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FEDERAL HOME LOAN BANK OF BOSTON – 10-Q – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Index to Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements 39 Executive Summary 41 Economic Conditions 42 Selected Financial Data 43 Results of Operations 45 Financial Condition 51 Liquidity and Capital Resources 63 Critical Accounting Estimates 69 Recent Accounting Developments 69 Legislative and Regulatory Developments 69
Forward-Looking Statements
This report includes statements describing anticipated developments,
projections, estimates, or predictions of ours that are "forward-looking
statements." These statements may involve matters related to, but not limited
to, projections of revenues, income, earnings, capital expenditures, dividends,
capital structure, or other financial items; repurchases of excess stock, our
minimum retained earnings target, or the interest-rate environment in which we
do business; statements of management's plans or objectives for future
operations; expectations of effects or changes in fiscal and monetary policies
and our future economic performance; projections or expectations regarding the
COVID-19 pandemic or its effects; or statements of assumptions
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underlying certain of the foregoing types of statements. These statements may
use forward-looking terminology such as, but not limited to, "anticipates,"
"believes," "continued," "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 Part I - Item 1A - Risk Factors in the 2020 Annual Report
and in Part II - Item 1A - Risk Factors of this report, along with the risks
set forth below. Actual results could differ materially from those expressed or
implied in these forward-looking statements or could affect the extent to which
a particular objective, projection, estimate, or prediction is realized. As a
result, you are cautioned not to place undue reliance on such statements. These
forward-looking statements speak only as of the date they are made, and we do
not undertake to update any forward-looking statement herein or that may be made
from time to time on our behalf.
Some of the risks and uncertainties that could affect our forward-looking
statements include the following:
•the effects of economic, financial, credit, and market conditions on our financial and regulatory condition and results of operations, including changes in economic growth, general liquidity conditions, inflation and deflation, employment rates, interest rates, interest rate spreads, interest rate volatility, mortgage originations, prepayment activity, housing prices, asset delinquencies, members' deposit flows, liquidity needs, and loan demand; changes in benchmark interest rates, including but not limited to the anticipated cessation of the LIBOR benchmark rate, the development of alternative rates, including the Secured Overnight Financing Rate (SOFR), and the adverse consequences these could have for market participants, including the Bank and its members; changes in the general economy, including changes resulting fromU.S. fiscal and monetary policy, actions of theFederal Open Market Committee (FOMC), or changes in ratings of theU.S. federal government; the condition of the mortgage and housing markets on our mortgage-related assets; the condition of the capital markets on our COs; •issues and events across theFHLBank System and in the political arena that may lead to executive branch, legislative, regulatory, judicial, or other developments impacting the scope of our business, investor demand for COs, our financial obligations with respect to COs, our ability to access the capital markets, our members, our counterparties, the manner in which we operate, or the organization and structure of theFHLBank System ; •the impact of COVID-19 or other pandemics, epidemics, or health emergencies and responses to such events, including, among other things, the effect on the Bank resulting from illness or quarantines of employees or business partners on which we rely or from remote work arrangements; negative effects on our members' businesses and their demands for our products, including demand for advances; and effects on the economy and financial markets fromFederal Reserve monetary policy, fiscal stimulus programs (or changes to or cessation of such programs), state and local government restrictions on business activities including, among other things, federal and state vaccine mandates and reactions thereto, or generally; •our ability to declare and pay dividends consistent with past practices as well as any plans to repurchase excess capital stock, and any amendments to our capital plan; •competitive forces including, without limitation, other sources of funding available to our members and other entities borrowing funds in the capital markets; •changes in the value and liquidity of collateral we hold as security for obligations of our members and counterparties; •the impact of new accounting standards and the application of accounting rules, including the impact of regulatory guidance on our application of such standards and rules? •changes in the fair value and economic value of, impairments of, and risks, including risks related to changes in or cessation of benchmark interest rates such as LIBOR, overnight index swap (OIS), and SOFR, associated with the Bank's investments in mortgage loans and MBS or other assets and the related credit-enhancement protections? •membership conditions and changes, including changes resulting from member failures, mergers or changing financial health, changes due to member eligibility, changes in the principal place of business of members, or the addition of new members; •external events, such as general economic and financial instabilities, political instability, wars and natural disasters, including disasters caused by significant climate change, which, among other things, could damage our facilities or the facilities of our members, damage or destroy collateral that members have pledged to secure advances or mortgages that we hold for our portfolio, and which could cause us to experience losses or be exposed to a greater risk that pledged collateral would be inadequate in the event of a default; •the pace of technological change and our ability to develop and support internal controls, information systems, and other operating technologies that effectively manage the risks we face, including but not limited to, failures, interruptions, or security breaches (cyber-attacks), which could increase as a result of COVID-19 related changes in our operating environment; and •our ability to attract and retain skilled employees, including key personnel. 40
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These risk factors are not exhaustive. New risk factors 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 three, and the 2020 Annual Report.
EXECUTIVE SUMMARY
For the three months endedSeptember 30, 2021 , net income was$16.5 million , compared with net income of$53.6 million for the same period in 2020. The decrease in net income for the quarter was primarily due to the absence of gains on sale of investment securities versus$32.9 million recorded in the third quarter of 2020, and a decrease of$11.1 million in net interest income after provision for credit losses offset by a reduction in net unrealized losses on trading securities of$8.5 million . Net interest income after provision for credit losses for the three months endedSeptember 30, 2021 , was$51.1 million , compared with$62.3 million for the same period in 2020. Although average total earning assets declined$7.4 billion to$34.6 billion for the three months endedSeptember 30, 2021 , from$42.0 billion for the same period in 2020, the impact on net interest income after provision for credit losses was partially offset as our net interest margin increased 0.04 percentage points to 0.58 percent for the three months endedSeptember 30, 2021 , from 0.54 percent for the same period in 2020. Our retained earnings grew to$1.5 billion atSeptember 30, 2021 , an increase of$29.3 million fromDecember 31, 2020 and equals 4.44 percent of total assets atSeptember 30, 2021 . We continue to satisfy all regulatory capital requirements as ofSeptember 30, 2021 . OnOctober 22, 2021 , our board of directors declared a cash dividend that was equivalent to an annual yield of 2.05 percent, the approximate daily average of SOFR for the third quarter of 2021 plus 200 basis points, which represented an increase of 50 basis points in the spread over SOFR compared to our dividend rate calculation in the prior quarter. Our overall results of operations are influenced by the economy and financial markets, and, in particular, by members' demand for advances and our ability to maintain sufficient access to funding at relatively favorable costs. The continued COVID-19 pandemic, which began to affect businesses and the economy inMarch 2020 , and the response of theU.S. government and theFederal Reserve through changes in monetary policy and implementation of unprecedented fiscal stimulus programs, led to interest rates that remain historically low and substantially elevated deposits reported by member depository institutions. The elevated level of deposits at member depository institutions has been the primary cause of the significant and continued decline in advances balances which began in the second quarter of 2020. In addition, Agency mortgage-backed security purchases by theFederal Reserve aimed at supporting the housing market through the pandemic have tightened yield spreads we earn on new mortgage acquisitions and have provided an incentive to some of our members to sell loans to Fannie Mae and Freddie Mac rather than to us. This activity has reduced our outstanding balances of mortgage loans. These developments impacted our financial condition as ofSeptember 30, 2021 , and results of operations for the three months endedSeptember 30, 2021 . Generally, investor demand for high credit quality, fixed-income investments, including COs, continued to be strong relative to other investments. Moreover, a declining supply of COs, primarily as a result of lower advances balances throughout theFHLBank System has further increased the relative demand for COs and improved our relative cost of borrowing. Our flexibility in utilizing various funding tools, in combination with a diverse investor base and our status as a government-sponsored enterprise, have helped provide reliable market access and demand for consolidated obligations throughout fluctuating market environments and regulatory changes affecting dealers of and investors in COs. The Bank has continued to meet all funding needs during the three months endedSeptember 30, 2021 . Advances Balances
We continue to deliver on our primary mission, supplying liquidity to our
members. Advances balances totaled
to
short- and long-term fixed-rate advances, and was primarily due to excess
liquidity at member institutions.
Net Interest Income, Margin, and Spread
For the three months endedSeptember 30, 2021 , net interest margin was 0.58 percent, an increase of 0.04 percentage points from the three months endedSeptember 30, 2020 , and net interest spread was 0.56 percent for the quarter endedSeptember 30, 2021 , a 0.07 percentage point increase from the same period in 2020. The increase in both net interest spread and net interest margin results primarily from an improvement in funding costs and a reduction in net premium amortization on mortgage- 41 -------------------------------------------------------------------------------- Table of Contents related assets relative to the same period in 2020. The sharply-reduced interest rate environment in 2020 triggered refinancing incentives on residential mortgage loans, resulting in increases of mortgage prepayment activity that resulted in accelerated net premium amortization of our Agency residential MBS as well as our whole mortgage loans. Refinancing activity of mortgage loans remains high but has moderated during the first nine months of 2021.
Other Income and Expense
Net gains and losses on derivatives and hedging activities for the three months endedSeptember 30, 2021 , totaled a net loss of$387 thousand , compared with a net gain of$1.6 million for the same period in 2020. The$387 thousand net loss for the current quarter consisted of an unrealized gain of$3.3 million from changes in fair value on economic hedges offset by$3.7 million of interest expense on economic hedges. Additionally, unrealized losses on trading securities totaled$11.1 million for the three months endedSeptember 30, 2021 . Together, these realized and unrealized gains and losses provided an economic offset primarily to interest income from trading securities, which totaled$11.5 million for the three months endedSeptember 30, 2021 . See below under -
Results of Operations -
additional information.
Legislative and Regulatory Developments
Legislation has been proposed or enacted, and the FHFA and others with authority over the economy, our industry, and our business activities have taken action during 2021 as described in - Legislative and Regulatory Developments . Such developments affect the way we conduct business and could impact how we satisfy our mission as well as the value of our membership.
