other
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2008
69

 
—

 
69

 
—

 
—

 
—

 
7.37

 
31.80

 
21.76

2007
760

 
(13
)
 
806

 
(2
)
 
1

 
(1
)
 
18.11

 
26.92

 
8.18

2006
266

 
—

 
330

 
—

 
—

 
—

 
18.56

 
18.42

 
0.57

2005
1,187

 
(10
)
 
1,274

 
(1
)
 
1

 
—

 
11.88

 
14.42

 
3.90

2004 and earlier
344

 
(2
)
 
350

 
—

 
—

 
—

 
9.94

 
8.25

 
19.10

Total Alt-A, other
2,626

 
(25
)
 
2,829

 
(3
)
 
2

 
(1
)
 
14.17

 
18.24

 
6.87

Total
$
4,101

 
$
(36
)
 
$
4,456

 
$
(3
)
 
$
2

 
$
(1
)
 
13.93
%
 
21.76
%
 
7.89
%

(1)
Amounts are for the year ended March 31, 2018.
(2)
Represents total gross unrealized losses, including non-credit-related other-than-temporary impairment recognized in AOCI. The unpaid principal balance of Prime, Alt-A, option ARM, and Alt-A, other in a gross unrealized loss position was $197 million, $170 million, and $578 million, respectively, at March 31, 2018, and the amortized cost of Prime, Alt-A, option ARM, and Alt-A, other in a gross unrealized loss position was $197 million, $149 million, and $532 million, respectively, at March 31, 2018.

The following table presents a summary of the significant inputs used to determine potential OTTI credit losses in the Bank’s PLRMBS portfolio at March 31, 2018.


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Significant Inputs to OTTI Credit Analysis for All PLRMBS
 
 
 
 
 
 
 
 
March 31, 2018
 
 
 
 
 
 
 
 
Significant Inputs
 
Current
 
Prepayment Rates
 
Default Rates
 
Loss Severities
 
Credit Enhancement
Year of Securitization
Weighted Average %
 
Weighted Average %
 
Weighted Average %
 
Weighted Average %
Prime
 
 
 
 
 
 
 
2008
15.3
 
9.7
 
31.4
 
14.8
2007
12.8
 
3.4
 
20.0
 
8.8
2006
13.3
 
3.1
 
22.7
 
6.8
2005
19.4
 
3.8
 
19.5
 
12.7
2004 and earlier
20.0
 
3.0
 
20.8
 
13.2
Total Prime
18.0
 
4.9
 
23.6
 
13.2
Alt-A, option ARM
 
 
 
 
 
 
 
2007
8.3
 
33.2
 
42.3
 
11.6
2006
7.6
 
34.1
 
38.4
 
3.6
2005
8.7
 
24.0
 
35.4
 
5.2
Total Alt-A, option ARM
8.3
 
32.1
 
40.8
 
9.6
Alt-A, other
 
 
 
 
 
 
 
2007
12.1
 
22.8
 
39.0
 
4.0
2006
10.9
 
24.0
 
38.5
 
7.0
2005
14.2
 
18.5
 
34.9
 
4.2
2004 and earlier
18.4
 
10.4
 
31.1
 
19.5
Total Alt-A, other
13.5
 
19.7
 
36.2
 
6.4
Total
13.1
 
20.1
 
35.4
 
7.9

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

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


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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,
2018

 
December 31,
2017

 
September 30,
2017

 
June 30,
2017

 
March 31,
2017

Prime
 
 
 
 
 
 
 
 
 
2008
96.04
%
 
96.89
%
 
96.60
%
 
92.68
%
 
92.93
%
2007
86.73

 
86.40

 
86.17

 
83.80

 
84.87

2006
93.40

 
93.86

 
93.98

 
93.21

 
92.25

2005
100.36

 
100.58

 
100.02

 
99.55

 
99.44

2004 and earlier
100.78

 
100.47

 
100.21

 
99.70

 
99.09

Weighted average of all Prime
95.69

 
95.65

 
95.44

 
94.14

 
94.15

Alt-A, option ARM
 
 
 
