Forward-Looking Statements
This report includes statements describing anticipated developments,
projections, estimates, or future predictions of ours that are "forward-looking
statements." These statements may use forward-looking terminology such as, but
not limited to, "anticipates," "believes," "expects," "plans," "intends," "may,"
"could," "estimates," "assumes," "should," "will," "likely," or their negatives
or other variations on these terms. We caution that, by their nature,
forward-looking statements are subject to a number of risks or uncertainties,
including the risk factors set forth in Item 1A - Risk Factors in the 2011
Annual Report and Part II - Item 1A - Risk Factors of this quarterly report, and
the risks set forth below. Accordingly, we caution that actual results could
differ materially from those expressed or implied in these forward-looking
statements or could impact the extent to which a particular objective,
projection, estimate or prediction is realized. As a result, you are cautioned
not to place undue reliance on such statements. We do not undertake to update
any forward-looking statement herein or that may be made from time to time on
our behalf.
Forward-looking statements in this report may include, among others, our
expectations for:
• income, retained earnings, and dividend payouts;
• repurchases of our stock held in excess of the owner's total stock investment
requirement (excess stock);
• credit losses on advances and investments in mortgage loans and ABS,
particularly private-label MBS;
• balance-sheet changes and components thereof, such as changes in advances
balances and the size of our portfolio of investments in mortgage loans;
• our retained earnings target; and
• the interest-rate environment in which we do business.
Actual results may differ from forward-looking statements for many reasons,
including, but not limited to:
• changes in interest rates, the rate of inflation (or deflation), housing
prices, employment rates, and the general economy;
• changes in the size of the residential mortgage market;
• changes in demand for our advances and other products resulting from changes
in members' deposit flows and credit demands or otherwise;
• the willingness of our members to do business with us despite limited
repurchases of excess stock and modest dividend payments;
• changes in the financial health of our members;
• insolvencies of our members;
• increases in borrower defaults on mortgage loans;
• deterioration in the credit performance of our private-label MBS portfolio
beyond forecasted assumptions concerning loan default rates, loss severities,
and prepayment speeds resulting in the realization of additional
other-than-temporary impairment charges;
• deterioration in the credit performance of our investments in mortgage loans
and increases in loss severities from those investments;
• an increase in advance prepayments as a result of changes in interest rates
or other factors;
• the volatility of market prices, rates, and indices that could affect the
value of collateral we hold as security for obligations of our members and
counterparties to interest-rate-exchange agreements and similar agreements;
• issues and events across the FHLBank System and in the political arena that
may lead to regulatory, judicial, or other developments may affect the
marketability of the COs, our financial obligations with respect to COs, our
ability to access
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the capital markets, our members, the manner in which we operate, or the
organization and structure of the FHLBank System;
• competitive forces including, without limitation, other sources of funding
available to our members, other entities borrowing funds in the capital
markets, and the ability to attract and retain skilled employees;
• the pace of technological change and our ability to develop and support
technology and information systems sufficient to manage the risks of our
business effectively;
• the loss of large members through mergers and similar activities;
• changes in investor demand for COs and/or the terms of
interest-rate-exchange-agreements and similar agreements;
• the timing and volume of market activity;
• the volatility of reported results due to changes in the fair value of
certain assets and liabilities, including, but not limited to, private-label
MBS;
• the ability to introduce new (or adequately adapt current) products and
services and successfully manage the risks associated with those products and
services, including new types of collateral used to secure advances;
• the availability of derivative financial instruments of the types and in the
quantities needed for risk-management purposes from acceptable
counterparties;
• the realization of losses arising from litigation filed against us or one or
more of the other FHLBanks;
• the realization of losses arising from our joint and several liability on COs;
• significant business disruptions resulting from natural or other disasters,
acts of war or terrorism; and
• the effect of new accounting standards, including the development of
supporting systems.
These risk factors are not exhaustive. We operate in a changing economic and
regulatory environment, and new risk factors will emerge from time to time. We
cannot predict such new risk factors nor can we assess the impact, if any, of
such new risk factors on our business or the extent to which any factor, or
combination of factors, may cause actual results to differ materially from those
implied by any forward-looking statements.
The Management's Discussion and Analysis of Financial Condition and Results of
Operations should be read in conjunction with our interim financial statements
and notes, which begin on page 3, and the 2011 Annual Report.
EXECUTIVE SUMMARY
Our financial condition continued to strengthen during the quarter ended June
30, 2012, as we recognized net income of $56.0 million for the three months
ended June 30, 2012, versus $21.8 million for the same period in 2011. Credit
losses from the other-than-temporary impairment of investments in private-label
MBS totaled $1.5 million for the three months ended June 30, 2012, compared with
such credit losses of $35.8 million for the comparable period of 2011.
Additionally:
• retained earnings increased from $398.1 million at December 31, 2011, to
$491.8 million at June 30, 2012;
• accumulated other comprehensive loss related to the noncredit portion of
other-than-temporary impairment losses on held-to-maturity securities
improved from an accumulated other comprehensive loss of $451.0 million at
December 31, 2011, to an accumulated other comprehensive loss of $420.4
million at June 30, 2012; and
• we continue to be in compliance with all regulatory capital requirements, as
of June 30, 2012.
On July 26, 2012, our board of directors declared a cash dividend that was
equivalent to an annual yield of 0.52 percent and reiterated that it anticipates
that it will continue to declare modest cash dividends through 2012 consistent
with this dividend declaration, although a quarterly loss or a significant
unforeseen adverse event or trend would cause a dividend to be suspended.
Although our financial condition continues to improve, we continue to face
certain challenges, the foremost of which arise from uncertainties about the
future performance of our private-label MBS, and the continuing, prolonged
low-interest rate environment. We continue to believe that these factors are
likely to negatively impact future earnings, absent unpredictable
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events such as prepayment fee income, and we remain focused on achieving our
retained earnings target through the payment of modest dividends.
• Investments in Private-Label MBS. Although the amortized cost of our total
investments in private-label MBS has fallen to $1.8 billion at June 30, 2012,
compared with $6.4 billion at September 30, 2007, additional losses from that
portfolio are possible. We have determined that eight of our private-label
MBS, representing an aggregated par value of $138.4 million, incurred
additional other-than-temporary impairment credit losses of $1.5 million for
the three months ended June 30, 2012. We continue to update our modeling
assumptions to reflect current developments impacting the loan performance of
the mortgage loans that back our investments in these securities,
particularly Alt-A mortgage loans originated in the period from 2005 to 2007,
which comprise a significant portion of the loans backing these securities.
Such developments include continuing elevated unemployment rates and
generally slow economic growth, high levels of foreclosures and troubled real
estate loans, projections of further declines in house prices and slow
housing price recovery, and limited refinancing opportunities for many
borrowers, especially those whose houses are now worth less than the balance
of their mortgages.
We also update our modeling assumptions based on non-economic factors that
impact or could impact the performance of these investments, including certain
federal programs (and proposed programs) intended to assist and/or protect
borrowers, and related developments that could result in further losses. We
continue to monitor these and related developments, including litigation
involving private-label MBS, which could result in loss severities beyond
current expectations due to disruptions of cash flows from impacted securities
and further depression in real estate prices.
• Advances Balances. The outstanding par balance of advances increased slightly
from $24.6 billion at December 31, 2011, to $25.9 billion at June 30, 2012.
This increase occurred in June and was attributable mainly to short-term
advances. Demand for advances continues to be muted, as our members continue
to experience high levels of deposits. Generally, deposits serve as liquidity
alternatives to advances.
The trend in advances balances is illustrated by the following graph:
[[Image Removed]]
• Continuing and Prolonged Low Interest-Rate Environment. We continue to
operate in a prolonged, historically low interest-rate environment for short-
and long-term financial instruments. We expect the current historically low
interest-rate environment to persist based on actions by the Federal Reserve
to maintain low interest rates combined with other systemic events, such as
the European sovereign debt crisis, which has raised concerns that a Eurozone
recession could slow the U.S. economy. These factors are discussed in greater
detail under Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations - Executive Summary - Continuing and
Prolonged Low-Interest Rate Environment in the 2011 Annual Report. The
Federal Reserve has stated that it anticipates that economic conditions are
likely to warrant exceptionally low levels for the federal funds rate at
least through late 2014. A prolonged low interest-rate environment continues
to adversely impact us in various ways such as members experiencing continued
deposit growth as
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investors face fewer attractive investment alternatives; members significantly
increasing their reliance on short-term advances in lieu of longer-term advances
to enhance their own net interest margins but which typically have lower market
yields for us than longer-term advances; lower market yields on investments (as
we continue to experience), including money market investments in which our
capital is deployed; and faster prepayments on our mortgage-related assets, with
resultant reinvestment risk. Accordingly, our net income and, in turn, our
financial condition and results of operations, are likely to be adversely
impacted by a prolonged low interest-rate environment.
The following chart demonstrates the persistent low interest-rate environment.
[[Image Removed]]
Other significant trends and developments include the following:
• Strong Net Interest Margin. Despite the historically low interest rate
environment, we continue to achieve a favorable net interest margin. Net
interest margin is expressed as the percentage of net interest income to
average earning assets. Net interest margin for the three months ended
June 30, 2012, was 0.78 percent, a 21 basis point increase from net interest
margin for the three months ended June 30, 2011. Prepayment-fee income was an
important contributor to net interest margin for the three months ended
June 30, 2012, as demonstrated by the tables captioned "Net Interest Spread
and Margin without Prepayment-Fee Income" under - Results of Operations -
Rate and Volume Analysis. These prepayment fees represent a substantial and
atypical contribution to our net income that should not be counted on to
recur every year. Further, the increase in net interest margin was achieved
despite the continuing low-interest rate environment due in part to continued
low average funding costs, which were attributable to two main factors.
First, demand for COs remained strong and funding costs remained low
throughout the first half of 2012. Second, as interest rates remained at low
levels, we continued to benefit from having refinanced callable debt used to
fund our fixed-rate residential mortgage loans in prior periods as interest
rates fell, due in part to the fact that prepayment and refinancing activity
in that loan portfolio has been muted relative to our expectations at the
time we acquired the loans. During the 12 months ended June 30, 2012, we
exercised redemption options on $1.9 billion of callable bonds that were not
swapped to a floating rate coupon. Other factors behind the improvement in
net interest margin include an increase in yields on certain previously
other-than-temporarily impaired private-label MBS for which a significant
improvement in cash flows has been projected and lower than expected
prepayment activity on fixed-rate mortgage-related assets.
Notwithstanding our success in achieving strong net interest margin and strong
net interest spread for the quarter, we expect these measurements to modestly
decline in the remaining half of 2012 based on the sustained low interest-rate
environment noted above combined with the fact that we face limited
opportunities to redeem and refinance our debt, while our seasoned investments
in mortgage loans (including fixed-rate agency MBS) will continue to amortize.
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• Legislative and Regulatory Developments. We continue to operate in a
legislative and regulatory environment undergoing profound change with
additional changes occurring during the period covered by this report. These
changes are likely to have multiple important impacts on us, as discussed
under - Legislative and Regulatory Developments.
• Unsecured Credit Exposure to Eurozone Counterparties. We have unsecured
credit exposures to counterparties from time to time, including
Eurozone-domiciled counterparties. Eurozone refers to the economic and
monetary union of 17 European Union member states that have adopted the euro.
Some of those exposures arise from the sale of federal funds. However, we
only sell federal funds to highly rated Eurozone counterparties on an
overnight basis at our discretion. Further, these counterparties are only
domiciled in Eurozone countries that have not been identified as countries
experiencing significant sovereign distress as a result of the Eurozone
crisis. We sell federal funds principally for the short-term investment of
our liquidity. For additional information on our periodic unsecured credit
exposures and management of those exposures, see -Financial Condition -
Investments Credit Risk and - Financial Condition - Derivatives Instruments
Credit Risk.
• Key Management Changes. Earl W. Baucom, executive vice president and chief
operations officer, retired on May 15, 2012. Mr. Baucom's responsibilities
were reallocated internally.
On July 17, 2012, Michael C. Clifton joined us as senior vice president and
chief information officer. Most recently, Mr. Clifton was vice president and
chief information officer with The Hanover Insurance Group, where he had been
employed since 2003 in progressively expansive roles. Mr. Clifton is a graduate
of the University of Massachusetts Lowell with a B.S. in Industrial Engineering.
SELECTED FINANCIAL DATA
The following financial highlights for the statement of condition for December
31, 2011, have been derived from our audited financial statements. Financial
highlights for the quarter-ends have been derived from our unaudited financial
statements.
SELECTED FINANCIAL DATA
STATEMENT OF CONDITION
(dollars in thousands)
June 30, March 31, December 31, September 30, June 30,
2012 2012 2011 2011 2011
Statement of Condition Data
at Quarter End
Total assets $ 49,763,227 $ 46,911,899 $ 49,968,337 $ 48,574,433 $ 52,233,694
Investments (1) 19,363,944 18,589,831 21,379,548 19,916,085 22,087,442
Advances 26,456,739 24,891,964 25,194,898 25,024,689 26,204,125
Mortgage loans held for
portfolio (2) 3,311,457 3,166,457 3,109,223 3,128,725 3,132,935
Deposits 668,836 760,374 654,246 740,946 745,493
Consolidated obligations
Bonds 27,622,744 28,533,735 29,879,460 32,446,525 34,887,060
Discount notes 16,610,160 12,834,056 14,651,793 10,673,491 12,052,598
Total consolidated
obligations 44,232,904 41,367,791 44,531,253 43,120,016 46,939,658
Mandatorily redeemable
capital stock 215,863 214,859 227,429 227,429 227,429
Class B capital stock
outstanding - putable (3) 3,420,870 3,402,556 3,625,348 3,583,749 3,572,301
Unrestricted retained
earnings 448,330 408,154 375,158 326,099 288,520
Restricted retained
earnings 43,496 32,299 22,939 9,997 -
Total retained earnings 491,826 440,453 398,097 336,096 288,520
Accumulated other
comprehensive loss (528,442 ) (519,832 ) (534,411 ) (516,717 ) (495,261 )
Total capital 3,384,254 3,323,177 3,489,034 3,403,128 3,365,560
Other Information
Total regulatory capital
ratio (4) 8.3 % 8.7 % 8.5 % 8.5 % 7.8 %
_________________________
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(1) Investments include available-for-sale securities, held-to-maturity
securities, trading securities, interest-bearing deposits, securities
purchased under agreements to resell, and federal funds sold.
(2) The allowance for credit losses amounted to $6.1 million, $6.6 million, $7.8
million, $7.2 million, and $7.2 million as of June 30, 2012, March 31, 2012,
December 31, 2011, September 30, 2011, and June 30, 2011, respectively.
(3) Capital stock is putable at the option of a member.
(4) Total regulatory capital ratio is capital stock (including mandatorily
redeemable capital stock) plus retained earnings as a percentage of total
assets. See - Liquidity and Capital Resources - Capital regarding our regulatory
capital ratios.
SELECTED FINANCIAL DATA
RESULTS OF OPERATIONS AND OTHER INFORMATION
(dollars in thousands)
For the Three Months Ended
June 30, March 31, December 31, September 30, June 30,
2012 2012 2011 2011 2011
Results of Operations
Net interest income $ 89,552 $ 68,342 $ 82,026 $ 80,410 $ 76,589
(Reduction of) provision
for credit losses (383 ) (1,151 ) 627 - (1,509 )
Net impairment losses on
held-to-maturity securities
recognized in income (1,492 ) (2,960 ) (3,479 ) (7,210 ) (35,794 )
Other income (loss) (10,531 ) 1,245 10,001 (1,659 ) 5,007
Other expense 15,671 15,746 15,994 15,982 17,803
AHP and REFCorp assessments
(1) 6,253 5,232 7,220 5,573 7,732
Net income $ 55,988 $ 46,800 $ 64,707 $ 49,986 $ 21,776
Other Information
Dividends declared $ 4,615 $ 4,444 $ 2,706 $ 2,410 $ 2,800
Dividend payout ratio 8.24 % 9.49 % 4.18 % 4.82 % 12.86 %
Weighted average dividend
rate (2) 0.52 0.49 0.30 0.27 0.31
Return on average equity
(3) 6.70 5.44 7.43 5.84 2.63
Return on average assets 0.49 0.38 0.51 0.39 0.16
Net interest margin (4) 0.78 0.56 0.65 0.63 0.57
Average equity to average
assets 7.25 7.06 6.88 6.64 6.18
___________________________
(1) The FHLBanks satisfied their obligation to REFCorp in the second quarter of
2011.
(2) Weighted-average dividend rate is dividend amount declared divided by the
average daily balance of capital stock.
(3) Return on average equity is net income divided by the total of the average
daily balance of outstanding Class B capital stock, accumulated other
comprehensive loss, and retained earnings.
(4) Net interest margin is net interest income before provision for credit losses
as a percentage of average earning assets.
RESULTS OF OPERATIONS
Second Quarter of 2012 Compared with Second Quarter of 2011
For the three months ended June 30, 2012, and 2011, we recognized net income of
$56.0 million and $21.8 million, respectively. This $34.2 million increase was
driven by a decrease of $34.3 million in other-than-temporary impairment losses
of certain private-label MBS, a $13.0 million increase in net interest income, a
decrease in assessments of $1.5 million due to the fulfillment of the REFCorp
obligation in August 2011, a $2.2 million increase in other income, and a
decline of $2.5 million in other expense. The increases to net income were
offset by a loss on early extinguishment of debt of $12.0 million, a decline of
$4.4 million in realized gains on sales of available-for-sale securities, and a
$1.1 million net change to the provision for (reduction of) credit losses on
mortgage loans.
Six Months Ended June 30, 2012, Compared with Six Months Ended June 30, 2011
For the six months ended June 30, 2012, and 2011, we recognized net income of
$102.8 million and $44.9 million, respectively. This $57.9 million increase was
driven by a decrease of $61.9 million in other-than-temporary impairment losses
of certain
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private-label MBS, a $14.4 million increase in net interest income, a decrease
in assessments of $4.6 million due to the fulfillment of the REFCorp obligation
in August 2011, a decline of $2.4 million in other expense, and a $2.2 million
increase in other income. The increases to net income were partially offset by a
decline of $12.8 million in realized gains on sales of available-for-sale
securities, and a loss on early extinguishment of debt of $12.0 million.