LIBOR Transition Preparations
InJuly 2017 , theUnited Kingdom's Financial Conduct Authority (FCA), which regulates LIBOR, announced its intention to stop persuading or compelling the major banks that sustain LIBOR to submit rate quotations after 2021. OnMarch 5, 2021 , theFCA further announced that LIBOR will either cease to be provided by any administrator or no longer be representative immediately afterDecember 31, 2021 , in the case of 1-week and 2-monthU.S. dollar LIBOR, and immediately afterJune 30, 2023 , in the case of the remainingU.S. dollar LIBOR settings. Although theFCA does not expect LIBOR to become non-representative before the applicable cessation dates and intends to consult on requiring the administrator of LIBOR to continue publishing LIBOR of certain currencies and tenors on a non-representative, synthetic basis for a period after the applicable cessation date, there is no assurance that LIBOR, of any particular currency or tenor, will continue to be published or be representative through any particular date. There is no assurance that LIBOR will continue to be accepted or used in the markets generally, or by any issuers, investors, or counterparties at any time, even if LIBOR continues to be available. We recognize that the discontinuance of LIBOR as an interest rate benchmark and the transition to alternative reference rates, including SOFR, present significant risks and challenges that could affect our business. Certain of our advances, investment securities and derivatives are indexed to LIBOR, and we continue to assess legacy contracts across products and monitor risks to determine the effect of LIBOR discontinuance. Under a steering committee comprised of members of senior management and a working group of representatives from departments across the Bank, we developed and continue to implement a multi-year plan and initiative to transition from LIBOR. We worked with the other FHLBanks and theOffice of Finance to transition our floating-rate note issuance from LIBOR. In addition, we offer a SOFR-based advance. We are updating our operational processes and models to support new alternative reference rate activity. For further details see the following Risk Factors in our 2020 Annual Report: Part I - Item 1A - Risk Factors - Market and Liquidity Risks - Changes to and replacement of the LIBOR benchmark interest rate could adversely affect our business, financial condition, and results of operations; and - We use derivatives to manage interest-rate risk, however, we could be unable to enter into effective derivative instruments on acceptable terms. Additional information is provided in - Financial Condition - Transition from LIBOR to Alternative Reference Rates . ECONOMIC CONDITIONS Economic Environment The economy continued to rebound in the third quarter from the recessionary effects of the pandemic, though at a slower rate than in the first two quarters of 2021. Real gross domestic product (GDP) grew at an annualized rate of 2.0 percent in the third quarter driven by consumer expenditures, business investment, and state and local government spending. The level of GDP now exceeds the pre-pandemic level at the end of 2019. 42 -------------------------------------------------------------------------------- Table of Contents TheU.S. labor market recorded average monthly gains of 550,000 jobs in the third quarter. Notable job gains occurred in leisure and hospitality, professional and business services, and transportation and warehousing industries. The unemployment rate for theU.S. stood at 4.8 percent inSeptember 2021 . The unemployment rate for theNew England region was 5.3 percent inAugust 2021 , with the highest unemployment rate in the region at 7.2 percent inConnecticut and the lowest unemployment rate at 3.0 percent inNew Hampshire andVermont . The continuing expansion of the economy, combined with supply chain challenges, led to an increase in the inflation rate in the third quarter. The personal consumption expenditures (PCE) price index increased year-over-year by 5.3 percent in the third quarter, driven by prices for energy and durable goods, particularly new and used cars. Excluding food and energy, the PCE price index increased by 4.5 percent in the third quarter. The housing market remained strong driven by strong demand and low levels of available inventory. The FHFA reported that home prices rose 18.5 percent nation-wide fromAugust 2020 toAugust 2021 and by 19.2 percent nation-wide fromJuly 2020 toJuly 2021 . The rate of increase for theNew England region fromJuly 2020 toJuly 2021 was 20.8 percent.
Interest-Rate Environment
OnNovember 3, 2021 , theFOMC maintained the target range for the federal funds rate at between 0 and 25 basis points. TheFOMC stated that it expects to maintain this range until the labor market has reached levels consistent with maximum employment and inflation has risen to 2.0 percent and is on track to moderately exceed 2.0 percent for some time. TheFederal Reserve continues to increase its holdings ofTreasury and Agency mortgage-backed securities. TheFOMC further stated that it will begin to reduce the pace of its bond purchase program beginning inNovember 2021 , and is prepared to adjust the pace of purchases each month if warranted by changes in the economic outlook. After rising sharply in the first quarter and declining in the second quarter, long-term interest rates were relatively stable in the third quarter. 10-yearTreasury rates rose slightly over the three months endingSeptember 30, 2021 , consistent with concerns about rising COVID-19 cases due to more transmissible variants of the virus and increased slightly inSeptember 2021 , consistent with elevated levels of inflation potentially persisting longer than expected.
Table 1 - Key Interest Rates(1)
Three Month Average Nine Month Average Ending Rate
September 30, 2021 September 30, 2020 September 30, 2021 September 30, 2020 September 30, 2021 December 31, 2020
SOFR 0.05% 0.09% 0.04% 0.45% 0.05% 0.07%
Federal funds
effective rate 0.09% 0.09% 0.08% 0.45% 0.06% 0.09%
3-month LIBOR 0.13% 0.25% 0.16% 0.79% 0.13% 0.24%
3-month U.S. Treasury
yield 0.04% 0.10% 0.03% 0.43% 0.03% 0.06%
2-year U.S. Treasury
yield 0.22% 0.14% 0.17% 0.47% 0.28% 0.12%
5-year U.S. Treasury
yield 0.80% 0.27% 0.75% 0.59% 0.96% 0.36%
10-year U.S. Treasury
yield 1.32% 0.65% 1.41% 0.90% 1.49% 0.91%
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(1) Source: Bloomberg
SELECTED FINANCIAL DATA
The following financial highlights for the statement of condition and statement
of operations for
financial statements. Financial highlights for the quarter-ends have been
derived from our unaudited financial statements.
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Table 2 - Selected Financial Data
(dollars in thousands)
As of and for the Three Months Ended
September 30, 2021 June 30, 2021 March 31, 2021 December 31, 2020 September 30, 2020
Statement of Condition
Total assets $ 34,448,917 $ 35,683,602 $ 36,676,723 $ 38,461,035 $ 45,025,341
Investments, net(1) 16,404,424 16,053,111 15,474,566 13,341,538 13,345,453
Advances 14,056,991 15,176,625 16,798,082 18,817,002 26,961,561
Mortgage loans held for portfolio, net(2) 3,283,925 3,470,505 3,726,343 3,930,252 4,160,091
Deposits and other borrowings 970,732 970,282 1,088,187 1,088,987 1,227,702
Consolidated obligations:
Bonds 25,097,469 23,475,165 22,704,460 21,471,590 23,970,889
Discount notes 5,554,103 8,365,460 9,927,167 12,878,310 16,511,187
Total consolidated obligations 30,651,572 31,840,625 32,631,627 34,349,900 40,482,076
Mandatorily redeemable capital stock 13,890 7,432 6,164 6,282 6,135
Class B capital stock outstanding-putable(3) 1,028,177 1,081,057 1,181,665 1,267,172 1,594,859
Unrestricted retained earnings 1,159,509 1,147,279 1,145,756 1,130,222 1,121,875
Restricted retained earnings 368,420 368,420 368,420 368,420 368,420
Total retained earnings 1,527,929 1,515,699 1,514,176 1,498,642 1,490,295
Accumulated other comprehensive income (loss) 40,604 47,645 21,223 16,139 (24,067)
Total capital 2,596,710 2,644,401 2,717,064 2,781,953 3,061,087
Results of Operations (for the period ended)
Net interest income after provision for credit
losses $ 51,145 $ 43,122 $ 61,484 $ 61,826 $ 62,261
Litigation settlements - - - 25,998 -
Other (loss) income, net (10,453) (13,104) (15,763) (24,601) 18,110
Other expense 22,330 23,177 22,513 38,512 20,858
AHP assessments 1,842 687 2,323 2,474 5,957
Net income $ 16,520 $ 6,154 $ 20,885 $ 22,237 $ 53,556
Other Information
Dividends declared $ 4,290 $ 4,631 $ 5,351 $ 13,890 $ 18,845
Dividend payout ratio 25.97 % 75.25 % 25.62 % 62.46 % 35.19 %
Weighted-average dividend rate(4) 1.52 1.54 1.59 3.76 4.12
Return on average equity(5) 2.50 0.92 3.09 3.14 7.39
Return on average assets 0.18 0.07 0.23 0.22 0.50
Net interest margin(6) 0.58 0.48 0.68 0.60 0.54
Average equity to average assets 7.36 7.29 7.46 7.09 6.72
Total regulatory capital ratio(7) 7.46 7.30 7.37 7.21 6.87
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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. The allowance for credit
losses relating to private label MBS amounted to $124 thousand as of September
30, 2020 . All private-label MBS were sold subsequent to September 30, 2020 .
(2)The allowance for credit losses for mortgage loans amounted to $2.1 million
as of September 30, 2021 , $2.1 million as of June 30, 2021 , $1.9 million as of
March 31, 2021 , $3.1 million as of December 31, 2020 , and $4.6 million as of
September 30, 2020 , respectively.
(3)Capital stock is putable at the option of a member upon five years' written
notice, subject to applicable restrictions.
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(4)Weighted-average dividend rate is the dividend amount declared divided by the
average daily balance of capital stock eligible for dividends.
(5)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 total retained earnings.
(6)Net interest margin is net interest income before provision for credit losses
as a percentage of average earning assets.
(7)Total regulatory capital ratio is capital stock (including mandatorily
redeemable capital stock) plus total retained earnings as a percentage of total
assets. See Item 1 - Notes to the Financial Statements - Note 10 - Capital .
RESULTS OF OPERATIONS
Third Quarter of 2021 Compared with Third Quarter of 2020
Net income was
compared to
reasons for the decrease are discussed under - Executive Summary .
Net interest income after provision for credit losses for the three months endedSeptember 30, 2021 , was$51.1 million , compared with$62.3 million for the same period in 2020. The$11.1 million decrease in net interest income after provision for credit losses is attributable to several factors. In the third quarter of 2020, the Bank sold a majority of its private-label mortgage-backed securities resulting in a reduction of the provision for credit losses of$5.1 million , whereas in the third quarter of 2021 the provision for credit losses, which is now solely attributable to mortgage loans, decreased by$80 thousand . Additionally, in the third quarter of 2021 compared to the third quarter of 2020, the Bank experienced an$8.9 billion decrease in the average balance of advances and an$899.2 million decrease in the average balance of mortgage loans. The Bank also experienced a decline of$419.8 million in the average balance of outstanding capital stock in the third quarter of 2021 compared to the third quarter of 2020, thereby negatively affecting net interest income from investing the Bank's capital. These negative factors were partially offset by increases to net interest income resulting from an increase in net interest margin and net interest spread as further discussed in the Executive Summary above, and a$1.5 billion increase in the average balance ofU.S. Treasury obligations.
For additional information see - Rate and Volume Analysis.
Nine Months Ended
30, 2020
Net income was$43.6 million for the nine months endedSeptember 30, 2021 , compared to$98.0 million for the nine months endedSeptember 30, 2020 . The$54.5 million decrease in net income was primarily due to an increase of$48.3 million in net unrealized losses on trading securities, and a$73.6 million decrease in realized net gains from sale of investment securities, partially offset by a decrease of$51.3 million in net losses on derivatives and hedging activities as well as a$23.0 million increase in net interest income after provision for credit losses. Net interest income after provision for credit losses for the nine months endedSeptember 30, 2021 , was$155.8 million , compared with$132.7 million for the same period for 2020. The increase of$23.0 million in net interest income after provision for credit losses is attributable to several favorable factors, including: the absence of margin compression on liquidity investments that we experienced during the second quarter of 2020 following the sudden interest-rate cuts by theFOMC inMarch 2020 ; a$24.6 million decrease in net amortization of premium on mortgage-backed securities and mortgage loans; a$16.9 million increase in net unrealized gains from fair value hedges; a$1.3 billion increase in the average balance ofU.S. Treasury obligations held as investment securities; and a general improvement in funding costs. These factors were partially offset by reductions to net interest income resulting from average balance decreases of$14.2 billion for advances,$837.1 million for mortgage loans, and$626.1 million for mortgage-backed securities, as well as an$8.9 million decrease in accretion of significant improvement in projected cash flows resulting from sales of previously impaired private-label MBS as all private-label MBS were sold in 2020. In addition, net interest income was negatively affected by lower income from investing our capital, resulting from the near zero, and substantially lower, average short-term interest rates in the nine months endedSeptember 30, 2021 , compared to the same period a year prior and the$607.3 million decline in the average balance of outstanding capital stock in the nine months endedSeptember 30, 2021 compared to the same period a year prior. For the nine months endedSeptember 30, 2021 , net interest margin was 0.58 percent, an increase of 0.25 percentage points from the nine months endedSeptember 30, 2020 , and net interest spread was 0.54 percent for the nine months endedSeptember 30, 2021 , an increase of 0.28 percentage points from the same period in 2020. The increase in both net interest spread and net interest margin mainly reflect significant improvement in funding costs in 2021 relative to the same period in 2020, as well as the improvements in net interest income after provision for credit losses described above. 45
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Table 3 presents major categories of average balances, related interest
income/expense, and average yields/rates 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.