 
 
 
 
 
 
2007
91.46

 
90.43

 
90.00

 
87.34

 
83.66

2006
92.83

 
91.66

 
89.62

 
86.82

 
83.04

2005
70.79

 
68.99

 
65.67

 
62.10

 
57.79

Weighted average of all Alt-A, option ARM
88.76

 
87.53

 
86.46

 
83.66

 
79.82

Alt-A, other
 
 
 
 
 
 
 
 
 
2008
97.03

 
97.22

 
96.70

 
94.73

 
93.62

2007
89.69

 
89.07

 
88.80

 
87.38

 
86.49

2006
88.55

 
87.40

 
87.02

 
85.55

 
83.63

2005
90.83

 
90.44

 
90.35

 
88.96

 
87.31

2004 and earlier
100.60

 
100.47

 
100.21

 
99.54

 
99.10

Weighted average of all Alt-A, other
91.46

 
90.98

 
90.80

 
89.60

 
88.33

Weighted average of all PLRMBS
91.71
%
 
91.18
%
 
90.84
%
 
89.36
%
 
87.89
%

The Bank determined that, as of March 31, 2018, the gross unrealized losses on the PLRMBS that have not had an OTTI loss are primarily due to illiquidity in the PLRMBS market and market expectations of the credit performance of loan collateral underlying these securities, which caused these assets to be valued at discounts to their amortized cost. The Bank does not intend to sell these securities, it is not more likely than not that the Bank will be required to sell these securities before its anticipated recovery of the remaining amortized cost basis, and the Bank expects to recover the entire amortized cost basis of these securities. As a result, the Bank determined that, as of March 31, 2018, 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 deteriorate, 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, 2018. Additional future credit-related OTTI losses 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 credit-related OTTI losses on its PLRMBS in the future.

Derivative Counterparties. The Bank has also adopted credit policies and exposure limits for uncleared derivatives credit exposure. Over-the-counter derivatives may be either entered into directly with a counterparty (uncleared derivatives) or executed either with an executing dealer or on a swap execution facility and then cleared through a futures commission merchant (clearing agent) with a derivatives clearing organization (cleared derivatives).

Uncleared Derivatives. The Bank selects only highly rated derivative dealers and major banks (derivative dealer counterparties) that meet the Bank’s eligibility criteria to act as counterparties for its uncleared derivative activities. In addition, for all uncleared derivative transactions, the Bank has entered into master netting agreements and bilateral credit support agreements with all active derivative dealer counterparties that provide for delivery of

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collateral at specified levels 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 derivative dealer counterparty is set at zero (subject to a minimum transfer amount).

The Bank is subject to the risk of potential nonperformance by the counterparties to derivative agreements. A counterparty generally must deliver collateral to the Bank if the total market value of the Bank’s exposure to that counterparty rises above a specific trigger point. Currently, all of the Bank’s active uncleared derivative counterparties have a zero threshold. As a result of these risk mitigation initiatives, the Bank does not anticipate any credit losses on its uncleared derivative transactions with counterparties as of March 31, 2018.

Cleared Derivatives. The Bank is subject to nonperformance by the derivatives clearing organizations (clearinghouses) and clearing agents. The requirement that the Bank post initial and variation margin through a clearing agent, to the clearinghouse, exposes the Bank to institutional credit risk in the event that the clearing agent or the clearinghouse fails to meet its obligations. The use of cleared derivatives, however, mitigates the Bank’s overall credit risk exposure because a central counterparty is substituted for individual counterparties. Variation margin and initial margin are posted for changes in the value and risk profile of cleared derivatives. The Bank does not anticipate any credit losses on its cleared derivatives as of March 31, 2018.

