Item 1. Business and in “Mortgage Partnership Finance Program” in Item 7. Management’s Discussion and Analysis, both in this 2008 Annual Report filed on Form 10-K.
The Bank’s spread between asset yields and the cost of underlying funds is an area of keen focus for management. While earnings on capital are driven by market interest rates, the spread that the Bank earns between interest-earning assets and interest-bearing liabilities is determined by several factors. These factors include, but are not limited to, the amount, timing, structure and hedging of its debt issuance and the deployment of funds in loans to members or in attractive investment opportunities as they arise. With respect to investments, 2008 was a difficult year, as ongoing market disruptions led to widening spreads on agencies and a reduction in liquidity in the mortgage issuance sector. The Bank must maintain balance sheet liquidity for which the cost is holding a portfolio of lower-yielding assets. Management is also challenged to find and position investment assets that conform to standards of AAA- or AA- rated credit quality while respecting limits on interest rate risk exposure.
The Bank is required to maintain a level of liquidity in accordance with certain regulations and Bank policies established by management and the Board and certain regulations, including Finance Agency guidance to target as many as 15 days of liquidity under certain scenarios. To maintain this level, the Bank invests in short-term instruments with lower yields than are available with other investment alternatives. As the FHLBank System cost of funds has increased and the Bank has had to hold an increased amount of liquidity, it has become increasingly difficult for the Bank to earn a positive spread on these larger balances. See the Liquidity and Funding Risk discussion in “Risk Management” in Item 7. Management’s Discussion and Analysis for additional information regarding the Finance Agency’s guidance.
Leverage. Under the GLB Act, the Bank is required at all times to maintain a ratio of regulatory capital-to-assets at a level of four percent or higher. The reciprocal of this ratio, known as leverage, is the ratio of assets to capital and cannot exceed 25 times. The degree of leverage that the Bank maintains directly affects the Bank’s resulting return on capital and, therefore, its dividend-earning capacity. The higher the degree of leverage, the higher the potential return on capital that the Bank can achieve; this higher level of leverage also results in additional risk to the Bank. The size of the Bank’s balance sheet is heavily impacted by the volume of the loans to members portfolio. Management strives to maintain leverage generally in a range of 21 times to 24 times capital. This is intended to maintain an acceptable return on capital within the Bank’s applicable regulatory limits. The Bank’s leverage increased from 21.2 times for 2006 to 23.6 times for 2007 as the 31.0% growth in total assets, driven by loans to members, outpaced the 17.9% growth in capital. While capital stock activity is directly dependent on the change in the volume in the loans to members portfolio, there is not a one-for-one match in growth between the two. The impact of paydowns on loans at the end of 2006 was reflected in the December 31, 2006 asset balance; however, the excess capital stock related to those loan balances was not repurchased until the following month. The Bank’s leverage fell from 2007 to 2008 as the crises in the credit markets led the Bank to voluntarily reduce its money market portfolio and to not re-enter the MBS market. On December 23, 2008, the Bank announced its decision to voluntarily suspend excess capital stock repurchases until further notice, in an attempt to preserve capital.
Duration of Equity, Return Volatility and PCSP. The Bank uses various metrics to measure, monitor and control its market risk exposure. Policies established by the Board have focused on duration of equity and PCSP as key measurements and control devices for managing and reporting on the Bank’s exposure to changing market environments. Under the original Board policy, the Bank was required to maintain a base case duration of equity within +/-4.5 years, and in shock cases of +/-200 basis points, within +/-7 years. In early 2008, the Bank developed an Alternative Risk Profile approach which excludes the effect of certain mortgage-related asset credit spreads. Under this revised approach, the acceptable ranges remain the same as in the actual calculation.
The return volatility metric is utilized to manage the impact of interest rate risk on the Bank’s return on average capital stock compared to a dividend benchmark interest rate. This metric excludes future other-than-temporary impairment charges that may occur. This metric is calculated on multiple interest rate shock scenarios over rolling forward one to 12 month and 13 to 24 month time periods. The metric is presented above as a spread over 3-month LIBOR.
With respect to PCSP, the Board established a PCSP floor of 85% and a target of 95%. The Bank strives to manage its overall risk profile in a manner that attempts to preserve the PCSP at or near the target ratio of 95%. The difference between the actual PCSP and the floor or target, if any, represents a range of additional retained earnings that will need to be accumulated over time to restore the PCSP and retained earnings to an adequate level. The PCSP is also calculated under the Alternative Risk Profile approach. In both calculations, the floor and target are the same.
Previously, the Bank had also considered market value of equity volatility as a key measurement and control device for managing the Bank’s exposure to market changes. However, in late 2008 the Board approved various changes to the Bank’s market risk management strategies which resulted, in part, in the market value of equity volatility metrics being discontinued as Board-approved metrics, although they will continue to be monitored by Asset/Liability Committee (ALCO).
For additional information regarding the Alternative Risk Profile assumptions and approach, see Risk Governance in “Risk Management” in Item 7. Management’s Discussion and Analysis in this 2008 Annual Report on Form 10-K.
It is the intent of the Board and management to maintain a market risk profile within Board limits. The Bank’s liquid asset portfolios, because of their short-term maturity, do not expose the Bank to meaningful market risk. The Bank’s member loan portfolio has a modest amount of interest rate risk. Another portion of the market risk in the Bank’s balance sheet is driven by the MBS and MPF portfolios and the associated funding. These mortgage portfolios may be mismatched with respect to funding or option risks to a degree, giving rise to duration risk. The extension and prepayment risk inherent in mortgage assets is the major source of negative convexity risk in the Bank. The Bank’s mortgage assets are funded with consolidated obligations. As a result, the mortgage portfolios are also subject to basis risk, that is, the risk that mortgage spreads and agency spreads do not move correspondingly.
This basis risk generally consists of credit, illiquidity and prepayment spreads. Declines in the market value of equity due to further private label MBS credit spread widening in the fourth quarter of 2008 reduced the current capital stock price from which the PCSP is projected and significantly increased the differential between the actual and Alternative Risk Profile calculations. The Bank is also exposed to interest rate risk with respect to the rollover of existing debt and the ability to replace maturing debt at comparable cost, as well as the risk of rate resets on both assets and liabilities.
The flow of assets, funding and capital causes the Bank’s duration of equity, market value of equity volatility, and PCSP positions to fluctuate on a daily basis. Rising interest rates exert upward pressure on the Bank’s duration of equity, while falling rates tend to have the opposite effect. In a rising interest rate environment, generally associated with a strong economy, the Bank’s financial performance may improve due to higher earnings on capital, widening net interest spreads and growing loan demand. Yet these positive influences are offset to some degree because the same economic circumstances increase the Bank’s duration of equity and create a need to reduce this exposure. In a falling rate environment, typical of a weakening economy, duration of equity typically declines. This reduces the Bank’s duration and the costs of policy compliance, but this benefit may be offset by declining earnings on capital.
In 2008, U.S. Treasury yields in the two- to ten-year portion of the yield curve were volatile. On a trend basis, two-, five- and ten-year U.S. Treasury yields declined from year-end 2007 levels through March 2008 then increased to their highs of the year in June. Two- and five-year U.S. Treasury yields trended down for the rest of 2008, ending the year at 0.77% and 1.55%, respectively. Ten-year U.S. Treasury yields had a slightly downward bias from June through early November, then declined steeply over the last two months of 2008, ending the year at 2.22%. In addition, credit spreads continued to widen significantly, with mortgage spreads widening more than FHLBank term debt spreads, exposing the Bank to basis risk. These basis changes, which are difficult to hedge, had a significant negative impact on the Bank’s duration of equity in 2008. The incremental costs of hedging duration, convexity and MVE volatility, and to a lesser extent, basis risk, by issuing fixed-rate debt or purchasing option contracts reduce the Bank’s earnings. Results for 2008 were characterized by falling rates due to credit concerns related primarily to the deterioration of mortgage-related investments.
See the Quantitative Disclosures Regarding Market Risk discussion in “Risk Management” in Item 7. Management’s Discussion and Analysis for further discussion of Duration of Equity and PCSP calculations and results.
Interest Rates and Yield Curve Shifts. Another important determinant in the financial performance of the Bank involves shifting movements in the yield curve. The Bank’s earnings are affected not only by rising or falling interest rates, but also by the particular path and volatility of changes in market interest rates and the prevailing shape of the yield curve. Theoretically, flattening of the yield curve tends to compress the Bank’s net interest margin, while steepening of the curve offers better opportunities to purchase assets with wider net interest spread. During 2008, the U.S. Treasury curve steepened significantly as the decline in short-term yields exceeded the decline in long-term yields. However, as a result of management’s decision to not purchase MBS, the Bank was unable to capitalize on investment opportunities in the steepening yield curve environment.
The performance of the Bank’s portfolios of mortgage assets is particularly affected by shifts in the ten-year maturity range of the yield curve, which is the point that heavily influences mortgage pricing and refinancing trends. Changes in the shape of the yield curve, particularly the portion that drives fixed-rate residential mortgage yields, can also have a pronounced effect on the pace at which borrowers refinance to prepay their existing loans. Since the Bank’s mortgage loan portfolio is composed of fixed-rate mortgages, changes in the yield curve can have a significant effect on earnings. Under normal circumstances, when rates decline, prepayments increase, resulting in a shorter average loan life which can cause an accelerated accretion/amortization of any associated premiums or discounts. In addition, when higher coupon mortgage loans prepay at a faster pace, the resulting aggregate yield on the remaining loan portfolio declines. The Bank’s average mortgage loan portfolio has not experienced this decline in yield as paydown activity has been more concentrated in the older, lower-yielding portion of the portfolio.
The volatility of yield curve shifts may also have an effect on the Bank’s duration of equity and the cost of duration policy compliance. Volatility in interest rates may force management to spend resources on duration hedges to maintain compliance, even though a subsequent, sudden reversal in rates may make such hedges
unnecessary. Volatility in interest rate levels and in the shape and slope of the yield curve increases the cost of compliance with the Bank’s duration limit.
In summary, volatility in interest rates, the shifting slope of the yield curve, and movements in the ten-year maturity range of the curve challenge management as it seeks to maintain an acceptable net interest spread, maintain duration of equity compliance at the least cost and hedge the volatility of mortgage loan premium expense.
Credit Spreads. 2008 was once again a volatile year for credit spreads. During 2008, delinquencies on subprime and Alt-A mortgages increased; credit spreads widened and the universe of mortgage lenders contracted due to bankruptcies and brokers exiting the business. Banks remained reluctant to lend to one another, the liquidity of the asset-backed commercial paper market dried up, and there was little, if any, securitization of MBS. During 2008, mortgage spreads continued to widen with their widest point being November 2008.
The widening of mortgage spreads impacted the Bank’s duration of equity. This was due to the magnitude of the change in mortgage spreads, which far exceeded the movement in the Bank’s funding spread. This widening also drove the decline in the Bank’s market value of equity.
In addition, the Bank has experienced a widening of debt spreads, due in part to several government-sponsored programs which provided alternatives to GSE debt for investor funds, including a new class of debt with an explicit government guarantee. Investors have become generally cautious of any investments linked to the U.S. housing market, including GSE debt. This concern has increased funding costs and reduced availability of long-term FHLBank debt. This resulted in a deterioration in the pricing of FHLBank debt and increased the Bank’s cost of funding.
For additional information regarding the impact of credit spreads on the Bank’s risk metrics and financials, see the “Risk Management” section in Item 7. Management’s Discussion and Analysis in this 2008 Annual Report filed on Form 10-K.
Liquidity Requirements. The Bank maintains contingency liquidity sufficient to meet its estimated needs for a minimum of five business days without access to the consolidated obligation debt markets and to adhere to Finance Agency guidance to target as much as 15 days of liquidity under certain scenarios. To meet this additional requirement, the Bank has had to maintain significantly higher balances in shorter-term balances, earning a much lower interest rate than alternate investment options. These larger balances in lower-earning assets has had a negative impact on the Bank’s profitability. For additional information regarding the Finance Agency’s liquidity guidance, see the Liquidity and Funding Risk discussion in “Risk Management” in Item 7. Management’s Discussion and Analysis in this 2008 Annual Report filed on Form 10-K.
Key Business Strategies and 2009 Outlook
The Bank developed a 2009 operating plan with goals directed at adding value to our membership and the communities they serve. These goals include the following focal points: (1) Member Loans and Services; (2) Member Value; and (3) Community Investment and Economic Development.
Member Loans and Services. This concept continues the customer-centric focus strategic goal originally initiated in 2007. The Bank continually strives to identify new opportunities to effectively manage the loans to members portfolio and portfolio-related activity, recognizing the importance of the members, both as customers and stockholders.
Within this area, the 2009 operating plan includes several specific goals. The first of these goals is a commitment to manage the expected decrease in the loans to members balances. This includes recruiting new institutions for membership, providing pricing on loans to members to create value for the member and identifying and implementing new products, programs and services for the members as appropriate. The Bank is also committed to focusing on the issuance of letters of credit on behalf of members who credit enhance tax-exempt bond transactions. A third goal addresses the desire to increase the number of Participating Financial Institutions (PFIs) in the MPF Program and the community bank MPF balances. A fourth goal supports an increase in member transactions using the Bank4Banks online transaction tool, which provides an easy and efficient tool for members to perform transactions and manage accounts. A final goal addresses the increase of safekeeping assets held under
custody; this provides a competitively priced, reliable custodial service for members and can be managed through Bank4Banks.
While working toward these goals to improve the products and services offered to members, management will remain focused on its most important mission - ensuring that the Bank is poised and prepared to ensure a reliable flow of liquidity to its members and the communities they serve in all market cycles.
Member Value. Because Bank members are both customers and stockholders, management views member value as access to liquidity, competitively priced products, and a suitable return on investment. The Bank must deliver all of these components, while protecting the stockholders’ investment, prudently managing the Bank’s capital position and supporting community development. In the current environment, the Bank is focused on protecting the members’ investments and building adequate retained earnings. Therefore, as previously discussed, on December 23, 2008, the Bank suspended dividend payments until further notice. In addition, management continues to address ways to manage expense growth while providing desired products and pricing.
Community Investment and Economic Development. The Bank’s mission includes focus on providing programs for affordable housing and community development. In addition, Bank management provides leadership and opportunities for members to bring about sustainable economic development within their communities.
Imperatives within this area include expanding member participation in the FHLBank programs, marketing the community investment products and services to emerging communities, supporting the member services initiative to increase letter of credit volume for tax-exempt bond issuances, develop and implement a long-term foreclosure mitigation strategy and complete an evaluation of the Blueprint Communities Initiatives recently implemented in the Bank’s district.
In addition to the goals discussed above, infrastructure is a necessary foundation for continued success in the current business environment. Management is committed to providing the necessary technology resources to address changing business and regulatory needs to support the framework needed to achieve these goals and still prudently manage costs. These resources will be focused on areas such as enhancement of risk modeling, collateral management and analysis, business and information analysis and compliance with legal and regulatory requirements and business continuation plan enhancements.
Net Interest Income
The following table summarizes the interest income or interest expense, related yields and rates paid and the average balance for each of the primary balance sheet classifications as well as the net interest margin for each of three years ended December 31.
Average Balances and Interest Yields/Rates Paid(1)
Notes:
(1)
Average balances do not reflect the impact of reclassifications due to FIN 39-1; average balances do, however, reflect the reclassification of certificates of deposit to investments as described in Note 3 to the audited financial statement in this 2008 Annual Report filed on Form 10-K.
(2)
The average balance of Federal funds sold, related interest income and average yield calculations may include loans to other FHLBanks.
(3)
Investment securities include trading, held-to-maturity and available-for-sale securities. The average balances of trading investment securities and available-for-sale investment securities represent fair values. The related yield, however, is calculated based on cost.
(4)
Average balances reflect reclassification of noninterest-earning/noninterest-bearing hedge accounting adjustments to other assets or other liabilities.
(5)
Nonaccrual mortgage loans are included in average balances in determining the average rate. BOB loans are reflected in other assets.
Net interest income was $281.9 million for full year 2008, a decline of $85.1 million, or 23.2%, from full year 2007, as the impact of falling interest rates more than offset the benefit of higher volumes. Total average interest-earning assets were $96.2 billion for full year 2008, an increase of $15.2 billion, or 18.7%, over the full year 2007 average, driven by the higher demand for loans to members. However, the overall yield on interest-earning assets declined 179 bps to 3.48% while the overall rate paid on interest-bearing liabilities declined only 170 bps to 3.32%, resulting in a 9 bps compression in the net interest spread. The net interest margin decreased 16 bps, to 29 bps, from 2007 to 2008. The primary driver of the decline in net interest margin was the lower yield earned on noninterest-bearing funds (capital stock) which are typically invested in short-term assets (e.g. target overnight Federal funds rate fell 322 bps in the year-over-year comparison). Interest expense from funding the loans to members portfolio increased due to the accelerated recognition of concession fees on called bonds that funded this portfolio. In addition, late in fourth quarter 2008, the Bank shifted a portion of overnight discount note funding to term discount
notes to better manage member availability to liquidity, resulting in increased funding costs. Yields on the MBS and MPF portfolios were relatively flat as prepayments have been slow on these assets and additional purchases have been relatively small. However, accelerated amortization of fees on called debt funding these portfolios and generally higher rates on replacement of long-term maturing debt resulted in higher interest expense related to those portfolios in the year-over-year comparison. The Bank’s investments in interest-earning deposits, including certificates of deposit, which are reported in held-to-maturity securities, have benefited from favorable discount note pricing, offsetting the declines discussed above. Additional details and analysis regarding the shift in the mix of these categories is included in the Rate/Volume Analysis discussion below.
Rate/Volume Analysis. Changes in both volume and interest rates influence changes in net interest income and net interest margin. The following table summarizes changes in interest income and interest expense between 2008 and 2007 and between 2007 and 2006.
Average interest-earning assets for full year 2008 increased $15.2 billion, or 18.7%, from full year 2007, driven primarily by the loans to members portfolio. During the second half of 2007, the Bank began to experience unprecedented growth in the loans to members portfolio, which drove the overall increase in average interest-earning assets; this average growth continued into early 2008, leveled off through much of the year, and fell off somewhat during the fourth quarter of 2008. This year-over-year increase in loans to members was primarily due to instability in the credit market, which resulted in increased demand from members for liquidity. Increases in Federal funds sold, interest-earning deposits and investment securities were slightly offset by the continuing decline of the mortgage loan portfolio.
For full year 2008, average Federal funds sold increased $361.7 million, or 9.3%, over full year 2007, while interest income on these balances decreased $118.0 million in the same comparison. This decrease in interest income was driven by a 322 basis point decline in the portfolio yield year-over-year, which more than offset the moderate increase in volume. The full year 2008 average interest-earning deposits portfolio increased $638.1 million over full year 2007. There was a corresponding increase in interest income on the portfolio year-over-year of $8.9 million, with the increase in volume more than offsetting the 342 basis point decline in yields on the portfolio. The yields on these two portfolios are affected by the changes in overall short-term rates, which declined significantly from 2008 to 2007, as evidenced in the interest rate trend presentation in the “Current Financial and Mortgage Market Events and Trends” discussion in Item 7. Management’s Discussion and Analysis in this 2008 Annual Report filed on Form 10-K. The combination of the balances in these two categories in part reflects the Bank’s continued strategy to maintain a strong liquidity position in short-term investments in order to meet members’ loan demand as well as to efficiently leverage the balance sheet. The Bank is also required to maintain sufficient liquidity in accordance with certain Finance Agency guidance as well as management and Board policies.
For additional information regarding the Finance Agency’s liquidity guidance, see the Liquidity and Funding Risk discussion in “Risk Management” in Item 7. Management’s Discussion and Analysis in this 2008 Annual Report filed on Form 10-K.
The increase in the full year average investment securities portfolio from 2007 to 2008 was $490.2 million, or 2.8%; however, the interest income on this portfolio declined $80.2 million in the same comparison. The increase in volume was more than offset by a decrease in the portfolio yield. The investment securities portfolio includes trading, available-for-sale and held-to-maturity securities, the majority of which are held-to-maturity MBS. The yield on held-to-maturity MBS for full year 2008 increased approximately 7 basis points over full year 2007. However, yields on non-MBS securities fell dramatically, resulting in an overall yield decrease of 59 basis points. The market has become extremely cautious toward investments linked to the U.S. housing market, including MBS. Despite the temporary increase authorized to the FHLBanks with respect to investments in agency MBS, the Bank continues to be prudent in its review and due diligence related to potential MBS investment opportunities. The increase in investments year-over-year was due to purchases of Agency MBS and certificates of deposit.
The full year 2008 average loans to members portfolio increased $14.1 billion, or 26.4%, from full year 2007. However, the corresponding interest income on this portfolio decreased $715.3 million year-over-year, with the decline in yield more than offsetting the considerable increase in volume. The interest income on this portfolio was significantly impacted by the decline in short-term rates, as evidenced in the interest rate trend presentation in the “Current Financial and Mortgage Market Events and Trends” discussion in Item 7. Management’s Discussion and Analysis in this 2008 Annual Report filed on Form 10-K. Full year yields on this portfolio declined 219 basis points from full year 2007. The portfolio mix shifted to shorter-term loans and new portfolio pricing strategies were implemented, both of which contributed to the rate impact on the portfolio interest income. Specific mix changes within the portfolio are discussed more fully below under “Average Loans to Members Portfolio Detail.”
The full year average mortgage loans held for portfolio balances continued to decline from 2007 to 2008, decreasing $443.5 million, or 6.8%. The related interest income on this portfolio declined $21.9 million. The volume of mortgages purchased from members increased in 2008, but was outpaced by the run-off of the existing portfolio, resulting in a continued decline in the overall balance. The increase in volume was partially attributable to the Bank’s agreement to purchase up to $300 million of 100% participation interest in new MPF loans from FHLBank of Chicago; as of December 31, 2008, $218.0 million of MPF loans had been purchased. This agreement expired October 31, 2008. The decline in interest income was primarily due to the lower average portfolio balances; the overall portfolio yield remained relatively flat. Although the amount of MPF loans being generated from large members has declined in recent years, community bank fundings, a main focus of the program, have increased significantly, from $130.9 million to $732.7 million in the year-over-year comparison.