Table 3 - Net Interest Spread and Margin
(dollars in thousands)
For the Three Months Ended September 30,
2021 2020
Interest Interest
Average Income / Average Average Income / Average
Balance Expense Yield/Rate(1) Balance Expense Yield/Rate(1)
Assets
Advances $ 14,609,839 $ 46,174 1.25 % $ 23,558,516 $ 76,864 1.30 %
Interest-bearing deposits 55,953 13 0.09 903,625 271 0.12
Securities purchased under agreements to
resell 298,913 68 0.09 1,092,391 239 0.09
Federal funds sold 3,024,544 672 0.09 1,166,043 275 0.09
Investment securities(2) 13,271,856 31,001 0.93 11,011,662 42,517 1.54
Mortgage loans (2)(3) 3,380,302 22,984 2.70 4,279,474 28,732 2.67
Total interest-earning assets 34,641,407 100,912 1.16 42,011,711 148,898 1.41
Other non-interest-earning assets 465,337 322,180
Fair-value adjustments on investment
securities 514,343 568,842
Total assets $ 35,621,087 $ 100,912 1.12 % $ 42,902,733 $ 148,898 1.38 %
Liabilities and capital
Consolidated obligations
Discount notes $ 8,390,753 $ 904 0.04 % $ 14,079,541 $ 8,728 0.25 %
Bonds 23,606,437 48,861 0.82 24,565,107 82,962 1.34
Other interest-bearing liabilities 933,293 82 0.03 1,029,191 90 0.03
Total interest-bearing liabilities 32,930,483 49,847 0.60 39,673,839 91,780 0.92
Other non-interest-bearing liabilities 69,751 346,854
Total capital 2,620,853 2,882,040
Total liabilities and capital $ 35,621,087 $ 49,847 0.56 % $ 42,902,733 $ 91,780 0.85 %
Net interest income $ 51,065 $ 57,118
Net interest spread 0.56 % 0.49 %
Net interest margin 0.58 % 0.54 %
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For the Nine Months Ended September 30,
2021 2020
Interest Interest
Average Income / Average Average Income / Average
Balance Expense Yield(1) Balance Expense Yield(1)
Assets
Advances $ 16,032,165 $ 150,921 1.26 % $ 30,269,846 $ 351,343 1.55 %
Interest-bearing deposits 424,804 107 0.03 1,230,896 5,625 0.61
Securities purchased under agreements to
resell 643,780 360 0.07 2,293,985 14,813 0.86
Federal funds sold 3,003,974 1,768 0.08 3,068,960 17,416 0.76
Investment securities(2) 11,917,968 98,685 1.11 11,267,700 127,540 1.51
Mortgage loans (2)(3) 3,597,242 71,128 2.64 4,434,353 98,911 2.98
Other earning assets - - - 5,475 47 1.15
Total interest-earning assets 35,619,933 322,969 1.21 52,571,215 615,695 1.56
Other non-interest-earning assets 319,933 307,851
Fair-value adjustments on investment
securities 452,120 414,967
Total assets $ 36,391,986 $ 322,969 1.19 % $ 53,294,033 $ 615,695 1.54 %
Liabilities and capital
Consolidated obligations
Discount notes $ 10,049,420 $ 3,989 0.05 % $ 24,134,196 $ 183,792 1.02 %
Bonds 22,499,288 164,146 0.98 24,863,963 300,765 1.62
Other interest-bearing liabilities 978,714 190 0.03 908,048 1,322
0.19
Total interest-bearing liabilities 33,527,422 168,325 0.67 49,906,207 485,879
1.30
Other non-interest-bearing liabilities 182,912 313,189 Total capital 2,681,652 3,074,637 Total liabilities and capital$ 36,391,986 $ 168,325 0.62 %$ 53,294,033 $ 485,879 1.22 % Net interest income$ 154,644 $ 129,816 Net interest spread 0.54 % 0.26 % Net interest margin 0.58 % 0.33 %
_________________________
(1) Yields are annualized. (2) The average balances are reflected at amortized cost. (3) Nonaccrual loans are included in the average balances used to determine average yield. Rate and Volume Analysis Changes in both average balances (volume) and interest rates influence changes in net interest income and net interest margin. Table 4 summarizes changes in interest income and interest expense for the three and nine months endedSeptember 30, 2021 and 2020. Changes in interest income and interest expense that are not identifiable as either volume- or rate-related, but are 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. 47 -------------------------------------------------------------------------------- Table of Contents Table 4 - Rate and Volume Analysis (dollars in thousands) For the Three Months Ended For the Nine Months Ended September 30, 2021 vs. 2020 September 30, 2021 vs. 2020 Increase (Decrease) due to Increase (Decrease) due to Volume Rate Total Volume Rate Total Interest income Advances$ (28,352) $ (2,338) $ (30,690) $ (142,979) $ (57,442) $ (200,421) Interest-bearing deposits (208) (50) (258) (2,259) (3,259) (5,518) Securities purchased under agreements to resell (180) 9 (171) (6,368) (8,085) (14,453) Federal funds sold 414 (17) 397 (361) (15,287) (15,648) Investment securities 7,548 (19,064) (11,516) 7,011 (35,866) (28,855) Mortgage loans (6,109) 361 (5,748) (17,348) (10,435) (27,783) Other earning assets - - - (24) (24) (48) Total interest income (26,887) (21,099) (47,986) (162,328) (130,398) (292,726) Interest expense Consolidated obligations Discount notes (2,570) (5,254) (7,824) (68,518) (111,285) (179,803) Bonds (3,123) (30,978) (34,101) (26,410) (110,209) (136,619) Other interest-bearing liabilities (8) - (8) 96 (1,228) (1,132) Total interest expense (5,701) (36,232) (41,933) (94,832) (222,722) (317,554) Change in net interest income$ (21,186) $ 15,133 $ (6,053) $ (67,496) $ 92,324 $ 24,828
Average Balance of Advances Outstanding
The average balance of total advances decreased$14.2 billion , or 47.0 percent, for the nine months endedSeptember 30, 2021 , compared with the same period in 2020 as members pay off advances, in many cases prior to maturity. We believe it is likely that advances balances will remain for some time at a level that is significantly lower than that of the past several years, and could decline further, due to high levels of deposits relative to loans among our members as well as acquisitions of borrowing members by institutions ineligible for membership with the Bank. For the nine months endedSeptember 30, 2021 and 2020, net prepayment fees on advances were$17.3 million and$10.6 million , 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, and generally when prevailing reinvestment yields are lower than those of the prepaid advances. For additional information see Item 8 - Financial Statements and Supplementary Data - Notes to the Financial Statements - Note 2 - Summary of Significant Accounting Policies - Advances in the 2020 Annual Report.
Average Balance of Investments
Average short-term money-market investments, consisting of interest-bearing deposits, securities purchased under agreements to resell, and federal funds sold, decreased$2.5 billion , or 38.2 percent, for the nine months endedSeptember 30, 2021 , compared with the same period in 2020, as liquidity needs were sharply lower in the first nine months of 2021 as compared to the first nine months of 2020 amid much lower advances borrowing activity. The yield earned on short-term money-market investments is highly correlated to short-term market interest rates. As a result of the sharp decrease in theFOMC's target range for the federal funds rate, average yields on overnight federal funds sold decreased from 0.76 percent during the nine months endedSeptember 30, 2020 , to 0.08 percent during the nine months endedSeptember 30, 2021 , while average yields on securities purchased under agreements to resell decreased from 0.86 percent for the nine months endedSeptember 30, 2020 , to 0.07 percent for the nine months endedSeptember 30, 2021 . Average investment-securities balances increased$650.3 million , or 5.8 percent for the nine months endedSeptember 30, 2021 , compared with the same period in 2020. 48
-------------------------------------------------------------------------------- Table of Contents Average Balance of COs Average CO balances decreased$16.4 billion , or 33.6 percent, for the nine months endedSeptember 30, 2021 , compared with the same period in 2020, resulting from our decreased funding needs principally due to the decrease in our average advances balances. This overall decrease consisted of declines of$14.1 billion in CO discount notes and$2.4 billion in CO bonds. The average balance of CO discount notes represented approximately 30.9 percent of total average COs during the nine months endedSeptember 30, 2021 , compared with 49.3 percent of total average COs during the nine months endedSeptember 30, 2020 . The average balance of CO bonds represented 69.1 percent and 50.7 percent of total average COs outstanding during the nine months endedSeptember 30, 2021 and 2020, respectively.
Impact of Derivatives and Hedging Activities
Net interest income includes interest accrued on interest-rate-exchange agreements that are associated with advances, investments, and debt instruments that qualify for hedge accounting. The fair value gains and losses of derivatives and hedged items designated in fair-value hedge relationships are also recognized as interest income or interest expense. We enter into derivatives to manage the interest-rate-risk exposures inherent in otherwise unhedged assets and liabilities and to achieve our risk-management objectives. We generally use derivative instruments that qualify for hedge accounting as interest-rate risk-management tools. These derivatives serve to stabilize net income when interest rates fluctuate. Accordingly, the impact of derivatives on net interest income and net interest margin, as well as other income, should be viewed in the overall context of our risk-management strategy. Table 5 below provides a summary of the impact of derivatives and hedging activities on our earnings, excluding derivatives that are economically hedging trading securities and not designated in qualifying fair-value hedge relationships. Table 6 below provides a summary of the impact on our earnings from economically hedged trading securities and the associated derivatives.