Net Interest Income
Second Quarter of 2012 Compared with Second Quarter of 2011
Net interest income for the three months ended June 30, 2012, was $89.6 million,
compared with $76.6 million for the same period in 2011. This increase was
primarily attributable to the $17.6 million increase in prepayment fee income,
which partly contributed to an increase of 26 basis points in the yield on
interest earning assets to 1.71 percent. In addition, the average cost of
interest-bearing liabilities increased 7 basis points to 1.03 percent.
Net interest margin for the three months ended June 30, 2012, in comparison with
the same period in 2011, increased to 78 basis points from 57 basis points, and
net interest spread increased to 68 basis points from 49 basis points for the
same period in 2011. Partially offsetting the increase in net interest spread
was a decrease in average earning assets, which declined by $7.7 billion from
$53.7 billion for the three months ended June 30, 2011, to $46.1 billion for the
three months ended June 30, 2012.
Six Months Ended June 30, 2012, Compared with Six Months Ended June 30, 2011
Net interest income for the six months ended June 30, 2012, was $157.9 million,
compared with $143.5 million for the same period in 2011. This increase was
primarily attributable to the $20.8 million increase in prepayment fee income,
which partly contributed to an increase of 15 basis points in the yield on
interest earning assets to 1.58 percent. In addition, the average cost of
interest-bearing liabilities increased 3 basis points to 1.01 percent.
Net interest margin for the six months ended June 30, 2012 increased to 67 basis
points compared with 53 basis points in the same period in 2011, and net
interest spread increased to 57 basis points compared with 45 basis points in
the same period in 2011. Partially offsetting the increase in net interest
spread was a decrease in average earning assets, which declined by $7.1 billion
from $54.5 billion for the six months ended June 30, 2011, to $47.4 billion for
the six months ended June 30, 2012.
The following tables present major categories of average balances, related
interest income/expense, and average yields for interest-earning assets and
interest-bearing liabilities. Our primary source of earnings is net interest
income, which is the interest earned on advances, mortgage loans, and
investments less interest paid on COs, deposits, and other sources of funds. Net
interest spread is the difference between the yields on interest-earning assets
and interest-bearing liabilities.
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Net Interest Spread and Margin
(dollars in thousands)
For the Three Months Ended June 30,
2012 2011
Interest Interest
Average Income / Average Average Income / Average
Balance Expense Yield (1) Balance Expense Yield (1)
Assets
Advances $ 23,757,804 $ 101,139 1.71 % $ 25,728,128 $ 93,153 1.45 %
Interest-bearing
deposits 271 1 0.91 196 - 0.35
Securities purchased
under agreements to
resell 5,519,231 2,425 0.18 1,462,088 405 0.11
Federal funds sold 1,382,033 517 0.15 5,085,670 1,357 0.11
Investment
securities(2) 12,144,420 57,664 1.91 18,314,492 62,138 1.36
Mortgage loans 3,254,214 34,548 4.27 3,141,594 37,855 4.83Other earning assets - - - 2,473 1 0.12
Total
interest-earning
assets 46,057,973 196,294 1.71 % 53,734,641 194,909 1.45 %
Other
non-interest-earning
assets 486,899 435,971
Fair value
adjustments on
investment securities (150,352 ) (363,184 )
Total assets $ 46,394,520 $ 196,294 1.70 % $ 53,807,428 $ 194,909 1.45 %
Liabilities and
capital
Consolidated
obligations
Discount notes $ 12,437,517 $ 2,913 0.09 % $ 12,833,972 $ 2,123 0.07 %
Bonds 28,395,930 103,532 1.47 35,669,691 115,990 1.30
Deposits 717,819 13 0.01 762,167 73 0.04
Mandatorily
redeemable capital
stock 215,079 284 0.53 204,858 133 0.26
Other borrowings 1,781 - 0.16 1,341 1 0.30
Total
interest-bearing
liabilities 41,768,126 106,742 1.03 % 49,472,029 118,320 0.96 %
Other
non-interest-bearing
liabilities 1,263,194 1,009,611
Total capital 3,363,200 3,325,788
Total liabilities and
capital $ 46,394,520 $ 106,742 0.93 % $ 53,807,428 $ 118,320 0.88 %
Net interest income $ 89,552 $ 76,589
Net interest spread 0.68 % 0.49 %
Net interest margin 0.78 % 0.57 %
_________________________
(1) Yields are annualized.
(2) The average balances of held-to-maturity securities and
available-for-sale securities are reflected at amortized cost; therefore the
resulting yields do not give effect to changes in fair value or the noncredit
component of a previously recognized other-than-temporary impairment reflected
in accumulated other comprehensive loss.
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Net Interest Spread and Margin
(dollars in thousands)
For the Six Months Ended June 30,
2012 2011
Interest Interest
Average Income / Average Average Income / Average
Balance Expense Yield (1) Balance Expense Yield (1)
Assets
Advances $ 24,285,950 $ 184,960 1.53 % $ 26,303,453 $ 180,834 1.39 %
Interest-bearing
deposits 264 1 0.69 199 - 0.44
Securities purchased
under agreements to
resell 6,131,319 4,614 0.15 1,316,575 945 0.14
Federal funds sold 1,676,994 1,028 0.12 5,453,254 3,758 0.14
Investment
securities(2) 12,101,203 113,439 1.89 18,267,935 125,665 1.39
Mortgage loans 3,183,640 69,313 4.38 3,174,916 76,189 4.84Other earning assets - - - 1,519 1 0.13
Total
interest-earning
assets 47,379,370 373,355 1.58 % 54,517,851 387,392 1.43 %
Other
non-interest-earning
assets 493,203 466,655
Fair-value
adjustments on
investment securities (153,936 ) (408,036 )
Total assets $ 47,718,637 $ 373,355 1.57 % $ 54,576,470 $ 387,392 1.43 %
Liabilities and
capital
Consolidated
obligations
Discount notes $ 13,051,978 $ 4,496 0.07 % $ 14,023,513 $ 7,262 0.10 %
Bonds 29,015,791 210,359 1.46 35,280,936 236,116 1.35
Deposits 758,471 31 0.01 774,882 202 0.05
Mandatorily
redeemable capital
stock 219,666 574 0.53 148,176 269 0.37
Other borrowings 2,093 1 0.14 3,762 3 0.16
Total
interest-bearing
liabilities 43,047,999 215,461 1.01 % 50,231,269 243,852 0.98 %
Other
non-interest-bearing
liabilities 1,258,487 1,026,506
Total capital 3,412,151 3,318,695
Total liabilities and
capital $ 47,718,637 $ 215,461 0.91 % $ 54,576,470 $ 243,852 0.90 %
Net interest income $ 157,894 $ 143,540
Net interest spread 0.57 % 0.45 %
Net interest margin 0.67 % 0.53 %
_________________________
(1) Yields are annualized.
(2) The average balances of held-to-maturity securities and
available-for-sale securities are reflected at amortized cost; therefore the
resulting yields do not give effect to changes in fair value or the noncredit
component of a previously recognized other-than-temporary impairment reflected
in accumulated other comprehensive loss.
Rate and Volume Analysis
Changes in both average balances (volume) and interest rates influence changes
in net interest income and net interest margin. The following table summarizes
changes in interest income and interest expense for the three and six months
ended June 30, 2012, and 2011. Changes in interest income and interest expense
that are not identifiable as either volume-related or rate-related, but rather
equally attributable to both volume and rate changes, have been allocated to the
volume and rate categories based upon the proportion of the absolute value of
the volume and rate changes.
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Rate and Volume Analysis
(dollars in thousands)
For the Three Months Ended For the Six Months Ended
June 30, 2012 vs. June 30, 2011June 30, 2012 vs. June 30, 2011
Increase (Decrease) due to Increase (Decrease) due to
Volume Rate Total Volume Rate Total
Interest income
Advances $ (7,514 ) $ 15,500 $ 7,986 $ (14,492 ) $ 18,618 $ 4,126
Interest-bearing
deposits - - - - - -
Securities purchased
under agreements to
resell 1,668 352 2,020 3,621 48 3,669
Federal funds sold (1,244 ) 404 (840 ) (2,354 ) (376 ) (2,730 )
Investment securities (24,760 ) 20,286 (4,474 ) (49,838 ) 37,612 (12,226 )
Mortgage loans 1,320 (4,627 ) (3,307 ) 209 (7,085 ) (6,876 )
Other earning assets - - - (1 ) (1 ) (2 )
Total interest income (30,530 ) 31,915 1,385 (62,855 ) 48,816 (14,039 )
Interest expense
Consolidated
obligations
Discount notes (67 ) 857 790 (474 ) (2,292 ) (2,766 )
Bonds (25,451 ) 12,993 (12,458 ) (44,306 ) 18,549 (25,757 )
Deposits (4 ) (56 ) (60 ) (4 ) (167 ) (171 )
Mandatorily
redeemable capital
stock 7 144 151 160 145 305
Other borrowings - (1 ) (1 ) (1 ) (1 ) (2 )
Total interest
expense (25,515 ) 13,937 (11,578 ) (44,625 ) 16,234 (28,391 )
Change in net
interest income $ (5,015 ) $ 17,978 $ 12,963 $ (18,230 ) $ 32,582 $ 14,352
The average balance of total advances decreased $2.0 billion, or 7.7 percent,
for the six months ended June 30, 2012, compared with the same period in 2011.
The trend of muted demand for advances is discussed under - Executive Summary -
Advances Balances. The following table summarizes average balances of advances
outstanding during the six months ending June 30, 2012 and 2011, by product
type.
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Average Balance of Advances Outstanding by Product Type
(dollars in thousands)
For the Six Months Ended June 30,
2012 2011
Fixed-rate advances-par value
Long-term $ 10,095,932 $ 11,037,192
Putable 4,352,082 5,662,023
Short-term 3,913,311 2,606,701
Amortizing 1,205,402 1,640,340
Overnight 295,727 524,088
Expander 20,604 10,000
Fixed-rate plus cap 10,000 166
Callable 7,940 6,749
19,900,998 21,487,259
Variable-rate indexed advances-par value
Simple variable 3,768,247 4,198,274
Floating rate advances with embedded caps and /
or floors 10,000 10,914
Overnight 9,917 10,472
3,788,164 4,219,660
Total average par value 23,689,162 25,706,919
Net premiums and (discounts) 13,908 6,527
Hedging adjustments 582,880 590,007
Total average balance of advances $ 24,285,950 $ 26,303,453
Putable advances that are classified as fixed-rate advances in the table above
are typically hedged with interest-rate-exchange agreements in which a
short-term rate is received, typically three-month LIBOR. In addition,
approximately 24.1 percent of average long-term fixed-rate advances were
similarly hedged with interest-rate swaps. Therefore, a significant portion of
our advances, including overnight advances, short-term fixed-rate advances,
fixed-rate putable advances, certain fixed-rate bullet advances, and
variable-rate advances, either earn a short-term interest rate or are swapped to
a short-term index, resulting in yields that closely follow short-term market
interest-rate trends. The average balance of all such advances totaled $14.8
billion for the six months ended June 30, 2012, representing 62.4 percent of the
total average balance of advances outstanding during the six months ended
June 30, 2012. The average balance of all such advances totaled $16.0 billion
for the six months ended June 30, 2011, representing 62.2 percent of the total
average balance of advances outstanding during the six months ended June 30,
2011.
For the six months ended June 30, 2012 and 2011, net prepayment fees on advances
were $32.5 million and $11.3 million, respectively. For the six months ended
June 30, 2012 and 2011, prepayment fees on investments were $202,000 and
$549,000, respectively. Prepayment-fee income is unpredictable and inconsistent
from period to period, occurring only when advances and investments are prepaid
prior to the scheduled maturity or repricing dates.
Because prepayment-fee income recognized during these periods does not
necessarily represent a trend that will continue in future periods, and due to
the fact that prepayment-fee income represents a one-time fee that is generally
recognized in the period in which the corresponding advance or investment
security is prepaid, we believe it is important to review the results of net
interest spread and net interest margin excluding the impact of prepayment-fee
income. These results are presented in the following table.
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Net Interest Spread and Margin without Prepayment-Fee Income
(dollars in thousands)
For the Three Months Ended June 30, For the Six Months Ended June 30,
2012 2011 2012 2011
Interest Interest Interest
Income Average Yield Income Average Yield Interest Income Average Yield Income Average Yield
Advances $ 72,967 1.24 % $ 83,019 1.29 % $ 152,486 1.26 % $ 169,507 1.30 %
Investment
securities 57,549 1.91 61,603 1.35 113,237 1.88 125,116 1.38
Total
interest-earning
assets 168,007 1.47 184,240 1.38 340,679 1.45 375,516 1.39
Net interest
income 61,265 65,920 125,218 131,664
Net interest
spread 0.44 % 0.42 % 0.44 % 0.41 %
Net interest
margin 0.53 % 0.49 % 0.53 % 0.49 %
Average short-term money-market investments, consisting of interest-bearing
deposits, securities purchased under agreements to resell, and federal funds
sold, increased $1.0 billion, or 15.3 percent, for the six months ended June 30,
2012, compared with the same period in 2011. The yield earned on short-term
money-market investments is highly correlated to short-term market interest
rates. These investments are used for liquidity management and to manage our
leverage ratio in response to fluctuations in other asset balances. For the six
months ended June 30, 2012, average balances of federal funds sold decreased
$3.8 billion and average balances of securities purchased under agreements to
resell increased $4.8 billion in comparison to the six months ended June 30,
2011.
Average investment-securities balances decreased $6.2 billion or 33.8 percent
for the six months ended June 30, 2012, compared with the same period in 2011,
which occurred in the following investment categories:
• $4.8 billion decline in certificates of deposit
• $620.1 million decline in MBS
• $591.5 million decline in agency and supranational banks, and
• $154.7 million decline in corporate bonds.
The average aggregate balance of our investments in mortgage loans for the six
months ended June 30, 2012, was $8.7 million higher than the average aggregate
balance of these investments for the six months ended June 30, 2011,
representing an increase of 0.3 percent.
Average CO balances decreased $7.2 billion, or 14.7 percent, for the six months
ended June 30, 2012, compared with the same period in 2011, resulting from our
reduced funding needs principally due to the decline in our investments and
member demand for advances. This overall decline consisted of a decrease of $1.0
billion in CO discount notes and a decrease of $6.3 billion in CO bonds.
The average balance of term CO discount notes increased $1.5 billion and
overnight CO discount notes decreased $2.5 billion for the six months ended
June 30, 2012, in comparison with the same period in 2011. The average balance
of CO discount notes represented approximately 31.0 percent of total average COs
during the six months ended June 30, 2012, as compared with 28.4 percent of
total average COs during the six months ended June 30, 2011. The average balance
of bonds represented 69.0 percent and 71.6 percent of total average COs
outstanding during the six months ended June 30, 2012 and 2011, respectively.
Impact of Derivative and Hedging Activity
Net interest income includes interest accrued on interest-rate-exchange
agreements that are associated with advances, investments, deposits, and debt
instruments that qualify for hedge accounting. We generally use derivative
instruments that qualify for hedge accounting as interest-rate-risk-management
tools. These derivatives serve to stabilize net interest income and net interest
margin when interest rates fluctuate. Accordingly, the impact of derivatives on
net interest income and net interest margin should be viewed in the overall
context of our risk-management strategy. The following tables show the net
effect of
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derivatives and hedging activities on net interest income, net gains (losses) on
derivatives and hedging activities, and net unrealized gains (losses) on trading
securities for the three months ended June 30, 2012 and 2011 (dollars in
thousands).
For the Three Months Ended June 30, 2012
Net Effect of Derivatives
and Hedging Activities Advances Investments Mortgage Loans Deposits CO Bonds Total
Net interest income
Amortization/accretion of
hedging activities in net
interest income (1) $ (2,602 ) $ - $ (19 ) $ - $ 5,643 $ 3,022
Net interest settlements
included in net interest
income (2) (49,414 ) (10,227 ) - 385 23,052 (36,204 )
Total effect on net
interest income (52,016 ) (10,227 ) (19 ) 385 28,695 (33,182 )
Net gains (losses) on
derivatives and hedging
activities
(Losses) gains on
fair-value hedges (1,913 ) 111 - - 400 (1,402 )
Losses on derivatives not
receiving hedge accounting (498 ) (7,562 ) - - (9 ) (8,069 )
Other - - 1,309 - - 1,309
Net (losses) gains on
derivatives and hedging
activities (2,411 ) (7,451 ) 1,309 - 391 (8,162 )
Subtotal (54,427 ) (17,678 ) 1,290 385 29,086 (41,344 )
Net gains on trading
securities - 5,720 - - - 5,720
Total net effect of
derivatives and hedging
activities $ (54,427 ) $ (11,958 ) $ 1,290
$ 385$ 29,086 $ (35,624 )
_____________________
(1) Represents the amortization/accretion of hedging fair-value adjustments for
closed hedge positions.
(2) Represents interest income/expense on derivatives included in net interest
income.
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For the Three Months Ended June 30, 2011
Net Effect of Derivatives
and Hedging Activities Advances Investments Mortgage Loans Deposits CO Bonds Total
Net interest income
Amortization/accretion of
hedging activities in net
interest income (1) $ (3,373 ) $ - $ 42 $ - $ 1,175 $ (2,156 )
Net interest settlements
included in net interest
income (2) (72,546 ) (11,889 ) - 392 42,738 (41,305 )
Total effect on net
interest income (75,919 ) (11,889 ) 42 392 43,913 (43,461 )
Net gains (losses) on
derivatives and hedging
activities
Gains on fair-value hedges 113 290 - - 266 669
Losses on derivatives not
receiving hedge accounting (1,197 ) (7,692 ) - - - (8,889 )
Other - - 346 - - 346
Net (losses) gains on
derivatives and hedging
activities (1,084 ) (7,402 ) 346 - 266 (7,874 )
Subtotal (77,003 ) (19,291 ) 388 392 44,179 (51,335 )
Net gains on trading
securities (3) - 5,868 - - - 5,868
Total net effect of
derivatives and hedging
activities $ (77,003 ) $ (13,423 ) $ 388 $ 392 $ 44,179 $ (45,467 )
_____________________
(1) Represents the amortization/accretion of hedging fair-value adjustments for
closed hedge positions.