Total full year average interest-bearing deposits increased $296.3 million, or 19.4%, from 2007 to 2008. However, interest expense on the portfolio decreased $40.3 million in the same comparison, due to a 302 basis point decline in rates paid, which more than offset the volume increase. Average interest-bearing deposit balances fluctuate periodically.
The full year average total consolidated obligations portfolio balance, including both discount notes and bonds, has seen an overall increase from 2007 to 2008. The full year average balance of discount notes increased $4.8 billion, or 21.8%, from 2007 to 2008, while the average balance of bonds increased $9.3 billion, or 17.2%, during the same period. Most of the volume increase in bonds occurred in the first half of 2008, then fell during the remainder of the year. Discount note activity was relatively steady during the second half of 2008. As previously discussed, the Bank has been limited in its ability to issue longer-term debt, particularly in the last half of 2008. The Bank currently continues to issue discount notes sufficient to meet member demand.
Interest expense on discount notes decreased $420.1 million from full year 2007 to full year 2008. The decrease in interest expense was driven by a 245 basis point decrease in rates paid year-over-year, which more than offset the increase in the volume. Interest expense on bonds decreased $379.5 million from full year 2007 to full year 2008. Rates paid on bonds decreased 134 basis points, which more than offset the increase in bond volume in the comparison. In addition, a substantial portion of the bond portfolio is swapped to 3-month LIBOR; therefore, as the LIBOR rate (decreases) increases, interest expense on swapped bonds, including the impact of the swaps, (decreases) increases. See details regarding the impact of swaps on the full year rates paid in the “Net Interest
Income Derivatives Effects” discussion below. Current market conditions have impacted the spreads on the Bank’s consolidated obligations. The Bank has continued to experience obstacles in attempting to issue longer-term debt, including at spreads consistent with historical levels; the funding costs associated with issuing long-term debt have risen sharply relative to short-term debt. This reflected general investor reluctance to buy longer-term GSE obligations as well as strong investor demand for short-term GSE debt.
For additional information, see the Liquidity and Funding Risk discussion in “Risk Management” in Item 7. Management’s Discussion and Analysis in this 2008 Annual Report filed on Form 10-K.
compared with 2006
Net interest income increased $22.7 million, or 6.6%, to $367.0 million from full year 2006 to full year 2007. Full year average interest-earning assets and interest-bearing liabilities increased 9.5% and 9.7%, respectively, in 2007 compared to 2006. However, the net interest income increase was primarily rate driven as the increase in interest income more than offset the increase in interest expense. The net interest margin decreased 1 basis point to 0.45% year-over-year.
The increase in interest-earning assets was driven by increases in investments, interest-bearing deposits and loans to members. The Bank focused on maintaining a strong liquidity position in short-term investments, in order to meet members’ loan demand; the Bank invested in short-term liquid assets when short-term rates were increasing, resulting in an increase to interest income due to both volume and rates. Increases in the investment portfolio balances, as well as increases in the overall portfolio yields and related interest income, were driven primarily by increases in the MBS portfolio. Interest income from the loans to members portfolio was primarily volume driven. The portfolio experienced significant growth, particularly in the second half of 2007, due to instability in the credit markets, which resulted in increased demand from members for additional sources of liquidity.
Offsetting the increase in interest income was an increase in interest expense related primarily to discount notes. During 2007, the composition of the consolidated obligation portfolio shifted from longer-term bonds to shorter-term discount notes; this shift coincided with the shift in the loans to members portfolio to shorter-term borrowing. The significant increase in interest expense on discount notes was primarily volume driven, as rates paid on discount notes remained relatively flat from full year 2006 to full year 2007. By comparison, the interest expense on bonds reflected only a slight increase, as the decline in volume of bonds was offset by a meaningful increase in the rates paid on those bonds.
Average Loans to Members Portfolio Detail:
The Bank’s average loans to member portfolio grew 26.4% in 2008, almost double the pace of the previous year. The financial market turmoil and the continued uncertain conditions in the credit and mortgage markets have resulted in the need for members to accumulate liquidity. The increases in the average loans to members portfolio over the past two years spanned most loan products. The most significant dollar and percentage increase from 2007 to 2008 was in the Mid-Term RepoPlus product, which increased $9.9 billion, or 43.9%, year-over-year. The Term Loan and RepoPlus products also had significant increases year-over-year, but at a smaller rate of growth.
Average balances for the Mid-Term RepoPlus product increased in 2008 as members, driven by market uncertainty, sought additional term liquidity. The largest increase in this loan type was related to the significant funding needs of one of the Bank’s largest members, driven by their increased liquidity needs due to uncertainty in the bank note and commercial paper markets.
The slower growth in the RepoPlus product from 2007 to 2008 reflected the rapid growth of the product in previous years and increased competition from the Federal Reserve banks and other new government-supported lending programs in 2008.
Increases in Term Loans in the year-over-year comparison were primarily driven by a decline in interest rates; members elected to lock in lower rates on longer-term funding when possible. In addition, certain members had funding needs for term liquidity.
As of December 31, 2008, 37.0% of the par value of loans in the portfolio had a remaining maturity of one year or less, compared to 45.4% at December 31, 2007. Details of the portfolio components are included in Note 8 to the audited financial statements in this 2008 Annual Report filed on Form 10-K.
The ability to grow the loans to members portfolio may be affected by, among other things, the following: (1) the liquidity demands of the Bank’s borrowers; (2) the composition of the Bank’s membership itself; (3) the Bank’s liquidity position and how management chooses to fund the Bank; (4) current, as well as future, credit market conditions; (5) member reaction to the Bank’s voluntary decision to suspend dividend payments and excess capital stock repurchases until further notice; (6) actions of the U.S. government; (7) housing market trends; and (8) the shape of the yield curve.
During 2008, the Federal Reserve took a series of unprecedented actions that have made it more attractive for eligible financial institutions to borrow directly from the Federal Reserve Banks (FRBs). The Federal Reserve has significantly lowered the interest rate on funding from FRBs and reduced the discount they are requiring on collateral that eligible institutions use to support their borrowings. In addition, on October 7, 2008, the Federal Reserve announced the creation of the Commercial Paper Funding Facility (CPFF). The CPFF provides a liquidity backstop to U.S. issuers of commercial paper rated at least A-1/P-1/F1 by an NRSRO. As the Bank’s customers use these sources of funding, it has the potential to reduce the amount of loans made by the Bank to its members.
On February 27, 2009, the FDIC approved a final regulation increasing the FDIC assessment on those FDIC-insured financial institutions with outstanding FHLBank loans and other secured liabilities where the ratio of secured liabilities to domestic deposits is greater than 25 percent. The FDIC also announced a program to guarantee new senior unsecured debt issued by FDIC-insured institutions, where such debt is issued on or before October 31, 2009. The Bank has started to see an impact from these government lending and debt guarantee programs in the form of reduced borrowings and/or paydowns by some if its members and expects that the trend may continue. With respect to the FDICs final regulation regarding an assessment adjustment for secured liabilities such as the Bank’s loans to members above the specified level, the Bank is assessing the potential impact on its members’ borrowing levels.
See the “Legislative and Regulatory Actions” discussion in Item 7. Management’s Discussion and Analysis in this 2008 Annual Report filed on Form 10-K for additional information regarding these government actions.
In late July 2008, the U.S. Treasury issued guidance on covered bonds in order to increase liquidity in the capital markets. To the extent that the covered bond market develops, future demand for FHLBank loans to members could be affected.
The Bank accepts various forms of collateral including, but not limited to, AAA-rated investment securities and residential mortgage loans. In light of recent market conditions, the Bank recognizes that there is the potential for an increase in the credit risk of the portfolio. However, the Bank continues to monitor its collateral position and the related policies and procedures, to help ensure adequate collateral coverage. The Bank believes it is fully secured as of December 31, 2008. For more information on collateral, see the “Loan Products” disclosure in Item 1. Business and the Credit and Counterparty Risk discussion in “Risk Management” in Item 7. Management’s Discussion and Analysis, both in this 2008 Annual Report filed on Form 10-K.
Net Interest Income Derivative Effects. The following tables separately quantify the effects of the Bank’s derivative activities on its interest income and interest expense for each of the years ended December 31, 2008, 2007 and 2006. Derivative and hedging activities are discussed below in the other income (loss) section.
The Bank uses derivatives to hedge the fair market value changes attributable to the change in the London Interbank Offered Rate (LIBOR) benchmark interest rate. The hedge strategy generally uses interest rate swaps to hedge a portion of loans to members and consolidated obligations which convert the interest rates on those instruments from a fixed rate to a variable rate based on 3-month LIBOR. The purpose of this strategy is to protect the interest rate spread. Using derivatives to convert interest rates from fixed to variable can increase or decrease net interest income.
The variances in the loans to members and consolidated obligation derivative impacts from period to period are driven by the change in average 3-month LIBOR, the timing of interest rate resets and the average hedged portfolio balances outstanding during any given period. For 2008, the average 3-month LIBOR declined 237 basis points and the average level of hedged loans to members relative to the level of consolidated obligations was much higher than in the previous years presented, resulting in a negative derivative impact to net interest income. This unfavorable variance was offset by the interest rate changes to variable rate debt. The Bank used a high percentage of variable rate debt in its interest rate strategy during 2008. For full year 2008, the impact of derivatives decreased net interest income $309.9 million and reduced the interest rate spread 31 basis points; this compared to increases of $74.4 million and 8 basis points, respectively, for full year 2007 and decreases of $4.8 million and 2 basis points, respectively, for full year 2006. The mortgage loans held for portfolio derivative impact for all periods presented was affected by the amortization of basis adjustments resulting from hedges of commitments to purchase mortgage loans through the MPF program.
Other Income (Loss)
n/m - not meaningful
2008 results included total other losses of $192.2 million, compared to income of $18.0 million in 2007. Service fees in 2008 decreased $1.0 million in comparison to 2007 primarily due to the Bank’s decision to discontinue the Coin and Currency service to its customers as of July 31, 2008. The net loss on trading securities reflects the decline in value of the Rabbi trust investments, held to offset the market risk of certain deferred compensation agreements. Full year 2008 results included $266.0 million of other-than-temporary impairment charges, reflected in the above table as “net realized losses on available-for-sale and held-to-maturity securities.” Gains on derivatives and hedging activities were $66.3 million for 2008, compared to $10.8 million in 2007; this activity is discussed in detail below. All other income increased $3.5 million in 2008 compared to 2007, due primarily to higher standby letter of credit fees.
Derivatives and Hedging Activities. The Bank enters into interest rate swaps, caps, floors, swaption agreements and TBA securities, referred to collectively as interest rate exchange agreements and more broadly as derivative transactions. The Bank enters into derivatives transactions to offset all or portions of the financial risk exposures inherent in its member lending, investment and funding activities. All derivatives are recorded on the balance sheet at fair value. Changes in derivatives fair values are either recorded in the Statement of Operations or accumulated other comprehensive income within the capital section of the Statement of Condition depending on the hedge strategy.
The Bank’s hedging strategies consist of fair value and cash flow accounting hedges as well as economic hedges. Fair value and other hedges are discussed in more detail below. Economic hedges address specific risks inherent in the Bank’s balance sheet, but they do not qualify for hedge accounting. As a result, income recognition on the derivatives in economic hedges may vary considerably compared to the timing of income recognition on the underlying asset or liability. The Bank does not enter into derivatives for speculative purposes to generate profits.
Regardless of the hedge strategy employed, the Bank’s predominant hedging instrument is an interest rate swap. At the time of inception, the fair market value of an interest rate swap generally equals or is close to zero. Notwithstanding the exchange of interest payments made during the life of the swap, which are recorded as either interest income / expense or as a gain (loss) on derivative, depending upon the accounting classification of the hedging instrument, the fair value of an interest rate swap returns to zero at the end of its contractual term. Therefore, although the fair value of an interest rate swap is likely to change over the course of its full term, upon maturity any unrealized gains and losses generally net to zero.
The following table details the net gains and losses on derivatives and hedging activities, including hedge ineffectiveness.
Fair Value Hedges. The Bank uses fair value hedge accounting treatment for most of its fixed-rate loans to members and consolidated obligations using interest rate swaps. The interest rate swaps convert these fixed-rate instruments to a variable-rate (i.e. LIBOR). For the full year 2008, total ineffectiveness related to these fair value hedges resulted in a loss of $9.9 million compared to a gain of $13.7 million in 2007. During the same period, the overall notional amount decreased from $71.7 billion in 2007 to $57.8 billion in 2008. Fair value hedge ineffectiveness represents the difference between the change in the fair value of the derivative compared to the change in the fair value of the underlying asset/liability hedged. Fair value hedge ineffectiveness is generated by movement in the benchmark interest rate being hedged and by other structural characteristics of the transaction involved. For example, the presence of an upfront fee associated with a structured debt hedge will introduce valuation differences between the hedge and hedged item that will fluctuate through time. In addition, loans to member fair value hedge ineffectiveness for the twelve months ended December 31, 2008 included a loss of $10.9 million resulting from the replacement of 63 LBSF derivatives that were in fair value hedging relationships. See discussion of the Lehman bankruptcy and the resulting effects on the Bank’s financial statements in the “Current Financial and Mortgage Market Events and Trends” discussion in Management’s Discussion and Analysis in this 2008 Annual Report filed on Form 10-K.
Economic Hedges. For economic hedges, the Bank includes the net interest income and the changes in the fair value of the hedges in net gain (loss) on derivatives and hedging activities. Total amounts recorded for economic hedges were a gain of $63.2 million in 2008 compared to a loss of $3.8 million in 2007. The overall notional amount of economic hedges decreased from $1.5 billion at December 31, 2007 to $0.8 billion at December 31, 2008. For the year ended December 31, 2008, gains associated with economic hedges include a $69.0 million gain associated with the replaced LBSF derivatives that remained as economic hedges for a one day period after they were replaced in the fair value hedges of certain loans to members as described above. The gains (losses) associated with economic hedges for the twelve months ended December 31, 2008 also included a gain of $0.2 million associated with 40 additional replacement derivatives. See the above discussion of the Lehman bankruptcy and the resulting effects on the Bank’s financial statements in the “Current Financial and Mortgage Market Events and Trends” discussion in Management’s Discussion and Analysis in this report filed on Form 10-K.
Intermediary Transactions. Derivatives in which the Bank is an intermediary may arise when the Bank enters into derivatives with members and offsetting derivatives with other counterparties to meet the needs of members. Net gains on intermediary activities were not significant for the twelve months ended December 31, 2008 and 2007.
Other Derivative Activities. Generally, other net gains (losses) on derivatives and hedging activities includes the fair value impact of certain loan purchase commitments as well as other miscellaneous activity. For the twelve months ended December 31, 2008, other gains (losses) on derivatives and hedging activities also includes a gain of $11.8 million associated with the termination of certain LBSF derivatives. These derivatives and the respective fair value hedge relationships were legally terminated on September 19, 2008. See the above discussion of the Lehman bankruptcy and the resulting effects on the Bank’s financial statements in the “Current Financial and Mortgage Market Events and Trends” discussion in Management’s Discussion and Analysis in this 2008 Annual Report filed on Form 10-K.
Other hedging techniques used by the Bank to offset the potential earnings effects of loan prepayments include callable debt instruments in the funding mix. Costs associated with callable debt instruments are reflected in the overall cost of funding included in the calculation of net interest margin.
compared with 2006
2007 results included total other income of $18.0 million, compared to $13.6 million in 2006. Service fees in 2007 decreased $0.2 million in comparison to 2006 primarily due to the Bank’s decision to exit the Official Check business in the third quarter 2006. In addition the pricing for wire services was lowered at the beginning of 2007. Gains on derivatives and hedging activities were $10.8 million for 2007, compared to $7.0 million in 2006. All other income decreased $0.7 million in 2007 compared to 2006.
Derivative and Hedging Activities. The Bank uses fair value hedge accounting treatment for most of its fixed-rate loans to members and consolidated obligations using interest rate swaps. For the full year 2007, total ineffectiveness related to these fair value hedges resulted in a gain of $13.7 million compared to a gain of $9.5 million in 2006.
For economic hedges, a loss of $3.8 million was recorded in 2007 compared to a loss of $3.5 million in 2006.
Other Expense
Other expenses totaled $56.2 million in 2008 compared to $61.1 million in 2007. Excluding the operating expenses of the Finance Agency and OF described below, other expenses decreased $5.3 million, or 9.5%, compared to the prior year. The decrease was primarily due to the market decline in the SERP Thrift Plan year-over-year and no incentive compensation expense in 2008.
Collectively, the twelve FHLBanks are responsible for the operating expenses of the Finance Agency and the Office of Finance. These payments, allocated among the FHLBanks according to a cost-sharing formula, are reported as other expense on the Bank’s Statement of Operations and totaled $5.6 million in 2008 and $5.2 million in 2007. The Bank has no control over the operating expenses of the Finance Agency. The FHLBanks are able to exert a limited degree of control over the operating expenses of the Office of Finance due to the fact that two directors of the Office of Finance are also FHLBank presidents.
compared with 2006
Other expenses totaled $61.1 million in 2007 compared to $60.9 million in 2006. Excluding the operating expenses of the Finance Agency and OF described below, other expenses decreased $1.1 million, or 1.9%, compared to the prior year. The majority of this decrease was due to lower professional fee expense, driven by a decline in staffing contractors for special projects.
As noted above, the twelve FHLBanks are responsible for the operating expenses of the Finance Agency and the OF. These payments, reported as other expense on the Bank’s Statement of Operations, totaled $5.2 million in 2007 and $3.9 million in 2006.
Affordable Housing Program (AHP) and Resolution Funding Corp. (REFCORP) Assessments
The Bank’s mission includes the important public policy goal of making funds available for housing and economic development in the communities served by the Bank’s member financial institutions. In support of this goal, the Bank administers a number of programs, some mandated and some voluntary, which make funds available through member financial institutions. In all of these programs, Bank funds flow through member financial institutions into areas of need throughout the region.
The Affordable Housing Program (AHP), mandated by statute, is the largest and primary public policy program. The AHP funds, which are offered on a competitive basis, provide grants and below-market loans for both rental and owner-occupied housing for households at 80% or less of the area median income. The AHP program is mandated by the Act, and the Bank is required to contribute approximately 10% of its net earnings after REFCORP to AHP and makes these funds available for use in the subsequent year. Each year, the Bank’s Board adopts an implementation plan that defines the structure of the program pursuant to the AHP regulations.
In 2008, the Bank held two funding rounds. The 2008A funding round received 91 eligible applications. Grants totaling more than $10.9 million were awarded to 26 projects in June. These projects had total development costs of $212.8 million and provided 1,084 units of affordable housing. The 2008B funding round received 97 eligible applications. In December, grants totaling more than $10.2 million were awarded to 26 projects. These projects had total development costs of $164.9 million and provided 908 units of affordable housing. In addition to these awards, the Bank moved 6 projects from back-up status to prime. In March, the Bank awarded $0.8 million in grants to 3 back-up projects from the 2007B round, which had total development costs of $25.4 million and provided 108 units of affordable housing, and in August, the Bank awarded $1.1 million to 3 back-up projects from the 2008A funding round, which had total development costs of $45.3 million and which provided 192 units of affordable housing.
The First Front Door (FFD) program, which is a set-aside from the AHP, provides grants to qualified low-income first-time homebuyers to assist with closing costs and down payments. For 2008, $6.6 million was allocated to FFD. For the year ended December 31, 2008, commitments totaled $8.7 million and funding totaled approximately $7.4 million. The new commitments included available funds from the prior year allocation.
The Home Rehabilitation Program (HRP), which is also a set-aside from the AHP, was allocated $1 million in 2007 under a pilot program for the rehabilitation of owner-occupied homes. A small portion of the funds were disbursed in 2007, and the remaining amount of $974 thousand was disbursed in 2008.
The Community Lending Program (CLP) offers loans to members at the Bank’s cost of funds, providing the full advantage of a low-cost funding source. CLP loans help member institutions finance housing construction and rehabilitation, infrastructure improvement, and economic and community development projects that benefit targeted neighborhoods and households. At the close of business on December 31, 2008, the CLP loan balance totaled $604.0 million, as compared to $445.1 million at December 31, 2007, reflecting an increase of $158.9 million, or 35.7%.
Assessment Calculations. Although the FHLBanks are not subject to federal or state income taxes, the combined financial obligations of making payments to REFCORP (20%) and AHP contributions (10%) equate to a proportion of the Bank’s net income comparable to that paid in income tax by fully taxable entities. Inasmuch as both the REFCORP and AHP payments are each separately subtracted from earnings prior to the assessment of each, the combined effective rate is less than the simple sum of both (i.e., less than 30%). In passing the Financial Services Modernization Act of 1999, Congress established a fixed 20% annual REFCORP payment rate beginning in 2000 for each FHLBank. The fixed percentage replaced a fixed-dollar annual payment of $300 million which had previously been divided among the twelve FHLBanks through a complex allocation formula. The law also calls for an adjustment to be made to the total number of REFCORP payments due in future years so that, on a present value
basis, the combined REFCORP payments of all twelve FHLBanks are equal in amount to what had been required under the previous calculation method. The FHLBanks’ aggregate payments through 2008 exceeded the scheduled payments, effectively accelerating payment of the REFCORP obligation and shortening its remaining term to a final scheduled payment during the second quarter of 2013. This date assumes that the FHLBanks pay exactly $300 million annually until 2013. The cumulative amount to be paid to REFCORP by the FHLBank is not determinable at this time due to the interrelationships of the future earnings of all FHLBanks and interest rates.