Table 5 - Effect of Derivative and Hedging Activities
(dollars in thousands)
For the Three Months Ended September 30, 2021
Net Effect of Derivatives and
Hedging Activities Advances Investments Mortgage Loans CO Bonds Other Total
Net interest income
Amortization / accretion of hedging
activities (1) $ (363) $ - $ (248) $ (847) $ - $ (1,458)
Gains on designated fair-value
hedges 167 2,832 - 168 -
3,167
Net interest settlements on derivatives (15,531) (32,980) - 20,442 - (28,069) Total net interest income (15,727) (30,148) (248) 19,763 - (26,360) Net (losses) gains on derivatives and hedging activities Losses on derivatives not receiving hedge accounting (420) - - (310) - (730) CO Bond firm commitment - - - 302 - 302 Mortgage delivery commitments - - 94 - - 94 Net (losses) gains on derivatives and hedging activities (420) - 94 (8) -
(334)
Total net effect of derivatives and hedging activities$ (16,147) $ (30,148) $ (154)$ 19,755 $ -$ (26,694) 49
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For the Three Months Ended September 30, 2020
Net Effect of Derivatives and Hedging
Activities Advances Investments Mortgage Loans CO Bonds
Total
Net interest income Amortization / accretion of hedging activities in net interest income (1) $ (383) $ - $ (521)$ (984) $
(1,888)
Gains (losses) on designated fair-value hedges 451 1,961 - (285)
2,127
Net interest settlements on derivatives (18,663) (20,361) - 7,625 (31,399) Total net interest income (18,595) (18,400) (521) 6,356 (31,160) Net (losses) gains on derivatives and hedging activities Losses on derivatives not receiving hedge accounting (723) - - -
(723)
Mortgage delivery commitments - - 409 -
409
Net (losses) gains on derivatives and hedging activities (723) - 409 -
(314)
Total net effect of derivatives and hedging activities$ (19,318) $ (18,400) $ (112)$ 6,356 $ (31,474) For the Nine Months Ended September 30, 2021 Net Effect of Derivatives and Mortgage Hedging Activities Advances Investments Loans CO Bonds Other Total Net interest income Amortization / accretion of hedging activities (1)$ (1,767) $ -$ (1,076) $ (2,249) $ - $
(5,092)
Gains on designated fair-value hedges 940 6,347 - 467 - 7,754 Net interest settlements on derivatives (47,398) (84,764) - 43,912 - (88,250) Total net interest income (48,225) (78,417) (1,076) 42,130 - (85,588) Net losses on derivatives and hedging activities Losses on derivatives not receiving hedge accounting (384) - - (329) (148) (861) CO Bond firm commitment - - - 321 - 321 Mortgage delivery commitments - - (339) - - (339) Net losses on derivatives and hedging activities (384) - (339) (8) (148) (879) Total net effect of derivatives and hedging activities$ (48,609) $ (78,417) $ (1,415) $ 42,122 $ (148) $ (86,467) For the Nine Months Ended September 30, 2020 Net Effect of Derivatives and Hedging Mortgage Activities Advances Investments Loans CO Bonds
Total
Net interest income Amortization / accretion of hedging activities (1)$ (1,213) $ -$ (1,301) $ (2,819) $ (5,333) Losses on designated fair-value hedges (866) (6,627) - (1,662) (9,155) Net interest settlements on derivatives (35,971) (49,918) - 17,621 (68,268) Total net interest income (38,050) (56,545) (1,301) 13,140 (82,756) Net (losses) gains on derivatives and hedging activities Losses on derivatives not receiving hedge accounting (787) - - - (787) Mortgage delivery commitments - - 979 - 979 Net (losses) gains on derivatives and hedging activities (787) - 979 - 192 Total net effect of derivatives and hedging activities$ (38,837) $ (56,545) $ (322) $ 13,140 $ (82,564) _____________________ 50
-------------------------------------------------------------------------------- Table of Contents (1) Represents the amortization/accretion of hedging fair-value adjustments and cash-flow hedge amortization reclassified from accumulated other comprehensive income.
We maintain a portfolio of economically hedged trading securities consisting ofU.S Treasury obligations, which totaled$1.8 billion atSeptember 30, 2021 . Because these securities are not designated in qualifying fair-value hedge relationships, the income statement impacts of the economic hedge relationships appear within multiple line items of our income statement. Table 6 presents the net impact to our earnings arising from these economically hedged trading securities.
Table 6 -
(dollars
For the Three Months Ended For the Nine Months Ended September
September 30, 30,
2021 2020 2021 2020
Interest income
Net interest settlements on trading
securities $ 11,471 $
23,161
Net unrealized (losses) gains on trading securities (11,091) (19,657) (40,568) 7,955 Net gains (losses) on derivatives and hedging activities Net interest settlements on derivatives (3,654) (11,038) (16,432) (25,280) Change in fair value of derivatives 3,599 12,962 16,515 (27,104) Price alignment interest (2) 2 14 8 97 Total net impact of economically hedged trading securities$ 327 $ 5,442 $ 3,262 $ 17,833 _____________________
(1) Includes only trading securities that are economically hedged with an
associated derivative.
(2) Represents the amount for derivatives for which variation margin, or
payments made for the changes in the market value of the transaction, is
characterized as a daily settlement amount.
FINANCIAL CONDITION
Advances
AtSeptember 30, 2021 , the advances portfolio totaled$14.1 billion , a decrease of$4.8 billion compared with$18.8 billion atDecember 31, 2020 . The demand for advances experienced further reduction during the quarter, as member deposit levels continued to be elevated. 51 -------------------------------------------------------------------------------- Table of Contents Table 7 - Advances Outstanding by Product Type (dollars in thousands) September 30, 2021 December 31, 2020 Par Value Percent of Total Par Value Percent of Total Fixed-rate advances Long-term$ 7,887,675 56.3 %$ 9,839,714 52.6 % Putable 1,741,425 12.4 1,874,925 10.0 Short-term 1,656,196 11.8 4,180,412 22.3 Amortizing 602,712 4.3 667,506 3.6 Overnight 79,095 0.6 170,045 0.9 All other fixed-rate advances 10,000 0.1 10,000 0.1 11,977,103 85.5 16,742,602 89.5 Variable-rate advances Simple variable (1) 2,028,875 14.4 1,906,575 10.2 All other variable-rate indexed advances 9,597 0.1 55,335 0.3 2,038,472 14.5 1,961,910 10.5 Total par value$ 14,015,575 100.0 %$ 18,704,512 100.0 % _____________________
(1) Includes floating-rate advances that may be contractually prepaid by the
borrower on a floating-rate reset date without incurring prepayment or
termination fees.
See Item 1 - Notes to the Financial Statements - Note 4 - Advances for
disclosures relating to redemption terms of the advances portfolio.
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 the Bank from credit losses. All pledged collateral is subject to collateral discounts, or haircuts, to the market value or unpaid principal balance, as applicable, based on our opinion of the risk that such collateral presents. We are prohibited by Section 10(a) of theFHLBank Act from making advances without sufficient collateral. We have never experienced a credit loss on an advance.
We assign each non-insurance company borrower to one of the following three
credit status categories based 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 financial weakness or 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.
We monitor the financial condition of our insurance company members quarterly.
We lend to them based on our assessment of their financial condition and their
pledge of sufficient amounts of eligible collateral.
52
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Table 8 - Advances Outstanding by Borrower Credit Status Category
(dollars in thousands)
As of September 30, 2021
Par Value of
Advances Discounted Ratio of Discounted
Number of Borrowers Outstanding Collateral Collateral to Advances
Category-1 206 $ 9,061,776 $ 93,030,588 1,026.6 %
Category-2 13 355,592 919,799 258.7
Category-3 13 235,812 419,976 178.1
Insurance companies 24 4,362,395 6,042,518 138.5
Total 256 $ 14,015,575 $ 100,412,881 716.4 %
The method by which a borrower pledges collateral depends upon the type of
borrower (depository vs. non-depository), the category to which the borrower is
assigned, and the type of collateral that the borrower pledges. Moreover,
borrowers in Category-1 are eligible to specifically list and identify
single-family owner-occupied residential mortgage loans at a lower discount than
is allowed if the collateral is not specifically listed and identified.
The Bank may adjust the credit status category of a member from time to time
based on the financial reviews and other circumstances of the member.
We have not recorded any allowance for credit losses on advances at
- Notes to the Financial Statements - Note 4 - Advances .
Table 9 - Top Five Advance-Borrowing Institutions
(dollars in thousands)
September 30, 2021
Par Value of Percent of Total Par
Name Advances
Value of Advances Weighted-Average Rate (1)
15.0 % 1.81 % Voya Retirement Insurance and Annuity Company 825,000 5.9 0.47 SalemFive Cents Savings Bank 580,401 4.1 0.27 People's United Bank, National Association 569,812 4.1 0.37 East Boston Savings Bank 560,625 4.0 2.44 Total of top five advance-borrowing institutions$ 4,635,838 33.1 % December 31, 2020 Par Value of Percent of Total Par Name Advances
Value of Advances Weighted-Average Rate (1)
9.0 % 1.90 % Voya Retirement Insurance and Annuity Company 795,000 4.3 0.53Metropolitan Property & Casualty Insurance Company 700,000 3.7 0.38 SalemFive Cents Savings Bank 620,316 3.3 0.30 East Boston Savings Bank 610,625 3.3 2.33 Total of top five advance-borrowing institutions$ 4,405,941
23.6 %
_______________________
(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 we may use as hedging instruments.
53 -------------------------------------------------------------------------------- Table of Contents Investments
At
instruments totaled
Short-term money-market investments decreased$961.0 million to$2.3 billion atSeptember 30, 2021 , compared withDecember 31, 2020 . The decrease was attributable to a$412.0 million decrease in federal funds sold, a$299.0 million decrease in interest bearing deposits, and a$250.0 million decrease in securities purchased under agreement to resell. Investment securities increased$4.0 billion to$14.1 billion atSeptember 30, 2021 , compared withDecember 31, 2020 . This was attributable to increases of$2.5 billion inU.S. Treasury obligations and$1.6 billion in MBS.
Investments Credit Risk
We are subject to credit risk on unsecured investments consisting primarily of short-term (meaning one year and under to maturity and currently only consisting of overnight risk) money-market instruments issued by high-quality financial institutions and long-term (original maturity in excess of one year) debentures issued or guaranteed byU.S. agencies,U.S government-owned corporations, GSEs, and supranational institutions. We place short-term funds with large, high-quality financial institutions that must be rated in at least the third-highest internal rating category on a rating scale of FHFA1 through FHFA7, reflecting progressively lower credit quality. The internal rating categories of FHFA1 through FHFA4 are considered to be investment quality. All of these placements currently either expire within one day or are payable upon demand. See Part 1 - Item 1 - Business - Business Lines - Investments in the 2020 Annual Report for additional information. In addition to these unsecured investments, we also make secured investments in the form of securities purchased under agreements to resell secured byU.S. Treasury and agency obligations, with current terms to maturity up to 35 days and in MBS and HFA securities that are directly or indirectly supported by underlying mortgage loans. We actively monitor our investment credit exposures and the credit quality of our counterparties, including assessments of each counterparty's financial performance, capital adequacy, sovereign support, and collateral quality and performance, as well as related market signals such as securities prices and credit default swap spreads. We may reduce or suspend credit limits and/or seek to reduce existing exposures, as appropriate, as a result of these monitoring activities. 54
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Table 10 - Credit Ratings of Investments at Carrying Value
(dollars in thousands)
As of September 30, 2021
Long-Term Credit Rating
Investment Category Triple-A Double-A Single-A Unrated
Money-market instruments: (1)
Interest-bearing deposits $ - $ 149 $ - $ -
Securities purchased under agreements to
resell - - 500,000 -
Federal funds sold - 340,000 1,508,000 -
Total money-market instruments - 340,149 2,008,000 -
Investment securities:(2)
Non-MBS:
U.S. Treasury obligations - 6,143,821 - -
Corporate bonds - - - 1,524
U.S. government-owned corporations - 304,506 - -
GSE - 126,308 - -
Supranational institutions 411,601 - - -
HFA securities 44,765 29,077 - -
Total non-MBS 456,366 6,603,712 - 1,524
MBS:
U.S. government guaranteed - single-family - 29,725 - -
U.S. government guaranteed - multifamily - 453,891 - -
GSE - single-family - 1,383,149 - -
GSE - multifamily - 5,127,908 - -
Total MBS - 6,994,673 - -
Total investment securities 456,366 13,598,385 - 1,524
Total investments $ 456,366 $ 13,938,534 $ 2,008,000 $ 1,524
_______________________
(1) The counterparty NRSRO rating is used for money-market instruments. Counterparty ratings are obtained from Moody's,Fitch, Inc. (Fitch), and S&P and are each as ofSeptember 30, 2021 . If there is a split rating, the lowest rating is used. In certain instances where a counterparty is unrated, we may assign a deemed rating to the counterparty and that deemed rating is used. (2) The issue rating is used for investment securities. Issue ratings are obtained from Moody's, Fitch, and S&P. If there is a split rating, the lowest rating is used. FHFA regulations include limits on the amount of unsecured credit we may extend to a counterparty or to a group of affiliated counterparties based on a percentage of regulatory capital and an internal credit rating determined by each FHLBank. See Part 1 - Item 1 - Business - Business Lines - Investments in the 2020 Annual Report for additional information. Under these regulations, the level of regulatory capital is determined as the lesser of our total regulatory capital or the regulatory capital of the counterparty. The applicable regulatory capital is then multiplied by a specified percentage for each counterparty, which product is the maximum amount of unsecured credit exposure we may extend to that counterparty. The percentage that we may offer for extensions of unsecured credit other than overnight sales of federal funds ranges from one to 15 percent based on the counterparty's credit rating. From time to time, we may establish internal credit limits lower than permitted by regulation for individual counterparties. 55 -------------------------------------------------------------------------------- Table of Contents Table 11 - Unsecured Credit Related to Money-Market Instruments and Debentures by Carrying Value (dollars in thousands) Carrying Value September 30, 2021 December 31, 2020 Interest bearing deposits $ 149 $ 299,149 Federal funds sold 1,848,000 2,260,000 Supranational institutions 411,601 430,069 U.S. government-owned corporations 304,506 322,061 GSEs 126,308 134,992 Mortgage Loans
We invest in mortgages through the MPF program. The MPF program is further
described under - Mortgage Loans Credit Risk and in Part I - Item 1 - Business -
Business Lines - Mortgage Loan Finance in the 2020 Annual Report.