(2) Represents interest income/expense on derivatives included in net interest
income.
(3) Includes only those gains or losses on trading securities that have an
economic derivative assigned, and therefore, this line does not reconcile with
the statement of operations.
For the Six Months Ended June 30, 2012
Net Effect of Derivatives
and Hedging Activities Advances Investments Mortgage Loans Deposits CO Bonds Total
Net interest income
Amortization/accretion of
hedging activities in net
interest income (1) $ (4,797 ) $ - $ (90 ) $ - $ 9,585 $ 4,698
Net interest settlements
included in net interest
income (2) (103,679 ) (20,370 ) - 766 48,005 (75,278 )
Total effect on net interest
income (108,476 ) (20,370 ) (90 ) 766 57,590 (70,580 )
Net (losses) gains on
derivatives and hedging
activities
(Losses) gains on fair-value
hedges (1,552 ) 793 - - 417 (342 )
Losses on derivatives not
receiving hedge accounting (539 ) (6,852 ) - - (9 ) (7,400 )
Other - - 1,319 - - 1,319
Net (losses) gains on
derivatives and hedging
activities (2,091 ) (6,059 ) 1,319 - 408 (6,423 )
Subtotal (110,567 ) (26,429 ) 1,229 766 57,998 (77,003 )
Net gains on trading
securities - 3,622 - - - 3,622
Total net effect of
derivatives and hedging
activities $ (110,567 ) $ (22,807 ) $ 1,229 $ 766 $ 57,998 $ (73,381 )
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_____________________
(1) Represents the amortization/accretion of hedging fair-value adjustments for
closed hedge positions.
(2) Represents interest income/expense on derivatives included in net interest
income.
For the Six Months Ended June 30, 2011
Net Effect of Derivatives
and Hedging Activities Advances Investments Mortgage Loans Deposits CO Bonds Total
Net interest income
Amortization/accretion of
hedging activities in net
interest income (1) $ (5,821 ) $ - $ 129 $ - $ 1,592 $ (4,100 )
Net interest settlements
included in net interest
income (2) (149,809 ) (23,934 ) - 786 85,578 (87,379 )
Total effect on net
interest income (155,630 ) (23,934 ) 129 786 87,170 (91,479 )
Net gains (losses) on
derivatives and hedging
activities
Gains on fair-value hedges 468 708 - - 225 1,401
Losses on derivatives not
receiving hedge accounting (1,218 ) (6,655 ) - - - (7,873 )
Other - - 419 - - 419
Net (losses) gains on
derivatives and hedging
activities (750 ) (5,947 ) 419 - 225 (6,053 )
Subtotal (156,380 ) (29,881 ) 548 786 87,395 (97,532 )
Net gains on trading
securities (3) - 3,962 - - - 3,962
Total net effect of
derivatives and hedging
activities $ (156,380 ) $ (25,919 ) $ 548 $ 786 $ 87,395 $ (93,570 )
_____________________
(1) Represents the amortization/accretion of hedging fair-value adjustments for
closed hedge positions.
(2) Represents interest income/expense on derivatives included in net interest
income.
(3) Includes only those gains or losses on trading securities that have an
economic derivative assigned, and therefore, this line does not reconcile with
the statement of operations.
Net interest margin for the three months ended June 30, 2012 and 2011, was 0.78
percent and 0.57 percent, respectively. If derivative instruments had not been
used as hedges to mitigate the impact of interest-rate fluctuations, net
interest margin would have been 1.10 percent and 0.88 percent, respectively.
Net interest margin for the six months ended June 30, 2012 and 2011, was 0.67
percent and 0.53 percent, respectively. If derivative instruments had not been
used as hedges to mitigate the impact of interest-rate fluctuations, net
interest margin would have been 0.99 percent and 0.86 percent, respectively.
Interest paid and received on interest-rate-exchange agreements that are used in
asset and liability management, but which do not meet hedge-accounting
requirements (economic hedges), are classified as net losses on derivatives and
hedging activities in other income. As shown under Other Income (Loss) and
Operating Expenses below, interest accruals on derivatives classified as
economic hedges totaled a net expense of $1.9 million and $2.3 million,
respectively for the three months ended June 30, 2012 and 2011. For the six
months ended June 30, 2011, interest accruals on derivatives classified as
economic hedges totaled a net expense of $3.8 million and $4.9 million,
respectively.
For more information about our use of derivative instruments to manage
interest-rate risk, see Item 3 - Quantitative and Qualitative Disclosures about
Market Risk - Strategies to Manage Market and Interest-Rate Risk.
Other Income (Loss) and Operating Expenses
The following table presents a summary of other income (loss) for the three and
six months ended June 30, 2012 and 2011.
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Additionally, detail on the components of net gains (losses) on derivatives and
hedging activities is provided, indicating the source of these gains and losses
by type of hedging relationship and hedge accounting treatment.
Other Income (Loss)
(dollars in thousands)
For the Three Months Ended For the Six Months Ended
June 30, June 30,
2012 2011 2012 2011
Gains (losses) on derivatives and
hedging activities:
Net (losses) gains related to
fair-value hedge ineffectiveness $ (1,403 ) $ 669 $ (343 ) $ 1,401
Net unrealized (losses) gains
related to derivatives not
receiving hedge accounting
associated with:
Advances (430 ) (782 ) (397 ) (201 )
Trading securities (5,716 ) (5,761 ) (3,176 ) (2,799 )
Mortgage delivery commitments 1,309 346 1,319 419
Net interest-accruals related to
derivatives not receiving hedge
accounting (1,922 ) (2,346 ) (3,826 ) (4,873 )
Net losses on derivatives and
hedging activities (8,162 ) (7,874 ) (6,423 ) (6,053 )
Net impairment losses on
held-to-maturity securities
recognized in income (1,492 ) (35,794 ) (4,452 ) (66,378 )
Loss on early extinguishment of
debt (12,001 ) - (12,001 ) -
Service-fee income 1,492 2,412 2,991 4,457
Net unrealized gains on trading
securities 5,720 5,853 3,622 3,956
Realized net gain from sale of
available-for-sale securities - 4,432 - 12,801
Other 2,420 184 2,525 338
Total other loss $ (12,023 ) $ (30,787 ) $ (13,738 ) $ (50,879 )
Losses on early extinguishment of debt resulted from the retirement of $316.5
million (par amount) of CO bonds. These debt extinguishments followed the
prepayment of $1.3 billion of advances by First Niagara Bank in April 2012, as
discussed under - Financial Condition - Advances.
The following tables display held-to-maturity securities for which
other-than-temporary impairment was recognized in the three and six months
ending June 30, 2012 and 2011, based on whether the security is newly impaired
or previously impaired (dollars in thousands).
For the Three Months Ended June 30, 2012 For the Three Months Ended June 30, 2011
Net Amount of
Impairment Net Amount of
Total Other- Losses Net Impairment
Than- Reclassified Impairment Total Other- Losses Net Impairment
Temporary to Losseson Than-Temporary Reclassified Losses on
Impairment Accumulated Investment Impairment to (from) Investment
Other-Than- Losses on Other Securities Losses on Accumulated Securities
Temporarily Impaired Investment Comprehensive Recognized in Investment Other Recognized in
Investment: Securities Loss Income Securities Comprehensive Loss Income
Securities newly
impaired during the
period specified $ (579 ) $ 579 $ - $ (1,144 ) $ 1,100 $ (44 )
Securities previously
impaired prior to the
period specified (5,184 ) 3,692 (1,492 ) (15,715 ) (20,035 ) (35,750 )
Total
other-than-temporarily
impaired securities $ (5,763 ) $ 4,271 $ (1,492 ) $ (16,859 ) $ (18,935 ) $ (35,794 )
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For the Six Months Ended June 30, 2012 For the Six Months Ended June 30, 2011
Net Amount of
Impairment Net Amount of
Total Other- Losses Net Impairment
Than- Reclassified Impairment Total Other- Losses Net Impairment
Temporary to Losseson Than-Temporary Reclassified Losses on
Impairment Accumulated Investment Impairment to (from) Investment
Other-Than- Losses on Other Securities Losses on Accumulated Securities
Temporarily Impaired Investment Comprehensive Recognized in Investment
Other Recognized in
Investment: Securities Loss Income Securities Comprehensive Loss Income
Securities newly
impaired during the
period specified $ (3,109 ) $ 3,108 $ (1 ) $ (6,072 ) $ 6,026 $ (46 )
Securities previously
impaired prior to the
period specified (9,032 ) 4,581 (4,451 ) (17,574 ) (48,758 ) (66,332 )
Total
other-than-temporarily
impaired securities $ (12,141 ) $ 7,689 $ (4,452 ) $ (23,646 ) $ (42,732 ) $ (66,378 )
The following table displays held-to-maturity securities for which
other-than-temporary impairment was recognized in the quarter ending June 30,
2012 (dollars in thousands). Securities are classified in the table below based
on the classification at the time of issuance. We have instituted litigation on
certain of the private-label MBS in which we have invested, as discussed in Part
II - Item 1 - Legal Proceedings. Our complaint asserts among others, claims for
untrue or misleading statements in the sale of securities, and it is possible
that classifications of private-label MBS as provided herein when based on
classification at the time of issuance as disclosed by those securities'
issuance documents, as well as other statements made by or on behalf of the
issuers about the securities, are inaccurate.
For the Three Months Ended
At June 30, 2012 June 30, 2012
Other-than-Temporary
Other-Than-Temporarily Amortized Carrying Impairment Related to
Impaired Investment: Par Value Cost Value Fair Value
Credit Loss
Private-label residential
MBS - Alt-A $ 138,447 $ 103,445 $ 74,615 $ 75,316 $ (1,492 )
See Item 1 - Notes to the Financial Statements - Note 5 - Held-to-Maturity
Securities, Note 6 - Other-Than-Temporary Impairment, and - Financial Condition
- Investments Credit Risk below for additional detail and analysis of our
portfolio of held-to-maturity investments in private-label MBS.
Changes in the fair value of trading securities are recorded in other loss. For
the three months ended June 30, 2012 and 2011, we recorded net unrealized gains
on trading securities of $5.7 million and $5.9 million, respectively. Changes in
the fair value of the associated economic hedges amounted to net losses of $5.7
million and $5.8 million for the three months ended June 30, 2012 and 2011,
respectively. Also included in other loss are interest accruals on these
economic hedges, which resulted in a net expense of $1.8 million and $1.9
million for the three months ended June 30, 2012 and 2011, respectively.
For the six months ended June 30, 2012 and 2011, we recorded net unrealized
gains on trading securities of $3.6 million and $4.0 million, respectively.
Changes in the fair value of the associated economic hedges amounted to net
losses of $3.2 million and $2.8 million for the three months ended June 30, 2012
and 2011, respectively. Also included in other loss are interest accruals on
these economic hedges, which resulted in a net expense of $3.7 million and $3.9
million for the six months ended June 30, 2012 and 2011, respectively.
For the three months ended June 30, 2012, compensation and benefits expense and
other operating expenses amounted to $13.3 million, an increase of $229,000 from
the June 30, 2011 amount of $13.0 million.
For the six months ended June 30, 2012, compensation and benefits expense and
other operating expenses amounted to $26.4 million, an increase of $807,000 from
the June 30, 2011 amount of $25.6 million.
Our share of the costs and expenses of operating the Finance Agency and the
Office of Finance totaled $1.8 million and $1.7 million for the three months
ended June 30, 2012 and 2011, respectively, and totaled $3.8 million and $4.0
million for the six months ended June 30, 2012 and 2011, respectively.
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FINANCIAL CONDITION
Advances
At June 30, 2012, the advances portfolio totaled $26.5 billion, an increase of
$1.3 billion compared with $25.2 billion at December 31, 2011.
The following table summarizes advances outstanding by product type at June 30,
2012, and December 31, 2011.
Advances Outstanding by Product Type
(dollars in thousands)
June 30, 2012 December 31, 2011
Percent of Percent of
Par Value Total Par Value Total
Fixed-rate advances
Overnight $ 545,288 2.1 % $ 268,888 1.1 %
Long-term 9,736,879 37.6 10,546,190 42.9
Putable 3,987,625 15.4 4,693,575 19.1
Short-term 7,579,825 29.3 3,161,265 12.9
Amortizing 1,017,123 4.0 1,394,071 5.7
Callable 32,500 0.1 2,500 -
Expander 30,000 0.1 20,000 0.1
Fixed-rate plus cap 10,000 - 10,000 -
22,939,240 88.6 20,096,489 81.8
Variable-rate advances
Overnight 10,467 - 7,683 -
Simple variable 2,920,000 11.3 4,457,000 18.1
Floating rate advances with embedded
caps and / or floors 20,000 0.1 20,000 0.1
2,950,467 11.4 4,484,683 18.2
Total par value $ 25,889,707 100.0 % $ 24,581,172 100.0 %
See Item 1 - Notes to the Financial Statements - Note 7 - Advances for
disclosures relating to redemption terms of the advances portfolio.
We lend to members and housing associates with principal places of business
within our district, which consists of the six New England states. Outstanding
advances are generally diversified among our borrowers throughout our district,
with some concentrations, as set forth in the table below. At June 30, 2012, we
had advances outstanding to 310, or 67.2 percent, of our 461 members. At
December 31, 2011, we had advances outstanding to 317, or 68.6 percent, of our
462 members.
The following table presents the top five advance-borrowing institutions at
June 30, 2012, and the interest earned on outstanding advances to such
institutions during the three and six months ended June 30, 2012.
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Top Five Advance-Borrowing Institutions
(dollars in thousands)
June 30, 2012
Advances Advances
Interest Interest
Income for Income for
the Three the Six
Percent of Total Months Ended Months Ended
Par Value of Par Value of Weighted-Average June 30, June 30,
Name Advances Advances Rate (1) 2012 2012
RBS Citizens, N.A. $ 5,070,218 19.6 % 0.26 % $ 2,584 $ 5,212
Bank of America Rhode
Island, N.A. 1,597,457 6.2 0.56 1,626 2,977
Webster Bank, N.A. 1,529,005 5.9 0.72 2,992 6,196
Salem Five Cents Savings
Bank 671,712 2.6 2.01 3,367 6,686
Massachusetts Mutual Life
Insurance Company 600,000 2.3 1.96 2,975 5,950
_______________________
(1) Weighted-average rates are based on the contract rate of each advance without
taking into consideration the effects of interest-rate-exchange agreements
that may be used as a hedging instrument.
At December 31, 2011, First Niagara Bank, N.A. was among the top five
advance-borrowing institutions due to its acquisition of NewAlliance Bank, our
former member. Moreover, First Niagara Bank was our largest single source of
advances interest income for the three months ended March 31, 2012. First
Niagara Bank, N.A., as a nonmember, is ineligible to borrow from us but was able
to maintain the advances balances that NewAlliance Bank had borrowed when it was
our member. In April 2012, First Niagara Bank, N.A. paid off its outstanding
advances.
Advances Credit Risk
We endeavor to minimize credit risk on advances by monitoring the financial
condition of our borrowers and by holding sufficient collateral to protect us
from credit losses. Our approaches to credit risk on advances are described
under Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations - Financial Condition - Advances Credit Risk in the 2011
Annual Report. We have never experienced a credit loss on an advance.
Our membership continues to be challenged by the continuing weak economic
conditions, although there have been some measures of improvement. Aggregate
nonperforming assets for depository institution members declined from 1.12
percent of total assets as of December 31, 2011, to 1.10 percent of assets as of
March 31, 2012. The aggregate ratio of tangible capital to assets among the
membership increased from 8.67 percent as of December 31, 2011, to 8.98 percent
as of March 31, 2012. March 31, 2012, is the date of our most recent data on our
membership for this report. As of June 30, 2012, there have been no member
failures during 2012. All of our extensions of credit to our members are secured
by eligible collateral as noted herein. No member has ever defaulted on an
advance. However, if a member were to default, and the value of the collateral
pledged by the member declined to a point such that we were unable to realize
sufficient value from the pledged collateral to cover the member's obligations
and we were unable to obtain additional collateral to make up for the reduction
in value of such collateral, we could incur losses. Although not expected, a
default by a member with significant obligations to us could result in
significant financial losses, which would adversely impact our results of
operations and financial condition.
We assign each borrower to one of the following three credit status categories
based primarily on our assessment of the borrower's overall financial condition
and other factors:
• Category-1: members that are generally in satisfactory financial condition;
• Category-2: members that show weakening financial trends in key financial
indices and/or regulatory findings; and
• Category-3: members with financial weaknesses that present an elevated level
of concern. In addition, we generally place insurance company members in
Category-3 status because, unlike other members, insurance companies are
subject to different laws and regulations in their particular states that
could expose us to unique risks. We place housing associates in Category-3.
For additional information on the Bank's classification of its borrowers, see
the 2011 Annual Report under Item 7 - Management's Discussion and Analysis of
Financial Condition and Results of Operations - Financial Condition - Advances
Credit Risk in the 2011 Annual Report.
Advances outstanding to borrowers in Category-1 status at June 30, 2012, totaled
$17.2 billion. For these advances, we have access to collateral through security
agreements, where the borrower agrees to hold such collateral for our benefit,
totaling
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$45.1 billion as of June 30, 2012. Of this total, $10.1 billion of securities
have been delivered to us or to an approved third-party custodian, an additional
$1.6 billion of securities are held by borrowers' securities corporations, and
$6.4 billion of residential mortgage loans have been pledged by borrowers'
real-estate-investment trusts.
The following table provides information regarding advances outstanding with our
borrowers in Category-1, Category-2, and Category-3 status at June 30, 2012,
along with their corresponding collateral balances.