Application of the REFCORP and AHP assessment percentage rates as applied to earnings during 2008, 2007 and 2006 resulted in annual assessment expenses for the Bank of $7.0 million, $85.6 million and $78.3 million, respectively. The year-to-year changes in assessments reflect the changes in pre-assessment earnings. Application of the REFCORP and AHP assessment percentage rates as applied to earnings during 2007 and 2006 resulted in annual assessment expenses for the Bank of $85.6 million and $78.3 million, respectively.
In 2008, the Bank overpaid its 2008 REFCORP assessment as a result of the loss recognized in fourth quarter 2008. As instructed by the U.S. Treasury, the Bank will use its overpayment as a credit against future REFCORP assessments (to the extent the Bank has positive net income in the future) over an indefinite period of time. This overpayment was recorded as deferred assets by the Bank and reported in as “prepaid REFCORP assessment” on the Statement of Condition at December 31, 2008. Over time, as the Bank uses this credit against its future REFCORP assessments, the deferred asset will be reduced until the deferred asset has been exhausted. If any amount of the deferred asset still remains at the time that the REFCORP obligation for the FHLBank System as a whole is fully satisfied, REFCORP, in consultation with the U.S. Treasury, will implement a procedure so that the Bank would be able to collect on its remaining deferred asset. The Bank’s prepaid REFCORP assessment balance at December 31, 2008 was $39.6 million.
Financial Condition
The following is Management’s Discussion and Analysis of the Bank’s financial condition as of December 31, 2008, which should be read in conjunction with the Bank’s audited financial statements and notes to financial statements in this 2008 Annual Report filed on Form 10-K.
Asset Composition. A steady decrease in loan demand by members during the fourth quarter of 2008, along with reductions in investment securities and interest-earning deposits, resulted in a decrease in Bank assets of $10.1 billion, or 10.0%, to $90.8 billion at December 31, 2008, down from $100.9 billion at December 31, 2007. Loans to members decreased $6.6 billion and investment securities decreased $4.5 billion. These decreases were slightly offset by a $1.6 billion increase in combined interest-earning deposits and Federal funds sold.
Total housing finance-related assets, which include MPF Program loans, loans to members, mortgage-backed securities and other mission-related investments, decreased $8.7 billion, or 9.8%, to $79.6 billion at year-end 2008, down from $88.3 billion at year-end 2007. Total housing finance-related assets accounted for 87.7% of assets at December 31, 2008, compared to 87.5% of assets at December 31, 2007.
Loans to Members. At year-end 2008, total loans to members equaled $62.2 billion, compared to $68.8 billion at year-end 2007, representing a decrease of 9.6%. The decrease in loans to members reflects the impact of current credit market conditions. As market conditions continued to deteriorate throughout 2008, other sources of funding became available to the Bank’s members, particularly the larger borrowers, and member demand decreased. See the Loan Concentrations discussion in “Risk Management” in Item 7. Management’s Discussion and Analysis in this 2008 Annual Report filed on Form 10-K for further information.
The average loan balance was $67.4 billion and $53.3 billion for the years ended December 31, 2008 and 2007, respectively. Average loans to members increased during 2008, although the balances decreased on a spot basis. This increase was primarily driven by member reaction to the current credit market conditions. During 2008, the Bank’s members required additional liquidity, as other sources of funding were not readily available. Much of this demand focused on short-term and overnight funding.
Total membership decreased from 332 members at the end of 2007 to 323 members at the end of 2008. During 2008, the Bank added nine new members, including eight commercial banks and one credit union. However, fifteen
members merged into existing members and there were two out-of-district mergers. One member was closed by the OTS and the FDIC was named as receiver. The following table provides a distribution of the number of members, categorized by individual member asset size, which had an outstanding loan balance during 2008 and 2007.
On a spot basis, the combined mid-term and short-term products decreased $10.2 billion, or 23.3%, to $33.5 billion as of December 31, 2008, compared to $43.7 billion at December 31, 2007. These products represented 56.3% and 64.5% of the Bank’s total loans to members portfolio in 2008 and 2007, respectively. The decrease in short-term borrowings was the result of a reduction in the need for short-term liquidity among some of the Bank’s larger members. Longer-term funding increased as members sought to take advantage of low interest rates. As market conditions change, the short-term nature of this lending could materially impact the Bank’s outstanding loan balance. See Item 1. Business for further information.
A number of the Bank’s members have a high percentage of long-term mortgage assets on their balance sheets; these members generally fund these assets through longer-term borrowings with the Bank to mitigate interest rate risk. Meeting the needs of such members has been, and will continue to be, an important part of the Bank’s loans to members business. In 2008, the Bank’s term loans increased by $3.8 billion, or 33.8%. Term loans to members represented 25.0% and 16.4% of the Bank’s loans to members portfolio in 2008 and 2007, respectively. Long-term loans to members increased as members took advantage of lower short-term interest rates and locked up term funding in the uncertain market environment.
The remaining loans to members products are longer-term option embedded products. The Bank hedges the interest rate risk of these products. Longer-term option embedded products represented 18.7% and 19.1% of the Bank’s loans to members portfolio in 2008 and 2007, respectively.
On October 13, 2008, Sovereign Bancorp, the holding company of the Bank’s largest member and borrower, Sovereign Bank, entered into an agreement to be acquired by Banco Santander, S.A. The holding company acquisition was completed on January 30, 2009. The future impact of this acquisition, if any, to the Bank’s loans to members portfolio is not known at this time.
Mortgage Loans Held for Portfolio. Mortgage loan balances remained flat at $6.2 billion as of December 31, 2008 and December 31, 2007. Increases in MPF loan volume due to an increase in PFIs as well as the impact of the Bank’s purchase of $218.0 million of MPF loan participation interests from FHLBank of Chicago was offset by continued runoff of the existing portfolio. See Item 1. Business and the section entitled “Mortgage Partnership Finance Program” in Item 7. Management’s Discussion and Analysis in this 2008 Annual Report filed on Form 10-K for further information regarding the Bank’s mortgage loan portfolio.
Loan Portfolio Analysis. The Bank’s outstanding loans, nonaccrual loans and loans 90 days or more past due and accruing interest are as presented in the following table. The amount of forgone interest income on BOB loans and net nonaccrual mortgage loans, respectively, for each of the periods presented was less than $1 million. The
Bank recorded $68 thousand, $103 thousand and $114 thousand of cash basis interest income in 2008, 2007 and 2006, respectively, and none for the periods 2004 and 2005.
Notes:
(1)
There are no loans to members balances which are past due or on nonaccrual status.
(2)
All of the real estate mortgages held in portfolio by the Bank are fixed-rate. Balances are reflected net of allowance for credit losses.
(3)
All nonaccrual mortgage loans are reported net of interest applied to principal.
(4)
Government-insured or -guaranteed loans (e.g., FHA, VA, HUD or RHS) continue to accrue interest after becoming 90 days or more delinquent.
(5)
Due to the nature of the program, all BOB loans are considered nonaccrual loans. Balances are reflected net of allowance for credit losses.
Allowance for Credit Losses. The allowance for credit losses is evaluated on a quarterly basis by management to identify the losses inherent within the portfolio and to determine the likelihood of collectibility. The allowance methodology determines an estimated probable loss for the impairment of the mortgage loan portfolio consistent with the provisions of Statement of Financial Accounting Standards No. 5, Accounting for Contingencies.
The Bank has not incurred any losses on loans to members since inception. Due to the collateral held as security and the repayment history for member loans, management believes that an allowance for credit losses for member loans is unnecessary at this time. See additional discussion regarding collateral policies and standards on the loans to members portfolio in the “Loan Products” discussion in Item 1. Business in this Annual Report filed on Form 10-K.
The Bank purchases government-guaranteed/insured and conventional fixed-rate residential mortgage loans. Because the credit risk on the government-guaranteed/insured loans is predominantly assumed by other entities, only conventional mortgage loans are evaluated for an allowance for credit losses. The Bank’s conventional mortgage loan portfolio is comprised of large groups of smaller-balance homogeneous loans made to borrowers by PFIs that are secured by residential real estate. A mortgage loan is considered impaired when it is probable that all contractual principal and interest payments will not be collected as scheduled in the loan agreement based on current information and events. The Bank collectively evaluates the homogeneous mortgage loan portfolio for impairment; therefore, it is scoped out of the provisions of Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan (SFAS 114). Conventional mortgage loans that are 90 days or more delinquent are placed on nonaccrual status. Government mortgage loans that are 90 days or more delinquent remain in accrual status due to guarantees or insurance. The Bank records cash payments received on nonaccrual
loans as a reduction of principal. The allowance for credit losses on the mortgage loans held for portfolio as of December 31, 2004 through 2008 was as follows:
The ratio of net charge-offs to average loans outstanding was less than 1 basis point for the periods presented.
The allowance for credit losses for the BOB program provides a reasonable estimate of losses inherent in the BOB portfolio based on the portfolio’s characteristics. Both probability of default and loss given default are determined and used to estimate the allowance for credit losses. Loss given default is considered to be 100% due to the fact that the BOB program has no collateral or credit enhancement requirements. Probability of default is based on small business default statistics from the NRSROs as well as the Small Business Administration (SBA) and trends in Gross Domestic Product. Based on the nature of the program, all of the loans in the BOB program are classified as nonaccrual loans. The allowance for credit losses on the BOB loans as of December 31, 2004 through 2008 was as follows:
Based on the nature of the BOB program, in that its purpose is to assist small and start-up businesses, the Bank expects that some of the loans will default. During 2008, the ratio of charge-offs to average loans outstanding, net, was approximately 2.4% and 14.5% during 2008 and 2007, respectively.
Interest-Earning Deposits and Federal Funds Sold. At December 31, 2008, these short-term investments totaled $6.4 billion, an increase of $1.6 billion, or 34.3%, from December 31, 2007. By the year end, the Bank had shifted most of its Fed funds sold to an interest-earning cash account at the Federal Reserve due to more favorable yields available there. This increase is due to the Bank maintaining an adequate level of short-term liquidity sufficient to meet members’ loan demand and comply with management and Board policies and Finance Agency guidance. See the Liquidity and Funding Risk discussion in “Risk Management” in Item 7. Management’s Discussion and Analysis for additional information on the Finance Agency liquidity guidance.
Investment Securities. The $4.5 billion, or 22.6%, decrease in investment securities from December 31, 2007 to December 31, 2008, was primarily due to a decrease in held-to-maturity securities. These investments include MBS that are collateralized and provide a return that is expected to exceed the return on other types of investments. The decrease in MBS was driven primarily by paydowns and/or maturities of principal as well as management’s decision to slow the purchase of additional MBS in 2008 due in part to ongoing market volatility. There were no private label MBS purchased in 2008. The Bank did purchase $425.4 million of Agency MBS during 2008. All MBS continue to pay principal and interest in accordance with contractual terms. In addition, certificates of deposit decreased $2.5 billion as some of these short-term investments matured and were not replaced.
Historically, the amount that the Bank can invest in MBS is limited by regulation to 300 percent of regulatory capital; however, in March 2008 an increase was authorized for two years in the amount of MBS the FHLBanks are permitted to purchase. Subject to approval by the Board and filing of required documentation, the Bank may invest
up to 600 percent of regulatory capital in MBS. The Bank will continue to monitor its MBS position and determine the proper portfolio level. At the current time, the Bank does not expect to seek regulatory approval to exceed the original 300 percent limit.
The following tables summarize key investment securities portfolio statistics.
As of December 31, 2008, investment securities had the following maturity and yield characteristics.
As of December 31, 2008, the available-for-sale and held-to-maturity securities portfolios included gross unrealized losses of $14.5 million and $2.1 billion, respectively, which were considered temporary. As of December 31, 2007, these portfolios included gross unrealized losses of $1.9 million and $306.7 million, respectively, which were also considered temporary. The increases in gross unrealized losses on these portfolios resulted from ongoing market volatility, illiquidity in certain market sectors and widening credit spreads. In addition, in fourth quarter 2008, the Bank recorded other-than-temporary impairment charges of $2.8 million and $263.2 million on the available-for-sale and held-to-maturity securities portfolios, respectively. The basis for determination that the declines in fair value for these portfolios are temporary is explained in further detail in the “Critical Accounting Policies” discussion in Item 7. Management’s Discussion and Analysis and Notes 6 and 7 of the audited financial statements included in this 2008 Annual Report filed on Form 10-K.
As of December 31, 2008, the Bank held securities from the following issuers with a book value greater than 10% of Bank total capital.
For additional information on the credit risk of the investment portfolio, see Credit and Counterparty Risk discussion in “Risk Management” in Item 7. Management’s Discussion and Analysis in this 2008 Annual Report filed on Form 10-K.
Deposits. At December 31, 2008, time deposits in denominations of $100 thousand or more totaled $15.7 million. The table below presents the maturities for time deposits in denominations of $100 thousand or more:
Short-term Borrowings. Borrowings with original maturities of one year or less are classified as short-term. The following is a summary of key statistics for the Bank’s short-term borrowings.
Contractual Obligations. The following table summarizes the expected payment of significant contractual obligations by due date or stated maturity date at December 31, 2008 at par.
Note:
(1)
Specific bonds or notes incorporate features, such as calls or indices, which could cause redemption at different times than the stated maturity dates.
Commitment and Off-balance Sheet Items. At December 31, 2008, the Bank is obligated to fund approximately $4.4 million in additional loans to members, $31.2 million of mortgage loans and $10.0 billion in outstanding standby letters of credit, and to issue $635.0 million in consolidated obligations. The Bank does not have any off-balance sheet special purpose entities or any other type of off-balance sheet conduits.
Retained Earnings. The Finance Agency has issued regulatory guidance to the FHLBanks relating to capital management and retained earnings. The guidance directs each FHLBank to assess, at least annually, the adequacy of its retained earnings with consideration given to future possible financial and economic scenarios. The guidance also outlines the considerations that each FHLBank should undertake in assessing the adequacy of its retained earnings.
Effective September 26, 2008, the Bank revised its previous retained earnings policy and established a new capital adequacy metric, referred to as the Projected Capital Stock Price (PCSP). This metric retains the overall risk components approach of the previous policy but expands and refines the risk components to calculate an estimate of capital-at-risk, or the projected variability of capital stock. The sum of these risk components is expressed in percentage points of capital stock book value and is applied to the current capital stock price to calculate the PCSP. The Board has established a PCSP floor of 85% and a target of 95%. In addition to this actual calculation, the Bank also calculates the PCSP under the Alternative Risk Profile approach, which excludes the effects of further increases in certain mortgage-related asset credit spreads. See Risk Governance in “Risk Management” in Item 7. Management’s Discussion and Analysis in this 2008 Annual Report on Form 10-K for additional details regarding the Alternative Risk Profile.
Management strives to manage the overall risk profile of the Bank in a manner that attempts to preserve the PCSP at or near the target ratio of 95%. The difference between the actual PCSP and the floor or target, if any, represents a range of additional retained earnings that will need to be accumulated over time to restore the PCSP and retained earnings to an adequate level. Under the revised retained earnings policy, when the PCSP is below the target, the Board is required to establish an implementation approach for reaching the target that includes an analysis of various recovery periods and a restriction in the dividend payout ratio to no greater than 67.0% of the previous quarter’s earnings. As of September 30, 2008, the Bank’s PCSP was 57.1% under the actual calculation and 83.7% under the Alternative Risk Profile approach; as a result, the Board established an implementation approach and restricted the dividend payout. At December 31, 2008, the Bank’s PCSP was 9.9% and 74.2% under the actual calculation and the Alternative Risk Profile approach, respectively.
Previously, the retained earnings policy required the calculation of a recommended level of retained earnings based on a risk component approach moderately different from the current approach. When forecasted retained earnings were sufficiently below the recommended level, the Board established an implementation approach and timetable for reaching an adequate level of retained earnings. For the first three quarters of 2008, forecasted retained earnings were below the recommended level. This shortfall was primarily due to an increase in the Bank’s market risk capital component of required risk-based capital. The significant increase in market risk-based capital requirement was primarily caused by widening mortgage credit spreads and the resulting decline in the ratio of the Bank’s market value of equity to book value of equity. The ratio fell from 85.6% at December 31, 2007 to 23% at December 31, 2008. In accordance with the Finance Agency’s risk-based capital regulation, the Bank is required to provide for additional market risk-based capital when the ratio falls below 85%. In connection with the previous policy and the Board’s desire to build retained earnings in this volatile credit environment, the payout ratio had already been limited in the previous three quarters. On December 23, 2008, the Bank announced its decision to voluntarily suspend dividend payments until further notice in an effort to build retained earnings.
At December 31, 2008, retained earnings were $170.5 million, representing a decrease of $125.8 million, or 42.5%, from December 31, 2007. Further details of the components of required risk-based capital are presented in the “Capital Resources” discussion in Management’s Discussion and Analysis in this 2008 Annual Report filed on Form 10-K. See Note 18 to the audited financial statements in this 2008 Annual Report filed on Form 10-K for further discussion of risk-based capital and the Bank’s policy on capital stock requirements.
As discussed above, the Bank considers a number of factors in determining the appropriate level of dividend. The Bank believes that it is prudent to exercise additional caution with respect to its current dividend. The Bank is focused on building capital through increased retained earnings. All dividend payments are subject to the approval of the Board. The amount the Board determines to pay out will be affected by these changes in the retained earnings policy as noted above, as well as these other factors.
Other Financial Information
Selected Quarterly Financial Data
The following is a summary of the Bank’s unaudited quarterly operating results for each quarter for the two years ended December 31, 2008 and 2007.
Mortgage Partnership Finance (MPF) Program
Mortgage Loan Portfolio
As of December 31, 2008, the par value of the Bank’s mortgage loan portfolio totaled $6.1 billion, a decrease of $0.1 billion, or 0.7%, from the December 31, 2007 balance of $6.2 billion. These balances were approximately 6.7% and 6.1% of period-end total assets, respectively. The average mortgage loan portfolio balance for 2008 was $6.1 billion, a decrease of $0.4 billion, or 6.8%, from 2007. The mortgage loan portfolio balance at December 31, 2008 remained flat from prior year-end while the average mortgage loan portfolio balances experienced a decrease from December 31, 2007 to December 31, 2008. The slight changes in the year-end balance was due primarily to purchases of 100% loan participations from FHLBank of Chicago as well as an increase in PFIs and MPF fundings, offset by paydowns of existing portfolio loans. The decrease in the average balance year-over-year reflected the continued portfolio runoff and the fact that the purchases from FHLBank of Chicago were concentrated in the last half of 2008. The Bank entered into an agreement with FHLBank of Chicago to purchase up to $300 million of 100% participation interest in new MPF loans from FHLBank of Chicago. The agreement expired October 31, 2008; however, commitments made through October 31, 2008 were funded throughout the remainder of 2008. As of December 31, 2008, the Bank had purchased $218.0 million of MPF loans under this agreement. The Bank undertook a concerted effort to increase the number of participating PFIs during 2008. As a result, the Bank increased PFIs by 20, which increased the volume of purchases. These events occurred later in 2008; therefore the average mortgage loan portfolio balance decreased while the mortgage loan portfolio balance remained relatively flat from December 31, 2007 to December 31, 2008. The tables below present additional mortgage loan portfolio statistics including portfolio balances categorized by product. The data in the FICO and Loan-to-Value (LTV) ratio range tables is based on original FICO scores and LTV ratios and unpaid principal balance for the loans remaining in the portfolio at the end of each period. The geographic breakdown tables are also based on the unpaid principal balance at the end of each period.
Participating Financial Institution (PFI). Members must specifically apply to become a PFI. The Bank reviews the general eligibility of the member including servicing qualifications and ability to supply documents, data and reports required to be delivered under the MPF Program. The Bank added 20 new PFI’s in 2008, and as of December 31, 2008, 91 members were approved participants in the MPF Program. Of the Bank’s 10 largest members, based on asset size, four members have executed PFI agreements. The Bank did not purchase any volume from these four members during 2008.
Mortgage Loan Purchases. The Bank and the PFI enter into a Master Commitment which provides the general terms under which the PFI will deliver mortgage loans, including a maximum loan delivery amount, maximum credit enhancement amount and expiration date. Mortgage loans are purchased by the Bank directly from a PFI pursuant to a delivery commitment, which is a binding agreement between the PFI and the Bank.
Mortgage Loan Participations. The Bank may sell participation interests in purchased mortgage loans to other FHLBanks, institutional third party investors approved in writing by the FHLBank of Chicago, the member that provided the credit enhancement, and other members of the FHLBank System. For the year ended December 31, 2008, there was no volume of participation interests sold to FHLBank of Chicago or any other FHLBank. As noted above, the Bank purchased $218.0 million of participation interests from FHLBank of Chicago during the year ended December 31, 2008 based on a three-month agreement with FHLBank of Chicago which expired October 31,
2008. Excluding these purchases, the Bank currently holds no other participations in other FHLBank mortgage loans and has not sold any loans to third party investors.
Servicing
Mortgage Loan Servicing. Under the MPF Program, PFIs may retain or sell servicing to third parties. The Bank does not service loans or own any servicing rights. The FHLBank of Chicago acts as the master servicer for the Bank and has contracted with Wells Fargo Bank, N.A. to fulfill the master servicing duties. The Bank pays the PFI or third party servicer a servicing fee to perform these duties; the fee is generally 25 basis points for conventional loans.