As ofSeptember 30, 2021 , our mortgage loan investment portfolio totaled$3.3 billion , a decrease of$646.3 million fromDecember 31, 2020 . We expect continued competition from Fannie Mae and Freddie Mac, as well as from private mortgage loan acquirers, for loan investment opportunities. In addition, prepayment activity in the three months endedSeptember 30, 2021 , has been elevated and has outpaced our purchases of mortgage loans, a trend we expect to continue through 2021. For additional information on our investments in mortgage loans, see Legislative and Regulatory Developments .
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 Part II - Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition - Mortgage Loans - Mortgage Loans Credit Risk in the 2020 Annual Report. For information on the credit performance of our mortgage loan portfolio as ofSeptember 30, 2021 , see Item I - Financial Statements - Note 5 - Mortgage Loans Held for Portfolio in this report.
Although our mortgage loan portfolio includes loans throughout the
concentrations of 5 percent or greater of the outstanding principal balance of
our conventional mortgage loan portfolio are shown in Table 12.
Table 12 - State Concentrations by Outstanding Principal Balance
Percentage of Total Outstanding Principal Balance
of Conventional Mortgage Loans
September 30, 2021 December 31, 2020
Massachusetts 63 % 62 %
Maine 10 10
Connecticut 8 8
All others 19 20
Total 100 % 100 %
We place conventional mortgage loans on nonaccrual status when the collection of
interest or principal is doubtful or contractual principal or interest is 90
days or more past due. Accrued interest on nonaccrual loans is excluded from
interest income. We monitor the delinquency levels of the mortgage loan
portfolio on a monthly basis.
56
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Table 13 - Delinquent Mortgage Loans
(dollars in thousands)
2021 December 31, 2020
Total par value of government loans past due 90 days or more and
still accruing interest
$ 5,342 $ 5,472 Nonaccrual loans, par value 25,467 74,348 Troubled debt restructurings (not included above) 5,567 6,095 Mortgage Insurance Companies. We are exposed to credit risk from primary mortgage insurance coverage (PMI) on individual loans. As ofSeptember 30, 2021 , we were the beneficiary of PMI coverage of$114.9 million on$299.1 million of conventional mortgage loans. These amounts relate to loans originated with PMI and for which current loan-to-value ratios exceed 78 percent (determined by recalculating the original loan-to-value ratio using the current unpaid principal balance divided by the appraised home value at the time of loan origination). We have analyzed our potential loss exposure to all of the mortgage insurance companies and do not expect incremental losses based on these exposures at this time. Consolidated Obligations
See - Liquidity and Capital Resources for information regarding our COs.
Derivative Instruments
All derivatives are recorded on the statement of condition at fair value and classified as either derivative assets or derivative liabilities. Bilateral and cleared derivatives outstanding are classified as assets or liabilities according to the net fair value of derivatives aggregated by each counterparty. Derivative assets' net fair value, net of cash collateral and accrued interest, totaled$356.3 million and$161.2 million as ofSeptember 30, 2021 , andDecember 31, 2020 , respectively. Derivative liabilities' net fair value, net of cash collateral and accrued interest, totaled$21.4 million and$24.1 million as ofSeptember 30, 2021 , andDecember 31, 2020 , respectively. The following table presents a summary of the notional amounts and estimated fair values of our outstanding derivatives, excluding accrued interest, and related hedged item by product and type of accounting treatment as ofSeptember 30, 2021 , andDecember 31, 2020 . The notional amount represents the hypothetical principal basis used to determine periodic interest payments received and paid. However, the notional amount does not represent an actual amount exchanged or our overall exposure to credit and market risk. 57
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Table 14 - Hedged Item and Hedge-Accounting Treatment
(dollars in thousands)
September 30, 2021 December 31, 2020
Hedged Item Derivative Designation(2) Notional Amount Fair Value Notional Amount Fair Value
Advances (1) Swaps Fair value $ 3,631,110 $ (5,665) $ 4,532,123 $ (21,870)
Swaps Economic 644,800 (29,171) 670,300 (44,466)
Total associated with advances 4,275,910 (34,836) 5,202,423 (66,336)
Available-for-sale securities Swaps Fair value 9,856,041 48,102 3,735,362 33,751
Trading securities Swaps Economic 1,750,000 11,834 3,550,000 19,669
COs Swaps Fair value 11,722,220 (68,936) 1,692,990 (3,443)
Swaps Economic 75,000 (296) - -
Forward starting
swaps Cash Flow 1,391,000 (376) 17,000 (14)
Total associated with COs 13,188,220 (69,608) 1,709,990 (3,457)
Balance Sheet Swaps Economic - - 1,316,522 29
Total 29,070,171 (44,508) 15,514,297 (16,344)
CO bond firm commitments 75,000 296 - -
Mortgage delivery commitments 8,019 31 28,386 220
Total derivatives $ 29,153,190 (44,181) $ 15,542,683 (16,124)
Accrued interest (60,925) (62,464)
Cash collateral, including related
accrued interest 439,966 215,764
Net derivatives $ 334,860 $ 137,176
Derivative asset $ 356,261 $ 161,238
Derivative liability (21,401) (24,062)
Net derivatives $ 334,860 $ 137,176
_______________________
(1) As ofSeptember 30, 2021 , andDecember 31, 2020 , embedded derivatives separated from certain advance contracts with notional amounts of$644.8 million and$670.3 million , respectively, and fair values of$29.2 million and$44.5 million , respectively, are not included in the table. (2) The hedge designation "fair value" represents the hedge classification for transactions that qualify for hedge-accounting treatment and hedge changes in fair value attributable to changes in the designated benchmark interest rate. 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 derivatives hedging specific or nonspecific assets, liabilities, or firm commitments that do not qualify or were not documented as fair-value or cash-flow hedges but that are documented as serving a non-speculative use and are hedging strategies under our risk-management policy. Tables 15 and 16 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 fair-value hedge relationships of advances and COs totals$15.4 billion , representing 52.7 percent of all derivatives outstanding as ofSeptember 30, 2021 . Economic hedges and cash-flow hedges are not included within the two tables below. 58 -------------------------------------------------------------------------------- Table of Contents Table 15 - Fair-Value Hedge Relationships of Advances By Year of Contractual Maturity (dollars in thousands) As of September 30, 2021 Weighted-Average Yield (4) Derivatives Advances(2) Derivatives Benchmark Fair-Value Receive Floating Pay Fixed Net Receive Maturity Notional Fair Value(1) Hedged Amount Adjustment(3) Advances Rate Rate Result Due in one year or less$ 1,041,275 $ (6,307) $ 1,041,275 $ 6,266 2.04 % 0.10 % 1.59 % 0.55 % Due after one year through two years 409,300 (9,219) 409,300 9,175 2.15 0.11 1.74 0.52 Due after two years through three years 317,500 (9,380) 317,500 9,264 2.09 0.06 1.52 0.63 Due after three years through four years 958,425 (8,360) 958,425 8,338 1.38 0.06 0.65 0.79 Due after four years through five years 181,360 370 181,360 (366) 1.18 0.09 0.63 0.64 Thereafter 723,250 (4,330) 723,250 4,266 1.68 0.06 1.07 0.67 Total$ 3,631,110 $ (37,226) $ 3,631,110 $ 36,943 1.77 % 0.08 % 1.20 % 0.65 % _______________________ (1) Not included in the fair value is$31.6 million of variation margin, or payments made for changes in the market value of the derivatives position, paid or received for daily settled contracts. (2) Included in the advances hedged amount are$1.1 billion of putable advances, which would accelerate the termination date of the derivative and the hedged item if the put option is exercised. (3) The benchmark fair-value adjustment of hedged advances represents the amounts recorded for changes in the fair value attributable to changes in the designated benchmark interest rate. (4) The yield for floating-rate instruments and the floating-rate leg of interest-rate swaps is the coupon rate in effect as ofSeptember 30, 2021 . Table 16 - Fair-Value Hedge Relationships of Consolidated Obligations By Year of Contractual Maturity (dollars in thousands) As of September 30, 2021 Weighted-Average Yield (4) Derivatives CO Bonds (2) Derivatives Benchmark Fair-Value Receive Fixed Pay Floating Year of Maturity Notional Fair Value(1) Hedged Amount Adjustment(3) CO Bonds Rate Rate Net Pay Result Due in one year or less$ 442,220 $ 2,443 $ 442,220 $ (2,444) 2.00 % 2.02 % 0.02 % 0.00 % Due after one year through two years 325,000 1,003 325,000 (1,011) 0.47 0.43 0.06 0.10 Due after two years through three years 1,310,000 (2,400) 1,310,000 2,398 0.46 0.46 (0.01) (0.01) Due after three years through four years 1,789,000 (6,289) 1,789,000 6,268 0.60 0.58 0.01 0.03 Due after four years through five years 4,834,000 (21,502) 4,834,000 21,486 0.71 0.71 0.00 0.00 Thereafter 3,022,000 (44,064) 3,022,000 43,496 1.17 1.02 0.01 0.16 Total$ 11,722,220 $ (70,809) $ 11,722,220 $ 70,193 0.82 % 0.78 % 0.01 % 0.05 % _______________________ (1) Not included in the fair value is$1.9 million of variation margin, or payments made for changes in the market value of the derivatives position, paid or received for daily settled contracts. (2) Included in the CO bonds hedged amount are$10.7 billion of callable CO bonds, which would accelerate the termination date of the derivative and the hedged item if the call option is exercised. (3) The benchmark 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, plus remaining unamortized premiums or discounts on hedged CO bonds where applicable. (4) The yield for floating-rate instruments and the floating-rate leg of interest-rate swaps is the coupon rate in effect as ofSeptember 30, 2021 . Derivative Instruments Credit Risk. We are subject to credit risk on derivatives. This risk arises from the risk of counterparty default on the derivative contract. The amount of unsecured credit exposure to derivative counterparty default is the amount by which the replacement cost of the defaulted derivative contract exceeds the value of any collateral held by us (if the counterparty is the net obligor on the derivative contract) or is exceeded by the value of collateral pledged by us to counterparties (if we are the net obligor on the derivative contract). We accept cash and securities collateral in accordance with 59 -------------------------------------------------------------------------------- Table of Contents the terms of the applicable master netting agreement for uncleared derivatives from counterparties with whom we are in a current positive fair-value position by an amount that exceeds an exposure threshold (if any) defined in our master netting agreement with the counterparty. The resulting net exposure at fair value is reflected in Table 17 below. We pledge cash and securities collateral in accordance with the terms of the applicable master netting agreement for uncleared derivatives to counterparties with whom we are in a current negative fair-value position by an amount that exceeds an exposure threshold (if any) defined in our master netting agreement with the counterparty. From time to time, due to timing differences or derivatives valuation differences between our calculated derivatives values and those of our counterparties, and to the contractual haircuts applied to securities, we pledge to counterparties cash or securities collateral whose fair value is greater than the current net negative fair-value of derivative positions outstanding with them adjusted for any applicable exposure threshold. Similarly, from time to time, due to timing differences or derivatives valuation differences, we receive from counterparties cash or securities collateral whose fair value is less than the current net positive fair-value of derivatives positions outstanding with them adjusted for any applicable exposure threshold. We currently pledge only cash collateral, including initial and variation margin, for cleared derivatives, but may also pledge securities for initial margin as allowed by the applicable DCO and clearing member.