The following table presents the Bank’s credit exposure to its derivative dealer counterparties at the dates indicated.
Credit Exposure to Derivative Dealer Counterparties
 
 
 
 
 
 
 
 
(In millions)
 
 
 
 
 
 
 
March 31, 2018
 
 
 
 
 
 
 
Counterparty Credit Rating(1)
Notional Amount

 
Net Fair Value of Derivatives Before Collateral

 
Cash Collateral Pledged
to/ (from) Counterparty

 
Net Credit
Exposure to Counterparties

Asset positions with credit exposure:
 
 
 
 
 
 
 
Uncleared derivatives
 
 
 
 
 
 
 
A
$
3,153

 
$
27

 
$
(24
)
 
$
3

Liability positions with credit exposure:
 
 
 
 
 
 
 
Uncleared derivatives
 
 
 
 
 
 
 
A
621

 
(3
)
 
3

 
—

Cleared derivatives(2)
62,455

 
(2
)
 
101

 
99

Total derivative positions with credit exposure to nonmember counterparties
66,229

 
22

 
80

 
102

Member institutions(3)
11

 
—

 
—

 
—

Total
66,240

 
$
22

 
$
80

 
$
102

Derivative positions without credit exposure
10,787

 
 
 
 
 
 
Total notional
$
77,027

 
 
 
 
 
 


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December 31, 2017
 
 
 
 
 
 
 
Counterparty Credit Rating(1)
Notional Amount

 
Net Fair Value of Derivatives Before Collateral

 
Cash Collateral Pledged
to/ (from) Counterparty

 
Net Credit
Exposure to Counterparties

Asset positions with credit exposure:
 
 
 
 
 
 
 
Uncleared derivatives
 
 
 
 
 
 
 
A
$
4,879

 
$
7

 
$
(5
)
 
$
2

Cleared derivatives(2)
85,692

 
83

 
(2
)
 
81

Liability positions with credit exposure:
 
 
 
 
 
 
 
Uncleared derivatives
 
 
 
 
 
 
 
AA
300

 
(1
)
 
1

 
—

A
638

 
—

 
—

 
—

BBB
1,641

 
(1
)
 
1

 
—

Total derivative positions with credit exposure to nonmember counterparties
93,150

 
88

 
(5
)
 
83

Member institutions(3)
16

 
—

 
—

 
—

Total
93,166

 
$
88

 
$
(5
)
 
$
83

Derivative positions without credit exposure
6,443

 
 
 
 
 
 
Total notional
$
99,609

 
 
 
 
 
 

(1)
The credit ratings used by the Bank are based on the lower of Moody's or S&P ratings.
(2)
Represents derivative transactions cleared with LCH Ltd, the Bank’s clearinghouse, which is not rated. LCH Ltd’s parent, LCH Group Holdings Limited, was rated A+ by S&P. On May 31, 2017, S&P lowered the rating to A and withdrew the rating at LCH Group Holdings Limited’s request. LCH Ltd’s ultimate parent, London Stock Exchange Group, plc., is rated A3 by Moody’s and A- by S&P.
(3)
Member institutions include mortgage delivery commitments with members.

The increase or decrease in the credit exposure net of cash collateral, from one period to the next, may be affected by changes in several variables, such as the size and composition of the portfolio, market values of derivatives, and accrued interest.

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 derivative agreements.

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 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 the Bank believes these judgments, estimates, and assumptions to be reasonably accurate, actual results may differ.

In the Bank’s 2017 Form 10-K, the following accounting policies and estimates were identified as critical because they require the Bank 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 AFS, 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; accounting for other-than-temporary impairment for investment securities; and estimating the prepayment speeds on MBS and mortgage loans for the accounting of amortization of premiums and accretion of discounts on MBS and mortgage loans.

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There have been no significant changes in the judgments and assumptions made during the first three months of 2018 in applying the Bank’s critical accounting policies. These policies and the judgments, estimates, and assumptions are also described in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” and “Item 8. Financial Statements and Supplementary Data – Note 1 – Summary of Significant Accounting Policies” in the Bank’s 2017 Form 10-K and in “Item 1. Financial Statements – Note 16 – Fair Value.”

Recently Issued Accounting Guidance and Interpretations

See “Item 1. Financial Statements – Note 2 – Recently Issued and Adopted Accounting Guidance” for a discussion of recently issued accounting standards and interpretations.