Credit Exposure
Underwriting Standards. Purchased mortgage loans must meet certain underwriting standards established in the MPF Program guidelines. Key standards and/or eligibility guidelines include the following loan criteria:
•
Conforming loan size, established annually; may not exceed the loan limits permitted to be set by the Finance Agency;
•
Fixed-rate, fully-amortizing loans with terms from 5 to 30 years;
•
Secured by first lien mortgages on owner-occupied residential properties and second homes;
•
Generally, 95% maximum LTV; all LTV ratios are based on the loan purpose, occupancy and borrower citizenship status; all loans with LTV ratios above 80% require primary mortgage insurance coverage; and
•
Unseasoned or current production with up to 12 payments made by the borrowers.
The following types of mortgage loans are not eligible for delivery under the MPF Program: (1) mortgage loans that are not ratable by S&P; (2) mortgage loans not meeting the MPF Program eligibility requirements as set forth in the MPF Guides and agreements; and (3) mortgage loans that are classified as high cost, high rate, Home Ownership and Equity Protection Act (HOEPA) loans, or loans in similar categories defined under predatory lending or abusive lending laws.
Under the MPF Program, the FHLBank of Chicago, the PFI and the Bank all conduct quality assurance reviews on a sample of the conventional mortgage loans to ensure compliance with MPF Program requirements. The PFI may be required to repurchase, at the greater of book value or market value, individual loans which fail these reviews. Additionally, MPF Government residential mortgage loans which are 90 days or more past due are permitted to be repurchased by the PFI. While the repurchase of these government mortgage loans is not required, PFIs have historically exercised their option to repurchase these loans. For the years 2008 and 2007, the total funded amount of repurchased mortgage loans was $13.6 million and $14.4 million, or 1.9% and 11.0% of total funded loans, respectively.
Layers of Loss Protection. The Bank is required to put a credit enhancement structure in place that assures that the Bank’s exposure to credit risk on mortgage loans is no greater than that of a mortgage asset rated at least AA. The PFI must bear a specified portion of the direct economic consequences of actual loan losses on the individual mortgage loans or pool of loans, which may be provided by a credit enhancement obligation or SMI.
Each MPF product structure has various layers of loss protection as follows:
*
The FLA either builds over time or is an amount equal to an agreed-upon percentage of the aggregate balance of the mortgage loans purchased. The type of FLA is established by MPF product. The Bank does not receive fees in connection with the FLA.
**
The PFI’s credit enhancement amount for each pool of loans, together with any primary mortgage insurance or supplemental mortgage insurance coverage, is sized to equal the amount of losses in excess of the FLA to the equivalent of an AA rated mortgage investment.
By credit enhancing each loan pool, the PFI maintains an interest in the performance of the mortgage loans it sells to the Bank and may service for the Bank. For managing this risk, the PFI is paid a monthly credit enhancement fee by the Bank. Credit enhancement fees are recorded as an offset to mortgage loan net interest income in the Statement of Operations. For the years ended December 31, 2008, 2007 and 2006, the credit enhancement fees were $7.1 million, $7.7 million and $8.5 million, respectively. Performance based credit enhancement fees paid are reduced by losses absorbed through the FLA, where applicable.
The product differences are described in more detail below.
Original MPF. Under Original MPF, the FLA is zero on the day the first loan is purchased and generally increases steadily over the life of the Master Commitment based on the month-end outstanding aggregate principal balance. Loan losses not covered by primary mortgage insurance, but not to exceed the FLA, are deducted from the FLA and recorded as losses by the Bank for financial reporting purposes. Losses in excess of FLA are allocated to the PFI under its credit enhancement obligation for each pool of loans. The PFI is paid a fixed credit enhancement fee for providing this credit enhancement obligation. Loan losses in excess of both the FLA and the credit enhancement amount are unlikely, but if any such losses should occur, they would be recorded as losses by the Bank based on the Bank’s participation interest in the master commitment.
MPF Plus. Under MPF Plus, the first layer of losses (following any primary mortgage insurance coverage) is applied to the FLA equal to a specified percentage of the loans in the pool as of the sale date. Any losses allocated to this FLA are the responsibility of the Bank. The PFI obtains additional credit enhancement in the form of a supplemental mortgage insurance policy to cover losses in excess of the deductible of the policy, which is equal to the FLA. Loan losses not covered by the FLA and supplemental mortgage insurance are paid by the PFI, up to the amount of the PFI’s credit enhancement obligation, if any, for each pool of loans. If applicable, the PFI is paid a fixed credit enhancement fee and a performance-based fee for providing the credit enhancement obligation. Loan losses applied to the FLA as well as losses in excess of the combined FLA, the supplemental mortgage insurance policy amount, and the PFI’s credit enhancement obligation are recorded by the Bank based on the Bank’s participation interest. Losses incurred by the Bank up to its exposure under the FLA can be recaptured through the recovery of future performance based credit enhancement fees earned by the PFI. Although unlikely, any loan losses in excess of both the FLA and the credit enhancement would be treated in the same manner as Original MPF.
The following are outstanding balances in the FLAs for the Original MPF and MPF Plus products:
MPF Government. Effective February 1, 2007, the name “Original MPF for FHA/VA” was changed to “MPF Government” and has been expanded from FHA and VA to also include U.S. Department of Housing and Urban Development (HUD) Section 184 and Rural Housing Service (RHS) Section 502 loan programs. Only government-insured or government-guaranteed mortgage loans are eligible for sale under this product. With MPF Government loans, PFIs obtained the applicable FHA insurance or a VA or RHS guarantee, were responsible for all unreimbursed servicing expenses and received a 44 basis point servicing fee; in addition, for master commitments issued prior to February 2, 2007, the PFI received a government loan fee. Since the PFI servicing these mortgage loans takes the risk with respect to amounts not reimbursed by either the FHA, VA, or RHS, this product results in the Bank having mortgage loans that are expected to perform similar to Federal agency securities.
MPF Xtra. In January 2009, the Bank received approval from the Finance Agency to offer MPF Xtra to its members. MPF Xtra is a new product option under the MPF Program which was introduced by the FHLBank of Chicago in 2008. This new product option allows PFIs to sell residential conforming fixed-rate mortgages directly to FHLBank of Chicago, which concurrently sells them to Fannie Mae on a nonrecourse basis. FHLBank of Chicago will pay the Bank a counterparty fee for each loan. The Bank is responsible for monitoring the PFI’s credit quality and servicing on FHLBank of Chicago’s behalf.
Real Estate Owned. When a PFI forecloses on a delinquent mortgage loan, the Bank reclassifies the carrying value of the loan to other assets as real estate owned (REO) at the lower of cost or fair value less estimated selling expenses. If the value of the REO property is lower than the carrying value of the loan, then the difference to the extent such amount is not expected to be recovered through recapture of performance-based credit enhancement fees is recorded as a charge-off to the allowance for credit losses. If the fair value of the REO property is higher than the carrying value of the loan, then the REO property is recorded in other assets at the carrying value of the loan. If a charge-off is required, the fair value less estimated costs to sell the property becomes the new cost basis for subsequent accounting. A PFI is charged with the responsibility for disposing of real estate on defaulted mortgage loans on behalf of the Bank. Once a property has been sold, the PFI presents a summary of the gain or loss for the individual mortgage loan to the master servicer for reimbursement of any loss. Gains on the sale of REO property are held and offset by future losses in the pool of loans, ahead of any remaining balances in the first loss account. Losses are deducted from the first loss account, if it has not been fully used. As of December 31, 2008 and 2007, the Bank held $5.9 million and $3.2 million, respectively, of REO.
See the Credit and Counterparty Risk discussion in “Risk Management” in Item 7. Management’s Discussion and Analysis for additional information regarding the credit risk of the MPF loan portfolio.
Capital Resources
The following is Management’s Discussion and Analysis of the Bank’s capital resources as of December 31, 2008, which should be read in conjunction with Note 18 to the audited financial statements in this 2008 Annual Report filed on Form 10-K.
Liquidity and Funding. Please refer to the presentation of the Bank’s liquidity and funding risk analysis in the Liquidity and Funding Risk section of “Risk Management” in Item 7. Management’s Discussion and Analysis in this 2008 Annual Report filed on Form 10-K for details.
Capital Plan. Under Finance Agency implementation of the GLB Act, the Bank adopted and maintains a plan (capital plan). Since the adoption of the capital plan, two members have notified the Bank that they wanted to voluntarily withdraw from membership and redeem their capital stock. One of those two members is in receivership. None of these redemptions were complete as of December 31, 2008. The total amount of the pending stock redemptions is $4.7 million. In addition, one member was placed in receivership by the FDIC and its charter was
dissolved. In total, five members have been merged out of district; two of these former members continue to maintain a balance in mandatorily redeemable capital stock. In 2008 and 2007, the Bank repurchased $53.7 million and $9.3 million, respectively, of capital stock related to out-of-district mergers.
Under the capital plan, member institutions are required to maintain capital stock in an amount equal to no less than the sum of three amounts: (1) a specified percentage of their outstanding loans from the Bank; (2) a specified percentage of their unused borrowing capacity (defined generally as the remaining collateral value that can be borrowed against) with the Bank; and (3) a specified percentage of the principal balance of residential mortgage loans previously sold to the Bank and still held by the Bank (any increase in this percentage will be applied on a prospective basis only). These specified percentages may be adjusted by the Bank’s Board within pre-established ranges as contained in the capital plan.
These specified percentage ranges and established rates are as follows:
The stock purchase requirement for unused borrowing capacity is referred to as the membership capital stock purchase requirement because it applies to all members. The other two stock purchase requirements are referred to as activity-based requirements. The Bank determines membership capital stock purchase requirements by considering the aggregate amount of capital necessary to prudently capitalize the Bank’s business activities. The amount of capital is dependent upon the size of the current balance sheet, expected members’ borrowing requirements and other forecasted balance sheet changes. As required by Finance Agency regulation, the Bank’s Board is required to evaluate its capital requirements periodically and to make adjustments as warranted and as permitted under the Bank’s capital plan. The Bank’s Board utilizes the flexibility designed into the capital plan to provide what it deems to be the best overall capitalization profile to enhance stockholder value, consistent with the safe and sound operation of the Bank. Effective May 1, 2009, the Board has approved a change in the Acquired Member Asset (AMA) capital stock purchase requirement under the Capital Plan on MPF loans sold to and held by the Bank, increasing to 4.0%. This capital stock requirement will be applied prospectively to loans funded under new MPF master commitments executed on or after May 1, 2009, and after. The decision to increase the AMA requirement aligns the Bank more closely with other FHLBanks offering AMA programs and ensures the portfolio is properly capitalized going forward. On December 23, 2008, the Bank announced its decision to voluntarily suspend excess capital stock repurchases until further notice in an effort to preserve capital. This action followed the significant increase in the Bank’s risk-based capital requirement in November 2008 due to deterioration in the market values of the Bank’s private label MBS. The Bank submitted a capital restoration plan to the Finance Agency on February 27, 2009; the Finance Agency’s review is pending. The plan submitted to the Finance Agency requests that the Bank not be required to increase member capital requirements unless it becomes significantly undercapitalized, which by definition would mean the Bank meets less than 75% of its risk-based, total or leverage capital requirements. The Bank was in compliance with its risk-based, total and leverage capital requirements at December 31, 2008.
Dividends. The amount of dividends the Board determines to pay out, if any, is affected by, among other factors, the level of retained earnings recommended by the new retained earnings policy. See the “Capital Resources” discussion in Item 1. Business for additional information. Dividends may be paid in either capital stock or cash; the Bank has historically paid cash dividends only. On December 23, 2008, the Bank announced its decision to voluntarily suspend payment of dividends until further notice.
Risk-Based Capital (RBC)
The Bank became subject to the Finance Agency’s Risk-Based Capital (RBC) regulations upon implementation of its capital plan on December 16, 2002. This regulatory framework requires the Bank to maintain sufficient
permanent capital, defined as retained earnings plus capital stock, to meet its combined credit risk, market risk and operational risk. Each of these components is computed as specified in regulations and directives issued by the Finance Agency.
Note:
(1)
Capital stock includes mandatorily redeemable capital stock
The Bank held excess permanent capital over RBC requirements of $233.8 million and $3.6 billion at December 31, 2008 and 2007, respectively.
Credit Risk Capital. The Bank’s credit risk capital requirement is determined by adding together the credit risk capital charges computed for assets, off-balance sheet items, and derivative contracts based on the credit risk percentages assigned to each item as determined by the Finance Agency. The increase in the credit risk capital component of the risk-based capital requirement was primarily driven by downgrades of private label MBS.
Market Risk Capital. The Bank’s market risk capital requirement is determined by adding together the market value of the Bank’s portfolio at risk from movements in interest rates and the amount, if any, by which the Bank’s current market value of equity is less than 85% of the Bank’s book value of equity as of the measurement calculation date. The Bank calculates the market value of its portfolio at risk and the current market value of its total capital by using an internal market risk model that is subject to annual independent validation.
The market risk component of the overall RBC framework is designed around a “stress test” approach. Simulations of several hundred historical market interest rate scenarios are generated and, under each scenario, the hypothetical beneficial/adverse effects on the Bank’s current market value of equity are determined. The hypothetical beneficial/adverse effect associated with each historical scenario is calculated by simulating the effect of each set of market conditions upon the Bank’s current risk position, which reflects current assets, liabilities, derivatives and off-balance-sheet commitment positions as of the measurement date.
From the resulting simulated scenarios, the most severe deterioration in market value of capital is identified as that scenario associated with a probability of occurrence of not more than 1% (i.e., a 99% confidence interval). The hypothetical deterioration in market value of equity in this scenario, derived under the methodology described above, represents the market value risk component of the Bank’s regulatory RBC requirement which, in conjunction with the credit risk and operations risk components, determines the Bank’s overall RBC requirement.
The increase in the market risk capital component of the risk-based capital requirement was due primarily to widening mortgage credit spreads causing a significant decline in the fair value of the Bank’s private label MBS portfolio. This resulted in a significant decline in the ratio of the Bank’s market value of equity to book value of equity.
Operational Risk Capital. The Bank’s operational risk capital requirement is equal to 30 percent of the sum of its credit risk capital requirement and its market risk capital requirement, unless the Finance Agency were to approve a request for a percentage reduction by the Bank. As a result, this risk-based capital requirement increased
commensurate with the increases in the credit risk and market risk capital components. The Bank requested a reduction and/or a waiver of the operational risk capital requirement. This request is pending.
Capital and Leverage Ratios
In addition to the requirements for RBC, the Finance Agency has mandated maintenance of certain capital and leverage ratios. The Bank must maintain total regulatory capital and leverage ratios of at least 4.0% and 5.0% of total assets, respectively. Management has an ongoing program to measure and monitor compliance with the ratio requirements. As a matter of policy, the Board has established an operating range for capitalization that calls for the capital ratio to be maintained between 4.08% and 5.0%. To enhance overall returns, it has been the Bank’s practice to utilize leverage within this operating range when market conditions permit, while maintaining compliance with statutory, regulatory and Bank policy limits.
Management reviews, on a routine basis, projections of capital leverage that incorporate anticipated changes in assets, liabilities, and capital stock levels as a tool to manage overall balance sheet leverage within the Board’s operating ranges. In connection with this review, when management believes that adjustments to the current member stock purchase requirements within the ranges established in the capital plan are warranted, a recommendation is presented for Board consideration. The member stock purchase requirements have been adjusted several times since the implementation of the capital plan in December 2002. The current percentages are 4.75% and 0.75% of member loans outstanding and unused borrowing capacity, respectively. As previously discussed, effective May 1, 2009, there will be an increase in the stock purchase requirement percentage for AMA activity to 4.0%; the current percentage is 0.0%.
As of December 31, 2008 and December 31, 2007, excess capital stock available for repurchase at a member’s request and at the Bank’s discretion totaled $371.5 million and $34.9 million, respectively. The Bank’s prior practice was to promptly repurchase the excess capital stock of its members upon their request (except with respect to directors’ institutions during standard blackout periods). On November 10, 2008, the Bank first changed its excess capital stock repurchase practice, stating that the Bank would no longer make excess capital stock repurchases at a member’s request and noting that the previous practice of repurchasing excess capital stock from all members on a periodic basis was revised. Subsequently, as announced on December 23, 2008, the Bank suspended excess capital stock repurchases until further notice. When the Bank reinstates excess capital stock repurchases, it plans to do so pursuant to a quarterly repurchase practice whereby it will send notice to members at least three business days prior to the repurchase date.
Critical Accounting Policies
The Bank’s consolidated financial statements are prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP). Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. The use of estimates, assumptions and judgments is necessary when financial assets and liabilities are required to be recorded at, or adjusted to reflect, fair value. Assets and liabilites carried at fair value inherently result in more financial
statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When such information is not available, valuation adjustments are estimated in good faith by management, primarily through the use of internal cash flow and other financial modeling techniques.
The most significant accounting policies followed by the Bank are presented in Note 2 to the audited financial statements. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Management views critical accounting policies to be those which are highly dependent on subjective or complex judgments, estimates or assumptions, and those for which changes in those estimates or assumptions could have a significant impact on the financial statements.
Other-Than-Temporary Impairment for Investment Securities. For investments classified as available-for-sale or held-to-maturity with a fair value less than carrying value the Bank evaluates their impairment to determine if it is other-than-temporary. When there is an other-than-temporary impairment of an investment, the decline in value is recognized as a loss and presented in the Statement of Operations as a loss. This quarterly other-than-temporary impairment assessment is subjective and complex and has increased in importance as a result of current market conditions.
The Bank will conclude that a loss is other-than-temporary if it is determined it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the security. This evaluation is inherently subjective and considers a number of factors. As part of this evaluation, the Bank considers its intent and ability to hold each security for a sufficient time to allow for any anticipated recovery of unrealized losses, including holding the security until maturity. To determine which individual securities are at risk for other-than-temporary impairment, the Bank considers various characteristics of each security including, but not limited to, the following: the credit rating and related outlook or status; the perceived riskiness of the underlying type of collateral; the duration and level of the unrealized loss; and certain other collateral-related characteristics such as FICO credit scores and delinquency rates.
As a result of this security level review, the Bank then identifies individual securities believed to be at risk for other-than-temporary impairment. Securities which the Bank believes are at risk for other-than-temporary impairment are evaluated further by analyzing the performance of the security. Securities with weaker performance measures are evaluated by estimating projected cash flows using a model based on the structure of the security and certain economic environment assumptions such as default rates, loss severity, home price appreciation/depreciation and prepayment speeds to determine whether the Bank expects to receive the contractual cash flows to which it is entitled. During the fourth quarter 2008, the Bank utilized a third party to estimate the projected cash flows of certain of the Bank’s securities. As noted above, the Bank writes down an other-than-temporarily impaired security to its fair value. The fair value change may be more than the amount the Bank expects to realize by holding the security to maturity. Accordingly, the Bank records the recovery to interest income using the contractual method. See Notes 6 and 7 to the audited financial statements for further discussion.
Proposed FSP FAS 115-a, FAS 124-a and EITF 99-20-b. Recognition and Presentation of Other-Than-Temporary Impairments (FSP 115-a). On March 17, 2009, the FASB proposed FSP FAS 115-a. FSP 115-a is proposed only and therefore could change prior to issuance. FSP 115-a is intended to amend other-than-temporary impairment accounting guidance to make it more operational and to improve the presentation of other-than-temporary impairments in financial statements. FSP 115-a would apply to both debt and equity securities. In the event of an other-than-temporary impairment, FSP 115-a would require that the total impairment related to credit losses be recognized in earnings and the total impairment related to all other factors should be recorded in other-comprehensive income, if it is not likely that an investor will have to sell the security prior to recovery. If approved, the proposed FSP would be applied prospectively and be effective for financial statements issued for interim and annual reporting periods ending after March 15, 2009 (March 31, 2009 for the Bank). The Bank has determined that the adoption of this FSP as currently proposed could have a material effect on results of operations to the extent that the Bank has material other-than-temporary impairment charges in the future.
Fair Value Calculations and Methodologies. The Bank carries certain assets and liabilities, including investments classified as available-for-sale and trading, and all derivatives on the Statement of Condition at fair
value. The Bank also provides certain fair value based disclosures. The Bank adopted SFAS 157 on January 1, 2008. SFAS 157 establishes a framework for measuring fair value, establishes a fair value hierarchy based on the inputs used to measure fair value and requires additional disclosures for instruments carried at fair value on the Statement of Condition. SFAS 157 defines “fair value” as the price that would be received to sell an asset, or paid to transfer a liability (i.e., an exit price), in an orderly transaction between market participants at the measurement date.
Fair values are based on quoted market prices, if such prices are available. If quoted market prices are not available, fair values are determined using a modified matrix pricing approach or are based on valuation models that use either:
•
discounted cash flows, using market estimates of interest rates and volatility; or
•
dealer prices or similar instruments.
Pricing models and their underlying assumptions are based on the best estimates of management with respect to:
•
discount rates;
•
prepayments;
•
market volatility; and
•
other factors.
These assumptions may have a significant effect on the reported fair values of assets and liabilities, including derivatives, and the income and expense related thereto. The use of different assumptions, as well as changes in market conditions, could result in materially different net income and retained earnings.
The Bank’s process for estimating the fair value of the Bank’s mortgage-related securities involves requesting a price for each security from three third-party pricing services. These external prices and, in some cases, other available information, are evaluated based on a framework of criteria established by the Bank to determine the most appropriate price. In certain limited instances (e.g., not all third party services provide a price, etc.), the Bank may derive an internally modeled price that is deemed appropriate after consideration of all relevant facts and circumstances.
The Bank categorizes financial instruments carried at fair value into a three-level hierarchy in accordance with SFAS 157. The valuation hierarchy is based upon the transparency (the observable or unobservable) of inputs to the valuation of an asset or liability as of the measurement date. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Bank’s market assumptions. The Bank utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. However, as markets continue to remain illiquid, the Bank may utilize more unobservable inputs if they better reflect market value. As of December 31, 2008, the Bank does not carry a significant amount of financial instruments at fair value on the Statement of Condition which were valued using significant unobservable inputs. See Note 21 to the audited financial statements for further discussion.