Table 17 - Credit Exposure to Derivatives Counterparties
(dollars in thousands)
As of
Net Derivatives Cash Collateral Non-cash Collateral
Fair Value Before Pledged to Pledged to Net Credit Exposure
Credit Rating (1) Notional Amount Collateral Counterparty Counterparty to Counterparties
Liability positions with
credit exposure:
Interest-rate swaps
Uncleared derivatives -
Single-A $ 7,564,425 $
(51,893) $ 35,962 $ 18,565 $
2,634
Cleared derivatives 16,377,746 (3,998) 358,627 - 354,629 Total interest-rate swap positions with nonmember counterparties to which we had credit exposure 23,942,171 (55,891) 394,589 18,565 357,263 CO bond firm commitments 75,000 296 - - 296 Mortgage delivery commitments (2) 8,019 47 - - 47 Total$ 24,025,190 $ (55,548) $ 394,589 $ 18,565 $ 357,606 Derivative positions without credit exposure: (3) Single-A$ 5,118,000 Triple-B 10,000 Total derivative positions without credit exposure$ 5,128,000
_______________________
(1) Uncleared derivatives counterparty ratings are obtained from Moody's, Fitch, and S&P. Each rating classification includes all rating levels within that category. 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 or the counterparty 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 derivatives. 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) Represents derivatives positions with counterparties for which we are in a net liability position and for which we have delivered collateral to the counterparty in an amount equal to or less than the net derivative liability, or derivative positions with counterparties for which we are in a net asset position and for which the counterparty has delivered collateral to us in an amount that exceeds our net derivative asset.
For information on our approach to the credit risks arising from our use of
derivatives, see Part II - Item 7 - Management's Discussion and Analysis and
Results of Operations - Financial Condition - Derivative Instruments -
Derivative Instruments Credit Risk in the 2020 Annual Report.
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Transition from LIBOR to Alternative Reference Rates
InJuly 2017 , theUnited Kingdom's FCA , the regulator for LIBOR, announced that after 2021 it will no longer persuade or compel the major banks that sustain LIBOR to submit rates for the calculation of LIBOR. The Alternative Reference Rates Committee (ARRC), which was established in 2014 by theFederal Reserve and theFederal Reserve Bank of New York to help ensure a successful transition in theU.S. from LIBOR, recommended SOFR as the alternative reference rate toU.S. dollar LIBOR. We recognize that the discontinuance of LIBOR as an interest rate benchmark and the transition to alternative reference rates, including SOFR, present significant risks and challenges that could affect our business. Certain of our investment securities and derivatives, and certain collateral pledged to us, are indexed to LIBOR with exposure extending beyondDecember 31, 2021 . Under a steering committee comprised of members of senior management and a working group of representatives from departments across the Bank, we have developed and continue to implement a multi-year plan and initiative to transition from LIBOR. We are planning for the eventual replacement of the LIBOR benchmark interest rate, with SOFR as the dominant replacement benchmark. As a result, we have developed a LIBOR transition plan, which addresses considerations such as LIBOR exposure, contract "fallback" language (which provides for contractual alternatives to the use of LIBOR when LIBOR cannot be determined based on the method provided in the agreement), operational preparedness, and balance sheet management, as well as contingencies for the potential unavailability of the index prior toDecember 31, 2021 . In assessing our current exposure to LIBOR, we have developed an inventory of financial instruments impacted and identified contracts that may require adding or adjusting the fallback language, the provisions in the financial instrument or contract that specify how LIBOR is to be replaced with an alternative reference rate and related provisions, which may identify the replacement rate. We have added or adjusted fallback language to our advances agreements with members, and theFHLBank System has added fallback language to consolidated obligations. We monitor market-wide efforts to address fallbacks related to LIBOR-based derivatives and investment securities as well as fallback language for other financial instruments. We continue to assess our operational readiness, including updating processes and information technology systems to support the transition from LIBOR to an alternative reference rate. We worked with the other FHLBanks and theOffice of Finance to transition our floating-rate note issuance from LIBOR. The Bank has participated in theFHLBank System's issuances of SOFR-indexed COs as our funding needs require since theFHLBank System began issuing such COs inNovember 2018 . Market activity in SOFR-indexed financial instruments continues to increase. During the nine months endedSeptember 30, 2021 , we issued$3.2 billion in SOFR-indexed COs. InOctober 2019 , the Bank began to offer a SOFR-based advance. During the nine months endedSeptember 30, 2021 , we issued$5.3 billion in SOFR-indexed advances.
In
effective rate as an alternative interest rate hedging strategy for certain
financial instruments, rather than using LIBOR when entering into new derivative
transactions. In addition, a SOFR-based derivative market has begun to emerge.
OnSeptember 27, 2019 , the FHFA issued a Supervisory Letter that limits certain activities of the FHLBanks with respect to new LIBOR referenced financial assets, liabilities, and derivatives with maturities beyondDecember 31, 2021 . Early in 2019, before the issuance of the Supervisory Letter, we limited the maturities of certain advances that are linked to LIBOR toDecember 31, 2021 . In addition, prior to the issuance of the Supervisory Letter, we had ceased purchasing investments that reference LIBOR and mature afterDecember 31, 2021 , and we had suspended entering into LIBOR-indexed derivatives that terminate afterDecember 31, 2021 . OnOctober 16, 2020 , the clearing houses CME and LCH transitioned the rate for discounting allU.S. Dollar interest rate cleared swaps from the Effective Fed Funds Rate to SOFR. OnOctober 21, 2020 , we adhered to the ISDA 2020 IBOR Fallbacks Protocol, a multilateral mechanism that, effectiveJanuary 25, 2021 , through a Supplement to the ISDA 2006 Definitions (the Supplement), amended our legacy bilateral, over-the-counter LIBOR-based interest rate swaps to substitute SOFR for LIBOR as the benchmark rate following the cessation of LIBOR or if LIBOR is declared by theFCA to be no longer representative of the underlying market and economic reality that it is intended to measure. OnNovember 30, 2020 , theFederal Reserve , theOffice of the Comptroller of the Currency (OCC), and theFederal Deposit Insurance Corporation (FDIC) issued a joint statement encouraging banks to cease entering into new contracts that useU.S. dollar LIBOR as a reference rate as soon as practicable and no later thanDecember 31, 2021 . OnMarch 5, 2021 , theFCA announced that LIBOR will either cease to be provided by any administrator or no longer be representative immediately afterDecember 31, 2021 , in the case of 1-week and 2-monthU.S. dollar LIBOR, and immediately afterJune 30, 2023 , in the case of 61 -------------------------------------------------------------------------------- Table of Contents the remainingU.S. dollar LIBOR settings. Although theFCA does not expect LIBOR to become unrepresentative before the applicable cessation dates and intends to consult on requiring the administrator of LIBOR to continue publishing LIBOR of certain currencies and tenors on a non-representative, synthetic basis for a period after the applicable cessation date, there is no assurance that LIBOR, of any particular currency or tenor, will continue to be published or be representative through any particular date.The Financial Conduct Authority's announcement onMarch 5, 2021 , constitutes an index cessation event under the ISDA 2020 IBOR Fallbacks Protocol and the Supplement, and as a result, the fallbacks spread adjustment for each tenor is fixed as of the date of the announcement. See Legislative and Regulatory Developments for information on the 2021 ISDA Interest Rate Derivatives Definitions published by ISDA onJune 11, 2021 .
On
for an FHLBank's use of alternative rates other than SOFR. The Supervisory
Letter provides guidance on considerations, such as volume of underlying
transactions, credit sensitivity, modeling risk and others, that an FHLBank
should take into account prior to employing an alternative reference rate.
For further details see the following Risk Factors in our 2020 Annual Report: Part I - Item 1A - Risk Factors - Market and Liquidity Risks - Changes to and replacement of the LIBOR benchmark interest rate could adversely affect our business, financial condition, and results of operations; and - We use derivatives to manage interest-rate risk, however, we could be unable to enter into effective derivative instruments on acceptable terms. We have exposures to advances, investment securities and derivatives with interest rates indexed toU.S. dollar LIBOR. All of our LIBOR-indexed financial instruments utilize a LIBOR tenor that will either cease to be published or will no longer be representative afterJune 30, 2023 . Table 18 presents our exposure to LIBOR-indexed advances, investment securities, and LIBOR-indexed derivatives, atSeptember 30, 2021 .
Table 18 - Financial Instruments with LIBOR Exposure at
(dollars in thousands)
LIBOR Tenors That Cease
or Will no Longer be Representative Immediately After
Due/Terminates in Due/Terminates in Due/Terminates after
Due/Terminates in 2021 2022 2023, through June 30 June 30, 2023
Total
Assets with LIBOR exposure Advances, par amount by redemption term(1) $ 9,500 $ - $ - $ - $
9,500
Investment securities, par amount by contractual maturity Non-MBS - - - 13,045 13,045 MBS(2) - 6 - 760,646 760,652 Total investment securities - 6 - 773,691 773,697 Total financial instruments $ 9,500 $ 6 $ - $ 773,691$ 783,197 LIBOR-indexed interest-rate swaps, notional amount Receive leg Cleared $ 446,790 $ 59,625 $ 15,000 $ 25,750$ 547,165 Uncleared 31,500 221,000 526,600 435,900 1,215,000 Total interest-rate swaps, receive leg $ 478,290$ 280,625 $ 541,600 $ 461,650$ 1,762,165 Pay leg Cleared $ 145,000$ 137,220 $ - $ -$ 282,220 Uncleared 160,000 - - - 160,000 Total interest-rate swaps, pay leg $ 305,000$ 137,220 $ - $ -$ 442,220 _______________________ (1)For advances that have a conversion from a floating rate indexed to LIBOR to a fixed rate, the LIBOR exposure is considered to be due by the date which the financial instrument converts to a fixed rate. 62 -------------------------------------------------------------------------------- Table of Contents (2)Contractual maturity will likely differ from the expected maturity because borrowers of the underlying loans or securities are subject to a call right or prepayment right, with or without call or prepayment fees.