Recent Developments

Finance Agency Proposed Amendments to AHP Regulations. On March 14, 2018, the Finance Agency published a proposed rule to amend the operating requirements of the FHLBanks’ AHP with a comment deadline of May 14, 2018. On April 30, the Finance Agency issued a correction to the proposed rule and extended the comment period by 30 days to June 12, 2018.

If adopted as proposed, among many other updates, the AHP rule would: 
•
require an FHLBank to create its own scoring criteria that are designed to satisfy new regulatory outcome requirements, replacing the existing regulatory scoring guidelines;
•
permit an FHLBank to voluntarily increase its AHP homeownership set-aside funding program to 40% of its required annual AHP contributions (up from the current AHP rule’s 35% annual limit);
•
increase the maximum per-household set-aside grant amount to $22,000 with an annual housing price inflation adjustment (up from the current fixed limit of $15,000);
•
remove the retention agreement requirement for owner-occupied units;
•
further align AHP monitoring with certain federal government funding programs;
•
increase threshold requirements for certain project types, such as projects dedicated to homeless or special needs populations; and
•
authorize an FHLBank using market research empirical data to create special targeted grant programs that would be a sub-set of the regular AHP competitive funding program.
 
The rule, as proposed, would represent a substantial overhaul of the existing regulation on the FHLBanks’ AHP and fundamentally change the structure and methodology for awarding grants to affordable housing projects. The proposed rule would also increase AHP’s complexity and administrative burden.

The rule, as proposed, would require changes in the areas of operations, communications, and information systems of the FHLBanks. It would also require increased Board and Affordable Housing Advisory Council action and increased communications and education with members and sponsors. The Bank does not believe that the rule, if adopted substantially as proposed, would be material to its financial condition or results of operations, since, among other things, it would not increase the annual AHP funding requirement. However, the Bank expects there to be increased costs related to implementing the rule requirements and making related adjustments to its systems. In addition, if the rule is adopted as proposed, the Bank expects a possible change to the types of projects that may be funded on a go-forward basis in the Bank’s district, with a commensurate impact on AHP sponsors and their respective communities.

Off-Balance Sheet Arrangements 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

96


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 par value of the outstanding consolidated obligations of the FHLBanks was $1,019.2 billion at March 31, 2018, and $1,034.3 billion at December 31, 2017. The par value of the Bank’s participation in consolidated obligations was $101.6 billion at March 31, 2018, and $115.6 billion at December 31, 2017. The Bank had committed to the issuance of $15 million and $729 million in consolidated obligations at March 31, 2018, and December 31, 2017, respectively.

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 Statement of Condition or may be recorded on the Bank’s Statement of Condition 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, 2018, the Bank had $18 million in advance commitments and $16.3 billion in standby letters of credit outstanding. At December 31, 2017, the Bank had $1 million in advance commitments and $16.2 billion in standby letters of credit outstanding.

For additional information, see “Item 1. Financial Statements – Note 17 – Commitments and Contingencies.”

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is defined as the risk to the Bank's market 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) as a result of movements in market interest rates, interest rate spreads, interest rate volatility, and other market factors (market rate factors). 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 market risk.

The Bank’s Risk Management Policy includes a market risk management objective aimed at maintaining a relatively low adverse exposure of the market 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 market rate factors. See “Total Bank Market Risk” below.

Market risk identification and measurement are primarily accomplished through market value of capital sensitivity analyses and projected earnings and adjusted return on capital 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 as well as at the business segment level. Additional guidelines approved by the Bank’s Enterprise Risk Committee 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 Bank’s policy limits. Market risk is managed for each business segment on a daily basis, as discussed below in “Segment Market Risk.” Compliance with Bank policies and guidelines is reviewed by the Bank’s Board of Directors on a regular basis, along with a corrective action plan if applicable.

Total Bank Market Risk

Market 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.

97



The Bank’s market 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 –4.0% of the estimated market 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 –6.0% of the estimated market value of capital. In the case where a market risk sensitivity compliance metric cannot be estimated with a parallel shift in interest rates because of prevailing low interest rates, the sensitivity metric is not reported. The Bank’s measured market value of capital sensitivity was within the policy limits as of March 31, 2018.