Advances Outstanding by Borrower Collateral Status
As of June 30, 2012
(dollars in thousands)
Ratio of
Discounted
Number of Par Value of Advances Discounted Collateral
Borrowers Outstanding Collateral to Advances
Category-1 status 265 $ 17,216,748 $ 45,089,673 261.9 %
Category-2 status 24 7,244,669 17,764,087 245.2
Category-3 status 26 1,428,290 1,859,649 130.2
Total 315 $ 25,889,707 $ 64,713,409 250.0 %
The method by which a borrower pledges collateral is dependent upon the category
status to which it is assigned based on its financial condition and on the type
of collateral that the borrower pledges. Based upon the method by which
borrowers pledge collateral to us, the following table shows the total potential
lending value of the collateral that borrowers have pledged to us, net of our
collateral valuation discounts as of June 30, 2012.
Collateral by Pledge Type
(dollars in thousands)
Discounted Collateral
Collateral not specifically listed and identified $ 36,861,469
Collateral specifically listed and identified 20,531,385
Collateral delivered to us 17,741,094
For additional information on our collateral policies and practices, see Item 7
- Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Advances Credit Risk in the 2011 Annual
Report.
We accept nontraditional and subprime loans that are underwritten in accordance
with applicable regulatory guidance as eligible collateral for our advances as
discussed under Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations - Financial Condition - Advances Credit Risk
in the 2011 Annual Report. At June 30, 2012, and December 31, 2011, the amount
of pledged nontraditional and subprime loan collateral was 10 percent and 9
percent, respectively, of total member borrowing capacity.
We have not recorded any allowance for credit losses on credit products at
June 30, 2012, and December 31, 2011, for the reasons discussed in Item 1 -
Notes to the Financial Statements - Note 9 - Allowance for Credit Losses.
Investments
At June 30, 2012, investment securities and short-term money market instruments
totaled $19.4 billion, compared with $21.4 billion at December 31, 2011.
Investment securities increased $154.3 million to $12.4 billion at June 30,
2012, compared with December 31, 2011.
Short-term money market investments totaled $7.0 billion at June 30, 2012,
compared with $9.2 billion at December 31, 2011. This $2.2 billion net decrease
resulted from a $900.0 million decrease in securities purchased under agreements
to resell and a $1.3 billion decrease in federal funds sold.
Under our regulatory authority to purchase MBS, additional investments in MBS,
ABS, and certain securities issued by the Small Business Administration (SBA)
are prohibited if our investments in such securities exceed 300 percent of
capital. Capital
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for this calculation is defined as capital stock, mandatorily redeemable capital
stock, and retained earnings. At June 30, 2012, and December 31, 2011, our MBS,
ABS and SBA holdings represented 218 percent and 195 percent of capital,
respectively.
We endeavor to maintain our total investments at a level no greater than 50
percent of our total assets because investing activities are generally
incidental to our mission. Our total investments were 38.9 percent of our total
assets at June 30, 2012, versus 42.8 percent at December 31, 2011. We have been
able to satisfy this investment objective without a material impact on our
results of operations or financial condition because the reduction in
investments has been principally concentrated in short-term, very low-yielding
investments and because other components of our assets have maintained a strong
net interest spread to funding costs. We expect to continue to be able to
satisfy this investment objective for the foreseeable future without a material
impact on our results of operations or financial condition by continuing this
approach, as necessary.
Our MBS investment portfolio consists of the following categories of securities
as of June 30, 2012, and December 31, 2011. The percentages in the table below
are based on carrying value.
Mortgage-Backed Securities
June 30, 2012 December 31, 2011
Residential MBS - U.S. government-guaranteed and GSE 61.3 % 53.4 %
Commercial MBS - U.S. government-guaranteed and GSE 22.4
26.7
Private-label residential MBS 15.9
19.5
ABS backed by home-equity loans 0.3 0.3
Private-label commercial MBS 0.1 0.1
Total MBS 100.0 % 100.0 %
See Item 1 - Notes to the Financial Statements - Note 3 - Trading Securities,
Note 4 - Available-for-Sale Securities, Note 5 - Held-to-Maturity Securities,
and Note 6 - Other-Than-Temporary Impairment for additional information on our
investment securities.
Investments Credit Risk
We are subject to credit risk on unsecured investments consisting primarily of
short-term (under one year to maturity) money market instruments issued by
high-quality financial institutions and long-term (generally at least one year
to maturity) debentures issued or guaranteed by U.S. agencies, the FDIC under
the FDIC's Temporary Liquidity Guarantee Program, U.S government-owned
corporations, GSEs, and supranational institutions. We place short-term funds
with large, high-quality financial institutions with long-term credit ratings no
lower than single-A (or equivalent) on an unsecured basis; currently all such
placements expire within one day. We have counterparty exposure on these
short-term investments.
In addition to these unsecured short-term investments, we also make secured
investments in the form of reverse repurchase agreements secured by U.S. agency
obligations, whose terms to maturity are up to 35 days. We have also invested in
and are subject to secured credit risk related to MBS, ABS, and HFA securities
that are directly or indirectly supported by underlying mortgage loans.
According to Finance Agency regulation investments in MBS and ABS must be rated
triple-A (or equivalent) at the time of purchase and HFA securities must carry a
credit rating of double-A (or equivalent) or higher as of the date of purchase.
Credit ratings on total investments are provided in the following table.
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Credit Ratings of Investments at Carrying Value
As of June 30, 2012
(dollars in thousands)
Long-Term Credit Rating (1)
Below
Investment Category Triple-A Double-A Single-A Triple-B Triple-B Unrated
Money market instruments:
(2)
Interest-bearing deposits $ - $ 250 $ - $ - $ - $ -
Securities purchased under
agreements to resell - - 6,000,000 - - -
Federal funds sold - 1,000,000 - - - -
Total money market
instruments - 1,000,250 6,000,000 - - -
Investment securities:
Non-MBS:
U.S. agency obligations - 15,807 - - - -
U.S. government-owned
corporations - 290,771 - - - -
GSEs - 2,429,569 - - - -
Supranational institutions 472,277 - - - - -
Corporate bonds (3) - 359,660 - - - -
HFA securities 24,525 121,944 - 49,920 - 2,114
Total non-MBS 496,802 3,217,751 - 49,920 - 2,114
MBS:
U.S. government guaranteed
- residential (2) - 142,927 - - - -
U.S. government guaranteed
- commercial (2) - 466,976 - - - -
GSE - residential (2) - 5,127,257 - - - -
GSE - commercial (2) - 1,456,987 - - - -
Private-label - residential 14,972 13,667 103,441 88,356 1,146,503 -
Private-label - commercial 10,549 - - - - -
ABS backed by home-equity
loans 6,824 5,312 7,839 - 5,497 -
Total MBS 32,345 7,213,126 111,280 88,356 1,152,000 -
Total investment securities 529,147 10,430,877 111,280 138,276 1,152,000 2,114
Total investments $ 529,147 $ 11,431,127 $ 6,111,280 $ 138,276 $ 1,152,000 $ 2,114
_______________________(1) Ratings are obtained from Moody's, Fitch, Inc. (Fitch), and S&P and are each
as of June 30, 2012. If there is a split rating, the lowest rating is used.
(2) The issuer rating is used for these investments, and if a rating is on
negative credit watch, the rating in the next lower rating category is used
and then the lowest rating is determined.
(3) Consists of corporate debentures guaranteed by the FDIC under the FDIC's
Temporary Liquidity Guarantee Program. The FDIC guarantee carries the full
faith and credit of the U.S. government.
The following table details our investment securities with a long-term credit
rating below investment grade as of June 30, 2012.
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Credit Ratings of Investments Below Investment Grade at Carrying Value
As of June 30, 2012
(dollars in thousands)
Total Below
Investment
Investment Category Double-B Single-B Triple-C Double-C Single-C Single-D Grade
Private-label
residential MBS $ 50,028 $ 83,666 $ 583,238 $ 107,507 $ 63,942 $ 258,122 $ 1,146,503
ABS backed by
home-equity loans - 3,663 1,370 - - 464 5,497
Total $ 50,028 $ 87,329 $ 584,608 $ 107,507 $ 63,942 $ 258,586 $ 1,152,000
Finance Agency regulations include limits on the amount of unsecured credit an
individual FHLBank may extend to a counterparty or to a group of affiliated
counterparties. This limit is based on a percentage of eligible regulatory
capital and the counterparty's long-term unsecured credit rating. Under these
regulations, the level of eligible regulatory capital is determined as the
lesser of our total regulatory capital or the eligible amount of regulatory
capital of the counterparty. The eligible amount of regulatory capital is then
multiplied by a specified percentage for each counterparty, which product is our
maximum amount of unsecured credit exposure to that counterparty. The percentage
that we may offer for term extensions of unsecured credit ranges from 1 percent
to 15 percent based on the counterparty's credit rating. Term extensions of
unsecured credit include on- and off-balance sheet and derivative transactions.
See - Derivative Instruments Credit Risk for additional information related to
derivatives exposure.
Finance Agency regulations further allow additional unsecured credit for
overnight sales of federal funds. The specified percentage of eligible
regulatory capital for determining the maximum amount of unsecured credit
exposure which we may offer to a counterparty for overnight sales of federal
funds ranges from two percent to 30 percent based on the counterparty's credit
rating. However, per these Finance Agency regulations our total unsecured
exposure to a single counterparty may not exceed twice the regulatory limit for
term exposures, or a total of two percent to 30 percent of the eligible amount
of regulatory capital, based on the counterparty's credit rating. During the
quarter ended June 30, 2012, we were in compliance with Finance Agency
regulatory limits established for unsecured credit.
We are prohibited by a Finance Agency regulation from investing in financial
instruments issued by non-U.S. entities, including foreign sovereign
governments, other than those issued by U.S. branches and agency offices of
foreign commercial banks. Our unsecured credit exposures to U.S. branches and
agency offices of foreign commercial banks include, among other things, the risk
that, as a result of political or economic conditions in a country, the
counterparty may be unable to meet their contractual repayment obligations. Our
unsecured credit exposures to domestic counterparties and U.S. subsidiaries of
foreign commercial banks include the risk that these counterparties have
extended credit to foreign counterparties. We are in compliance with the Finance
Agency regulation and did not own any financial instruments issued by foreign
sovereign governments, including those countries that are members of the
European Union, as of June 30, 2012.
For information on how we mitigate our investments' credit risks, see Item 7 -
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Investments Credit Risk in the 2011 Annual
Report.
The table below presents our short-term unsecured money-market credit exposure
with counterparties by investment type. At June 30, 2012, we did not have any
aggregate unsecured credit exposure from investments of $1 billion or more to
any individual counterparty.
Short-term Unsecured Money-market Credit Exposure by Investment Type
(dollars in thousands)
Carrying Value (1) June 30, 2012 December 31, 2011
Federal funds sold $ 1,000,000 $ 2,270,000
_______________________(1) Excludes unsecured investment credit exposure to U.S. government, GSEs, U.S.
government agencies and instrumentalities, corporate debentures guaranteed by
the FDIC under the FDIC's Temporary Liquidity Guarantee Program, and triple-A
rated supranational institutions and does not include related accrued
interest as of June 30, 2012.
As of June 30, 2012, our unsecured investment credit exposure to U.S. branches
and agency offices of foreign commercial banks was limited to federal funds
sold. As of June 30, 2012, all of our unsecured investment credit exposure in
federal funds sold was to U.S. branches and agency offices of foreign commercial
banks.
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The table below presents the June 30, 2012 carrying values and average balances
for the three months ended June 30, 2012 of the short-term unsecured
money-market 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. We endeavor to mitigate this credit risk by
investing in unsecured investments of highly rated counterparties. At June 30,
2012, all short-term unsecured money-market investments held by the Bank were
rated double-A.
Period-End and Average Balance of Unsecured Credit Exposure,
by Country of Domicile of Counterparty (1)
(dollars in thousands)
Average Balance for the
Carrying Value as of Three Months ended June
Country of Domicile of Counterparty June 30, 2012 30, 2012
Domestic $ - $ 12,967
U.S branches and agency offices of foreign
commercial banks
Sweden 500,000 509,780
Canada 500,000 307,088
Germany - 177,747
Finland - 141,154
Norway - 90,165
United Kingdom - 87,637
Switzerland - 49,451
Netherlands - 6,044
Total U.S branches and agency offices of
foreign commercial banks 1,000,000
1,369,066
Total unsecured credit exposure $ 1,000,000 $
1,382,033
_______________________
(1) Excludes unsecured investment credit exposure to U.S. government, GSEs, U.S.
government agencies and instrumentalities, corporate debentures guaranteed by
the FDIC under the FDIC's Temporary Liquidity Guarantee Program, and triple-A
rated supranational institutions and does not include related accrued
interest as of June 30, 2012.
The table below presents the contractual maturity of short-term unsecured
money-market 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. We also endeavor to mitigate the credit risk on short-term
unsecured money-market investments by investing in investments that have
short-term maturities. At June 30, 2012, all of our outstanding unsecured
money-market investments had overnight maturities.
Contractual Maturity of Unsecured Credit Exposure, by Country of Domicile of Counterparty
(dollars in thousands)
Carrying Value (1) as of June 30, 2012
Country of Due 2 days Due 31 days Due 91 days Due 181 days
Domicile of through 30 through 90 through 180 through 270 Due after 270
Counterparty Overnight days days days days days Total
U.S branches and
agency offices of
foreign commercial
banks
Canada $ 500,000 $ - $ - $ - $ - $ - $ 500,000
Sweden 500,000 - - - - - 500,000
Total unsecured
investment credit
exposure $ 1,000,000 $ - $ - $ - $ - $ - $ 1,000,000
_______________________
(1) Excludes unsecured investment credit exposure to U.S. government, GSEs, U.S.
Government agencies and instrumentalities, corporate debentures guaranteed by
the FDIC under the FDIC's Temporary Liquidity Guarantee Program,
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and triple-A rated supranational institutions and does not include related
accrued interest as of June 30, 2012.
During the quarter ended June 30, 2012, we continued to invest in unsecured
overnight money market instruments issued by certain Eurozone financial
institutions rated at least single-A or higher by the three major NRSROs and
domiciled in Finland, Germany, and the Netherlands from time to time. We
continued to use the same safeguards and approaches to these counterparties to
protect against unanticipated exposures arising from possible contagion from the
Eurozone financial crisis that are discussed under Item 7 - Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Financial Market Conditions - European Sovereign Debt Crisis in the 2011 Annual
Report. On June 30, 2012, we had no unsecured money market exposure to Eurozone
financial institutions. Our maximum unsecured money market exposure to any
single Eurozone financial institution was $600.0 million on any day during the
quarter ended June 30, 2012.
At June 30, 2012, our unsecured credit exposure related to money-market
instruments and debentures, including accrued interest, was $4.6 billion to nine
counterparties and issuers, of which $1.0 billion was for federal funds sold,
and $3.6 billion was for debentures. The following issuers/counterparties
individually accounted for greater than 10 percent of total unsecured credit
exposure as of June 30, 2012:
Issuers / Counterparties Representing Greater Than
10 Percent of Total Unsecured Credit
As of June 30, 2012
Issuer / counterparty Percent
Fannie Mae 38.3 %
Freddie Mac 15.0
Svenska Handelsbanken 10.9
Bank of Nova Scotia 10.9
Inter-American Development Bank (a supranational institution) 10.4
The following table presents a summary of the average projected values over the
remaining lives of the securities for the significant inputs relating to our
private-label MBS during the quarter ended June 30, 2012, as well as related
current credit enhancement. Credit enhancement is defined as the percentage of
subordinated tranches, over-collateralization, and other accounts or cash flows
that provide additional credit support such as reserve funds, insurance
policies, and/or excess interest, if any, in a security structure that will
generally absorb losses before we will experience a loss on the security.
Subordinated tranches can serve as credit enhancement, because losses are
generally allocated to the subordinate tranches until their principal balances
have been reduced to zero before senior tranches are allocated losses.
Over-collateralization means available collateral in excess of the principal
balance of the related security. The calculated averages represent the
dollar-weighted averages of all the private-label residential MBS and home
equity loan investments in each category shown, regardless of whether or not the
securities have incurred an other-than-temporary impairment credit loss (dollars
in thousands).
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Significant Inputs
Projected Projected Projected Current
Prepayment Rates Default Rates Loss Severities Credit Enhancement
Private-label
MBS by Weighted Weighted Weighted Weighted
Year of Average Range Average Range Average Range Average Range
Securitization Par Value (1) Percent Percent Percent Percent Percent Percent Percent Percent
Private-label
residential
MBS
Prime (2)
2007 $ 22,563 7.8 % 7.8 % 6.4 % 6.4 % 30.9 % 30.9 % 7.6 % 7.6 %
2006 16,086 7.3 7.3 36.9 36.9 40.7 40.7 0.0 0.0
2005 57,628 8.4 5.5 - 9.8 31.1 18.0 - 50.0 46.6 32.2 - 53.0 14.6 3.5 - 47.8
2004 and prior 141,674 10.2 3.8 - 20.6 16.9 3.0 - 60.3 31.0 18.8 - 53.2 15.6 6.2 - 70.8
Total $ 237,951 9.4 % 3.8 - 20.6 20.7 % 3.0 - 60.3 35.4 % 18.8 - 53.2 13.6 % 0.0 - 70.8
Alt-A (2)
2007 $ 538,698 3.4 % 1.3 - 9.4 75.3 % 33.2 - 88.9 51.2 % 41.1 - 59.1 12.7 % 0.0 - 44.8
2006 885,049 3.8 1.6 - 7.1 71.7 39.2 - 87.0 53.7 39.2 - 60.9 14.6 0.0 - 48.9
2005 579,039 6.2 3.1 - 10.5 49.5 24.5 - 75.0 45.6 28.5 - 56.8 21.3 0.0 - 62.0
2004 and prior 56,290 9.9 7.1 - 16.6 34.5 2.1 - 55.0 40.8 20.2 - 54.3 24.6 7.4 - 39.7
Total $ 2,059,076 4.5 % 1.3 - 16.6 65.4 % 2.1 - 88.9 50.4 % 20.2 - 60.9 16.3 % 0.0 - 62.0
ABS backed by
home equity
loans
Subprime (2)
2004 and prior $ 27,392 5.7 % 3.8 - 7.3 31.3 % 3.0 - 43.7 77.2 % 18.8 - 95.0 35.8 % 6.2 - 99.8
_______________________
(1) Commercial private-label MBS with a par value of $10.6 million and a
private-label residential MBS with a par value of $3.4 million that are backed
by the Federal Housing Administration and the Department of Veteran Affairs
loans are not included in this table.