The following table presents our variable rate advances, investment securities,
and CO bonds by interest-rate index at
Table 19 - Variable Rate Financial Instruments by Interest-Rate Index
(dollars in thousands)
Par Value of Par Value of Par Value of CO
Advances Non-MBS Par Value of MBS Bonds
LIBOR $ 9,500 $ 13,045 $ 760,652 $ -
SOFR 795,000 - 869,899 4,903,000
FHLBank discount note auction
rate 1,233,972 - - -
Constant Maturity Treasury - - 47,008 -
Other - - 101 -
Total $ 2,038,472 $ 13,045 $ 1,677,660 $ 4,903,000
LIQUIDITY AND CAPITAL RESOURCES
Our financial structure is 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 Part I - Item 1 - Business - Consolidated Obligations of the 2020 Annual Report. Outstanding COs and the condition of the market for COs are discussed below under - Debt Financing - Consolidated Obligations. 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
We are required to maintain liquidity in accordance with theFHLBank Act , FHFA regulations and guidance, and policies established by our management and board of directors. We seek to be in a position to meet the credit and liquidity needs of our members and to meet all current and future financial commitments by managing liquidity positions to maintain stable, reliable, and cost-effective sources of funds while taking into account market conditions, member demand, and the maturity profile of our assets and liabilities. We may not be able to predict future trends in member credit needs because they are driven by complex interactions among a number of factors, including members' asset growth or reductions, deposit growth or reductions, and the attractiveness of advances compared to other wholesale borrowing alternatives. We regularly monitor current trends and anticipate future debt issuance needs and maintain a portfolio of highly liquid assets in an effort to be prepared to fund our members' credit needs and our investment opportunities. We are generally able to expand our CO debt issuance in response to our members' increased credit needs for advances and to increase our acquisitions of mortgage loans. Alternatively, in response to reduced member credit needs, we may allow our COs to mature without replacement, transfer debt to another FHLBank, or repurchase and retire outstanding COs, or redeem callable COs on eligible redemption dates, allowing our balance sheet to shrink.
Sources and Uses of Liquidity. Our primary sources of liquidity are proceeds
from the issuance of COs and advance repayments, and maturing short-term
investments, as well as cash and investment holdings that are primarily
high-quality, short-, and intermediate-term financial instruments.
During the nine months endedSeptember 30, 2021 , we maintained continual access to funding and adapted our debt issuance to meet the needs of our members. As we enteredMarch 2020 , markets were disrupted by uncertainty surrounding the COVID-19 pandemic, spurring twoFOMC actions to reduce the federal funds target rate by a total of 150 basis points. At that time, our short-term funding was generally driven by increased member demand for advances and was achieved primarily through the issuance of discount notes and short-term CO bonds. We maintained liquidity through short-term investments andU.S. Treasury securities in compliance with guidance from the FHFA. Maintaining liquidity on our balance sheet, however, can expose us to additional interest-rate risk, which could reduce net interest income when interest rates decline, as was the case during the second and third quarters of 2020, during which a substantial amount of short-term debt issued prior to theFOMC's 63 -------------------------------------------------------------------------------- Table of Contents combined 150 basis point rate cuts inMarch 2020 remained outstanding throughMay 2020 , resulting in sharp, temporary margin compression. Our primary uses of liquidity are advance originations and consolidated obligation payments. Other uses of liquidity are mortgage loan and investment purchases, dividend payments, and other contractual payments. We also maintain liquidity to redeem or repurchase excess capital stock, through our daily excess stock repurchases, upon the request of a member or as required under our capital plan. Secondary sources of liquidity include payments collected on mortgage loans, proceeds from the issuance of capital stock, and deposits from members. In addition, under theFHLBank Act , theU.S. Treasury may purchase up to$4 billion of COs of the FHLBanks. The terms, conditions, and interest rates in such a purchase would be determined by theU.S. Treasury . This authority may be exercised at the discretion of theU.S. Treasury with the agreement of the FHFA only if alternative means cannot be effectively employed to permit members of the FHLBanks to continue to supply reasonable amounts of funds to the mortgage market, and the ability to supply such funds is substantially impaired because of monetary stringency and a high level of interest rates. There were no such purchases by theU.S. Treasury during the nine months endedSeptember 30, 2021 . For information and discussion of our guarantees and other commitments we may have, see below - Off-Balance-Sheet Arrangements and Aggregate Contractual Obligations, and for further information and discussion of the joint and several liability forFHLBank COs , see below - Debt Financing - Consolidated Obligations.
Internal Liquidity Sources / Liquidity Management
We have developed a methodology and policies by which we measure and manage the
Bank's short-term liquidity needs based on projected net cash flow and
contingent obligations.
ProjectedNet Cash Flow . We define projected net cash flow as projected sources of funds less projected uses of funds based on contractual maturities or expected option exercise periods, and settlement of committed assets and liabilities, as applicable. For mortgage-related cash flows and callable debt, we incorporate projected prepayments and call exercise. Liquidity Management Action Trigger. We maintain a liquidity management action trigger pertaining to projected net cash flow: if projected net cash flow falls below zero on or before the 21st day following the measurement date, then management of the Bank is notified and determines whether any corrective action is necessary. We did not exceed this threshold at any time during the nine months endedSeptember 30, 2021 . 64 -------------------------------------------------------------------------------- Table of Contents Table 20 - ProjectedNet Cash Flow (dollars in thousands) As of September 30, 2021 21 Days Uses of funds Interest payable $ 27,973 Maturing or projected calls of liabilities 2,346,000 Committed asset settlements 22,565 Capital outflow 33,031 MPF delivery commitments 8,019 Other 3,054 Gross uses of funds 2,440,642 Sources of funds Interest receivable 37,413 Maturing or projected amortization of assets
3,823,720
Committed liability settlements
452,000
Cash and due from banks and interest bearing deposits 205,211 Gross sources of funds 4,518,344 Projected net cash flow $ 2,077,702 Base Case Liquidity Requirement. The Bank is subject to FHFA guidance on liquidity, Advisory Bulletin 2018-07 (Liquidity Guidance AB ), which communicates the FHFA's expectations with respect to the maintenance of sufficient liquidity to enable us to provide advances and letters of credit for members for a specified time without access to the capital markets or other unsecured funding sources.The Liquidity Guidance AB provides guidance on the level of on-balance sheet liquid assets related to base case liquidity. As part of the base case liquidity measure, the guidance also includes a separate provision covering off-balance sheet commitments from standby letters of credit. In addition, theLiquidity Guidance AB provides guidance related to asset/liability maturity funding gap limits. Under theLiquidity Guidance AB , FHLBanks are required to hold positive cash flow while rolling over maturing advances to all members and assuming no access to capital markets for a period of time between 10 and 30 calendar days, with a specific measurement period set forth in a supervisory letter.The Liquidity Guidance AB also sets forth the initial cash flow assumptions and formula to calculate base case liquidity. With respect to standby letters of credit, the guidance states that FHLBanks should maintain a liquidity reserve of between 1 percent and 20 percent of its outstanding standby letters of credit commitments, as specified in a supervisory letter.
We were in compliance with these additional liquidity requirements at all times
during the nine months ended
Balance Sheet FundingGap Policy . We may use a portion of the short-term COs issued to fund assets with longer terms, including longer-term floating-rate assets. Funding longer-term floating-rate assets with shorter-term liabilities generally does not expose us to significant interest-rate risk because the interest rates on both the floating-rate assets and liabilities typically reset similarly (either through rate resets or re-issuance of the obligations). However, deviations in the cost of our short-term liabilities relative to resetting assets can cause fluctuations in our net interest margin. Additionally, the Bank is exposed to refinancing risk since, over certain time horizons, it has more liabilities than assets maturing. In order to manage the Bank's refinancing risk, we maintain a policy that limits the potential difference between the amount of financial assets and the amount of financial liabilities expected to mature within three-month and one-year time horizons inclusive of projected mortgage-related prepayment activity. We measure this difference, or gap, as a percentage of 65 -------------------------------------------------------------------------------- Table of Contents total assets under two different measurement horizons - three months and one year. In conformity with the provisions of theLiquidity Guidance AB , the Bank has instituted a limit and management action trigger framework around these metrics as follows:
Table 21 - Funding Gap Metric
Three-Month Average Three-Month Average Funding Gap Metric (1) Limit Management Action Trigger September 30, 2021 December 31, 2020 3-month Funding Gap 15% 13% 0.5 % (0.9) % 1-year Funding Gap 30% 25% 5.7 % 9.8 % _______________________
(1) The funding gap metric is a positive value when maturing liabilities exceed
maturing assets, as defined, within the given time period. Compliance with
Limits and Management Action Triggers are evaluated against the rolling
three-month average of the month-end funding gaps.
External Sources of Liquidity
Amended and Restated FHLBanks P&I Funding Contingency Plan Agreement. We have a source of emergency external liquidity through the Amended and Restated FHLBanks P&I Funding Contingency Plan Agreement. Under the terms of that agreement, in the event we do not fund principal and interest payments due with respect to any CO for which issuance proceeds were allocated to us within deadlines established in the agreement, the other FHLBanks will be obligated to fund any shortfall to the extent that any of the other FHLBanks has 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 theOffice of Finance on the day the shortfall occurs. We would then be required to repay the funding FHLBanks. We have never drawn funding under this agreement, nor have we ever been required to provide funding to another FHLBank under this agreement.
Debt Financing - Consolidated Obligations
AtSeptember 30, 2021 , andDecember 31, 2020 , outstanding COs for which we are primarily liable, including both CO bonds and CO discount notes, totaled$30.7 billion and$34.3 billion , respectively. CO bonds outstanding for which we are primarily liable atSeptember 30, 2021 , andDecember 31, 2020 , include issued callable bonds totaling$10.7 billion and$1.7 billion , respectively. CO discount notes comprised 18.1 percent and 37.5 percent of the outstanding COs for which we are primarily liable atSeptember 30, 2021 , andDecember 31, 2020 , respectively, but accounted for 93.1 percent and 88.5 percent of the proceeds from the issuance of such COs during the nine months endedSeptember 30, 2021 and 2020, respectively. Overall, we continued to experience strong demand for COs among investors. We have been able to issue debt in the amounts and structures required to meet our funding and risk-management needs. For most of the period covered by this report, COs were issued at yields that were historically competitive versus those of comparable-termU.S. Treasury securities. COs continue to be issued at yields that are at or lower than LIBOR and SOFR for comparable short-term maturities, although the relevance of LIBOR in relation to COs is waning. However, periodic threats of Congressional failure to raise theU.S. Treasury debt ceiling raise the potential for defaults onU.S. Treasury debt, which could have impacts on demand for and pricing of CO debt. TheFederal Reserve's recent signaling that low interest rates would last for an extended period and its continued repurchase agreement offerings, purchases ofU.S. Treasury securities andU.S. Agency mortgage-backed securities, as well as the previous establishment of liquidity facilities, are potentially important factors that could continue to shape investor demand for debt, including COs. Moreover, expected increases inU.S. Treasury security issuance in response to higher fiscal deficits following fiscal stimulus programs underlying the CARES Act, American Rescue Plan Act, and any similar future legislation or any change or roll back of regulations governing money market investors may also have an impact on our funding costs. Capital
Total capital at
at year-end 2020.