To determine the Bank’s estimated risk sensitivities to interest rates for the market value of capital sensitivity, the Bank uses a third-party proprietary asset and liability system to calculate estimated market 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 third-party 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 mortgage prepayment assumptions. The Bank also compares the mortgage prepayment assumptions in the third-party model to other sources, including actual mortgage prepayment history.

The table below presents the sensitivity of the market value of capital (the market value of all of the Bank’s assets, liabilities, and associated interest rate exchange agreements, with mortgage assets valued using market spreads implied by current market prices) 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, 2018
 
December 31, 2017
 
+200 basis-point change above current rates
–3.7
%
–3.8
%
+100 basis-point change above current rates
–1.6
 
–1.7
 
–100 basis-point change below current rates(2)
+1.0
 
+2.0
 
–200 basis-point change below current rates(2)
+2.4
 
+5.0
 

(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, 2018, are comparable to the estimates as of December 31, 2017, for rising rate scenarios and show less favorable sensitivity in declining rate scenarios. The change in sensitivity in the declining rate scenarios is related to faster projected mortgage prepayment speeds for fixed rate mortgage loans purchased under the MPF Program. LIBOR interest rates as of March 31, 2018, were 52 basis points higher for the 1-year term, 45 basis points higher for the 5-year term, and 38 basis points higher for the 10-year term. Because interest rates in the declining rate scenarios are limited to non-negative interest rates and the current interest rate environments as of March 31, 2018, and December 31, 2017, were low, the interest rates in the declining rate scenarios may not decrease to the same extent that the interest rates in the rising rate scenarios can increase.

The Bank's Risk Management Policy provides guidelines for the payment of dividends and the repurchase of excess capital stock based on the ratio of the Bank's estimated market value of total capital to par value of capital stock. If this ratio at the end of any quarter is: (i) less than 100% but greater than or equal to 90%, any dividend would be

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limited to an annualized rate no greater than the daily average of the three-month LIBOR for the applicable quarter (subject to certain conditions), and any excess capital stock repurchases would not exceed $500 million (subject to certain conditions); (ii) less than 90% but greater than or equal to 70%, any dividend and any excess capital stock repurchases would be subject to the same limitations and conditions as in (i) above, except that any excess capital stock repurchases would not exceed 4% of the Bank's outstanding capital stock as of the repurchase date; and (iii) less than 70%, the Bank would not pay a dividend, not repurchase excess capital stock (but continue to redeem excess capital stock as provided in the Bank's Capital Plan), limit the acquisition of certain assets, and review the Bank's risk policies. A decision by the Board of Directors to declare or not declare any dividend or repurchase any excess capital stock 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. The ratio of the Bank's estimated market value of total capital to par value of capital stock was 214% as of March 31, 2018.

Adjusted Return on Capital – The adjusted return on capital is a measure used by the Bank to assess financial performance. The adjusted return on capital 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 under the fair value option, hedged assets and liabilities, and derivatives. Economic earnings also exclude the interest expense on mandatorily redeemable capital stock and the 20% of net income allocated to the Bank’s restricted retained earnings account in accordance with the FHLBanks’ JCE Agreement. Economic earnings exclude these amounts in order to more accurately reflect the amount of earnings that may be available to be paid as dividends to shareholders.

The Bank limits the sensitivity of projected financial performance through a Board of Directors policy limit on projected adverse changes in the adjusted return on capital. The Bank’s adjusted return on capital 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 adjusted return on capital. With the indicated interest rate shifts, the adjusted return on capital for the projected 12-month horizon would be expected to decrease by 56 basis points in the –200 basis points scenario, well within the policy limit of –120 basis points.

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 and does not have a policy limit. The Bank’s duration gap was one month at March 31, 2018, and one month at December 31, 2017.