(2) Securities are classified in the table above based upon the current
performance characteristics of the underlying pool and therefore the manner
in which the collateral pool group backing the security has been modeled (as
prime, Alt-A, or subprime), rather than the classification of the security at
the time of issuance.
For purposes of the tables below we classify private-label residential and
commercial MBS and ABS backed by home equity loans as prime, Alt-A, or subprime
based on the originator's classification at the time of origination or based on
the classification by an NRSRO upon issuance of the MBS. In some instances, the
NRSROs may have changed their classification subsequent to origination, which
would not necessarily be reflected in the following tables.
Of our $9.5 billion in par value of MBS and ABS investments at June 30, 2012,
$2.3 billion in par value are private-label MBS. These private-label MBS are
comprised of the following:
• $2.1 billion in par value are securities backed primarily by Alt-A loans;
• $251.9 million in par value are backed primarily by prime residential and/or
commercial loans; and
• $27.4 million in par value of these investments are backed primarily by
subprime mortgages.
While there are no universally accepted classifications of mortgage loans based
on underwriting standards, in general, subprime underwriting implies a
credit-impaired borrower with a FICO® score below 660, prime underwriting
implies a borrower without a history of delinquent payments as well as
documented income and a loan amount that is at or less than 80 percent of the
market value of the house, while Alt-A underwriting implies a prime borrower
with limited income documentation and/or a loan-to-value ratio of higher than 80
percent. FICO® is a widely used credit-industry model developed by Fair Isaac
and Company, Inc. to assess borrower credit quality with scores ranging from a
low of 300 to a high of 850. While we generally follow the collateral type
definitions provided by S&P, we do review the credit performance of the
underlying collateral, and revise the classification where appropriate, an
approach that is likewise incorporated into the modeling assumptions provided by
the OTTI Governance Committee. For additional information on the OTTI Governance
Committee, see - Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations - Critical Accounting Estimates of the 2011
Annual Report.
The third-party collateral loan performance platform used by the FHLBank of San
Francisco, with whom we have contracted to
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perform these analyses, assesses eight bonds that we own, totaling $74.8 million
in par value as of June 30, 2012, to have collateral that is Alt-A in nature,
while that same collateral is classified as prime by S&P. Accordingly, these
bonds have been modeled using the same credit assumptions applied to Alt-A
collateral. However, these bonds are reported as prime in the various tables
below in this section.
Additionally, one bond classified as Alt-A collateral by S&P, of which we held
$4.5 million in par value as of June 30, 2012, is classified and modeled as
prime by the third-party modeling software. However this bond is reported as
Alt-A in the various tables below in this section in accordance with S&P's
classification. See - Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations - Critical Accounting Estimates of the 2011
Annual Report for information on our key inputs, assumptions, and modeling
employed by us in our other-than-temporary impairment assessments.
Unpaid Principal Balance of Private-Label MBS and ABS Backed by Home Equity Loans
by Fixed Rate or Variable Rate
(dollars in thousands)
June 30, 2012 December 31, 2011
Fixed Variable Fixed Variable
Private-label MBS Rate (1) Rate (1) Total Rate (1) Rate (1) Total
Private-label
residential MBS
Prime $ 21,818 $ 219,517 $ 241,335 $ 23,846 $ 292,663 $ 316,509
Alt-A 39,912 2,019,163 2,059,075 42,153 2,147,908 2,190,061
Total private-label
residential MBS 61,730 2,238,680 2,300,410 65,999 2,440,571 2,506,570
Private-label
commercial MBS
Prime 10,586 - 10,586 10,586 - 10,586
ABS backed by home
equity loans
Subprime - 27,392 27,392 - 28,114 28,114
Total par value of
private-label MBS $ 72,316 $ 2,266,072 $ 2,338,388 $ 76,585 $ 2,468,685 $ 2,545,270
_______________________
(1) The determination of fixed or variable rate is based upon the contractual
coupon type of the security.
The following tables provide additional information related to our investments
in MBS issued by private trusts and ABS backed by home-equity loans, indicating
whether the underlying mortgage collateral is considered to be prime, Alt-A, or
subprime at the time of issuance. Additionally, the amounts outstanding as of
June 30, 2012, are stratified by year of issuance of the security. The tables
also set forth the credit ratings and summary credit enhancements associated
with our private-label MBS and ABS, stratified by collateral type and year of
securitization. Average current credit enhancements as of June 30, 2012, reflect
the percentage of subordinated class outstanding balances as of June 30, 2012,
to our senior class outstanding balances as of June 30, 2012, weighted by the
par value of our respective senior class securities, and shown by underlying
loan collateral type and year of securitization. Average current credit
enhancements as of June 30, 2012, are indicative of the ability of subordinated
classes to absorb loan collateral lost principal and interest shortfall before
senior classes are impacted.
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Private-Label MBS and
ABS Backed by Home Equity Loans
by Year of Securitization - Prime
At June 30, 2012
(dollars in thousands)
Private-label residential MBS -
Prime Total 2007 2006 2005 2004 and prior
Par value by credit rating
Triple-A $ 2,719 $ - $ - $ - $ 2,719
Double-A 8,436 - - - 8,436
Single-A 36,585 - - - 36,585
Triple-B 80,207 22,564 - - 57,643Below Investment Grade
Double-B 23,752 - - - 23,752
Single-B 16,823 - - 15,467 1,356
Triple-C 49,527 - - 34,960 14,567
Single-C 7,200 - - 7,200 -
Single-D 16,085 - 16,085 - -
Total $ 241,334 $ 22,564 $ 16,085 $ 57,627 $ 145,058
Amortized cost $ 230,653 $ 22,563 $ 12,703 $ 50,855 $ 144,532
Gross unrealized losses (34,620 ) (4,440 ) (1,099 ) (8,951 ) (20,130 )
Fair value 196,120 18,123 11,604 41,904 124,489
Weighted average percentage of
fair value to par value 81.27 % 80.32 % 72.14 % 72.72 % 85.82 %
Original weighted average credit
support 10.96 6.41 8.32 21.01 7.96
Weighted average credit support 13.47 7.55 - 14.59 15.45
Weighted average collateral
delinquency (1) 12.60 4.81 16.87 19.54 10.58
Private-label commercial MBS -
Prime Total 2007 2006 2005 2004 and prior
Par value by credit rating
Triple-A $ 10,586 $ - $ - $ - $ 10,586
Amortized cost 10,549 - - - 10,549
Fair value 11,035 - - - 11,035
Weighted average percentage of
fair value to par value 104.24 % - % - % - % 104.24 %
Original weighted average credit
support 12.50 - - - 12.50
Weighted average credit support 14.88 - - - 14.88
Weighted average collateral
delinquency (1) 1.19 - - - 1.19
_______________________
(1) Represents loans that are 60 days or more delinquent.
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Private-Label MBS and
ABS Backed by Home Equity Loans
by Year of Securitization - Alt-A
At June 30, 2012
(dollars in thousands)
Private-label residential MBS -
Alt-A Total 2007 2006 2005 2004 and prior
Par value by credit rating
Triple-A $ 12,253 $ - $ - $ 12,253 $ -
Double-A 5,232 - - - 5,232
Single-A 68,065 - - 47,817 20,248
Triple-B 8,149 - - 1,903 6,246Below Investment Grade
Double-B 26,435 - - 13,091 13,344
Single-B 67,947 2,604 - 54,123 11,220
Triple-C 990,923 221,463 498,001 271,459 -
Double-C 234,101 84,824 61,261 88,016 -
Single-C 102,516 21,344 38,221 42,951 -
Single-D 543,455 208,463 287,566 47,426 -
Total $ 2,059,076 $ 538,698 $ 885,049 $ 579,039 $ 56,290
Amortized cost $ 1,555,451 $ 371,878 $ 619,091 $ 508,192 56,290
Gross unrealized losses (440,437 ) (100,948 ) (188,561 ) (140,011 ) (10,917 )
Fair value 1,115,228 270,930 430,744 368,181 45,373
Other-than-temporary impairment
for the six months ended June
30, 2012:
Total other-than-temporary
impairment losses on
held-to-maturity securities $ (12,141 ) $ (290 ) $ (8,743 ) $ (2,529 ) $ (579 )
Net amount of impairment losses
reclassified to (from)
accumulated other comprehensive
loss 7,692 (97 ) 4,681 2,529 579
Net impairment losses on
held-to-maturity securities
recognized in income $ (4,449 ) $ (387 ) $ (4,062 ) $ - $ -
Weighted average percentage of
fair value to par value 54.16 % 50.29 % 48.67 % 63.58 % 80.60 %
Original weighted average credit
support 27.62 28.46 28.61 26.73 13.01
Weighted average credit support 16.26 12.72 14.57
21.33 24.58
Weighted average collateral
delinquency (1) 37.33 43.76 41.68 26.64 17.45
_______________________
(1) Represents loans that are 60 days or more delinquent.
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Private-Label MBS and
ABS Backed by Home Equity Loans
by Year of Securitization - Subprime
At June 30, 2012
(dollars in thousands)
ABS backed by home equity loans - Subprime 2004 and prior
Par value by credit rating
Triple-A $ 6,850
Double-A 5,312
Single-A 7,839
Below Investment Grade
Single-B 4,618
Triple-C 1,849
Single-D 924
Total $ 27,392
Amortized cost $ 26,699
Gross unrealized losses (6,137 )
Fair value 20,596Other-than-temporary impairment for the six months ended June 30,
2012:
Total other-than-temporary impairment losses on held-to-maturity
securities
$
-
Net amount of impairment losses reclassified to (from) accumulated
other comprehensive loss
(3 )
Net impairment losses on held-to-maturity securities recognized in
income
$
(3 )
Weighted average percentage of fair value to par value 75.19 %
Original weighted average credit support
10.03
Weighted average credit support
35.83
Weighted average collateral delinquency (1)
19.79
_______________________
(1) Represents loans that are 60 days or more delinquent.
Carrying values and fair values in the table below are as of June 30, 2012.
Rating Agency Actions (1)
Investments on Negative Watch as of July 31, 2012
(dollars in thousands)
ABS Backed by Home
Private-Label Residential MBS Equity Loans HFA Securities
Investment
Ratings Carrying Value Fair Value Carrying Value Fair Value Carrying Value Fair Value
Triple-A $ 2,246 $ 2,116 $ - $ - $ - $ -
Double-A 2,684 2,421 5,312 3,933 82,674 69,438
Triple-B 22,564 18,123 - - - -
Double-B 3,084 2,454 - - - -
_______________________
(1) Represents the lowest rating as of July 31, 2012 available for each security
based on the NRSROs we use.
The following table provides a summary of credit-rating downgrades that have
occurred during the period from July 1, 2012, through July 31, 2012 for our
investments. Carrying values and fair values are as of June 30, 2012.
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Rating Agency Actions (1)
Ratings Downgrades
from July 1, 2012, through July 31, 2012
(dollars in thousands)
Credit Rating as of Carrying Fair
Investment Category June 30, 2012 July 31, 2012 Value Value
Private-label - residential Double-A Single-A $ 2,759 $ 2,332
Private-label - residential Triple-B Double-B 2,552 2,119
_______________________
(1) Represents the lowest rating available for each security based on the NRSROs
we use.
The following table provides certain characteristics our private-label MBS that
are in a gross unrealized position by collateral
type.
Characteristics of Private-Label MBS in a Gross Unrealized Loss Position
As of June 30, 2012
(dollars in thousands)
July 31, 2012, Private-label MBS ratings
June 30, 2012 based on June 30, 2012, par value
Weighted
Average Percent
Gross Collateral Percent Below
Amortized Unrealized Delinquency Investment Investment Percent
Par Value Cost Losses Rates Percent AAA Percent AAA Grade Grade Watch List
Private-label
residential MBS
backed by:
Prime first lien $ 237,969 $ 227,288 $ (34,621 ) 12.45 % 1.1 % 1.1 % 51.3 % 48.7 % 10.4 %
Alt-A option ARM 820,408 677,379 (222,232 ) 42.38 - - - 100.0 -
Alt-A other 1,225,298 871,261 (218,204 ) 33.84 1.0 1.0 7.7 92.3 0.5
Total
private-label
residential MBS 2,283,675 1,775,928 (475,057 ) 34.68 0.7 0.7 9.5 90.5 1.3
ABS backed by home
equity loans:
Subprime first
lien 26,460 26,051 (6,137 ) 19.52 25.9 25.9 75.6 24.4 20.1
Totalprivate-label MBS $ 2,310,135$ 1,801,979 $ (481,194 ) 34.50 % 0.9 %
0.9 % 10.2 % 89.8 % 1.6 %
The following table provides the geographic concentrations by state and by
metropolitan statistical area of the loans underlying our private-label MBS and
ABS as of June 30, 2012, where such concentrations are five percent or greater
of all loans underlying these investments.
Geographic Concentrations of Loans Underlying our Private-Label MBS and ABS
Percentage of Total
Private-Label MBS
State concentrations and ABS
California 39.6 %
Florida 12.7
All Other 47.7
100.0 %
Metropolitan Statistical Area
Los Angeles - Long Beach, CA 10.4 %
Washington, D.C.-MD-VA-WV 6.1
All Other 83.5
100.0 %
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Since 2008, actual and projected delinquency, foreclosure, and loss rates for
prime, subprime, and Alt-A mortgage loans have increased significantly
nationwide. While trends have improved in some of these actual measures and
their projected assumptions, they remain elevated as of the date of this report.
In addition, home prices are severely depressed in many areas and nationwide
unemployment rates are high, increasing the likelihood and magnitude of
potential losses on troubled and/or foreclosed real estate. The widespread
impact of these trends has led to the recognition of significant losses by
financial institutions, including commercial banks, investment banks, and
financial guaranty providers. Actual and expected credit losses on these
securities together with uncertainty as to the degree, direction, and duration
of these loss trends has led to the reduction in the market values of securities
backed by residential mortgages, and has elevated the potential for additional
credit losses due to the other-than-temporary impairment of some of these
securities.
The following graph demonstrates how average prices have changed with respect to
various asset classes in our MBS portfolio during the 12 months ended June 30,
2012:
[[Image Removed]]
Insured Investments
Certain private-label MBS that we own are insured by monoline insurers, which
guarantee the timely payment of principal and interest on such MBS if such
payments cannot be satisfied from the cash flows of the underlying mortgage
pool. The assessment for other-than-temporary impairment of the MBS protected by
such third-party insurance is described in Item 1 - Notes to the Financial
Statements - Note 6 - Other-Than-Temporary Impairment.
The following table provides the credit ratings of the third-party insurers.
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Monoline Insurance and GSE Guarantees of MBS and
ABS Backed by Home Equity Loan Investments
Credit Ratings and Outlook
As of July 31, 2012
Moody's S&P Fitch
Outlook Outlook Outlook
/ / /
Credit Negative Credit Negative Credit Negative
Rating Watch Rating Watch Rating Watch
Ambac Assurance Corporation Not Not
(1) Removed NA Removed NA Rated Rated
Assured Guaranty Municipal Negative Not Not
Corp. Aa3 Watch AA- Stable Rated Rated
MBIA Insurance Negative Not Not
Corporation (2) B3 Watch B Negative Rated Rated
Positive Not Not
Syncora Guarantee Inc. (1) Ca Watch Removed NA Rated Rated
Financial Guaranty Insurance Not Not Not Not Not Not
Company (1) Rated Rated Rated Rated Rated Rated
Fannie Mae Aaa Negative AA+ Negative AAA Negative
Freddie Mac Aaa Negative AA+ Negative AAA Negative
_______________________(1) We placed no reliance on these monoline insurers in our models estimating the
projected cash flows to determine other-than-temporary impairment. See Item 1
- Notes to the Financial Statements - Note 6 - Other-Than-Temporary
Impairment for additional information.
(2) MBIA Insurance Corp.'s burnout period ends in September 2012. See Item 1 -
Notes to the Financial Statements - Note 6 - Other-Than-Temporary Impairment
for additional information.
The following table shows our private-label MBS and ABS backed by home equity
loan investments covered by monoline insurance and related gross unrealized
losses.
Par Value of Monoline Insurance Coverage and Related Unrealized Losses
of Private-Label MBS and
ABS Backed by Home Equity Loan Investments by Year of Securitization
At June 30, 2012
(dollars in thousands)
Ambac Assured Guaranty MBIA Syncora Financial Guaranty
Assurance Corp (1) Municipal Corp Insurance Corp (2) Guarantee Inc. (1) Insurance Co. (1)
Monoline Monoline Monoline Monoline Monoline
Insurance Unrealized Insurance Unrealized Insurance Unrealized Insurance Unrealized Insurance Unrealized
Coverage Losses Coverage Losses Coverage Losses Coverage Losses Coverage Losses
Private-label MBS by
Year of
Securitization
Alt-A
2007 $ 55,684 $ (3,577 ) $ - $ - $ - $ - $ - $ - $ - $ -
2006 13,642 (3,721 ) - - - - - - - -
2005 27,863 (8,062 ) - - - - - - - -
2004 and prior 1,306 (225 ) - - - - - - - -
Total Alt-A 98,495 (15,585 ) - - - - - - - -
Subprime
2004 and prior 1,856 (70 ) 7,047 (1,846 ) 14,039 (2,954 ) 3,534 (1,000 ) 917 (267 )
Total
private-label MBS $ 100,351 $ (15,655 ) $ 7,047 $ (1,846 ) $ 14,039 $ (2,954 ) $ 3,534 $ (1,000 )
$ 917 $ (267 )
_______________________
(1) We placed no reliance on these monoline insurers in our models estimating the
projected cash flows to determine other-than-temporary impairment. See Item 1
- Notes to the Financial Statements - Note 6 - Other-Than-Temporary
Impairment for additional information.