Capital stock decreased by
offset by the issuance of
66 -------------------------------------------------------------------------------- Table of ContentsThe FHLBank Act and FHFA regulations specify that each FHLBank is required to satisfy certain minimum regulatory capital requirements. We were in compliance with these requirements at September 30, 2021, as discussed in Item 1 - Notes to the Financial Statements - Note 10 - Capital. Subject to applicable law, following the expiry of the stock redemption period (which is five years for Class B stock), we redeem capital stock for any member that requests redemption of its excess stock, gives notice of intent to withdraw from membership, or becomes a nonmember due to merger, acquisition, charter termination, or involuntary termination of membership, provided that in so doing, we remain in compliance with all regulatory minimum capital requirements and the member remains in compliance with all applicable minimum stock investment requirements. Capital stock subject to a stock redemption period is reclassified to mandatorily redeemable capital stock in the liability section of the statement of condition. For additional information on the redemption of our capital stock, see Part 1- Item 1 - Business - Capital Resources - Redemption of Excess Stock and Item 8 - Financial Statements and Supplementary Data -Notes to the Financial Statements - Note 2 - Summary of Significant Accounting Policies - Mandatorily Redeemable Capital Stock in the 2020 Annual Report. Table 22 - Mandatorily Redeemable Capital Stock by Expiry of Redemption Notice Period (dollars in thousands) September 30, 2021 December 31, 2020 Past redemption date (1) $ 3,138 $ 5,558 Due in one year or less 92 - Due after one year through two years 20 93 Due after two years through three years 10 40 Due after three years through four years 435 - Due after four years through five years 10,195 581 Thereafter (2) - 10 Total $ 13,890 $ 6,282 _______________________ (1) Amount represents mandatorily redeemable capital stock that has reached the end of the five-year redemption-notice period but the member-related activity (for example, advances) remains outstanding. Accordingly, these shares of stock will not be redeemed until the activity is no longer outstanding. (2) TheDecember 31, 2020 amount represents reclassifications to mandatorily redeemable capital stock resulting from an FHFA rule effectiveFebruary 19, 2016 , that makes captive insurance companies ineligible for membership. Captive insurance company members that were admitted as members prior toSeptember 12, 2014 , had their memberships terminated onFebruary 19, 2021 .
Capital Rule
The FHFA'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 FHFA to determine on no less than a quarterly basis the capital classification of each FHLBank. By letter datedSeptember 28, 2021 , the Director of the FHFA notified us that, based on financial information as ofJune 30, 2021 , we met the definition of adequately capitalized under the Capital Rule.
Internal Capital Practices and Policies
We also take steps as we believe prudent beyond legal or regulatory requirements in an effort to ensure capital adequacy, reflected in our internal minimum capital requirement, which exceeds regulatory requirements, our minimum retained earnings target, and limitations on our dividends.
Internal Minimum Capital Requirement in Excess of Regulatory Requirements
To provide protection for our capital base, we maintain an internal minimum
capital requirement whereby the amount of paid-in capital stock and retained
earnings (together, our actual regulatory capital) must be at least equal to the
sum of 4 percent of our total assets plus an amount we measure as our risk
exposure with 99 percent confidence using our economic capital model
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(together, our internal minimum capital requirement). As of September 30, 2021 ,
this internal minimum capital requirement equaled $1.8 billion , which was
satisfied by our actual regulatory capital of $2.6 billion .
Minimum Retained Earnings Target
AtSeptember 30, 2021 , we had total retained earnings of$1.5 billion compared with our minimum retained earnings target of$700.0 million . We generally view our minimum retained earnings target as a floor for retained earnings rather than as a retained earnings limit and expect to continue to grow our retained earnings modestly even though we exceed the target. For information on limitations on dividends, including limitations when we are under our minimum retained earnings target, see Part II - Item 5 - Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases ofEquity Securities in the 2020 Annual Report.
Repurchases of Excess Stock
We have the authority, but are not obliged, to repurchase excess stock, as
discussed under Part I - Item 1 - Business - Capital Resources - Repurchase of
Excess Stock in the 2020 Annual Report.
Table 23 - Capital Stock Requirements and Excess Capital Stock
(dollars in thousands)
Outstanding Excess
Membership Stock Activity-Based Total Stock Class B Class B
Investment Stock Investment Investment Capital Stock Capital
Requirement Requirement Requirement (1) (2) Stock
September 30, 2021 $ 436,160 $ 572,855 $ 1,009,036 $ 1,042,067 $ 33,031
December 31, 2020 420,238 762,379 1,182,638 1,273,454 90,816
_______________________
(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 initiated daily repurchases of excess capital stock in 2017, in order to facilitate our ability to maintain a prudent level of capitalization and an efficient capital structure, while providing for an equitable allocation of excess stock ownership among members. As discussed under Part I - Item 1 - Business - Capital Resources - Repurchase of Excess Stock in the 2020 Annual Report, untilMay 18, 2021 , we conducted daily repurchases of excess stock held by any shareholder whose excess stock exceeds the lesser of$10.0 million or 10 percent of the shareholder's total stock investment requirement, subject to a minimum repurchase of$100,000 . Beginning with daily excess stock repurchases onMay 18, 2021 , the calculation of daily stock repurchases changed such that we currently conduct daily repurchases of excess stock from any shareholder whose excess stock exceeds the lesser of$3 million or 3 percent of the shareholder's total stock investment requirement, subject to the minimum repurchase of$100,000 . We plan to continue with this practice, subject to regulatory requirements and our anticipated liquidity or capital management needs, although continued repurchases remain at our sole discretion, and we retain authority to make adjustments to our excess stock repurchase practices subject to notice requirements defined in our Capital Plan, or to suspend repurchases of excess stock from any shareholder or all shareholders without prior notice.
Restricted Retained Earnings
AtSeptember 30, 2021 , our restricted retained earnings amount was$368.4 million , which exceeds the required contribution to the restricted retained earnings account of$319.8 million . Accordingly, no allocation of net income was made to restricted retained earnings in the third quarter of 2021 and no further allocations of net income into restricted retained earnings are required until such time as the contribution requirement exceeds the balance of restricted retained earnings.
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; and
• unsettled COs.
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Off-balance-sheet arrangements are more fully discussed in Item 8 - Financial Statements and Supplementary Data - Notes to the Financial Statements - Note 16 - Commitments and Contingencies in the 2020 Annual Report.
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 three 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, and accounting for deferred premiums and discounts on prepayable assets. The Audit Committee of our board of directors has reviewed these estimates. The assumptions involved in applying these policies are discussed in Part II - Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates in the 2020 Annual Report.
As of
estimates and assumptions used in applying our critical accounting policies and
estimates from those used to prepare our audited financial statements.
RECENT ACCOUNTING DEVELOPMENTS
See Item 1 - Notes to the Financial Statements - Note 2 - Recently Issued and Adopted Accounting Guidance for a discussion of recent accounting developments impacting or that could impact us.
LEGISLATIVE AND REGULATORY DEVELOPMENTS
We summarize certain significant legislative and regulatory actions and related
developments for the period covered by this report below.
Letter on
Requirements for De Novo Community Development Financial Institutions, (2)
Automatic Transfer of Membership, (3) Large Non-Member Institution Merging with
a Small Member, (4) Applicant's Compliance with "Financial Condition"
Requirement, and (5) Definition of
evaluate the Supervisory Letter and its effect on Bank membership.
Regulatory Interpretation on Eligibility of Mortgage Participations as Collateral forFHLBank Advances . OnOctober 4, 2021 , the FHFA published a Regulatory Interpretation on Eligibility of Mortgage Loan Participations as Collateral for Federal Home Loan Bank Advances. The Regulatory Interpretation addresses whether an FHLBank can accept as collateral to secure advances mortgage loan participations that cannot be readily liquidated in the form in which they are to be pledged. The Regulatory Interpretation concludes that mortgage loan participations must meet the requirements of FHFA regulation 12 CFR 1266.7(a)(4), including the requirement that the collateral can be "liquidated in due course" in order to be eligible to secure FHLBank advances. It further concludes that participations for which there would be a known impediment to liquidation do not meet such requirement and therefore are not eligible collateral for advances or letters of credit. Finally, the Regulatory Interpretation rescinds prior guidance fromFHLBank System regulators that provide mortgage loan participations may be eligible as collateral under regulatory provisions other than 12 CFR 1266.7(a)(4). The Regulatory Interpretation becomes effectiveDecember 13, 2021 .
Although we do not currently expect the Regulatory Interpretation to have a
material impact on our financial condition or results of operations, this
restriction on collateral may negatively impact future borrowing by certain
members.
Fair Housing and Fair Lending Enforcement. OnJuly 9, 2021 , the FHFA published a Policy Statement onFair Lending to communicate the FHFA's general position on monitoring and information gathering, supervisory examinations, and administrative enforcement related to the Equal Credit Opportunity Act, the Fair Housing Act, and the Federal Housing Enterprises Financial Safety and Soundness Act. The Policy Statement became effective on the date of publication. 69 -------------------------------------------------------------------------------- Table of Contents OnAugust 12, 2021 , the FHFA and theU.S. Department of Housing and Urban Development announced they had entered into a Memorandum of Understanding regarding fair housing and fair lending enforcement. Under the Memorandum of Understanding, the two agencies will focus on enhancing their enforcement of the Fair Housing Act, and their oversight of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks.
The Bank continues to monitor these actions and guidance as they evolve and to
evaluate their potential impact on the Bank.
U.S. Treasury and Fannie Mae Preferred Stock Purchase Agreement. OnJanuary 14, 2021 , theU.S. Treasury and Fannie Mae entered into a letter agreement amending the terms of their Preferred Stock Purchase Agreement, which could impact participating member financial institutions (PFIs) that participate in the MPF Program's MPF Xtra product (where MPF loans acquired are concurrently sold to Fannie Mae). Under the Preferred Stock Purchase Agreement, theU.S. Treasury provides liquidity to Fannie Mae in exchange for senior preferred stock. Under the Preferred Stock Purchase Agreement amendment, which was to take effectJanuary 1, 2022 , the FHFA (acting as conservator for Fannie Mae) and theU.S. Treasury agreed to limit the dollar volume of loans Fannie Mae could purchase from a single seller through Fannie Mae's cash window to$1.5 billion per year. As administrator of the MPF Program, the FHLBank ofChicago purchases MPF Xtra loans from PFIs and sells them to Fannie Mae via the cash window process. Based on recent volumes for the MPF Xtra product program, the Preferred Stock Purchase Agreement amendment would significantly curtail MPF Xtra cash window sales. OnSeptember 14, 2021 , the FHFA and theU.S. Treasury suspended certain provisions of the Preferred Stock Purchase Agreement, including limits on Fannie Mae's cash window purchases until at leastSeptember 14, 2022 . Although we do not currently expect the cash window limits to have a material impact on our financial condition or results of operations, when effective, these limits may negatively impact the volume of loans that PFIs are able to sell through the MPF Program.
Legislative and Regulatory Developments Related to COVID-19 Pandemic
Additional COVID-19 Presidential, Legislative and Regulatory Developments. In light of the COVID-19 pandemic, the executive branch, through executive orders, governmental agencies, including theSEC , OCC,Federal Reserve ,FDIC ,National Credit Union Administration , CFTC and the FHFA, as well as state governments and agencies, have taken, and may continue to take, actions to provide various forms of relief from, and guidance regarding, the financial, operational, credit, market, and other effects of the pandemic, and theU.S. Congress has enacted and may continue to enact pandemic relief legislation, some of which may have a direct or indirect impact on us or our members. Many of these actions are temporary in nature. We continue to monitor these actions and guidance as they evolve and to evaluate their potential impact on us.
Other Legislative Matters
Affordable Housing andCommunity Investment . As previously disclosed,Congress continues to consider a legislative proposal, recently as part of the reconciliation process, that, if enacted, would require the FHLBanks to increase the percentage of their annual net earnings devoted to their affordable housing programs over the amount that is currently required by law. The Bank continues to monitor the proposal.
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