Total Bank Duration Gap Analysis
 
 
 
 
 
 
 
 
 
2018
 
2017
  
Amount
(In millions)

 
Duration Gap(1)
(In months)

 
Amount
(In millions)

 
Duration Gap(1)(2)
(In months) 

Assets
$
109,225

 
5

 
$
123,385

 
4

Liabilities
102,549

 
4

 
116,579

 
3

Net
$
6,676

 
1

 
$
6,806

 
1


(1)
Duration gap values include the impact of interest rate exchange agreements.
(2)
Because of the low interest rate environment, the duration gap is estimated using an instantaneous, one-sided parallel change upward of 100 basis points from base case interest rates.

Segment Market Risk. The financial performance and interest rate risks of each business segment are managed within prescribed guidelines and policy limits.


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Advances-Related Business – Interest rate risk arises from the advances-related business primarily through the use of shareholder-contributed capital and retained earnings 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 all advances with embedded options are simultaneously hedged 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.

Money market investments used for liquidity management generally have maturities of one month or less. In addition, the Bank invests in non-MBS agency securities, generally with terms of less than three years. These investments may be variable rate or fixed rate, and the interest rate risk resulting from the fixed rate coupon is hedged with an interest rate swap or fixed rate debt.

The interest rate risk in the advances-related business is primarily associated with the Bank’s strategy for investing capital (capital stock, including mandatorily redeemable capital stock, and retained earnings). The Bank’s strategy is generally to invest 50% of capital in short-term investments (maturities of three months or less) and 50% in intermediate-term investments (a laddered portfolio of investments with maturities of up to four years). However, this strategy may be altered from time to time depending on market conditions. The strategy to invest 50% of capital in short-term assets is intended to mitigate the market value of capital risks associated with the potential repurchase or redemption of excess capital stock. Excess capital stock usually results from a decline in a borrower’s outstanding advances or by a membership termination. 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. The strategy to invest 50% of capital in a laddered portfolio of investments 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.

The Bank updates the repricing and maturity gaps for actual asset, liability, and derivative transactions that occur in the advances-related segment each day. The Bank 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, the Bank 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 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. The market value sensitivity analyses 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 (HTM) or available-for-sale (AFS), with a small amount 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 impact of mortgage prepayments and the existence of interest rate caps on certain adjustable rate MBS.

Historically, the Bank purchased a mix of intermediate-term fixed rate and adjustable rate MBS. The last purchase of a fixed rate MBS was in March 2014. Since March 2014, all MBS purchases were agency adjustable rate MBS.

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MPF loans that have been acquired are medium- or long-term fixed rate mortgage assets. This results in a mortgage portfolio that has a diversified set of interest rate risk attributes.

The estimated market risk of the mortgage-related business is managed both at the time an asset is purchased and on an ongoing basis for the total portfolio. At the time of purchase (for all significant mortgage asset acquisitions), the Bank analyzes the estimated earnings sensitivity and estimated market value sensitivity, taking into consideration the estimated mortgage prepayment sensitivity of the mortgage assets and anticipated funding and hedging activities 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, the Bank reviews the estimated market risk profile of the entire portfolio of mortgage assets and related funding and hedging transactions. The Bank then considers rebalancing strategies to modify the estimated mortgage portfolio market risk profile. Periodically, the Bank performs more in-depth analyses, which include an analysis of the impacts of non-parallel shifts in the yield curve and assessments of the impacts of unanticipated mortgage prepayment behavior. Based on these analyses, the Bank may take actions to rebalance the mortgage portfolio’s market risk profile. These rebalancing strategies may include entering into new funding and hedging transactions, forgoing or modifying certain funding or hedging transactions normally executed with new mortgage purchases, or terminating certain funding and hedging transactions for the mortgage asset portfolio.

The Bank manages the estimated interest rate risk associated with mortgage assets, including mortgage prepayment risk, through a combination of debt issuance and derivatives. The Bank may obtain funding through callable and non-callable FHLBank System debt and may execute derivative 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 mortgage prepayment risks associated with the mortgage assets. Debt issued to finance mortgage assets may be fixed rate debt, callable fixed rate debt, or adjustable rate debt. Derivatives may be used as temporary hedges of anticipated debt issuance or long-term hedges of debt used to finance the mortgage assets. The derivatives used to hedge the interest rate risk of fixed rate mortgage assets generally may be callable and non-callable pay-fixed interest rate swaps. Derivatives may also be used to offset the interest rate cap risk embedded in adjustable rate MBS.