(2) MBIA Insurance Corp.'s burnout period ends in September 2012. See Item 1 -
Notes to the Financial Statements - Note 6 - Other-Than-Temporary Impairment
for additional information.
Our total investments in HFA securities was $198.5 million as of June 30, 2012.
The following table provides the geographic concentrations by state of our HFA
investments where such concentrations are five percent or greater of our total
HFA
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investments as of June 30, 2012.
State Concentrations of HFA Securities
Carry Value Percent of Total HFA Investments
Massachusetts $ 113,790 57.3 %
Rhode Island 29,910 15.1
Connecticut 24,525 12.4
Maine 15,000 7.6
All Other 15,278 7.6
$ 198,503 100.0 %
Standby Bond-Purchase Agreements. We have entered into standby bond-purchase
agreements with one state HFA whereby we, for a fee, agree to purchase and hold
the HFA's unremarketed bonds until the designated remarketing agent can find a
new investor or the state HFA repurchases the bonds in accordance with a
schedule established by the agreement. Each agreement contains termination
provisions in the event of a rating downgrade of the subject bond. Standby bond
purchase commitments totaled $161.6 million at June 30, 2012, to this HFA. All
of the bonds underlying the commitments to this HFA maintain standalone ratings
of triple-A from two NRSROs.
Mortgage Loans
As of June 30, 2012, our mortgage loan investment portfolio totaled $3.3
billion, an increase of $202.2 million from the December 31, 2011, balance of
$3.1 billion. This increase occurred notwithstanding increasing prepayments on
these investments, which could reflect growing interest in MPF as Fannie Mae and
Freddie Mac increase their guarantee fees, reducing their competitiveness with
MPF.
References to our investments in mortgage loans throughout this report include
the 100 percent participation interests in mortgage loans purchased under a
participation facility we have with the FHLBank of Chicago. The expiration date
of this facility has been extended to September 30, 2013 and may be extended
further in the future. As of June 30, 2012, we had $271.5 million in 100 percent
participation interests outstanding that had been purchased under this facility.
For additional information on this facility, see Item 1 - Business - Mortgage
Loan Finance - MPF Loan Participations with the FHLBank of Chicago of the 2011
Annual Report .
Mortgage Loans Credit Risk.
We are subject to credit risk from the mortgage loans in which we invest due to
our exposure to the credit risk of the underlying borrowers and the credit risk
of the participating financial institutions when the participating financial
institutions retain credit-enhancement and/or servicing obligations. For
additional information on the credit risks arising from our participation in the
MPF program, see Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations - Financial Condition - Mortgage Loans -
Mortgage Loans Credit Risk in the 2011 Annual Report.
Although our mortgage loan portfolio includes loans throughout the U.S.,
concentrations of five percent or greater of the outstanding principal balance
of our conventional mortgage loan portfolio are shown in the following table:
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State Concentrations by Outstanding Principal Balance
Percentage of Total Outstanding
Principal Balance of Conventional
Mortgage Loans
June 30, 2012 December 31, 2011
Massachusetts 37 % 35 %
California 11 12
Connecticut 8 9
Maine 8 6
Wisconsin 7 6
All others 29 32
Total 100 % 100 %
Although delinquent loans in our portfolio are spread throughout the U.S.,
delinquent loan concentrations of five percent or greater of the outstanding
principal balance of our total conventional mortgage loans delinquent by more
than 30 days are shown in the following table:
State Concentrations of Delinquent Conventional Mortgage Loans
Percentage of Total Outstanding
Principal Balance of Delinquent
Conventional Mortgage Loans
June 30, 2012 December 31, 2011
California 25 % 23 %
Massachusetts 23 24
Connecticut 9 9
All others 43 44
Total 100 % 100 %
Allowance for Credit Losses on Mortgage Loans. The allowance for credit losses
on mortgage loans was $6.1 million at June 30, 2012, compared with $7.8 million
at December 31, 2011. The principal reason for this decline is the continuing
improvement in the delinquency rates of our investments in conventional mortgage
loans since December 31, 2011. For information on the determination of the
allowance at June 30, 2012, see Item 1- Notes to the Financial Statements - Note
9 - Allowance for Credit Losses, and for information on our methodology for
estimating the allowance, see Item 7 - Management's Discussion and Analysis of
Financial Condition and Results of Operations - Critical Accounting Estimates -
Allowance for Loan Losses in the 2011 Annual Report.
We place conventional mortgage loans on nonaccrual when the collection of the
contractual principal or interest is 90 days or more past due. Accrued interest
on nonaccrual loans is reversed against interest income. We monitor the
delinquency levels of the mortgage loan portfolio on a monthly basis. The
following table presents our delinquent loans (dollars in thousands).
June 30, 2012 December 31, 2011
Nonaccrual loans, par value $ 48,390 $ 54,927
Total par value past due 90 days or more and still
accruing interest (1) 24,653 24,438
_______________________(1) Represents government mortgage loans.
Higher-Risk Loans. Our portfolio includes certain higher-risk conventional
mortgage loans. These include high loan-to-value ratio mortgage loans and
subprime mortgage loans. The higher-risk loans represent a relatively small
portion of our conventional mortgage loan portfolio (7.7 percent by outstanding
principal balance), but a disproportionately higher portion of the conventional
mortgage loan portfolio delinquencies (35.9 percent by outstanding principal
balance). Our allowance for loan losses reflects the expected losses associated
with these higher-risk loan types. The table below shows the balance of
higher-risk conventional mortgage loans and their delinquency rates as of
June 30, 2012.
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Summary of Higher-Risk Conventional Mortgage Loans
As of June 30, 2012
(dollars in thousands)
Percent
Percent Percent Delinquent 90
Total Par Delinquent Delinquent Days or More and
High-Risk Loan Type Value 30 Days 60 Days Nonaccruing
Subprime loans (1) $ 191,034 6.74 % 2.58 % 6.52 %
High loan-to-value loans (2) 31,148 4.35 1.35 9.87
Subprime and high loan-to-value
loans (3) 3,765 16.73 6.19 13.67
Total high-risk loans $ 225,947 6.57 % 2.47 % 7.10 %
_______________________(1) Subprime loans are loans to borrowers with FICO® credit scores 660 or lower.
(2) High loan-to-value loans have an estimated current loan-to-value ratio
greater than 100 percent based on movements in property values in the
core-based statistical areas where the property securing the loan is located.
(3) These loans are subprime and also have a current estimated loan-to-value
ratio greater than 100 percent.
Our portfolio consists solely of fixed-rate conventionally amortizing first-lien
mortgage loans. The portfolio does not include adjustable-rate mortgage loans,
pay-option adjustable-rate mortgage loans, interest-only mortgage loans, junior
lien mortgage loans, or loans with initial teaser rates.
Mortgage Insurance Companies. We are exposed to credit risk from mortgage
insurance companies that provide credit enhancement in place of the
participating financial institution and for primary mortgage insurance coverage
on individual loans. As of June 30, 2012, we were the beneficiary of primary
mortgage insurance coverage on $230.9 million of conventional mortgage loans,
and we were the beneficiary of supplemental mortgage insurance coverage on
mortgage pools with a total unpaid principal balance of $31.3 million. Eight
mortgage insurance companies provide all of the coverage under these policies.
As of July 31, 2012, all of these mortgage insurance companies, with the
exception of Triad Guaranty Insurance Corporation, which is no longer rated by
any of the NRSROs, have a credit rating of triple-B or lower (or equivalent) by
at least one NRSRO as presented in the below table. Ordinarily we do not accept
primary mortgage insurance from a mortgage insurance company unless that company
is rated at least triple-B by S&P at the time of our investment in the loan
(although we may accept lower-rated mortgage insurance provided we obtain
additional credit enhancement in such form as we deem appropriate and of
substance sufficient to mitigate the risks of relying on such lower rated
primary mortgage insurance). Given that only two mortgage insurance companies
have a credit rating of at least triple-B as of July 31, 2012, we could develop
increasing concentrations of exposure to those mortgage insurance companies. We
have established and maintain limits on exposure to individual mortgage
insurance companies in an effort to mitigate those concentration risks. However,
those exposure limits have, in turn, led to fewer mortgage loan investment
opportunities for us.
We have analyzed our potential loss exposure to all of the mortgage insurance
companies and do not expect incremental losses based on these exposures. This
expectation is based on the credit-enhancement features of our master
commitments (exclusive of mortgage insurance), the underwriting characteristics
of the loans that back our master commitments, the seasoning of the loans that
back these master commitments, and the strong performance of the loans to date.
We have monitored the financial condition of these mortgage insurance companies.
Further, we required all new supplemental mortgage insurance policies be with
companies rated AA- or higher by S&P. However, none of the eight mortgage
insurance companies previously approved by us are currently eligible to write
new supplemental mortgage insurance policies for loan pools sold to us. We do
not currently invest in mortgage loans that rely on supplemental mortgage
insurance to be eligible investments.
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Mortgage Insurance Companies that Provide Mortgage Insurance Coverage
(dollars in thousands)
As of July 31, 2012 June 30, 2012
Mortgage
Insurance Balance of Percent of
Company Loans with Total
Ratings Credit Primary Primary Mortgage Mortgage
Mortgage Insurance (S&P/ Rating Mortgage Mortgage Supplemental Insurance Insurance
Company Moody's/Fitch Outlook Insurance Insurance Mortgage Insurance Coverage Coverage
United Guaranty
Residential
Insurance
Corporation BBB/Baa1/NR Stable $ 90,976 $ 21,119 $ - $ 21,119 39.9 %
Genworth Mortgage
Insurance
Corporation B/Ba1/NR Negative 51,611 12,321 - 12,321 23.3
Mortgage Guaranty
Insurance
Corporation B/B1/NR Negative 38,887 8,473 - 8,473 16.0
PMI Mortgage
Insurance Company
(1) R/Caa3/NR Negative 15,037 3,204 - 3,204 6.1
CMG Mortgage
Insurance Company BBB/NR/BBB- Negative 12,612 2,984 - 2,984 5.6
Radian Guaranty
Incorporated B/Ba3/NR Negative 9,661 1,832 - 1,832 3.5
Republic Mortgage
Insurance Negative
Company (2) R/NR/NR Watch 9,257 1,813 649 2,462 4.6
Triad Guaranty
Insurance
Corporation NR/NR/NR N/A 2,840 506 - 506 1.0
$ 230,881 $ 52,252 $ 649 $ 52,901 100.0 %
_______________________
(1) On October 20, 2011, the Arizona Department of Insurance took possession and
control of PMI Mortgage Insurance Company and beginning October 24, 2011, PMI
Mortgage Insurance Company has been directed to only pay 50 percent of the
claim amounts with the remaining claim amounts being deferred until the
company is liquidated.
(2) On January 19, 2012, the North Carolina Department of Insurance issued an
Order of Supervision providing for immediate
administrative supervision of Republic Mortgage Insurance Co. (RMIC). Under the
order, RMIC continues to manage the
business through its employees, and retains its status as a wholly-owned
subsidiary of its parent holding company, Old Republic International
Corporation. The primary effect is that RMIC may not pay more than 50 percent of
any claims allowed under any policy of insurance it has issued. The remaining 50
percent will be deferred and credited to a temporary surplus account on the
books of RMIC during an initial period not to exceed one year. Accordingly, all
claim payments made on January 19, 2012, and thereafter will be made at the rate
of 50 percent.
Deposits
At June 30, 2012, and December 31, 2011, deposits totaled $668.8 million and
$654.2 million, respectively.
Term deposits issued in amounts of $100,000 or greater at both June 30, 2012,
and December 31, 2011 amounted to $20.0 million, with a maturity date in 2014,
and a weighted average rate of 4.71 percent.
Derivative Instruments
All derivative instruments are recorded on the statement of condition at fair
value, and are classified as assets or liabilities according to the net fair
value of derivatives aggregated by counterparty. Derivative assets' net fair
value, net of cash collateral and accrued interest, totaled $103,000 and $16.5
million as of June 30, 2012, and December 31, 2011, respectively. Derivative
liabilities' net fair value, net of cash collateral and accrued interest,
totaled $954.7 million and $905.3 million as of June 30, 2012, and December 31,
2011, respectively.
The following table presents a summary of the notional amounts and estimated
fair values of our outstanding derivative instruments, excluding accrued
interest, and related hedged item by product and type of accounting treatment as
of June 30, 2012, and December 31, 2011. The notional amount is a factor in
determining periodic interest payments or cash flows received and paid.
Accordingly, the notional amount does not represent actual amounts exchanged or
our overall exposure to credit and market risk. The hedge designation "fair
value" represents the hedge classification for transactions that qualify for
hedge-
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accounting treatment and hedge changes in fair value attributable to changes in
the designated benchmark interest rate, which is LIBOR. The hedge designation
"cash flow" represents the hedge classification for transactions that qualify
for hedge-accounting treatment and hedge the exposure to variability in expected
future cash flows. The hedge designation "economic" represents hedge strategies
that do not qualify for hedge accounting, but are acceptable hedging strategies
under our risk-management policy.
Hedged Item and Hedge-Accounting Treatment
(dollars in thousands)
June 30, 2012 December 31, 2011
Notional Fair Notional Fair
Hedged Item Derivative Designation Amount Value Amount Value
Advances Swaps Fair value $ 6,920,507 $ (547,418 ) $ 7,850,557 $ (603,754 )
Swaps Economic 10,750 (150 ) 10,750 (282 )
Total associated with
advances 6,931,257 (547,568 ) 7,861,307 (604,036 )
Available-for-sale
securities Swaps Fair value 711,915 (392,438 ) 711,915 (379,375 )
Caps and
floors Economic 300,000 248 300,000 786
Total associated with
available-for-sale
securities 1,011,915 (392,190 ) 1,011,915 (378,589 )
Trading securities Swaps Economic 225,000 (32,679 ) 225,000 (29,503 )
COs Swaps Fair value 8,645,550 94,068 10,743,550 196,640
Swaps Economic 100,000 9 - -
Forward
starting
swaps Cash Flow 1,250,000 (54,407 ) 700,000 (31,981 )
Total associated with
COs 9,995,550 39,670 11,443,550 164,659
Deposits Swaps Fair value 20,000 3,371 20,000 3,986
Total 18,183,722 (929,396 ) 20,561,772 (843,483 )
Mortgage delivery
commitments 42,593 92 17,734 128
Total derivatives $ 18,226,315 (929,304 ) $ 20,579,506 (843,355 )
Accrued interest (24,916 ) (25,187 )
Cash collateral (330 ) (20,241 )
Net derivatives $ (954,550 ) $ (888,783 )
Derivative asset $ 103 $ 16,521
Derivative liability (954,653 ) (905,304 )
Net derivatives $ (954,550 ) $ (888,783 )
The following tables provide a summary of our hedging relationships for
fair-value hedges of advances and COs that qualify for hedge accounting by year
of contractual maturity. Interest accruals on interest-rate-exchange agreements
in qualifying hedge relationships are recorded as interest income on advances
and interest expense on COs in the statement of operations. The notional amount
of derivatives in qualifying hedge relationships of advances and COs totals
$15.6 billion, representing 85.4 percent of all derivatives outstanding as of
June 30, 2012. Economic hedges and cash flow hedges are not included within the
two tables below.
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Fair-Value Hedge Relationships of Advances
By Year of Contractual Maturity
As of June 30, 2012
(dollars in thousands)
Weighted-Average Yield (3)
Derivatives Advances(1) Derivatives
Receive Pay
Hedged Fair-Value Floating Fixed Net Receive
Maturity Notional Fair Value Amount Adjustment(2) Advances Rate Rate Result
Due in one year or less $ 1,059,500 $ (14,458 ) $ 1,059,500 $
14,372 3.57 % 0.47 % 3.44 % 0.60 %
Due after one year
through two years 767,310 (32,996 ) 767,310 32,927 3.70 0.46 3.49 0.67
Due after two years
through three years 945,615 (50,112 ) 945,615 50,000 3.01 0.47 2.73 0.75
Due after three years
through four years 725,562 (59,996 ) 725,562
59,885 3.21 0.47 3.01 0.67
Due after four years
through five years 1,576,130 (172,490 ) 1,576,130
170,861 3.42 0.47 3.18 0.71
Thereafter 1,846,390 (217,366 ) 1,846,390 216,368 3.43 0.47 3.20 0.70
Total $ 6,920,507 $ (547,418 ) $ 6,920,507 $ 544,413 3.40 % 0.47 % 3.18 % 0.69 %
_______________________
(1) Included in the advances hedged amount are $4.0 billion of putable advances,
which would accelerate the termination date of the derivative and the hedged
item if the put option is exercised.
(2) The fair-value adjustment of hedged advances represents the amounts recorded
for changes in the fair value attributable to changes in the designated
benchmark interest rate, LIBOR.
(3) The yield for floating-rate instruments and the floating-rate leg of
interest-rate swaps is the coupon rate in effect as of June 30, 2012.
Fair-Value Hedge Relationships of Consolidated Obligations
By Year of Contractual Maturity
As of June 30, 2012
(dollars in thousands)
Weighted-Average Yield (3)
Derivatives CO Bonds (1) Derivatives
Pay
Fair-Value Receive Floating Net PayYear of Maturity Notional Fair Value Hedged Amount Adjustment(2) CO Bonds Fixed Rate Rate Result
Due in one year or
less
$ 3,375,050 $ 21,853 $ 3,375,050 $
(21,856 ) 1.44 % 1.46 % 0.32 % 0.30 %
Due after one year
through two years 3,495,500
34,881 3,495,500 (34,734 ) 1.21 1.20 0.38 0.39
Due after two years
through three years 595,000 8,763 595,000 (8,784 ) 1.36 1.36 0.35 0.35
Due after three
years through four
years 655,000 25,294 655,000 (25,325 ) 1.77 1.74 0.35 0.38
Due after four years
through five years 365,000 2,047 365,000 (2,049 ) 0.95 0.95 0.34 0.34
Thereafter 160,000 1,230 160,000 (1,473 ) 1.40 1.40 0.13 0.13
Total $ 8,645,550 $ 94,068 $ 8,645,550 $ (94,221 ) 1.35 % 1.35 % 0.35 % 0.35 %
_______________________
(1) Included in the CO Bonds hedged amount are $530.0 million of callable CO
Bonds, which would accelerate the termination date of the derivative and the
hedged item if the call option is exercised.