Proposed FSP FAS 157-e. Determining Whether a Market is Not Active and a Transaction is Not Distressed (FSP 157-e). On March 17, 2009, the FASB proposed FSP FAS 157-e. FSP 157-e is proposed only and therefore could change prior to issuance. FSP 157-e is intended to provide additional guidance on determining whether a market for a financial asset is active and a transaction is not distressed for fair value measurements. If approved, the proposed FSP would be applied prospectively and be effective for financial statements issued for interim and annual reporting periods ending after March 15, 2009 (March 31, 2009 for the Bank). The Bank is currently evaluating what impact the adoption of this standard will have on our Statement of Operations and Statement of Condition if it is issued as proposed.
Accounting for Derivatives. The Bank regularly uses derivative instruments as part of its risk management activities to protect the value of certain assets, liabilities and future cash flows against adverse interest rate movements. The valuation and accounting assumptions related to derivatives are considered critical because
management must make estimates based on judgments and assumptions that can significantly affect financial statement presentation.
Derivative instruments are presented on the Statement of Condition at fair value. Any change in the fair value of a derivative is required to be reflected in current period earnings or other comprehensive income, regardless of how fair value changes in the assets or liabilities being hedged may be treated. This accounting treatment can cause significant volatility in reported net income from period to period.
Generally, the Bank strives to use derivatives when doing so is likely to provide a cost-effective means to mitigate the interest rate risk inherent in its business. The most common objectives of hedging with derivatives include: (1) preserving an interest spread between the yield of an asset and the cost of a supporting liability of mismatched maturity; (2) mitigating the adverse earnings effects resulting from the potential prepayment or extension of certain assets and liabilities; and (3) protecting the value of existing asset or liability positions or of anticipated transactions. Much of the Bank’s hedging activity is directed toward reducing interest rate risk and basis risk from loans and supporting debt. Historically, the Bank has used structured debt to create low-cost funding, which is used primarily to provide more attractively priced loans to the Bank’s members. Derivatives are also used to create loans with specialized embedded pricing features, customized to meet individual member funding needs and/or to reduce member borrowing costs.
The Bank’s policy remains consistent with Finance Agency regulation which is to use derivative instruments only to reduce the market risk exposures inherent in the otherwise unhedged asset and funding positions of the Bank. When doing so represents the most cost-efficient strategy and can be achieved while minimizing adverse earnings effects, management intends to continue utilizing derivative instruments as a means to reduce the Bank’s exposure to changes in market interest rates, as appropriate. See Notes 2 and 11 to the audited financial statements for further discussion.
Loans to Members and Related Allowance for Credit Losses. Loans to members represented 68.5% and 68.2% of total assets as of December 31, 2008 and 2007, respectively. The Statement of Condition presents loans to members, net of unearned commitment fees and discounts. Amortization of such fees and discounts is calculated using the interest method and is reflected as a component of interest income. Since its establishment in 1932, the Bank has never experienced a loan loss on loans to members. Further, management does not anticipate loan losses on any loans currently outstanding to members. The Bank is required by statute to obtain sufficient collateral on member loans to protect against losses and to accept as collateral on member loans only high quality investment securities (United States government, Federal agency or GSE securities or private label MBS rated AAA), residential mortgage loans, deposits in the Bank, and other real estate-related and Community Financial Institution assets. The Bank has historically had rights to mortgage loans and/or securities as collateral on a member-by-member basis with an estimated value in excess of the outstanding loans of each individual borrower. Accordingly, there is no allowance for credit losses for loans to members.
Guarantees and Consolidated Obligations. The Bank is jointly and severally liable for the payment of all the consolidated obligations of the entire FHLBank System. Accordingly, if one or more of the FHLBanks were unable to repay its direct participation in the consolidated obligations, each of the other FHLBanks could be called upon to repay all or part of those obligations, as approved or directed by the Finance Agency. The Bank does not recognize a liability for its joint and several obligations related to consolidated obligations issued for other FHLBanks because the Bank considers the joint and several liability a related party guarantee that meets the recognition scope exception in FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. The Bank records on its Statement of Condition a liability for consolidated obligations associated only with the proceeds it receives from the issuance of those consolidated obligations.
Accounting for Premiums and Discounts on Mortgage Loans and Mortgage-backed Securities. Typically, the Bank purchases mortgage loans and MBS at amounts that are different than the contractual note amount. The difference between the purchase price and the contractual note amount establishes a premium or discount. The Bank also receives or incurs various mortgage related fees. Mortgage loans and MBS are reported on the Statement of Condition at their principal amount outstanding net of deferred loan fees and premiums or discounts (including discounts as a result of other-than-temporary impairment). Bank policy requires the amortization or accretion of
these premiums or discounts to interest income occur using the contractual method, which produces a constant effective yield over the contractual life, which represents the stated maturity. Management prefers the contractual method to maturity because the income effects of the amortization or accretion are recognized in a manner that reflects the actual behavior of the underlying assets during the period in which the behavior occurs. Also, this method tracks the contractual terms of the assets without regard to changes in estimates based on assumptions about future borrower behavior.
Allowance for Credit Losses on Banking on Business Loans. The allowance for credit losses for the Banking on Business (BOB) program is based on the portfolio’s characteristics. Both probability of default and loss given default are determined and used to estimate the allowance for credit losses. Loss given default is considered to be 100% due to the fact that the BOB program has no collateral or credit enhancement requirements. Probability of default is based on small business default statistics for the NRSROs as well as the SBA and trends in Gross Domestic Product. Refer to further discussion regarding the allowance for credit losses in Notes 2 and 10 to the audited financial statements.
Allowance for Credit Losses on Mortgage Loans Held for Portfolio. The Bank bases the allowance for credit losses on management’s estimate of loan losses inherent in the Bank’s mortgage loan portfolio as of the balance sheet date taking into consideration, among other things, the Bank’s exposure within the first loss account. The Bank performs periodic reviews of its portfolio to identify the losses inherent within the portfolio and to determine the likelihood of collection of the portfolio. The overall allowance is determined based on historical default rates and/or loss percentages for similar loans in the MPF program, loan portfolio characteristics, collateral valuations, industry data, and prevailing economic conditions. Refer to further discussion regarding the allowance for credit losses in Notes 2 and 10 to the audited financial statements.
Future REFCORP Payments. The Bank’s financial statements do not include a liability for the Bank’s statutorily mandated future REFCORP payments. In the aggregate, the FHLBanks are required to fund a $300 million annual annuity whose final maturity date is April 15, 2030. The ultimate liability of the Bank is dependent on its own profitability and that of the other FHLBanks. The Bank pays 20% of its net earnings (after its AHP obligation) to support the payment of part of the interest on the bonds issued by REFCORP and, as such, the Bank is unable to estimate reasonably its future payments as would be required to recognize this future obligation as a liability on its Statement of Condition. Accordingly, the Bank discloses the REFCORP obligation as a long-term statutory payment requirement and treats it in a manner similar to the typical treatment of income tax expense for accounting purposes under GAAP, by recording it as an expense in the period in which the related net earnings are accrued. Further discussion is provided in Note 17 to the audited financial statements.
Recently Issued Accounting Standards and Interpretations. See Note 3 to the audited financial statements for a discussion of recent accounting pronouncements that are relevant to the Bank’s businesses.
Legislative and Regulatory Developments
Finance Agency Interim Final Regulation Regarding Minimum Capital Levels. On January 30, 2009, the Finance Agency issued an Interim Final Regulation implementing provisions of the Housing Act requiring the establishment of a minimum critical capital level for the FHLBanks and prompt corrective action mechanisms by the Finance Agency for an FHLBank that fails to meet the minimum capital requirements. The Interim Final Regulation does not change the existing risk-based, leverage and total capital requirements. Management is currently analyzing the effect of this Interim Final Regulation on the Bank.
Under the Interim Final Regulation, the Finance Agency has established four capital classification categories for an FHLBank:
•
Adequately Capitalized - the FHLBank meets all risk-based and minimum capital requirements;
•
Undercapitalized - the FHLBank does not meet all risk-based or minimum capital requirements;
•
Significantly Undercapitalized - the FHLBank has less than 75% of its risk-based capital requirements or minimum capital requirements (3.0% for the capital ratio and 3.75% for the leverage ratio) and has been reclassified from Undercapitalized to Significantly Undercapitalized; or
•
Critically Undercapitalized - the FHLBank’s total capital is less than or equal to 2.0% of the Bank’s total assets or has been reclassified from Significantly Undercapitalized to Critically Undercapitalized.
There are several mandatory actions which will be taken against an Undercapitalized FHLBank. These are as follows: (1) the FHLBank must submit and comply with a Capital Restoration Plan approved by the Finance Agency Director; (2) the FHLBank may not pay dividends, redeem capital stock or repurchase capital stock; (3) the FHLBank’s average assets can not exceed the previous quarter’s level of average assets without approval of the Finance Agency Director; and (4) the FHLBank may not conduct any new business activity without approval of the Finance Agency Director.
An FHLBank would receive a mandatory reclassification from Undercapitalized to Significantly Undercapitalized if it fails to submit, receive approval, or comply with a Capital Restoration Plan. Additional discretionary actions that can be taken against an Undercapitalized FHLBank include any mandatory and discretionary actions that can be taken against a Significantly Undercapitalized bank as noted below.
There are several mandatory actions which will be taken against a Significantly Undercapitalized FHLBank. These are as follows: (1) the FHLBank must submit and comply with a Capital Restoration Plan approved by the Finance Agency Director; (2) the FHLBank may not pay dividends, redeem capital stock or repurchase capital stock; and (3) the FHLBank may not give compensation increases or bonuses to executive officers as defined in the interim rule which includes executive officers as defined under 17 C.F.R. part 229 and certain additional Bank employees, without Finance Agency Director approval.
There are also various discretionary actions which can be taken against a Significantly Undercapitalized FHLBank. These are as follows: (1) a limit or reduction in obligations or classes of obligations, including off-balance sheet obligations; (2) a limit or reduction in assets or class of assets; (3) an increase in capital and/or retained earnings requirements; (4) a modification, limit or termination of any activity determined to create excessive risk; (5) an order for new director elections; (6) the dismissal of executive officers or directors; (7) a requirement to hire new executive officers subject to the Finance Agency Director’s approval; and/or (8) reclassification of an FHLBank from Significantly Undercapitalized to Critically Undercapitalized. This reclassification could occur if (1) the FHLBank fails to submit, receive approval, or comply with a Capital Restoration Plan; (2) another condition that is the basis for an initial reclassification exists; and/or (3) the Finance Agency Director determines that other actions are necessary to ensure safe and sound operations and capital compliance of the FHLBank.
The following mandatory actions are applicable to a Critically Undercapitalized FHLBank: (1) appointment of a conservator or receiver and (2) enforcement of all mandatory restrictions or obligations applicable to a Significantly Undercapitalized FHLBank.
Finance Agency Interim Final Regulation Regarding FHLBank Directors. On September 22, 2008, the Finance Agency issued an interim final regulation to implement the provisions of the Housing Act concerning the nomination and election of directors. The regulation substantially continues the prior rules governing elected director nominations, balloting, voting and reporting of results, while making certain modifications for the election of independent directors, as discussed below. The regulation:
•
required that the elections for member and independent directors with terms commencing on January 1, 2009 be completed by year-end 2008;
•
set terms for each directorship commencing after January 1, 2009 at four years, except as adjusted to achieve staggering required by the Housing Act; and
•
prescribed a process for conducting independent director and member director elections. With respect to independent director elections, an independent director nominee must receive at least 20 percent of the number of votes eligible to be cast in the election. If no nominee receives 20 percent of the votes eligible to be cast in the election, the FHLBank must identify additional nominees and conduct elections until the directorship is filled.
Proposed Bankruptcy Cramdown Legislation. The Bankruptcy Reform Act of 1994 substantially eliminated the risk of bankruptcy mortgage modifications, also known as “cramdowns,” on mortgages secured solely by
the debtor’s principal residence. Legislation to allow bankruptcy cramdowns on mortgages secured by owner-occupied homes has been passed by the House and is expected to be considered by the Senate. With this potential change in the law, the risk of losses on mortgages due to borrower bankruptcy filings could become material. The proposed legislation allows a bankruptcy judge, in specified circumstances, to reduce the mortgage amount to today’s market value of the property, reduce the interest rate paid by the debtor, and/or extend the repayment period. In the event that this legislation is passed and applies to existing mortgage debt (including residential MBS), then, the Bank could face increased risk of credit losses on its private-label MBS that include bankruptcy carve-out provisions and allocate bankruptcy losses over a specified dollar amount on a pro-rata basis across all classes of a security. The Bank has 73 private label MBS with a par value of $4.7 billion that include bankruptcy carve-out language that could be affected by cramdown legislation. The effect on the Bank will depend on the actual version of the legislation that is passed and whether mortgages held by the Bank, either within the MPF Program or as collateral for MBS held by the Bank, are subject to bankruptcy proceedings under the new legislation. Additional Bankruptcy Reform Act Amendments are also being discussed.
FDIC Actions. On February 27, 2009, the FDIC approved a final regulation that would increase the deposit insurance premium assessment for those FDIC-insured institutions that have outstanding FHLBank advances and other secured liabilities to the extent that the institutions’ ratio of secured liabilities to domestic deposits exceeds 25 percent. On October 14, 2008, the FDIC announced the TLGP, a program to guarantee newly issued senior unsecured debt (and the unsecured portion of any secured debt) issued by FDIC-insured institutions as well as bank, thrift and financial holding companies where such debt is issued on or before June 30, 2009. The amount of debt covered by the guarantee may not exceed 125 percent of debt that was outstanding as of September 30, 2008 that was scheduled to mature before June 30, 2009. For eligible debt issued on or before June 30, 2009, coverage would only be provided for three years beyond that date, even if the liability has not matured. The FDIC recently announced an extension of the unsecured debt guarantee program though October 31, 2009. Additionally, the FDIC has agreed to guarantee funds in noninterest-bearing transaction deposit accounts held by FDIC-insured banks until December 31, 2009.
The Bank has analyzed the impact some of these FDIC actions may have on its advances business and debt markets, including the extent to which these programs may reduce members’ needs for Bank funding. Management currently expects to see a reduction in the level of loans to members as a result of the TLGP. With respect to the increased FDIC insurance assessment on members with secured liabilities which are subject to the increased assessment, the Bank is determining the effect on its members. This new regulation may tend to decrease demand for loans from the Bank’s members affected by the regulation due to the increase in the effective “all-in” cost to members resulting from the assessment increase.
Proposed Rulemaking to Lower Risk Weights for Claims on, or Guaranteed by, Fannie Mae and Freddie Mac. Following the conservatorship of Fannie Mae and Freddie Mac, on September 7, 2008 the Treasury entered into senior preferred stock purchase agreements with Fannie Mae and Freddie Mac which effectively provide protection to the holders of senior debt, subordinated debt, and MBS issued or guaranteed by these entities. In light of the financial support provided under these agreements with the Treasury, on October 7, 2008 the FDIC, the Office of the Comptroller of the Currency (OCC), the Office of Thrift Supervision (OTS) and the Board of Governors of the Federal Reserve announced a joint notice of proposed rulemaking to amend their risk-based capital regulations for banks and thrifts to reduce the risk weight for Fannie Mae and Freddie Mac debt held by banks and thrifts from 20 percent to 10 percent. The proposal requests comments on whether the same treatment should be given to FHLBank debt. The comment period on the proposed rulemaking expired November 26, 2008. In the event that this proposed rule becomes a final regulation, the Bank is unable to predict what effect, if any, it will have on the FHLBanks. It may decrease the competitiveness of FHLBank debt compared to Fannie Mae and Freddie Mac debt.
Federal Reserve Board of Governors Actions. As an additional measure to further support the functioning of financial markets, on September 19, 2008, the Federal Reserve announced that it will begin purchasing short-term debt obligations issued by Fannie Mae, Freddie Mac and the FHLBanks in the secondary market. Similar to secondary market purchases of U.S. Treasury securities, purchases of Fannie Mae, Freddie Mac, and FHLBank debt will be conducted with the Federal Reserve’s primary dealers through a series of competitive auctions.
Additional Federal Reserve Bank Actions. The Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) is a lending facility that finances the purchases of high-quality asset-backed commercial paper (ABCP) from money market mutual funds by U.S. depository institutions and bank holding companies. The program is intended to assist money funds that hold such paper to meet the demands for redemptions by investors and to foster liquidity in the ABCP market and money markets more generally. The Commercial Paper Funding Facility (CPFF) is a facility, authorized under section 13(3) of the Federal Reserve Act, that enhances liquidity in the commercial paper markets. The CPFF provides a liquidity backstop to U.S. issuers of commercial paper. The Money Market Investor Funding Facility (MMIFF), announced on October 21, 2008 and authorized under section 13(3) of the Federal Reserve Act, is intended to provide liquidity to U.S. money market mutual funds and certain other money market investors, thereby increasing their ability to meet redemption requests and hence their willingness to invest in money market instruments, particularly term money market instruments. Under the MMIFF, the Federal Reserve Bank of New York can provide senior secured funding. On November 25, 2008, the Federal Reserve announced the creation of the Term Asset-Backed Securities Loan Facility (TALF). The TALF is a funding facility that will issue loans with a term of up to three years to U.S. persons that own eligible asset-backed security (ABS) collateral. The TALF is intended to (1) assist the financial markets in accommodating the credit needs of consumers and small businesses by facilitating the issuance of ABS collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (SBA) and (2) improve the market conditions for ABS more generally. TALF loans are non-recourse loans, meaning that the borrower’s obligation to repay the loan can be fulfilled by surrendering the collateral. The U.S. Treasury is providing credit protection to the FRBNY using funds authorized under the TARP. The loan from the FRBNY is senior to the TARP funds.
Since January 7, 2009, the Federal Reserve made a number of other money market investors eligible participants, including U.S.-based securities-lending cash-collateral reinvestment funds, portfolios, and accounts (securities lenders); and U.S.-based investment funds that operate in a manner similar to money market mutual funds, such as certain local government investment pools, common trust funds, and collective investment funds.
On February 10, 2009, the Federal Reserve Board announced that it is prepared to expand the size of the TALF to as much as $1.0 trillion and potentially to broaden the eligible collateral to encompass other types of newly issued AAA-rate asset-backed securities, such as ABS backed by commercial mortgages or private-label (non-agency) ABS backed by residential mortgages. Any expansion of the TALF would be supported by the Treasury providing additional funds from the TARP.
Emergency Economic Stabilization Act of 2008. On October 2, 2008, the President signed into law the Emergency Economic Stabilization Act of 2008 (EESA). Among other things, the EESA established TARP, under which the U.S. Treasury is authorized to purchase up to $700 billion of assets, including mortgage loans and mortgage-backed securities, from financial institutions. The U.S. Treasury has also determined that it can use authority under TARP to make direct investments in financial institutions in connection with its stabilization activities and such investments have been made, including in members of the Bank’s district. The EESA also increased the FDIC deposit insurance coverage limit from $100 thousand per account to $250 thousand per account through December 31, 2009. The Bank is unable to predict what effect the EESA may ultimately have on the Bank and its members.
The Housing and Economic Recovery Act of 2008. On July 30, 2008, the Housing Act was enacted. The Housing Act is designed to, among other things, address the current housing finance crisis, expand the Federal Housing Administration’s financing authority and address GSE reform issues. For further details, see the Bank’s periodic report filed on Form 10-Q for June 30, 2008.
The Housing Act created a newly established federal agency regulator, the Finance Agency, to become the new federal regulator of the FHLBanks, Fannie Mae and Freddie Mac effective July 30, 2008. It also authorized the U.S. Treasury to purchase obligations issued by the FHLBanks in any amount deemed appropriate by the U.S. Treasury under certain conditions. As discussed in the “Current Financial and Mortgage Market Events and Trends” section of Item 7. Management’s Discussion and Analysis and Note 22 to the audited financial statements in this 2008 Annual Report filed on Form 10-K as well as in the Bank’s periodic report filed on Form 10-Q for September 30, 2008, on September 9, 2008, the Bank, along with the other FHLBanks, entered into a
lending agreement with the U.S. Treasury, in connection with the establishment of the GSECF. The GSECF is designed to serve as a contingent source of liquidity. The Bank has not drawn on this source of liquidity and has no immediate plans to do so. See the Bank’s current report on Form 8-K filed on September 9, 2008 for more information. This temporary authorization expires December 31, 2009 and supplements the existing limit of $4.0 billion.
Risk Management
­ ­
The U.S. financial and residential mortgage markets have experienced an unprecedented downturn, which began to accelerate in the mortgage markets in mid-2007, deepened in 2008 and is expected to continue into 2009. During this time, concerns over the impact of residential mortgage lending practices precipitated a sharp deterioration in the subprime- and Alt-A-related mortgage markets, as well as the broader mortgage and credit markets. In particular, the market for MBS has experienced high levels of volatility and uncertainty, reduced demand and lack of liquidity, resulting in credit spreads widening significantly. This deterioration in the housing market was evidenced by growing delinquency and foreclosure rates on subprime, Alt-A and prime mortgages. Given the uncertainty in the mortgage markets, MBS, particularly those backed by nontraditional mortgage products, have continued to be subject to various rating agency downgrades. Central banks, including the Federal Reserve and the European Central Bank, have sought to prevent a serious and extended economic downturn resulting from these and other market difficulties by making significant interest rate reductions and taking other actions to free up credit. For further information regarding the markets in 2008, see the “Current Financial and Mortgage Markets and Trends” discussion in Item 7. Management’s Discussion and Analysis in this 2008 Annual Report filed on Form 10-K.