As discussed above in “Total Bank Market Risk – Market Value of Capital Sensitivity” the Bank uses market value of capital sensitivity as a primary market value metric for measuring the Bank’s exposure to interest rates. The Bank’s interest rate risk policies and guidelines for the mortgage-related business address the market value of capital sensitivity of the assets, liabilities, and derivatives of 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, 2018, and December 31, 2017.

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, 2018
 
December 31, 2017
 
+200 basis-point change
–1.6
%
–1.7
%
+100 basis-point change
–0.5
 
–0.7
 
–100 basis-point change(2)
+0.1
 
+1.1
 
–200 basis-point change(2)
+0.6
 
+3.2
 

(1)
Instantaneous change from actual rates at dates indicated.
(2)
Interest rates for each maturity are limited to non-negative interest rates.

For the mortgage-related business, the Bank’s estimates of the sensitivity of the market value of capital to changes in interest rates as of March 31, 2018, are comparable to the estimates as of December 31, 2017, for rising rate

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scenarios and show less favorable sensitivity in declining rate scenarios. The change in sensitivity in declining rate scenarios is related to faster projected mortgage prepayment speeds for fixed rate mortgage loans purchased under the MPF Program. LIBOR interest rates as of March 31, 2018, were 52 basis points higher for the 1-year term, 45 basis points higher for the 5-year term, and 38 basis points higher for the 10-year term. Because interest rates in the declining rate scenarios are limited to non-negative interest rates and the current interest rate environments as of March 31, 2018, and December 31, 2017, were low, the interest rates in the declining rate scenarios may not decrease to the same extent that the interest rates in the rising rate scenarios can increase.

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 and senior vice president and chief financial officer as of the end of the period covered by this report. Based on that evaluation, the Bank’s president and chief executive officer and senior vice president and chief financial officer have concluded that the Bank’s disclosure controls and procedures were effective at a reasonable assurance level as of the end of the period covered by this report.

Internal Control Over Financial Reporting

During the three months ended March 31, 2018, 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.

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 the 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. 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,

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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.


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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.

After consultation with legal counsel, the Bank is not aware of any legal proceedings that are expected to have a material effect on its 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 Bank’s 2017 Form 10-K. There have been no material changes from the risk factors disclosed in the “Part I. Item 1A. Risk Factors” section of the Bank’s 2017 Form 10-K.

ITEM 5.
OTHER INFORMATION

In accordance with the Bank’s Excess Stock Repurchase, Retained Earnings, and Dividend Framework, the Bank repurchased $428 million of excess capital stock on March 16, 2018.

ITEM 6.    EXHIBITS

Exhibit No.
 
Description
 
 
 

  
Certification of the President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 

  
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 

  
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
 
 
 

  
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
 
 
 
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Pursuant to Rule 405 of Regulation S-T, the following financial information from the Bank's quarterly report on Form 10-Q for the period ended March 31, 2018, is formatted in XBRL interactive data files: (i) Statements of Condition at March 31, 2018, and December 31, 2017; (ii) Statements of Income for the Three Months Ended March 31, 2018 and 2017; (iii) Statements of Comprehensive Income for the Three Months Ended March 31, 2018 and 2017; (iv) Statements of Capital Accounts for the Three Months Ended March 31, 2018 and 2017; (v) Statements of Cash Flows for the Three Months Ended March 31, 2018 and 2017; and (vi) Notes to Financial Statements.
    
.


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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 4, 2018.
 
 
Federal Home Loan Bank of San Francisco
 
 
 
/S/ J. GREGORY SEIBLY
 
J. Gregory Seibly President and Chief Executive Officer
 
 
 
/S/ KENNETH C. MILLER
 
Kenneth C. Miller Senior Vice President and Chief Financial Officer
(Principal Financial Officer)


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Federal Home Loan Bank of San Francisco Reports