(2) The fair-value adjustment of hedged CO bonds represents the amounts recorded
for changes in the fair value attributable to changes in the designated
benchmark interest rate, LIBOR.
(3) The yield for floating-rate instruments and the floating-rate leg of
interest-rate swaps is the coupon rate in effect as of June 30, 2012.
We engage in derivatives directly with affiliates of certain of our members that
act as derivatives dealers to us. These derivatives are entered into for our own
risk-management purposes and are not related to requests from our members to
enter into such contracts. See Item 1 - Notes to the Financial Statements - Note
19 - Transactions with Related Parties for outstanding derivatives with
affiliates of members.
Derivative Instruments Credit Risk. We are subject to credit risk on derivative
instruments. This risk arises from the risk of counterparty default on the
derivative. The amount of loss created by default is the replacement cost of the
defaulted contract, net of any collateral held by us or pledged by us to
counterparties (unsecured derivatives exposure). We currently receive only cash
collateral from counterparties with whom we are in a current positive fair-value
position. The resulting net exposure at fair
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value is reflected in the below table. We presently pledge only securities
collateral to counterparties with whom we are in a current negative fair-value
position. From time to time, due to timing differences or derivatives valuation
differences, and the contractual haircuts applied, we pledge to counterparties
securities collateral whose fair value exceeds the current negative fair-value
positions with them. The resulting unsecured credit exposure to these latter
counterparties as of June 30, 2012 was $29.4 million.
We note that our derivatives instruments could require us to deliver additional
collateral to certain of our counterparties if our credit rating is downgraded
by an NRSRO, which could increase our exposure to loss in the event of a default
by a counterparty to which we were the net creditor at the time of any such
default, as further detailed in Item 1 - Notes to the Financial Statements -
Note 10 - Derivatives and Hedging Activities. For information on how we mitigate
the credit risk from unsecured credit exposures under our derivatives
instruments, see Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations - Financial Condition - Derivative
Instruments Credit Risk in the 2011 Annual Report.
We note that during the quarter ended June 30, 2012, we had two Eurozone
derivatives counterparties: one domiciled in France
and one domiciled in Germany, each of which is rated single-A or higher by all
three of the major NRSROs.
We continue to use the same safeguards and approaches to these counterparties to
protect against unanticipated exposures arising from possible contagion from the
Eurozone financial crisis that are discussed under Item 7 - Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Financial Market Conditions - European Sovereign Debt Crisis in the 2011 Annual
Report. We had $14.7 million in unsecured derivatives exposure to one of these
Eurozone financial institutions on June 30, 2012. Our maximum unsecured
derivatives exposure to any Eurozone counterparty was $22.1 million during the
quarter ended June 30, 2012.
The following table presents derivative counterparty credit exposure as of
June 30, 2012, and December 31, 2011.
Derivative Instruments
(dollars in thousands)
Total Net
Notional Number of Exposure at
Amount Counterparties Fair Value (3)
As of June 30, 2012
Interest-rate-exchange agreements: (1)
Double-A $ 25,000 1 $ -
Single-A 13,778,732 10 -
Triple-B 4,379,990 2 -
Total interest-rate-exchange agreements 18,183,722 13 -
Commitments to invest in mortgage loans (2) 42,593 - 103
Total derivatives $ 18,226,315 13 $ 103
As of December 31, 2011
Interest-rate-exchange agreements: (1)
Double-A $ 575,000 2 $ 16,393
Single-A 19,986,772 11 -
Total interest-rate-exchange agreements 20,561,772 13 16,393
Commitments to invest in mortgage loans (2) 17,734 - 128
Total derivatives $ 20,579,506 13 $ 16,521
_______________________(1) Ratings are obtained from Moody's, Fitch, and S&P. If there is a split
rating, the lowest rating is used. In the case where the obligations are
unconditionally and irrevocably guaranteed, the rating of the guarantor is
used.
(2) Total fair-value exposures related to commitments to invest in mortgage loans
are offset by certain pair-off fees. Commitments to invest in mortgage loans
are reflected as derivative instruments. We do not collateralize these
commitments. However, should the participating financial institution fail to
deliver the mortgage loans as agreed, the participating financial institution
is charged a fee to compensate us for the nonperformance.
(3) Total net exposure of positive fair value netted with cash collateral
received from derivative counterparties.
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The following counterparties accounted for more than 10 percent of the total
notional amount of interest-rate-exchange agreements outstanding (dollars in
thousands):
June 30, 2012
Percent of Total
Notional Amount Notional
Counterparty Outstanding Outstanding Fair Value
Deutsche Bank AG $ 3,024,965 16.6 % $ (421,815 )
Citigroup Financial Products, Inc. 2,567,840 14.1 (68,641 )
Barclays Bank PLC 1,982,795 10.9 (70,757 )
JP Morgan Chase Bank 1,946,650 10.7 (99,387 )
Goldman Sachs Capital Markets, LP 1,871,725 10.3 (97,334 )
December 31, 2011
Percent of Total
Notional Amount Notional
Counterparty Outstanding Outstanding Fair Value
Barclays Bank PLC $ 3,085,095 15.0 % $ (66,457 )
Deutsche Bank AG 2,957,965 14.4 (407,931 )
Citigroup Financial Products, Inc. 2,749,040 13.4 (73,395 )
Morgan Stanley Capital Services, Inc. 2,414,150 11.7 (115,873 )
Goldman Sachs Bank USA 2,286,725 11.1 (78,858 )
We may deposit funds with these counterparties and their affiliates for
short-term money-market investments, including overnight federal funds, term
federal funds, and interest-bearing certificates of deposit. Terms for
outstanding investments are currently overnight to 35 days. We also engage in
short-term secured reverse repurchase agreements with affiliates of these
counterparties. All of these counterparties affiliates buy, sell, and distribute
our COs.
LIQUIDITY AND CAPITAL RESOURCES
Our financial strategies are designed to enable us to expand and contract our
assets, liabilities, and capital in response to changes in membership
composition and member credit needs. Our primary source of liquidity is our
access to the capital markets through CO issuance, which is described in Item 1
- Business - Consolidated Obligations in the 2011 Annual Report. Outstanding COs
and the condition of the market for COs are discussed below under - External
Sources of Liquidity. Our equity capital resources are governed by our capital
plan, certain portions of which are described under - Capital below as well as
by applicable legal and regulatory requirements.
Liquidity
Internal Sources of Liquidity
We maintain structural liquidity to ensure we meet our day-to-day business needs
and our contractual obligations. We define structural liquidity as the
difference between projected sources and uses of funds (projected net cash flow)
adjusted to include certain assumed contingent, noncontractual obligations or
behavioral assumptions (cumulative contingent obligations). Cumulative
contingent obligations include the assumption that member overnight deposits are
withdrawn at a rate of 50 percent per day and commitments (MPF and other
commitments) are taken down at a conservatively projected pace. We define
available liquidity as the sources of funds available to us through our normal
access to the capital markets, subject to leverage, credit line capacity, and
collateral constraints. Our risk-management policy requires us to maintain
structural liquidity each day so that any excess of uses over sources is covered
by available liquidity for a four-week forecast period and 50 percent of the
excess of uses over sources is covered by available liquidity over eight- and
12-week forecast periods. In addition to these minimum requirements, management
measures structural liquidity over a three-month forecast period. If the excess
of uses over sources is not fully covered by available liquidity over a
two-month or three-month forecast period, a management action trigger is
breached and senior management is immediately notified so that a decision can be
made as to whether immediate remedial action is necessary.
The following table shows our structural liquidity as of June 30, 2012.
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Structural Liquidity
As of June 30, 2012
(dollars in thousands)
1 Month 2 Month 3 Months
Projected net cash flow (1) $ 645,951 $ (773,673 ) $ (1,468,209 )
Less: Cumulative contingent obligations (4,957,807 ) (6,571,679 ) (7,920,433 )
Equals: Net structural liquidity need (4,311,856 ) (7,345,352 ) (9,388,642 )
Available borrowing capacity (2) $ 40,162,324 $ 43,002,535 $ 45,711,605
Ratio of available borrowing capacity to net
structural liquidity need 9.31 5.85 4.87
Required ratio 1.00 0.50 0.50
Management action trigger - 1.00 1.00
_______________________(1) Projected net cash flow equals projected sources of funds less projected uses
of funds based on contractual maturities or expected option exercise periods,
as applicable.
(2) Available borrowing capacity is the CO issuance capacity based on achieving
leverage up to our internal minimum capital requirement. For information on
this internal minimum capital requirement, see - Internal Capital Practices
and Policies - Internal Minimum Capital Requirements.
Finance Agency regulations require us to hold contingency liquidity in an amount
sufficient to enable us to cover our liquidity requirements for a minimum of
five business days without access the CO debt markets. We complied with this
requirement at all times during the quarter ending June 30, 2012. As of June 30,
2012, and December 31, 2011, we held a surplus of $12.3 billion and $12.8
billion, respectively, of contingency liquidity for the following five days,
exclusive of access to the proceeds of CO debt issuance. The following table
demonstrates our contingency liquidity as of June 30, 2012.
Contingency Liquidity
As of June 30, 2012
(dollars in thousands)
Cumulative
Fifth
Business Day
Projected net cash flow (1) $ (1,877,150 )
Contingency borrowing capacity (exclusive of CO issuances) 14,195,516
Net contingency borrowing capacity
$ 12,318,366
_______________________
(1) Projected net cash flow equals projected sources of funds less projected uses
of funds based on contractual maturities or expected option exercise periods,
as applicable.
In addition, certain Finance Agency guidance requires us to maintain sufficient
liquidity, through short-term investments, in an amount at least equal to our
anticipated cash outflows under two different scenarios. One scenario assumes
that we cannot borrow funds from the capital markets for a period of 15 days and
that during that time members do not renew any maturing, prepaid, and put or
called advances. The second scenario assumes that we cannot borrow funds from
the capital markets for five days and that during that period we will renew
maturing and called advances for all members except very large, highly rated
members. We were in compliance with these liquidity requirements at all times
during the three months ended June 30, 2012.
Further, we are sensitive to maintaining an appropriate funding balance between
our assets and liabilities and have an established policy that limits the
potential gap between assets inclusive of projected prepayments, funded by
liabilities, inclusive of projected calls, maturing in less than one year. The
established policy limits this imbalance to a gap of 20 percent of total assets
with a management action trigger should this gap exceed 10 percent of total
assets. We maintained compliance with this requirement at all times during the
three months ended June 30, 2012. During the three months ended June 30, 2012,
this gap averaged 4.3 percent (maximum level 6.4 percent and minimum level 1.2
percent). As of June 30, 2012, this gap was 6.4 percent, compared with 9.2
percent at December 31, 2011.
External Sources of Liquidity
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FHLBank P&I Funding Contingency Plan Agreement
We have a source of emergency external liquidity through the FHLBank P&I Funding
Contingency Plan Agreement. Under the terms of that agreement, in the event we
do not fund our principal and interest payments under a CO by deadlines
established in the agreement, the other FHLBanks will be obligated to fund any
shortfall to the extent that any of the other FHLBanks have a net positive
settlement balance (that is, the amount by which end-of-day proceeds received by
such FHLBank from the sale of COs on that day exceeds payments by such FHLBank
on COs on the same day) in its account with the Office of Finance on the day the
shortfall occurs. We would then be required to repay the funding FHLBanks.
Neither we nor any of the other FHLBanks have ever drawn upon this agreement.
Debt Financing - Consolidated Obligations
At June 30, 2012, and December 31, 2011, outstanding COs, including both CO
bonds and CO discount notes, totaled $44.2 billion and $44.5 billion,
respectively.
CO bonds outstanding for which we are primarily liable at June 30, 2012, and
December 31, 2011, include issued callable bonds totaling $1.7 billion and $3.0
billion, respectively.
CO discount notes are also a significant funding source for us. CO discount
notes are short-term instruments with maturities ranging from overnight to one
year. We use CO discount notes primarily to fund short-term advances and
investments and longer-term advances and investments with short repricing
intervals. CO discount notes comprised 37.6 percent and 32.9 percent of the
outstanding COs for which we are primarily liable at June 30, 2012, and
December 31, 2011, respectively, but accounted for 94.0 percent and 98.3 percent
of the proceeds from the issuance of such COs during the six months ended
June 30, 2012 and 2011, respectively, due, in particular, to our frequent
overnight CO discount note issuances.
See Item 1 - Notes to the Financial Statements - Note 12 - Consolidated
Obligations for additional information on the COs for which we are primarily
liable.
Financial Conditions for Consolidated Obligations
We have experienced relatively favorable CO issuance costs and good market
access during the period covered by this report. Financial markets were
relatively calmer than during the preceding two quarters as uncertainties about
European sovereignties and financial institutions abated due, in part, to
actions by the European Central Bank to provide liquidity. The U.S. economy grew
modestly during the six months ended June 30, 2012, and employment growth was
generally stronger throughout this period than it had been throughout the second
half of 2011.
We continue to operate in a prolonged, historically low-interest rate
environment as discussed under - Executive Summary - Continuing and Prolonged
Low-Interest Rate Environment. Overall, we have experienced relatively low CO
issuance costs during the period covered by this report, reflecting the
low-interest rate environment together with a flight to quality due to the
sovereign debt crisis in Europe, though easing pressures in Europe caused a
slight increase in our relative cost of funding. We have experienced good market
demand for all tenors of COs with the strongest demand for short-term COs, and
have had no difficulty issuing debt in the amounts and structures required to
meet our funding and risk management needs. Throughout the six months ended
June 30, 2012, COs were issued at yields that were generally at or below
equivalent-maturity LIBOR swap yields for debt maturing in less than five years,
while longer term issues bore funding costs that were typically higher than
equivalent maturity LIBOR swap yields. We continue to experience similar pricing
into the third quarter of 2012.
Capital
Our total GAAP capital decreased $104.8 million to $3.4 billion at June 30,
2012, from $3.5 billion at December 31, 2011. The decrease was attributable to
our partial excess capital stock repurchase of $237.4 million in March 2012,
offset by a net reduction of $6.0 million in accumulated other comprehensive
loss, a $93.7 million increase in retained earnings, and the purchase of $33.9
million of capital stock by members during the six months ended June 30, 2012.
The FHLBank Act and Finance Agency regulations specify that each FHLBank is
required to satisfy certain minimum regulatory capital requirements. We were in
compliance with these requirements at June 30, 2012, as discussed in Item 1 -
Notes to the Financial Statements - Note 14 - Capital.
Our ability to expand in response to member-credit needs is based primarily on
the capital-stock requirements for advances. Members without excess stock are
required to increase their capital-stock investment as their outstanding
advances increase,
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as described in Item 1 - Business - Capital Resources in the 2011 Annual Report.
As discussed in that Item, we may repurchase excess stock in our sole
discretion, although we note our continuing moratorium on repurchases of excess
stock other than in limited, former member-related instances of insolvency.
Although we conducted a partial repurchase of excess stock on March 9, 2012,
there are no plans to conduct another excess stock repurchase in 2012. Further,
on April 26, 2012, our board of directors adopted a resolution that it will not
conduct excess stock repurchases other than in limited, former member-related
instances of insolvency without obtaining the Finance Agency's nonobjection,
which we do not expect to pursue in 2012. We will consider whether and how to
conduct other repurchases of excess stock as part of our 2013 business planning
process.
At June 30, 2012, and December 31, 2011, excess stock totaled $1.9 billion and
$2.1 billion, respectively, as set forth in the following table (dollars in
thousands):
Outstanding
Membership Stock Activity-Based Total Stock Class B
Investment Stock Investment Capital Stock Excess Class B
Requirement Requirement Requirement (1) (2) Capital Stock
June 30, 2012 $ 639,932 $ 1,139,201 $ 1,779,156 $ 3,636,732 $ 1,857,576
December 31, 2011 623,793 1,104,877 1,728,692 3,852,777 2,124,085
_______________________
(1) Total stock-investment requirement is rounded up to the nearest $100 on an
individual member basis.
(2) Class B capital stock outstanding includes mandatorily redeemable capital
stock.
We redeem our capital stock in accordance with our capital plan and applicable
law. Capital stock can become subject to redemption based on a member's request
for the redemption of its excess stock, upon termination of membership or in
such other cases as are set forth in our capital plan and subject to the
limitations therein. Our only class of capital stock outstanding is Class B
stock. Class B stock is subject to a minimum five-year stock redemption period.
For additional information on the redemption of our capital stock, see Item 1 -
Business - Capital Resources - Redemption of Excess Stock in the 2011 Annual
Report and Item 1 - Business - Capital Resources - Mandatorily Redeemable
Capital Stock in the 2011 Annual Report.
Capital stock subject to a stock redemption period is reclassified to
mandatorily redeemable capital stock in the liability section of the statement
of condition. Mandatorily redeemable capital stock totaled $215.9 million and
$227.4 million at June 30, 2012, and December 31, 2011, respectively.
The following table sets forth the amount of mandatorily redeemable capital
stock by year of expiry of redemption period at June 30, 2012, and December 31,
2011 (dollars in thousands).
June 30,
Expiry of Redemption Period 2012 December 31, 2011
Due in one year or less $ 80,161 $ -
Due after one year through two years 98 86,598
Due after two years through three years - 10
Due after three years through four years 134,590 -
Due after four years through five years 1,014 140,821
Total $ 215,863 $ 227,429
Capital Rule
The Finance Agency's regulation on FHLBank capital classification and critical
capital levels (the Capital Rule), among other things, establishes criteria for
four capital classifications and corrective action requirements for FHLBanks
that are classified in any classification other than adequately capitalized. The
Capital Rule requires the Director of the Finance Agency to determine on no less
than a quarterly basis the capital classification of each FHLBank. For
additional information on the Capital Rule, see Item 7 - Management's Discussion
and Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources - Capital - Capital Rule in the 2011 Annual Report
By letter dated June 19, 2012, the Acting Director of the Finance Agency
notified us that, based on March 31, 2012, financial information, we met the
definition of adequately capitalized under the Capital Rule. The Acting Director
of the Finance Agency has not yet notified us of our capital classification
based on June 30, 2012, financial information.