The Bank is heavily dependent on the residential mortgage market through the collateral securing member loans and holdings of mortgage-related assets. The Bank’s member collateral policies, practices and secured status are discussed in more detail below as well as in Item 1. Business. Additionally, the Bank has outstanding credit exposures related to the MPF Program and investments in private label MBS, which are affected by the mortgage market deterioration. All of these risk exposures are continually monitored and are discussed in more detail in the following sections.
Risk Governance
The Bank’s lending, investment and funding activities and use of derivative hedging instruments expose the Bank to a number of risks that include market and interest rate risk, credit and counterparty risk, liquidity and funding risk, and operating and business risk, among others, including those described in Item 1A.
Item 7. Management’s Discussion and Analysis.
Item 9:
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A:
Controls and Procedures
Disclosure Controls and Procedures
Under the supervision and with the participation of the Bank’s management, including the chief executive officer and chief financial officer, the Bank conducted an evaluation of its disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based on this evaluation, the Bank’s chief executive officer and chief financial officer concluded that the Bank’s disclosure controls and procedures were effective as of December 31, 2008.
Management’s Report on Internal Control Over Financial Reporting
See “Item 8. Financial Statements and Supplementary Financial Data - Management’s Annual Report of Internal Control over Financial Reporting.”
Changes in Internal Control Over Financial Reporting
There have been no changes in internal control over financial reporting that occurred during the fourth quarter of 2008 that have materially affected, or are reasonably likely to materially affect, the Bank’s internal control over financial reporting.
Item 9B:
Other Information
None
PART III
Item 10:
Directors, Executive Officers and Corporate Governance
Directors
Following enactment of the Housing Act, the Bank’s Board is comprised of a combination of industry directors elected by the Bank’s member institutions (Member Directors) on a state-by-state basis and independent directors elected by a plurality of the Bank’s members (Independent Directors). Prior to enactment of the Housing Act, the Bank’s Board was comprised of a combination of directors elected by the members and public interest directors appointed by the Finance Agency. No member of the Bank’s management may serve as a director of an FHLBank. The Bank’s Board currently includes nine Member Directors and six Independent Directors. As a result of the Housing Act, the procedures for nominating Independent Directors have changed over the past year. See Item 4. Submission of Matters to a Vote of Security Holders in this 2008 Annual Report filed on Form 10-K for details.
The following table sets forth certain information (ages as of February 28, 2009) regarding each of the Bank’s directors. No director of the Bank is related to any other director or executive officer of the Bank by blood, marriage, or adoption.
(a)
Member of Audit Committee
(b)
Member of Finance and Risk Management Committee
(c)
Member of Human Resources Committee
(d)
Member of Governance Committee
(e)
Member of Community Investment and Public Policy Committee
(f)
Member of Products & Services Committee
(g)
Member of Executive Committee
(*)
Rev. Cortés served a previous term from 2002 to 2004 as an appointed director.
(**)
Mr. Molnar served a previous term from 1982 to 1988 as an elected director.
(***)
Ms. Peck served a previous term from 1997 to 2002 as an appointed director.
(****)
Mr. Mason was appointed by the Board to fill a vacant non-guaranteed stock Member Director seat.
Dennis S. Marlo (Chair)
Dennis Marlo has served on the Board of Directors of the Bank since November 2002. Mr. Marlo is currently Managing Director of Sanctuary Group LTD, a financial and executive advisory firm located in Malvern, Pennsylvania. In addition, he is an Executive Vice President of Sovereign Bank, representing the Bank in various community, bank industry and Bank related activities. Mr. Marlo serves as a Director on the Board of NOVA Bank as well. Formerly, Mr. Marlo served as the Chief Risk Management Officer, Chief Financial Officer, Treasurer and President of the Pennsylvania Retail Banking Division of Sovereign Bancorp, Inc. (SOV - NYSE) and its wholly owned subsidiary, Sovereign Bank from 1998 to 2004. He came to Sovereign in 1998 through a merger with ML Bancorp, Inc. Previously, Mr. Marlo served as the President and Chief Executive Officer of ML Bancorp, Inc. (MLBC - NASDAQ) and its wholly owned subsidiary, Main Line Bank, as well as Chief Financial Officer from 1989 to 1998. Prior to his association with ML Bancorp, he was employed for 25 years at KPMG Peat Marwick and its predecessor organizations, where he retired as a partner in the firm. A graduate of LaSalle University and a Certified Public Accountant (CPA), Mr. Marlo also completed studies at the Graduate School of Community Bank Management, University of Texas/Austin. He is currently a member of the Board of Trustees of Harcum College in Bryn Mawr, Pennsylvania; the Board of Directors of EnerSys (ENS-NYSE) in Reading, Pennsylvania; the Board of Directors of Main Line Health Real Estate, LP; the Lankenau Hospital Foundation Board of Trustees in Wynnewood, Pennsylvania; and a member of the Council of President’s Associates of LaSalle University in Philadelphia. He is also a member of both the American and Pennsylvania Institutes of Certified Public Accountants and the Financial Managers Society, having served on its national board of directors. He is an active licensed Certified Public Accountant in the Commonwealth of Pennsylvania.
H. Charles Maddy, III (Vice Chair)
H. Charles Maddy, III joined the Board of Directors of the Bank in January 2002. Mr. Maddy is president and chief executive officer of Summit Financial Group, Inc. in Moorefield, West Virginia. He is also a member of the boards of directors for Summit Financial Group and its banking subsidiary Summit Community Bank. Mr. Maddy is also a director for the West Virginia Bankers Association and the Hardy County Child Care Center. He is a past president and past director of the West Virginia Association of Community Bankers, and a CPA certified by the West Virginia Board of Accountancy. Mr. Maddy graduated magna cum laude from Concord College in Athens, West Virginia, earning a bachelor of science degree in business administration with a concentration in accounting.
Patrick A. Bond
Patrick Bond joined the Board of Directors of the Bank in May 2007. He is a Founding General Partner of Mountaineer Capital, LP in Charleston, West Virginia. He graduated with a BS in Industrial Engineering and an MS in Industrial Engineering from West Virginia University. He is President of the West Virginia Symphony Orchestra, a member of the Board of Charleston Area Alliance, a member of the Board of Clay Center for the Arts and Sciences of West Virginia, a former President of Charleston Renaissance Corporation and a former member of the FHLBank Pittsburgh’s Affordable Housing Advisory Council.
Luis A. Cortés
Luis Cortés joined the Board of Directors of the Bank in April 2007. Reverend Cortés has served as the President and CEO of Nueva Esperanza since its inception in 1986. Esperanza, is the largest Hispanic faith-based organization in the country. The not-for-profit corporation has over 250 employees and manages an $18 million budget. The organization is networked with over ten thousand Latino congregations in the United States. He is also President Emeritus of Hispanic Clergy of Philadelphia, a religious organization. He has served as a board member of the FHLBank Pittsburgh from 2002-2004, which included his serving as vice chairman of the Board. He also serves on the board of The Cancer Treatment Centers of America, a privately held cancer hospital, as well as on the board of the Institute for the Study of Civic Values, a nonprofit in Pennsylvania, since 1993.
Walter D’Alessio
Walter D’Alessio joined the Board of Directors of the Bank in January 2008. A leader in the area of economic development in Greater Philadelphia, Mr. D’Alessio joined NorthMarq Capital in 2003. He is currently NorthMarq’s vice chairman, and a member of its board of directors; he also serves as president of the firm’s real estate consulting group. As chairman of the board of the Philadelphia Industrial Development Corporation (PIDC), Mr. D’Alessio has played a key role in building that organization’s international reputation. As a nonprofit partnership between the City of Philadelphia and the Chamber of Commerce, PIDC administers financing programs, land development and project management targeted to economic growth. During his time with the City’s Redevelopment Authority and at PIDC, Mr. D’Alessio has been involved in numerous large-scale projects including Market Street East, Penn’s Landing, Franklin Town and the development and expansion of the University of Pennsylvania, Temple University and Drexel University. Mr. D’Alessio has served on a wide array of corporate and nonprofit boards including Brandywine Realty Trust, the American Red Cross, the World Affairs Council and Independence Seaport Museum. He has been recognized locally and nationally with numerous awards.
John K. Darr
John Darr joined the Board of Directors of the Bank in January 2008. Mr. Darr, who retired from FHLBanks’ Office of Finance at the end of 2007 and resides in Delaware, served as managing director of the Office of Finance for 15 years. He had been responsible for issuing debt in the global capital markets on behalf of the twelve FHLBanks, consistent with their mission of providing low-cost liquidity to their respective member-owner financial institutions. He was also responsible for issuing the FHLBank System’s Combined Financial Statements and was intimately involved in the System’s SEC Registration process. Mr. Darr has a total of 35 years of business experience, including several years as Treasurer of FHLBank-San Francisco and as a director at Mortgage IT, a mortgage banking real estate investment trust. As a director of Manna, Inc. for more than ten years, Mr. Darr has served as chair of the board’s Audit and Finance Committee, as co-chair of its Leadership Committee and as a fund raiser for the $12 million organization. Manna, Inc., a faith-based institution, is devoted to building or rehabilitating very low-and low-income housing in the nation’s capital as well as providing homeownership counseling, mortgage brokerage and post-ownership support to project residents. It is credited with having provided more than 1,000 units of affordable housing over the past 25 years as well as counseling hundreds of homebuyers.
David R. Gibson
David Gibson was elected to the Board of Directors of the Bank and began his term January 1, 2007. Mr. Gibson, who has served Wilmington Trust for more than 20 years, was named its chief financial officer in 1996. He holds an MBA in Finance and Accounting from Vanderbilt University and earned his undergraduate degree from the University of Delaware. Mr. Gibson is a member of the finance committee of the board of Christiana Care Health Systems and a former member of the boards of the Delaware Workforce Investment Board, St. Edmond’s Academy and Junior Achievement of Delaware. He is a member of the Financial Executives Institute and the National Association of Accountants.
Brian A. Hudson
Brian Hudson joined the Board of Directors of the Bank in May 2007. Mr. Hudson is currently the Executive Director and Chief Executive Officer, Pennsylvania Housing Finance Agency (PHFA) in Harrisburg, Pennsylvania. He has a BA from Pennsylvania State University. He is a CPA and a Certified Treasury Professional (CTP). He is a member of the Board of National Council of State Housing Agencies, a member of the Board of Lackawanna College, Chair of Commonwealth Cornerstone Group and a former Chair of the Harrisburg Public School Foundation.
Glenn B. Marshall
Glenn Marshall was elected to the Board of Directors of the Bank and began his term January 1, 2008. Mr. Marshall is President and Chief Executive Officer of First Resource Bank, Exton, Pennsylvania. He has more than 25 years of banking experience. Mr. Marshall graduated from Drexel University with a bachelor’s degree in
Accounting and Marketing. He also holds a Master’s degree from St. Joseph’s University with a concentration in Finance and Banking. Mr. Marshall is the Chairman of the Audit Committee of West Whiteland Township, is a member of the Pension Board of West Whiteland Township and is a member of the Radnor Hunt Foundation.
John C. Mason
John Mason was appointed by the Bank’s Board to fill a vacant non-guaranteed stock seat on the Board and began his term January 1, 2009. Mr. Mason is ING Bank, FSB’s (ING DIRECT USA) Chief Investment Officer and Treasurer. Mr. Mason joined ING in June 2004. Mr. Mason has over 30 years of experience in the financial services industry. Mr. Mason graduated from Indiana University in Bloomington, Indiana with a Bachelor’s of Science degree in Business Economics. Mr. Mason is a participant in the Junior Achievement Titan and Economics for Success Programs.
John S. Milinovich
John Milinovich was elected to the Board of Directors of the Bank and began his term January 1, 2009. Mr. Milinovich is Executive Vice President, Treasurer and CFO of Washington Federal Savings Bank. Mr. Milinovich has 35 year’s experience including 10 years banking experience and 25 years of public accounting experience. Mr. Milinovich holds a Bachelor of Science degree in Accounting from Duquesne University and has continuously maintained his CPA license in Pennsylvania from 1976 to present. He has completed the graduate-level America’s Community Bankers - National School of Banking program at Fairfield University, where he received the prestigious Chairman’s Award for leadership ability and academic excellence. Mr. Milinovich serves on the Washington County Chamber of Commerce’s Board and Executive Committee, holding the office of Past Chairman. Mr. Milinovich has served on the Steering Committee of the Southwestern PA Growth Alliance, the Board of Directors of the Southwest Corner Workforce Investment Board, the Board of Governors of the Pennsylvania Economy League - Western Division, as Chairman of the Washington County Branch of the Pennsylvania Economy League, as Treasurer and Board Member of the United Way of Washington County, as Chairman of the PICPA State Continuing Professional Education Committee and as a Committee member of the PICPA State Education Committee.
Edward J. Molnar
Edward Molnar has served on the Board of Directors of the Bank since 2004. Mr. Molnar is Chairman of both Harleysville Savings Financial Corporation and Harleysville Savings Bank. With over 45 years’ experience in banking, Mr. Molnar is a past member of the board of directors of Americas’ Community Bankers, past chairman of the Pennsylvania Association of Community Bankers and past chairman of the bank advisory counsel of the Federal Reserve Bank of Philadelphia. Mr. Molnar also served as a member of the Thrift Advisory Council of the Federal Reserve Board.
Sarah E. Peck
Sarah Peck joined the Board of Directors of the Bank in April 2007. Ms. Peck is President and owner of Progressive Housing Ventures, LLC, Malvern, Pennsylvania. Her career includes thirty years of experience in real estate economics and development. She has a BA from Yale University and an MS from the London School of Economics. She is a former member and committee chair of the Board of Directors of FHLBank Pittsburgh; co-founder and member of the Commercial Real Estate Women; member, Planning Commission of Charlestown Township, Chester County; co-founder and member, Charlestown Citizens Forum; Director and Building Committee chair, Beth Chaim Reform Congregation; member, National Association of Homebuilders, Multifamily Council; member, Urban Land Institute; past president and co-founder, Housing Partnership of Chester County; past Marketing Committee chair and Board member, Chester County Fund for Women and Girls; and past member, Young President’s Organization. She has been honored with awards such as National Builder of the Year, Professional Builder Magazine; Woman of Distinction, Philadelphia Business Journal; Woman of Achievement and Business, March of Dimes; and Businesswoman of the Year, Great Valley Chamber of Commerce. Ms. Peck was also the recipient of the 2008 Pennsylvania Building Innovation Award by the PA Association of Homebuilders.
Patrick J. Ward
Patrick Ward has served on the Board of Directors of the Bank since January 2007. Mr. Ward is currently chairman and chief executive officer of Penn Liberty Bank. Mr. Ward has more than 20 years of experience in the banking industry, including executive experience with Citizens Bank of Pennsylvania and Commonwealth Bancorp in Malvern, Pennsylvania. He also held a variety of positions at Mellon Bank. Mr. Ward is a graduate of Carnegie Mellon University with a degree in Economics and earned his MBA at The University of Notre Dame. He serves on the boards of directors of the Philadelphia Police Athletic League, Phoenixville Area YMCA, EconomicsPennsylvania and the Chester County Chamber of Commerce.
Robert W. White
Robert White was elected to the Board of Directors of the Bank and began his term January 1, 2009. Mr. White began his banking career in 1970 after serving as a First Lieutenant in the United States Army from 1966 to 1969, including a tour of duty in Vietnam. He joined Abington Bank in 1974. In 1991, he was appointed President and subsequently became CEO and Chairman of the Board in 1994. Mr. White also served as Chairman of the Board, President and CEO of Abington Community Bancorp, Inc., after the Bank’s conversion to mutual holding company form in June 2004, and has served as Chairman of the Board, President and CEO of Abington Bancorp, Inc. (Nasdaq: ABBC), since the bank’s conversion to a full stock public company in June 2007.
Audit Committee
The Audit Committee has a written charter adopted by the Bank’s Board. The Audit Committee is directly responsible for the appointment, compensation and oversight of the Bank’s independent Registered Public Accounting Firm (RPAF) and Chief Internal Auditor. The Audit Committee is also responsible for approving all audit engagement fees, as well as any permitted non-audit services with the independent RPAF. The Audit Committee preapproves all auditing services and permitted non-audit services to be performed for the Bank by the independent RPAF. The independent RPAF reports directly to the Audit Committee. The Bank’s Chief Internal Auditor also reports directly to the Committee.
The Audit Committee assists the Board in fulfilling its responsibilities for general oversight of:
•
The Bank’s financial reporting processes and the audit of the Bank’s financial statements, including the integrity of the Bank’s financial statements;
•
the Bank’s administrative, operating, and internal accounting controls;
•
the Bank’s compliance with legal and regulatory requirements;
•
the independent auditors’ qualifications and independence; and
•
the performance of the Bank’s internal audit function and independent auditors.
As of February 28, 2009, the Audit Committee was composed of Messrs. Hudson (Chair), Ward, Darr, Gibson, Marshall and Milinovich. The Audit Committee regularly holds separate sessions with the Bank’s management, internal auditors, and independent RPAF.
The Board has determined that Messrs. Hudson, Ward, Darr, Gibson and Milinovich are each an “audit committee financial expert” within the meaning of the SEC rules. The Bank is required for the purposes of SEC rules regarding disclosure to use a definition of independence of a national securities exchange or a national securities association and to disclose whether each “audit committee financial expert” is “independent” under that definition. The Board has elected to use the New York Stock Exchange definition of independence, and under that definition, Messrs. Hudson, Ward, Gibson and Milinovich are not independent. Mr. Darr is independent. Messrs. Hudson, Ward, Gibson and Milinovich are independent according to the Finance Agency rules applicable to members of the audit committees of the boards of directors of the FHLBanks.
Executive Officers
The following table sets forth certain information (ages as of February 28, 2009) regarding the executive officers of the Bank.
John R. Price became President and Chief Executive Officer of the Bank on January 2, 2006. Prior to joining the Bank, Mr. Price was a senior advisor to the Institute of International Finance. Mr. Price also held several senior-level positions at JP Morgan Chase & Co. in New York (formerly Manufacturers Hanover Trust Co. which later merged into Chemical Bank and Chase Manhattan Bank). Mr. Price was responsible for the mortgage banking and consumer finance subsidiaries, led the team advising the U.S. government on the securitization on $5 billion of community development and rural low-income housing loans, and earlier served as corporate secretary. Mr. Price graduated from Grinnell College in Iowa, was named a Rhodes Scholar, earned advanced degrees in Development Economics and Diplomatic History from Queens College at Oxford University and received his law degree from Harvard Law School. Mr. Price was a member of the Board and chair of the Audit Committee of the Principal Financial Corporation, is a life trustee of Grinnell College and was the founding chairman of Americans for Oxford. Mr. Price also served as president of the Bankers Association for Finance and Trade.
Marshal S. Auron was named Chief Risk Officer in March, 2008. Between 2003 and 2008, he had been responsible for the Bank’s research, assessment and development of new product lines and business ideas. For the seven years prior to that, he was head of the Risk Management Department, responsible for measuring, modeling and assisting in managing the Bank’s interest rate risk profile. Prior to his time in Risk Management, Mr. Auron served as one of the Bank’s Credit Product Development Managers. Mr. Auron joined the Bank in 1992 from Pittsburgh National Bank (currently PNC Bank, NA), where he was a Vice President and Senior Portfolio Manager in the Asset and Liability Management Division. He is a graduate of the University of Pittsburgh where he received an MBA in Finance and he has a Bachelor of Science degree in Political Science and Economics from American University.
John J. Bendel joined the Bank in 1995 and is the Director of Community Investment. Mr. Bendel previously worked for Mullin & Lonergan Associates, an affordable housing and community development consulting firm based in Philadelphia. Mr. Bendel received a Master of Science degree in Public Administration from the University of Pittsburgh and a Bachelor of Science degree in Business Administration from St. Vincent College. Active in the community, Mr. Bendel serves as Chairman of the Board for Residential Resources, Inc., and is a Board member of the Pittsburgh Partnership for Neighborhood Development, Pennsylvania Rural Development Council and the Commonwealth Cornerstone Group. He also serves as Chairman of Rural Local Initiatives Support Corporation’s Pennsylvania Steering Committee and as a member of the West Virginia Interagency Housing Council.
Dale N. D’Alessandro joined the Bank in 2008 as the Managing Director of Human Resources. Prior to joining the Bank, Mr. D’Alessandro was the Vice President - Human Resources for Mylan Pharmaceuticals from 2003 to 2005. Before joining Mylan, Mr. D’Alessandro spent 27 years at Dominion Resources’ Pittsburgh office where he served in a variety of capacities. Mr. D’Alessandro earned a bachelor degree in Human Resource Management from Geneva College, and attended St. Francis University for a Masters degree in Human Resources and Industrial Relations. Mr. D’Alessandro is a member of the Pittsburgh Human Resources Association, Society of Human Resources Management and Leadership Pittsburgh.
Paul H. Dimmick joined the Bank in 2003, with the formation of the Mortgage Finance department. In December 2004, he was named Managing Director of Capital Markets, a newly formed group comprised of the Treasury and Mortgage Finance departments. Prior to joining the Bank, Mr. Dimmick held various senior management positions at Mellon Bank including Executive Vice President of Capital Markets. Mr. Dimmick was also a Senior Managing Director with Chemical Bank and its predecessor, Manufacturers Hanover Trust Co. Mr. Dimmick started his banking career as a bank examiner for the Federal Reserve Bank of New York. Mr. Dimmick holds a Bachelors degree in Economics and Business from Lafayette College and an MBA from the University of Pennsylvania’s Wharton School.
Teresa M. Donatelli joined the Bank in 1992, and held several managerial positions in Administration and Information Technology prior to assuming the position of Chief Information Officer in May 2004. Prior to joining the Bank, Ms. Donatelli held a variety of technical and managerial positions at Alcoa, Deloitte & Touche and Mellon Bank. Ms. Donatelli has a Bachelor of Arts degree in English from Duquesne University and a Masters degree in Business Administration from the University of Pittsburgh.