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Internal Capital Practices and Policies
We also take steps as we believe prudent beyond legal or regulatory requirements
in an effort to protect our capital, reflected in our capital ratio targets,
internal minimum capital requirement in excess of regulatory requirements, and
retained earnings target.
Targeted Capital Ratio Operating Range
We target an operating range of 4.0 percent to 7.5 percent for our capital
ratio, a range adopted in conjunction with our capital preservation measures.
Our capital ratio was 8.3 percent at June 30, 2012, a ratio in excess of the
targeted operating range. This results principally from our limited repurchases
of excess stock accompanied with a significant decline in advances balances
since 2008, as discussed under - Executive Summary - Advances Balances.
Internal Minimum Capital Requirement
To provide further protection for our capital base, we maintain an internal
minimum capital requirement whereby the amount of paid-in capital stock and
retained earnings must exceed the sum of our regulatory capital requirement plus
our retained earnings target. As of June 30, 2012, this internal minimum capital
requirement equaled $2.9 billion, which was satisfied by our actual regulatory
capital of $4.1 billion.
Retained Earnings Target
Our retained earnings target is $875.0 million. For information on how we select
and adjust our retained earnings target, including in response to Finance Agency
regulations, orders, or guidance, see Item 7 - Management's Discussion and
Analysis of Financial Condition and Results of Operations - Internal Capital
Practices and Policies - Retained Earnings Target in the 2011 Annual Report.
At June 30, 2012, we had total retained earnings of $491.8 million, consisting
of $448.3 million in unrestricted retained earnings and $43.5 million in
restricted retained earnings. For information on our restricted retained
earnings contribution requirement, see Item 1 - Notes to the Financial
Statements - Note 14 - Capital. Amounts in our restricted retained earnings
account are not available to pay dividends.
Dividend Limitations
Our board of directors has iterated its anticipation that any dividends declared
through the remainder of 2012 would be modest, as we remain focused on growing
our retained earnings to our retained earnings target, as discussed under -
Executive Summary. On April 26, 2012, our board of directors adopted a
resolution that it would not declare dividends in excess of 20 percent of
quarterly net income for the quarter on which the dividend is based for the
remainder of 2012 without the Finance Agency's nonobjection. Additionally, on
that same day, the board adopted a revision to our retained earnings policy that
now provides that when our retained earnings target exceeds the level of our
retained earnings, the quarterly dividend payout cannot exceed 40 percent of our
earnings for the quarter. This revised policy replaces the prior policy that had
limited the quarterly dividend payout to 50 percent of our earnings for the
quarter in such instances. For additional information on dividend limitations,
see Item 5 - Market for Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities in the 2011 Annual Report.
Off-Balance-Sheet Arrangements and Aggregate Contractual Obligations
Our significant off-balance-sheet arrangements consist of the following:
• commitments that obligate us for additional advances;
• standby letters of credit;
• commitments for unused lines-of-credit advances;
• standby bond-purchase agreements with state housing authorities; and
• unsettled COs.
Off-balance-sheet arrangements are more fully discussed in Item 1 - Notes to the
Financial Statements - Note 18 -
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Commitments and Contingencies.
Through the second quarter of 2011, we were required to pay 20 percent of our
net earnings (after the AHP assessment) to REFCorp to support payment of part of
the interest on bonds issued by REFCorp. Additionally, the FHLBanks must
annually set aside for the AHP the greater of an aggregate of $100 million or 10
percent of the current year's income before charges for AHP (but after expenses
for REFCorp). Based on our net income of $102.8 million for the six months ended
June 30, 2012, our AHP assessment was $11.5 million. See Item 1 - Business -
Assessments in the 2011 Annual Report for additional information regarding
REFCorp and AHP.
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in accordance with 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 and
expenses during the reported periods. Although management believes these
judgments, estimates, and assumptions to be reasonably accurate, actual results
may differ.
We have identified five accounting estimates that we believe are critical
because they require us 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 estimates include accounting for derivatives, the
use of fair-value estimates, accounting for deferred premiums and discounts on
prepayable assets, the allowance for loan losses, and
other-than-temporary-impairment of investment securities. The Audit Committee of
our board of directors has reviewed these estimates. The assumptions involved in
applying these policies are discussed in Item 7 - Management's Discussion and
Analysis of Financial Condition and Results of Operations - Critical Accounting
Estimates in the 2011 Annual Report.
As of June 30, 2012, we have not made any significant changes to the estimates
and assumptions used in applying our critical accounting policies and estimates
from those used to prepare our audited financial statements. Described below are
the results of the sensitivity analysis for private-label MBS.
Other-Than-Temporary Impairment of Investment Securities
See Item 1 - Notes to the Financial Statements - Note 6 - Other-Than-Temporary
Impairment for additional information related to management's
other-than-temporary impairment analysis for the current period.
In addition to evaluating our residential private-label MBS under a base-case
(or best estimate) scenario, a cash-flow analysis was also performed for each of
these securities under a more stressful housing price index (HPI) scenario that
was determined by the OTTI Governance Committee.
Our base-case housing price forecast as of June 30, 2012, assumed
current-to-trough home price declines ranging from 0.0 percent (for those
housing markets that are believed to have reached their trough) to 6.0 percent.
For those markets for which further home-price declines are anticipated, such
declines were projected to occur over the three- to nine-month period beginning
April 1, 2012. For the vast majority of markets where further home-price
declines are anticipated, the declines were projected to range from 1.0 percent
to 4.0 percent over the three-month period beginning April 1, 2012. From the
trough, home prices were projected to recover using one of five different
recovery paths that vary by housing market. The more stressful scenario was
based on a housing-price forecast that was five percentage points lower at the
trough than the base-case scenario followed by a flatter recovery path. Under
the more stressful scenario, current-to-trough home-price declines were
projected to range from 5.0 percent to 11.0 percent over the three- to
nine-month period beginning April 1, 2012. For most of the housing markets, the
declines were projected to occur over the three-month period beginning April 1,
2012. The following table presents projected home-price recovery ranges by month
under the base-case and adverse-case scenario.
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Recovery Range of Annualized Rates
Months Base Case Adverse Case
1 - 6 0.0% to 2.8% 0.0% to 1.9 %
7 - 18 0.0% to 3.0% 0.0% to 2.0 %
19 - 24 1.0% to 4.0% 0.7% to 2.7 %
25 - 30 2.0% to 4.0% 1.3% to 2.7 %
31 - 42 2.0% to 5.0% 1.3% to 3.4 %
43 - 66 2.0% to 6.0% 1.3% to 4.0 %
Thereafter 2.3% to 5.6% 1.5% to 3.8 %
The following table represents the impact on credit-related other-than-temporary
impairment using the more stressful scenario of the HPI, described above,
compared with actual credit-related other-than-temporary impairment recorded
using our base-case HPI assumptions as of June 30, 2012 (dollars in thousands):
Credit Losses as Reported Sensitivity Analysis - Adverse HPI Scenario
Number of Other-Than-Temporary Number of Other-Than-Temporary
For the quarter ending June 30, 2012 Securities Par Value Impairment Credit Loss Securities Par Value Impairment Credit Loss
Prime - $ - $ - 4 $ 31,735 $ (618 )
Alt-A 8 138,447 (1,492 ) 67 1,344,422 (40,801 )
Subprime - - - 1 924 (70 )
Total private-label MBS 8 $ 138,447 $ (1,492 ) 72 $ 1,377,081 $ (41,489 )
RECENT ACCOUNTING DEVELOPMENTS
See Item 1 - Notes to the Financial Statements - Note 2 - Recently Issued
Accounting Standards and Interpretations for a discussion of recent accounting
developments impacting or that could impact us.
LEGISLATIVE AND REGULATORY DEVELOPMENTS
The legislative and regulatory environment in which we operate continues to
undergo rapid change driven principally by reforms under the Housing and
Economic Reform Act of 2008, as amended (HERA) and the Dodd-Frank Wall Street
Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act). We expect HERA
and the Dodd-Frank Act as well as plans for housing finance and GSE reform to
result in still further changes to this environment. Our business operations,
funding costs, rights, obligations, and/or the environment in which we carry out
our housing finance mission are likely to continue to be significantly impacted
by these changes. Significant regulatory actions and developments for the period
covered by this report are summarized below.
Developments under the Dodd-Frank Act Impacting Derivatives Transactions
Definitions of Certain Terms under New Derivatives Requirements. The Dodd-Frank
Act will require swap dealers and certain other large users of derivatives to
register as "swap dealers" or "major swap participants," as the case may be,
with the U.S. Commodity Futures Trading Commission (the CFTC) and/or the SEC.
Based on the definitions in the final rules jointly issued by the CFTC and SEC
in April 2012, we will not be required to register as either a major swap
participant or as a swap dealer because of the derivative transactions that we
enter into for the purposes of hedging and managing our interest rate risk or
any derivatives transactions that we intermediate for our members.
Based on the final rules and accompanying interpretive guidance jointly issued
by the CFTC and SEC in July 2012, call and put optionality in certain advances
to our members will not be treated as "swaps" as long as the optionality relates
solely to the interest rate on the advance and does not result in enhanced or
inverse performance or other risks unrelated to the interest rate. Accordingly,
our ability to offer these advances to member customers should not be affected
by the new derivatives regulation.
Mandatory Clearing of Derivatives Transactions. The Dodd-Frank Act provides for
new statutory and regulatory requirements for derivative transactions, including
those utilized by us to hedge our interest rate and other risks. As a result of
these requirements, certain derivative transactions will be required to be
cleared through a third-party central clearinghouse and
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traded on regulated exchanges or new swap execution facilities. As further
discussed in the 2011 Annual Report, cleared swaps will be subject to new
requirements including mandatory reporting, record-keeping and documentation
requirements established by applicable regulators, and initial and variation
margin requirements established by the clearinghouse and its clearing members.
The CFTC is expected to issue proposals regarding which swaps will be subject to
mandatory clearing and compliance schedules for mandatory clearing requirements
during the third quarter of 2012. At this time, we do not expect that any of our
swaps will be subject to these new clearing and trading requirements until the
beginning of 2013, at the earliest.
The CFTC recently finalized an end-user exception to mandatory clearing that
would not apply to the derivatives transactions that we enter into to hedge and
manage our interest-rate risk but that would apply to any derivatives
transactions that we intermediate for our members with $10 billion or less in
assets as long as the member uses the swaps to hedge or mitigate their
commercial risk and the Bank or member comply with the rule's additional
reporting requirements. As a result, any such intermediated swaps would not be
subject to mandatory clearing, although such swaps would be subject to
applicable requirements for uncleared swaps, including requirements that are
expected to be issued under the Dodd-Frank Act.
Uncleared Derivatives Transactions. The Dodd-Frank Act will also change the
regulatory landscape for derivative transactions that are not subject to
mandatory clearing requirements (uncleared trades). While we expect to continue
to enter into uncleared trades on a bilateral basis, such trades will be subject
to new requirements, including mandatory reporting, record-keeping,
documentation, and minimum margin and capital requirements established by
applicable regulators. These requirements are discussed in the 2011 Annual
Report. At this time, we do not expect to have to comply with such requirements
until the beginning of 2013, at the earliest.
The CFTC, the SEC, the Finance Agency, and other bank regulators are expected to
continue to issue final rule makings implementing the foregoing requirements
between now and the end of 2012.
Effectiveness of Key Rules for Derivatives Transactions. Many of the provisions
of the Dodd-Frank Act relating to derivatives that are expected to have the most
effect on our derivatives transactions will take effect on a date determined by
the CFTC, no less than 60 days after the CFTC publishes final regulations
implementing such provisions. Compliance dates for certain of these rulemakings
that have been finalized and published by the CFTC, including new record-keeping
and reporting requirements, are based on the effectiveness of the final rules
further defining the term "swap" jointly issued by the CFTC and SEC. Such final
rules were issued in July 2012 but have not been published in the Federal
Register and will not become effective until at least 60 days after they are
published in the Federal Register. The implementation time frame for mandatory
clearing of eligible interest rate swaps is based on the effectiveness of the
CFTC's mandatory clearing determinations, which were released in proposed form
on July 24, 2012 for interest rate swaps that are currently clearable. The CFTC
will finalize these determinations in the beginning of November 2012, and we
will have to clear eligible interest-rate swaps within 180 days after
publication of the final determinations, which we estimate will be sometime
during the second quarter of 2013.
We, together with the other FHLBanks, will continue to monitor these rulemakings
and the overall regulatory process to implement the derivatives reform under the
Dodd-Frank Act. We will also continue to work with the other FHLBanks to
implement the processes and documentation necessary to comply with the
Dodd-Frank Act's new requirements for derivatives.
Developments Impacting Systemically Important Nonbank Financial Companies
Final Rule and Guidance on the Supervision and Regulation of Certain Nonbank
Financial Companies. On April 11, 2012, the Financial Stability Oversight
Council (the Oversight Council) issued a final rule and guidance, which became
effective on May 11, 2012, on the standards and procedures the Oversight Council
will follow in determining whether to designate a nonbank financial company for
supervision by the Federal Reserve Board (the Federal Reserve) and to be subject
to certain heightened prudential standards. If the Oversight Council determines
the Bank to be a nonbank financial company subject to the supervision by the
Federal Reserve, we would be subject to a separate prudential standards rule
that has been proposed by the Federal Reserve, but is not yet final. The
guidance issued with this final rule provides that the Oversight Council expects
generally to follow a process in making its determinations consisting of:
• a first stage that will identify those nonbank financial companies that have
$50 billion or more of total consolidated assets (as of June 30, 2012, we had
$49.8 billion in total assets) and exceed any one of five threshold indicators
of interconnectedness or susceptibility to material financial distress,
including whether a company has $20 billion or more in total debt outstanding
(as of June 30, 2012, we had $44.2 billion in total outstanding COs, our
principal form of outstanding debt);
• a second stage involving a robust analysis of the potential threat that the
subject nonbank financial company could pose to U.S. financial stability based
on additional quantitative and qualitative factors that are both industry and
company specific; and
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• a third stage analyzing the subject nonbank financial company using
information collected directly from it.
The final rule provides that the Oversight Council will consider as one factor
whether the nonbank financial company is subject to oversight by a primary
financial regulatory agency (for us, the Finance Agency) in making its
determinations. A nonbank financial company that the Oversight Council proposes
to designate for additional supervision and prudential standards under this rule
has the opportunity to contest the designation. If we are designated by the
Oversight Council for supervision by the Federal Reserve and to be subject to
the additional prudential standards, then our operations and business could be
adversely impacted by resulting additional costs and restrictions on our
business activities.
Developments under the Finance Agency
Finance Agency Final Rule on Prudential Management and Operations Standards. On
June 8, 2012, the Finance Agency issued a final rule, which became effective on
August 7, 2012, adopting certain prudential standards for the operation and
management of the FHLBanks, including, among others, prudential standards for
internal controls and information systems, internal audit systems, market and
interest-rate risks, liquidity, asset growth, investments, credit and
counterparty risk management, and records maintenance. The rule requires an
FHLBank that fails to meet a standard to file a corrective action plan to the
Finance Agency within 30 calendar days. If an acceptable corrective action plan
is not submitted by the deadline or the terms of such a plan are not complied
with, the Director of the Finance Agency can impose sanctions, such as limits on
asset growth, increases in the level of retained earnings, and prohibitions on
dividends or the redemption or repurchase of capital stock.
Designation of Size and Composition of the Board of Directors for 2013. On May
31, 2012, the Acting Director of the Finance Agency determined that a 15-member
board of directors will govern the Bank beginning January 1, 2013, comprised of
eight member directorships; which is a reduction of one member directorship
elected by Rhode Island members. The board will continue to have seven
independent directorships. The following table shows the allocation of member
directorships by state beginning January 1, 2013.
Number of Member
State Directorships
Connecticut 1
Maine 1
Massachusetts 3
New Hampshire 1
Rhode Island 1
Vermont 1
Total 8
The Director of the Finance Agency annually determines the size of the board of
directors for each FHLBank, with the designation of member directorships based
on the amount of FHLBank stock required to be held by members in each state.
Other Significant Developments
Basel Committee on Banking Supervision Capital Framework. In September 2010, the
Basel Committee on Banking Supervision (the Basel Committee) approved a new
capital framework for internationally active banks. Banks subject to the new
framework will be required to have increased amounts of capital with core
capital being more strictly defined to include only common equity and other
capital assets that are able to fully absorb losses.
On June 7, 2012, the Board of Governors of the Federal Reserve System (the
Federal Reserve), the Office of the Comptroller of the Currency, and the Federal
Deposit Insurance Corporation (the Agencies) concurrently published three joint
notices of proposed rulemaking (the NPRs) seeking comments on comprehensive
revisions to the Agencies' capital framework to incorporate the Basel
Committee's new capital framework. These revisions would, among other things:
• implement the Basel Committee's capital standards related to minimum
requirements, regulatory capital, and additional capital buffers;
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• revise the methodologies for calculating risk-weighted assets in the general
risk-based capital rules; and
• revise the rules by which large banks determine their capital adequacy.
The NPRs do not incorporate the Basel Committee's liquidity risk-measurement
standards, which are expected to be proposed in separate rulemakings.
If the NPRs are adopted as proposed, some of our members could need to divest
assets in order to comply with the more stringent capital and liquidity
requirements, thereby tending to decrease their need for advances. The
requirements may also adversely impact investor demand for COs to the extent
that impacted institutions divest or limit their investments in COs. On the
other hand, the new requirements could incent our members to borrow term
advances from us to create and maintain balance sheet liquidity.
AUDIT COMMITTEE CHARTER
Our board of directors' Audit Committee Charter is available in full on our
website at the following location:
http://www.fhlbboston.com/downloads/aboutus/Audit_Committee_Charter.pdf