Craig C. Howie joined the Bank in 1990, and is the Group Director of the Bank’s Member Services department which includes Member Money Desk, Sales and Marketing, Mortgage Partnership Finance, Bank4Banks and Safekeeping. Before joining the Bank, Mr. Howie worked for Chemical Bank in New York as an Assistant Vice President in Mortgage Capital Markets. Prior to that, Mr. Howie worked for GMAC as an Assistant Vice President in Secondary Marketing. Mr. Howie received a Bachelors degree in Finance and Marketing from Susquehanna University and a Masters degree in Business Administration with a concentration in Finance from Drexel University.
Kristina K. Williams joined the Bank on December 31, 2004 as Chief Accounting Officer. Ms. Williams became Chief Financial Officer February 1, 2006. Ms. Williams most recently was the Chief Financial Officer of Wholesale Banking for PNC Financial Services Group. Ms. Williams also spent time in SEC and Regulatory Reporting and served as Director of Accounting Policy for PNC. Ms. Williams previously spent several years in public accounting with PricewaterhouseCoopers and Deloitte & Touche. Ms. Williams graduated magna cum laude from West Liberty State College and received her Masters in Professional Accountancy from West Virginia University. Ms. Williams is a CPA and a member of the American Institute of Certified Public Accountants, Pennsylvania Institute of Certified Public Accountants and is the audit committee chairperson on the board of directors for the West Liberty State College Foundation.
Dana A. Yealy joined the Bank in 1986, and has served as General Counsel since August 1991. Mr. Yealy is responsible for the legal, government relations, corporate secretary and ethics functions of the Bank. Prior to joining the Bank, he was an attorney with the Federal Home Loan Bank of Dallas. Mr. Yealy earned his Bachelors degree in Economics from Westminster College, his Juris Doctorate from the Dickinson School of Law, and his LL.M in Banking Law from the Boston University School of Law. Mr. Yealy is a member of the Association of Corporate Counsel, the Society of Corporate Secretaries & Governance Professionals, and the Society of Corporate Compliance and Ethics. Mr. Yealy is also a member of the American, Pennsylvania and Allegheny County Bar Associations.
Each executive officer serves at the pleasure of the Board of Directors.
Code of Conduct
The Bank has adopted a code of ethics for all of its employees and directors, including its chief executive officer, chief financial officer, controller, and those individuals who perform similar functions. A copy of the code of ethics is on the Bank’s public website, www.fhlb-pgh.com, and will be provided without charge upon written request to the Legal Department of the Bank at 601 Grant Street, Pittsburgh, PA 15219, Attention: General Counsel. Any amendments to the Bank’s Code of Conduct are posted to the Bank’s public website, www.fhlb-pgh.com.
Item 11:
Executive Compensation
Compensation Discussion and Analysis
Executive Summary
This Compensation Discussion and Analysis (CD&A) presents information related to the Bank’s compensation program provided to its Principal Executive Officer (the CEO) and other Named Executive Officers (other Executives). The information includes, among other things, the objectives of the Bank’s compensation program and the elements of compensation the Bank provides to its CEO and other Executives.
The Bank’s Board has determined that in order to make executive compensation decisions in a comprehensive manner it is necessary to consider the nature and level of all elements of the Bank’s compensation and benefits program in order to establish each element of the program at the appropriate level.
Compensation Philosophy
The Bank’s Total Compensation Program is designed to:
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Attract, motivate and retain staff critical to the Bank’s long-term success; and, thereby,
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Enable the Bank to meet its public policy mission while balancing the evolving needs of customers and shareholders.
In 2008, the Bank’s CEO and other Executives were compensated through a mix of base salary, eligibility for incentive compensation awards, benefits and perquisites, with base salary as the core component of the total compensation package. The Bank’s compensation plan for the CEO and other Executives establishes each component of compensation to be competitive within the Federal Home Loan Bank System (FHLBank System). The salary range data for comparable positions at the other FHLBanks serves as the primary benchmark for the CEO and the other Executives with the Bank targeting to pay the median of such salary range. A periodic review of the financial services market survey data (defined as those institutions with assets less than $25 billion) is conducted at least annually, as well as on an interim basis should variations arise or if the data indicates a need to differ from this benchmarking approach. Although the Bank had assets of $91.0 billion at December 31, 2008, for compensation purposes the Board has considered institutions with assets less than $25 billion to be comparable to the Bank in terms of the relative complexity of the business. As the Bank is a cooperative, it does not offer equity-based compensation as is typically offered in publicly-traded financial services institutions; however, the Bank’s incentive compensation and enhanced retirement benefits for the CEO and other Executives together are intended to provide a competitive compensation package.
Human Resources Committee’s Role and Responsibilities
The Board’s Human Resources Committee (HR Committee) is responsible for the establishment and oversight of the CEO’s compensation and oversight of other Executives’ compensation. This includes setting the objectives of and reviewing performance under the Bank’s compensation, benefits and perquisites programs for the CEO and other Executives.
Additionally, the HR Committee has adopted the practice of periodically retaining compensation and benefit consultants and other advisors, as well as reviewing analysis from the Bank’s Human Resources Department (HR Department), to assist in performing its duties in regard to the CEO’s and other Executives’ compensation. A comprehensive total compensation study was conducted in 2007.
Role of the Federal Housing Finance Agency
Under the Housing Act, which became effective July 30, 2008, the FHLBanks’ regulator, the Finance Agency, has been granted certain authority over executive compensation. Specifically under the Housing Act the Director of the Finance Agency is: a) authorized to prohibit executive compensation that is not reasonable and comparable with compensation in similar businesses and b) if an FHLBank is undercapitalized, the Finance Agency Director may also restrict executive compensation. Additionally, until December 31, 2009, the Finance Agency Director has
additional authority to approve, disapprove or modify executive compensation. The Finance Agency has directed the Bank and all the FHLBanks to submit to the Agency at least four (4) weeks prior to action by the Bank’s board, all proposed compensation and benefits actions in regard to the CEO or other Executives that require approval by the Bank’s Board. Effective January 29, 2009, the Finance Agency issued a final regulation regarding prohibitions on golden parachute payments.
Determining the CEO’s Cash Compensation
Consistent with 2007, in 2008 the HR Committee used the FHLBanks as the peer group for benchmarking the CEO’s cash compensation. The Board determined that the chief executive officer positions at the other FHLBanks were the best comparison. The CEO’s cash compensation (including both base salary and incentive compensation) was compared to the median for all FHLBanks’ chief executive officers. The HR Committee considered the benchmark data, length of service in the position and job performance when determining the CEO’s cash compensation.
For 2009, the HR Department presented the data on CEO cash compensation at the other FHLBanks to the HR Committee and the HR Committee considered this information in determining the CEO’s cash compensation. However, in view of the Bank’s financial performance, the CEO recommended and the Board agreed to forego a 2009 base salary increase for the CEO.
Determining Other Executives’ Cash Compensation
For 2008, with respect to other Executives’ base salaries and incentive compensation, the HR department used the FHLBanks’ survey data to determine competitive cash compensation. The base salary range midpoint for other Executives was based on the median of the FHLBank System survey data. A review of the financial services industry survey data reflecting institutions with asset size of $25 billion or less was also used to determine consistency with FHLBank System survey data. Actual annual base salary and incentive compensation payout levels were determined based on review of the FHLBank survey data, length of service in the position, and job performance.
For 2009, the CEO’s recommendations for any adjustments to other Executives’ cash compensation were reviewed and approved by the HR Committee which, in turn, then recommended any adjustments to the full Board for final approval. Management recommended and the Board agreed to forego 2009 base salary increases for other Executives.
Variable Incentive Plan (VIP)
The Board has established VIP compensation award opportunities based upon the achievement of specific annual performance objectives that support the Bank’s operating and profitability goals. The VIP is designed to reward the CEO and other Executives for achievement of Bank and/or individual performance goals. These goals were both quantitative and qualitative as approved by the HR Committee and the Board. Award levels were generally set at threshold, target and maximum percentages of base salary; awards could also be paid for performance achievement at points in between these levels.
Additional key components of the VIP include the following:
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As a retention strategy, 20 percent of each award to the CEO and other Executives is retained and subject to forfeiture if employment terminates within three years (other than in the case of involuntary termination other than cause, retirement, death, disability); and
•
No award payments shall be made under the VIP if the Bank’s Member Value Focus goal (as described below) has not been achieved at the threshold level for the plan year. In 2008, in determining payouts above the threshold level, the Bank’s performance as compared to its peers was required to be considered by the Board.
The Board has the discretion to determine whether or not to pay out awards, increase awards or reduce awards. This includes cases in which the goals may or may not have been met. In 2006, 2007, and 2008, the Board did not exercise the discretion to increase, decrease or eliminate award payouts.
CEO’s VIP Goals. In its adoption of the VIP, the Board determined that higher level positions within the organization should have a greater impact on the achievement of Bank goals. Therefore, 90 percent of the VIP award opportunity for the CEO in 2008 was based on achievement of the following three Bank goals:
Bank Goals
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Member Value Focus - 30 percent. As the Bank’s financial performance, indicated by the earned dividend rate, is a key measure of the Bank’s success, achieve a dividend rate that exceeds the Bank’s Operating Plan and provides shareholders an appropriate yield given market conditions.
•
Customer Focus - 30 percent. Complete at least six of the following eight specific objectives related to the Bank’s core businesses: increase loans to members volume, increase loans to members penetration, implement new loan products, implementation of new capital plan amendment to create a subclass of capital stock to allow for payment of patronage dividend based on member loan volume, increase maximum borrowing capacity growth, MPF risk transfer mechanism proposal submission to the Finance Agency, new member recruitment, and recruiting new PFIs
•
Community and Economic Development Initiative Focus - 30 percent. Develop initiatives to promote quality community and economic development and support infrastructure finance opportunities as well as expand profits through new opportunities.
Individual Goal
The remaining 10 percent of the CEO’s VIP award opportunity was based on implementing a new governance process at the CEO level within the FHLBank System that provided for more effective administration of FHLBank System issues and information sharing.
Other Executives’ VIP Goals. The weighting of the other Executives’ Bank goals was established at 70-75 percent of each other Executives’ total award opportunity. The remaining annual award opportunities were weighted toward individual performance goals. See the Summary Compensation Table and accompanying narrative for additional information.
Status reports on all of the incentive goals were reviewed with the Committee at least once during the year and the goals were modified as appropriate.
VIP Award Opportunity. The award opportunity levels in 2008, expressed as a percentage of base salary were:
The results of the performance goals are detailed in the Summary Compensation Table and accompanying narrative.
Additional Incentives
From time to time, the CEO has recommended, and the Board has approved, additional incentive awards in connection with specific projects or other objectives of a unique, challenging and time sensitive nature. There were no additional incentive awards granted in 2008.
Perquisites and other Benefits
The Board views the perquisites afforded to the CEO and other Executives as an element of the total compensation program, provided primarily as a benefit associated with their overall position duties and responsibilities. Examples of perquisites for the CEO and/or other Executives may include the following:
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Personal use of a Bank-owned automobile;
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Financial and tax planning;
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Relocation; and
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Business club membership.
Additionally, the Bank provides a tax gross-up for some of the perquisites offered, including relocation benefits. Perquisites for the CEO and other Executives are detailed on the Summary Compensation Table and accompanying narrative, where aggregate perquisites exceeded $10,000 in 2008.
Employee Benefits
The Board and Bank management are committed to providing competitive, high-quality benefits designed to promote health, well-being and income protection for all employees. As described above, the Bank has benchmarked the level of benefits provided to the CEO and other Executives to the other FHLBanks and financial services firms. The Bank offers all employees a core level of benefits and the opportunity to choose from a variety of optional benefits. Core and optional benefits offered include, but are not limited to, medical, dental, prescription drug, vision, long-term disability, short-term disability, flexible spending accounts, parking or transportation subsidy, worker’s compensation insurance, and life and accident insurance. The CEO and other Executives participate in these benefits on the same basis as all other full-time employees.
Qualified and Nonqualified Defined Benefit Plans
The Bank participates in the Pentegra Defined Benefit Plan for Financial Institutions (PDBP), a tax-qualified, multiple-employer defined-benefit plan. The PDBP is a funded, noncontributory plan that covers all eligible employees. For all employees hired prior to January 1, 2008, including the CEO and all other Executives, benefits under the plan are based upon a 2 percent accrual rate, the employees’ years of service and highest average base salary for a consecutive three-year period. Employees are not fully vested until they have completed five years of employment. The regular form of retirement benefits provides a single life annuity, with a guaranteed 12-year payment; a lump-sum payment or other additional payment options are also available. The benefits are not subject to offset for Social Security or any other retirement benefits received.
The CEO and other Executives also participate in a Supplemental Executive Retirement Plan (SERP). The SERP provides the CEO and other Executives with a retirement benefit that the Bank is unable to offer under the qualified PDBP due to Internal Revenue Code (IRC) and qualified PDBP limitations, including the IRC limitations on qualified pension plan benefits for employees earning $230,000 or more for 2008.
As a nonqualified plan, the benefits do not receive the same tax treatment and funding protection as the qualified plan, and the Bank’s obligations under the SERP are a general obligation of the Bank. The terms of the SERP provide for distributions from the SERP upon termination of employment with the Bank or in the event of the death or disability of the employee. Payment options under the SERP include annuity options as well as a lump-sum distribution option.
At the normal retirement age of 65, the CEO and other Executives are eligible for a retirement benefit equal to 2 percent times years of benefit service times their high three-year average salary and VIP compensation. If the CEO or other Executives select the early retirement benefit, payments may commence as early as age 45 but are reduced by an early retirement factor of 3 percent per year.
The portion of the VIP award percentages that are included in determining the CEO’s and other Executives’ SERP benefit is limited to no more than the amount of the incentive award that was included in the SERP calculation under the former Short-Term Incentive Compensation Plan (STI).
In 2009, the Bank will be changing the security vehicle for the SERP to a Rabbi trust.
Qualified and Nonqualified Defined Contribution Plans
All employees have the option to participate in the Financial Institutions Thrift Plan (Thrift Plan), a qualified defined contribution plan under the IRC. Subject to IRC and Thrift Plan limitations, employees can contribute up to 50 percent of their base salary in the Thrift Plan. The Bank matches employee contributions based on their length of service and the amount of employee contribution as follows:
In addition to the Thrift Plan, the CEO and other Executives are also eligible to participate in the Supplemental Thrift Plan, an unfunded nonqualified defined contribution plan that, in many respects, mirrors the Thrift Plan. The Supplemental Thrift Plan ensures, among other things, that the CEO and other Executives whose benefits under the Thrift Plan would otherwise be restricted by certain provisions of the IRC or limitations in the Thrift Plan are able to make elective pretax deferrals and receive the Bank matching contributions on those deferrals. In addition, the Supplemental Thrift Plan permits deferrals of and Bank matching contributions on the VIP compensation awards, subject to the limits on deferrals of compensation under the Supplemental Thrift Plan.
Thirty days prior to the beginning of the calendar year in which the compensation is to be earned and paid, the CEO and other Executives may elect to defer a percentage of their cash compensation. The CEO and other Executives may defer up to 80 percent of their total cash compensation, less their contributions to the Qualified Thrift Plan. The 20 percent retained portion of each VIP award is not eligible for deferral under the Supplemental Thrift Plan.
For each deferral period in the Supplemental Thrift Plan, the Bank credits a matching contribution equal to:
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200 percent match on up to 3 percent of the CEO’s or other Executives’ base salary and annual incentive compensation irrespective of their years of service; less
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The Bank’s matching contribution to the Qualified Thrift Plan.
The terms of the Supplemental Thrift Plan provide for distributions upon termination of employment with the Bank, in the event of the death of the employee or upon disability, at the discretion of the Human Resources Committee and in accordance with applicable IRC and other applicable requirements. Payment options under the Supplemental Thrift Plan include a lump-sum payment and annual installments for up to 10 years. No loans are permitted from the Supplemental Thrift Plan.
The portion of the VIP award that is eligible for a Bank matching contribution under the Supplemental Thrift Plan is limited to the percentage of each incentive award under the former STI plan that was eligible for Bank match for each such participant. In 2007, the Bank established a Trust for the Supplemental Thrift Plan (Rabbi trust). Notional investment options available to participants in the Supplemental Thrift Plan are the investments offered by The Principal Financial Group, (the administrator of the Rabbi Trust), which are substantially equivalent to those available under the Bank’s qualified defined contribution plan. See the “Nonqualified Deferred Compensation Table” and accompanying narrative below for more information.
Additional Retirement Benefits
The Bank currently provides post-retirement medical and life insurance benefits for its employees, including the CEO and other Executives who retire at age 60 or older with 10 years of service. Retirees and their spouses age 65 and older pay 60 percent of the medical premium for the retirees’ coverage and 80 percent of the premium for coverage for their spouse.
The Bank also provides $5,000 in term life insurance for all retirees, including the CEO and other Executives. The employees can purchase an additional $15,000 of coverage at group rates. The employee’s spouse is not eligible for the life insurance benefit.
Severance Policy (excluding change in control)
The Bank provides severance benefits to the CEO and other Executives. These benefits reflect the potential difficulty employees may encounter in their search for comparable employment within a short period of time. The Bank’s severance policy is designed to help bridge this gap in employment.
The Board provided a separate severance agreement as part of the initial employment offer letter for the CEO, which is more fully described in the post-termination compensation table. The Board determined that such severance arrangements for CEOs are a common practice in the marketplace.
The policy provides the following for other Executives:
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Four weeks’ base salary continuation per year of service, with a minimum of 26 weeks and a maximum of 52 weeks;
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Medical coverage, based on current enrollment selections, for the length of the salary continuation; and
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Individualized outplacement service for a maximum of 12 months.
Change-in-Control (CIC) Agreements
The Bank has entered into CIC agreements with the CEO and other Executives. In 2007, the Board determined that CIC agreements are an important recruitment and retention tool and that having such agreements in place enables the CEO and other Executives to effectively perform and meet their obligations to the Bank if faced with the possibility of consolidation with another FHLBank. Several FHLBanks have such agreements in place with their executives. These agreements are a common practice in the financial services market.
In the event of a merger of the Bank with another FHLBank, where the merger results in the termination of employment (including resignation for “good reason” as defined under the CIC agreement) for the CEO or any other Executives, each such individual(s) is (are) eligible for severance payments under his/her CIC Agreement. Such severance is in lieu of severance under the Severance Policy discussed above. The Severance Policy (and in the case of the CEO, his separate severance agreement) continues to apply to employment terminations of the other Executives, other than those resulting from a Bank merger.
Benefits under the CIC Agreement for the CEO and other Executives are as follows:
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Two years base salary;
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Two times the VIP award payout eligibility at target in the year of separation from service;
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Bank contributions for medical insurance for the benefits continuation period of 18 months at the same level that the Bank contributes to medical insurance for its then-active employees; and
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Individualized outplacement for up to 12 months.
In addition, under his CIC Agreement, the CEO also receives a payment equal to:
•
The additional benefit amount that the CEO would receive for 2 additional years of credited service under the qualified and nonqualified defined benefit plans; and
•
Two times 6 percent of his annual compensation (as defined in the Supplement Thrift Plan as annual base salary and a portion of the annual VIP award) in the year of separation from service. This amount is intended to replace the Bank matching contribution under the Bank’s qualified and nonqualified defined contribution plans.
The CIC agreements were executed in November 2007. See Exhibits 10.9 and 10.9.1 to this 2008 Annual Report on Form 10-K for more information.
Compensation Committee Report
The HR Committee of the Bank’s Board has reviewed and discussed the CD&A with management. Based on its review and discussions with management, the HR Committee has recommended to the Board that the CD&A be included in the Bank’s 2008 Annual Report filed on Form 10-K.
The Human Resources Committee
of the Board of Directors
Edward J. Molnar, Chairman
Patrick A. Bond
Luis A. Cortés, Jr.
Walter D’Alessio
David R. Gibson
John C. Mason
Sarah E. Peck
Summary Compensation Table (SCT)
(1)
For 2008, Mr. Price’s non-equity incentive plan compensation is the VIP described below. All other compensation includes employer contributions to defined contribution plans of $49,005, and perquisites totaling $10,782. Perquisites include parking benefits, spousal travel and child care expenses, personal miles on a company vehicle, financial planning/tax preparation benefits, and non-business travel expenses. For 2007, Mr. Price’s non-equity incentive plan compensation is the short-term and long-term incentive plan awards described in the Bank’s 2007 Annual Report filed on Form 10-K. All other compensation includes employer contributions to defined contribution plans of $48,000. For 2006, Mr. Price’s non-equity incentive plan compensation is the annual incentive plan award as described in the Bank’s 2006 Annual Report filed on Form 10-K, as amended. All other compensation includes a $201,732 tax gross-up on relocation expenses, employer contributions to defined contribution plans of $30,000, and perquisites totaling $267,261. Perquisites include a relocation payment of $258,000, parking benefits, club memberships, spousal travel and child care expenses, personal miles on a company vehicle, and non-business travel expenses.
(2)
For 2008, Ms. Williams’ non-equity incentive plan compensation is the VIP described below. All other compensation includes employer contributions to defined contribution plans of $23,301. For 2007, Ms. Williams’ non-equity incentive plan compensation is the short-term and long-term incentive plan awards as described in the Bank’s 2007 Annual Report filed on Form 10-K. All other compensation includes employer contributions to defined contribution plans of $22,224. For 2006, Ms. Williams received a $25,000 increase in base salary in February when she was promoted to CFO. Ms. Williams was paid a $45,000 special additional award reflecting the magnitude of restating the Bank’s financials from 2001 to 2005 which was unplanned and which occurred concurrent with the SEC registration process. Non-equity incentive plan compensation is the annual incentive plan award as described in the Bank’s 2006 Annual Report filed on Form 10-K, as amended. All other compensation includes employer contributions to defined contribution plans of $20,247.
(3)
For 2008, Mr. Dimmick’s non-equity incentive plan compensation is the VIP described below. All other compensation includes employer contributions to defined contribution plans of $22,105. For 2007, Mr. Dimmick’s non-equity incentive plan compensation is the short-term and long-term incentive plan awards as described in the Bank’s 2007 Annual Report filed on Form 10-K. All other compensation includes employer contributions to defined contribution plans of $21,384. For 2006, Mr. Dimmick received a $15,000 salary adjustment in February to bring his base salary to a level comparable with other executives. Non-equity incentive plan compensation is the annual incentive plan award as described in the Bank’s 2006 Annual Report filed on Form 10-K, as amended. All other compensation includes employer contributions to defined contribution plans of $20,257.
(4)
For 2008, Mr. Howie’s non-equity incentive plan compensation is the VIP described below. All other compensation includes employer contributions to defined contribution plans of $20,257. For 2007, Mr. Howie’s non-equity incentive plan compensation is the short-term and long-term incentive plan awards as described in the Bank’s 2007 Annual Report filed on Form 10-K. All other compensation includes employer contributions to defined contribution plans of $19,114. Mr. Howie was an executive officer in 2006; however, he was not considered a named executive officer in 2006.
(5)
For 2008, Mr. Yealy’s non-equity incentive plan compensation is the VIP described below. All other compensation includes employer contributions to defined contribution plans of $19,980. Mr. Yealy was an executive officer in 2007; however, he was not considered a named executive officer in 2007. For 2006, Mr. Yealy’s non-equity incentive plan compensation is the annual incentive plan award as described in the Bank’s 2006 Annual Report filed on Form 10-K, as amended. All other compensation includes employer contributions to defined contribution plans of $17,498.
(6)
Mr. Batz was the Bank’s former Chief Operating Officer. His position was eliminated and his employment was terminated on May 31, 2008. Mr. Batz executed a severance agreement which provided payments equal to 12 months base salary, or $428,722, payable in installments from June 13, 2008 through May 29, 2009; a lump sum payment of $237,000; coverage under the group medical program through May 31, 2009; and $20,000 in outplacement assistance. Mr. Batz’s change in pension value reflects receipt of lump sum payments for qualified and nonqualified defined benefit plan benefits for 2008 (see Pension Table). As a result of the lump sum payments, the present value of his accumulated benefits at December 31, 2008 was $0. All other compensation includes the previously described severance payments of $665,722; tax gross-ups of $4,810; employer contributions to defined contribution plans of $21,279; medical insurance premiums paid during the severance period of $8,562; payment for accrued and unused vacation at termination; and perquisites totaling $15,662. Perquisites include parking benefits, retirement gifts, personal miles on a company vehicle, and financial planning/tax preparation benefits. For 2007, Mr. Batz’s non-equity incentive plan compensation is the short-term and long-term incentive plan awards as described as described in the Bank’s 2007 Annual Report filed on Form 10-K. All other compensation includes employer contributions to defined contribution plans of $35,089, and perquisites totaling $10,984. Perquisites include parking benefits, spousal travel, personal miles on a company vehicle, and financial planning/tax preparation. For 2006, Mr. Batz received a $50,000 increase in base salary in January. Mr. Batz had more than 17 years experience at the Bank at that point; therefore, in conjunction with the hiring of the new CEO, the Board determined that it would create a void if the top two positions turned over at approximately the same time. The Board entered into a retention agreement with Mr. Batz in which he would receive a payment of $200,000 if he remained a part of the Bank’s executive team through January 2, 2007. Non-equity incentive plan compensation is the annual incentive plan award as described in the Bank’s 2006 Annual Report filed on Form 10-K, as amended. All other compensation includes employer contributions to defined contribution plans of $30,996.
Non-Equity Incentive Plan Compensation:
VIP
The CEO and all other Executives shared three goals related to the Bank’s earned dividend rate, customer-centric objectives, and community and economic development initiatives with performance measures at threshold, target and maximum as outlined below:
Member Value Focus - The specific performance measure at maximum was to achieve an earned dividend rate that provides an attractive spread to 3-month LIBOR which at maximum will be based on exceeding the best case scenario identified through sensitivity analysis prepared in developing the Bank’s Operating Plan. As a result of the Bank’s other-than-temporary impairment charge taken in fourth quarter 2008 and the instability of the economic environment, the Member Value Focus goal was not achieved at threshold.
Customer Focus - The specific performance measure at maximum was to complete six objectives, including item 6, from the following:
1. Meet set full-year average balance of core advances.
2. Meet set target percentage of members initiating an advance.
3. Introduce two (2) new loans to members products or significant loans to members portfolio enhancements that are each implemented within a time frame of four (4) weeks or less.
4. Implement new Capital Plan Amendment within 90 days after FHFB approval.
5. Grow Maximum Borrowing Capacity (MBC) through collateral expansion initiatives.
6. Submit a proposal to the Finance Board for an MPF “risk transfer” mechanism.
7. Recruit ten (10) new members, of which three (3) are insurance companies.
8. Recruit twenty (20) new Participating Financial Institutions (PFIs).
The Customer Focus goal was achieved at threshold with completion of items 1, 2 and 8 from the objectives above.
Community and Economic Development Focus - The specific performance measure at maximum was to complete three objectives from the following:
1. Implement or participate in an initiative that addresses the foreclosure issue in the Bank’s district.
2. Increase number of community banks that have enrolled in or applied for community investment products or initiatives during 2006-2008 Strategic Planning Cycle.
3. Complete a new public finance negotiated transaction.
4. Research and present opportunities to the Board in: (i) community, economic development finance, and/or (ii) infrastructure finance that can be developed and implemented as a “for profit” product in 2009.
The Community and Economic Development Focus goal was achieved at target with completion of items 1 and 2 from the objectives listed above.
In addition to the three shared goals, the CEO and each other Executive also had one individual/department goal, as described below, which included performance measures at threshold, target and maximum.
Mr. Price and Mr. Yealy:
New Governance Processes - The specific performance measure at maximum was to gain the approval of the Bank Presidents’ Council or the Council of FHLBanks to adopt a plan for more effective information sharing between the FHLBanks. Actual performance was achieved at maximum.
Ms. Williams, Mr. Dimmick and Mr. Batz:
Market Risk - The specific performance measure at maximum was to design and implement a plan and timeline for new or improved measures for market value of equity and long-term earnings at risk. Actual performance was achieved at target.
Mr. Howie:
Upgrade Collateral Management Practices - The specific performance at maximum was to implement a new collateral management policy including the delivery of securities, implementing a comprehensive mortgage loan level listing program, and upgrading the Maximum Borrowing Capacity calculation process. Actual performance was achieved at maximum.
Based on the terms of the VIP, no award payment shall be made if the Bank Member Value Focus goal has not been achieved at the threshold level for the plan year. Therefore, no VIP payouts were awarded for 2008.
Change in Pension Value:
The qualified defined benefit plan, as described in the CD&A, provides a normal retirement benefit of 2% of a participant’s highest three-year average salary, multiplied by the participant’s years of benefit service. Earnings are defined as base salary, subject to an annual IRS limit of $230,000 on earnings for 2008. Annual benefits provided under the qualified plan also are subject to IRS limits, which vary by age and benefit payment type. The participant’s accrued benefits are calculated as of December 31, 2007 and December 31, 2008. The present value is calculated using the accrued benefit at each date valued multiplied by a present value factor based on an assumed age 65 retirement date, 6.70% interest and 50% of benefit valued using the 2000 RP Mortality table (static mortality table for lump sums) and 50% of benefit valued using the 2000 RP Mortality table (generational mortality table for annuities). The difference between the present value of the December 31, 2008 accrued benefit and the present value of the December 31, 2007 accrued benefit is the “change in pension value” for the qualified plan.
The nonqualified defined benefit plan, as described in the CD&A, provides benefits under the same terms and conditions as the qualified plan, except that earnings are defined as base salary plus VIP. Benefits provided under the qualified plan are an offset to the benefits provided under the nonqualified plan. The participants’ benefits are calculated as of December 31, 2007 and December 31, 2008. The present value is calculated using the accrued benefit at each date valued multiplied by a present value factor based on an assumed age 65 retirement date, 6.00% interest and the 2000 RP Mortality table (generational mortality table). The difference between the present value of the December 31, 2008 accrued benefit and the present value of the December 31, 2007 accrued benefit is the “change in pension value” for the nonqualified plan.
The total “Change in Pension Value” included in the Summary Compensation Table is the sum of the change in the qualified plan and the change in the nonqualified plan.
Grants of Plan-Based Awards
The following table shows the potential value of non-equity incentive plan awards granted to the named officers in 2008.
All are as described in the VIP section of the CD&A. Note that payment of 80 percent of any awarded amount will be made in 2010 and 20 percent of any award will accrue interest and be paid in 2013 as described in the VIP document. See Exhibit 10.10 to this 2008 Annual Report filed on Form 10-K. Payouts will be subject to achievement of performance goals established under the plan.
VIP
VIP Compensation for January 1, 2009, through December 31, 2009, and payouts are based on a percentage of the executive’s base salary as of December 31, 2009. Estimated future payouts were calculated based on executives’ salary on January 1, 2009, which reflects no annual merit increase above 2008 base salary as reported in the Summary Compensation Table.
Mr. Price’s VIP payout is 32.5% at threshold, 55% at target, and 100% at maximum. All of the other Executives have a variable incentive payout of 28.75% at threshold, 40% at target, and 77.5% at maximum.
The CEO and all other Executives share three goals related to the Bank’s financial performance (member value), community economic development, and customer centric performance with performance measures at threshold, target and maximum as outlined below:
Member Value - The specific performance measure at maximum is to achieve an earned dividend spread over 3-month LIBOR which at maximum will exceed best case scenario based on sensitivity analysis prepared in development of the Bank’s Operating Plan. In determining payouts above threshold, consideration will be given to the Bank’s performance in comparison to the other FHLBanks.
Community Economic Development - The specific performance measure at maximum is to increase the use of Letters of Credit to support bond issues.
Customer Centric - The specific performance measure at maximum is to increase the full-year average balance of core advances as outlined in the Bank’s Operating Plan.
The HR Committee is considering changes to the terms of the VIP for 2009 and is considering the 2009 goals. Changes to the VIP and approval of the goals are subject to a four-week regulatory review period by the Finance Agency and would then become effective following expiration of the regulatory review period and final ratification or approval (as applicable) by the Board.
Pension Benefits
The description of the Pentegra Defined Benefit Plan contained in the Summary Plan Description for the Financial Institutions Retirement Fund and the description of the SERP contained in the Supplemental Executive Retirement Plan are filed as Exhibits 10.13 and 10.6.1 to this 2008 Annual Report filed on Form 10-K and are incorporated herein by reference.
This table represents an estimate of retirement benefits payable at normal retirement age in the form of the actuarial present value of the accumulated benefit. The amounts were computed as of the same plan measurement date that the Bank uses for financial statement reporting purposes. The same assumptions were used that the Bank uses to derive amounts for disclosure for financial reporting, except the above information assumed normal retirement age as defined in the plan. See narrative discussion of the “Change in Pension Value” column in the Summary Compensation Table.
Compensation used in calculating the benefit for the Pentegra Defined Benefit Plan includes base salary only. Compensation used in calculating the benefit for the SERP includes base salary plus the VIP award limited to no more than the amount of the incentive award that was included in the SERP calculation under the former STI plan.
Benefits under the SERP vest after completion of 5 years of employment (the vesting requirement under the qualified plan) subject to forfeiture for cause provisions of the SERP.
Normal Retirement: Upon termination of employment at or after age 65 where an executive has met the vesting requirement of completing 5 years of employment, the executive is entitled to a normal retirement benefit under the Pentegra Defined Benefit Plan equal to: 2% of his/her highest three-year average salary multiplied by his/her years’ of benefit service. Under the SERP normal retirement benefit, the executive also would receive 2% of his/her highest three-year average short-term incentive payment for such same three-year period multiplied by his/her years’ of benefit service.
Early Retirement: Upon termination of employment prior to age 65, executives meeting the 5 year vesting and age 45 early retirement eligibility criteria are entitled to an early retirement benefit. The early retirement benefit amount is calculated by taking the normal retirement benefit amount and reducing it by 3% times the difference between the age of the early retiree and age 65. For example, if an individual retires at age 61, the early retirement benefit amount would be 88% of the normal retirement benefit amount, a total reduction of 12%. At December 31, 2008, Mr. Dimmick, Mr. Howie and Mr. Yealy were eligible for early retirement benefits. Mr. Batz was eligible for and received early retirement benefits following his employment termination on May 31, 2008. The amounts set forth above reflect the qualified and nonqualified pension plan payments made to him in 2008.
Nonqualified Deferred Compensation
See descriptions in the Qualified and Nonqualified Defined Contribution Plans section of the CD&A. A description of the Supplemental Thrift Plan is also contained in the Supplemental Thrift Plan filed as Exhibit 10.7.2 to this 2008 Annual Report filed on Form 10-K and incorporated herein by reference.
Amounts shown as “Executive Contributions in 2008” were deferred and reported as “Salary” in the Summary Compensation Table. Amounts shown as “Registrant Contributions in 2008” are reported as “All Other Compensation” in the Summary Compensation Table.
The CEO and other Executives may defer up to 80% of their total cash compensation (base salary and VIP compensation), less their contributions to the qualified thrift plan. VIP compensation is limited to no more than the maximum amount of incentive compensation that would have been included under the Bank’s former STI plan . All benefits are fully vested at all times subject to the forfeiture for cause provisions of the Supplemental Thrift Plan.
The investment options available under the nonqualified deferred compensation plan are closely matched to those available under the qualified defined contribution plan. Investment options include stock funds, bond funds, money market funds and target retirement funds.
Post-Termination Compensation
The CEO and other Executives would have received the benefits below in accordance with the Bank’s severance policy if their employment had been severed without cause during 2008.
Post-Termination Compensation - Severance (Excluding Change-In-Control)
Under the CIC Agreements, in the event of employment termination other than for cause (including constructive discharge) following a change in control event, in place of the severance benefits above, the CEO and all other executives would instead receive the following:
Post-Termination Compensation - Change-In-Control
n/a-not applicable
*
Estimated cost
**
Includes both qualified and nonqualified plans.
Notes:
(1)
CIC agreements stipulate two years of base salary for eligible participants.
(2)
CIC agreements stipulate two years of VIP award payout amount for eligible participants.
(3)
1CIC agreements stipulate 18 months of medical insurance coverage for eligible participants.
(4)
CIC agreements stipulate 12 months of outplacement services for eligible participants.
(5)
CIC agreement for CEO stipulates additional severance in an amount equivalent to the increase in the amount of the benefits that would be paid under the defined benefit plans with two years of additional defined benefit credit service.
(6)
CIC agreement for CEO stipulates additional severance in an amount equivalent to two years of defined contribution match.
Director Compensation
The Bank’s directors were compensated in accordance with the 2008 Directors’ Fee Policy. Since the passage of the GLB Act up until the adoption of the Housing Act on July 30, 2008, the total annual fees paid could not exceed the annual compensation limits set forth in the Federal Home Loan Bank Act as adjusted by the Federal Housing Finance Board annually to reflect changes in the preceding year’s Consumer Price Index (CPI). The 2008 limits on annual compensation were: $31,232 for the Chair; $24,986 for the Vice Chair; and $18,739 for all other directors. No retainer fees are paid. Fees paid for Board meeting attendance as follows: (a) Chair $1,500 per meeting; (b) Vice Chair $1,250 per meeting; and (c) All other directors, $1,000 per meeting. Board meeting fees are paid per meeting day. Additional fees paid for Board Committee meeting attendance: $1,000 per Committee meeting day to each director attending. The amount of the fee paid does not vary among the directors in attendance. No Committee meeting fees are paid if a Board meeting fee is paid for the same day. Committee meeting fees are paid per meeting day not per Committee meeting. An additional per meeting day attendance fee of $1,000 is also paid for: (a) special Committee meetings, task force or ad hoc Committee meetings; (b) FHLBank System meetings; (c) Advisory Council meetings; and (d) otherwise serving the Bank on official business. The amount of the fee paid did not vary among directors and such meeting fees are paid on a per meeting day basis.
*
Fees Earned or Paid in Cash are the aggregate of the following: (1) the fees paid by the Bank during the portion of the year during which Mr. Curtis served as an Advisory Board consultant and (2) the fees paid during the portion of the year he served as a director.
“Total Compensation” does not include previously deferred director fees for prior years’ service and earnings on such fees for those directors participating in the Bank’s nonqualified deferred compensation deferred fees plan for directors. The plan allows directors to defer their fees and receive earnings based on returns available under or comparable to certain publicly available mutual funds, including equity funds and money market funds. No Bank matching contributions are made under the plan.
“All Other Compensation” for each includes $24 per director annual premium for director travel and accident insurance.
The Bank also reimburses directors and pays for travel and related expenses associated with meeting attendance in accordance with its Travel & Expense Policy. Total expenses paid under that policy in 2008 were $123,171
With the enactment of the Housing Act, the statutory caps on director fees were removed. Director compensation levels are now established by each FHLBank’s board of directors. In connection with setting director compensation for 2009, the Bank participated in an FHLBank System review of director compensation,
which included a director compensation study prepared by McLagan Partners. The McLagan study included separate analysis of director compensation for small asset size commercial banks, farm credit banks and S&P 1500 firms. The Bank’s Board considered this study in establishing the Bank’s 2009 director fees and the 2009 director fees are relatively consistent with those at the other FHLBanks. For 2009, the Bank’s Board has adopted the 2009 Directors’ Fee Policy (2009 Fee Policy). Under the 2009 Fee Policy, the total annual director fees are paid as a combination of a quarterly retainer fee and per meeting fees. The following table sets forth the maximum fees that our directors can earn in 2009:
The 2009 Fee Policy is attached as Exhibit 10.5.1 to this 2008 Annual Report filed on Form 10-K. The Finance Agency has determined that the payment of director compensation is subject to Finance Agency review.
Item 12:
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Generally, the Bank may issue capital stock only to members. As a result, the Bank does not offer any compensation plan under which equity securities of the Bank are authorized for issuance.
Member Institutions Holding 5% or More of Outstanding Capital Stock
as of February 28, 2009
(a)
Formerly known as GMAC Automotive Bank. For Bank membership purposes, principal place of business is Horsham, PA.
Additionally, due to the fact that a majority of the Board of the Bank is elected from the membership of the Bank, these elected directors are officers and/or directors of member institutions that own the Bank’s capital stock. These institutions are provided in the following table.
Capital Stock Outstanding to Member Institutions
Whose Officers and/or Directors Served as a Director of the Bank
as of February 28, 2009
*
Less than 0.1%.
Note:
In accordance with Section 10(c) of the Act and the terms of the Bank’s security agreement with each member, the capital stock held by each member is pledged to the Bank as additional collateral to secure that member’s loans from and other indebtedness to the Bank.
Item 13:
Certain Relationships and Related Transactions and Director Independence
Corporate Governance Guidelines
The Bank has adopted corporate governance guidelines titled “Governance Principles” which are available at www.fhlb-pgh.com by first clicking “Investor Relations” and then “Governance.” The Governance Principles are also available in print to any member upon written request to the Bank, 601 Grant Street, Pittsburgh, PA 15219, Attention: General Counsel. These principles were adopted by the Board to best ensure that the Board is independent from management, that the Board adequately performs its function as the overseer of management and to help ensure that the interests of the Board and management align with the interests of the Bank’s members.
On an annual basis, each director and executive officer is obligated to complete a director and officer questionnaire which requires disclosure of any transactions with the Bank in which the director or executive officer, or any member of his or her immediate family, have a direct or indirect material interest. All directors must adhere to the Bank’s Code of Conduct which addresses conflicts of interest. Under the Code of Conduct, only the Board can grant a waiver of the Code’s requirements in regard to a director or executive officer.
Bank’s Cooperative Structure
All members are required by law to purchase capital stock in the Bank. The capital stock of the Bank can be purchased only by members. As a cooperative, the Bank’s products and services are provided almost exclusively to its members. In the ordinary course of business, transactions between the Bank and its members are carried out on terms that are established by the Bank, including pricing and collateralization terms that treat all similarly situated members on a nondiscriminatory basis. Loans included in such transactions did not involve more than the normal risk of collectibility or present other unfavorable terms. Currently, nine of the Bank’s fifteen directors are officers or directors of members. In recognition of the Bank’s status as a cooperative, in correspondence from the Office of Chief Counsel of the Division of Corporate Finance of the SEC, dated September 28, 2005, transactions in the ordinary course of the Bank’s business with member institutions are excluded from SEC Related Person Transaction disclosure requirements. No individual director or executive officer of the Bank or any of their immediate family members has been indebted to the Bank at any time.
Related Person Transaction Policy
In addition to the Bank’s Code of Conduct, which continues to govern potential director and executive officer conflicts of interest, effective January 31, 2007, the Bank adopted a Related Person Transaction Policy, which is in writing. (The Policy is subject to annual review and approval and was most recently approved by the Board in February, 2009 without change.) In accordance with the terms of the Policy, the Bank will enter into Related Person Transactions that are not in the ordinary course of Bank business only when the Governance Committee of the Board determines that the Related Person Transaction is in the best interests of the Bank and its investors. Ordinary course of Bank business is defined as providing the Bank’s products and services, including affordable housing products, to member institutions on terms no more favorable than the terms of comparable transactions with similarly situated members. A Related Person Transaction is a transaction, arrangement or relationship (or a series of transactions, arrangements or relationships) in which the Bank was, is or will be a participant, the amount involved exceeds $60 thousand and in which a Related Person had, has or will have a direct or indirect material interest. A Related Person is any director or executive officer of the Bank, any member of their immediate families or any holder of 5 percent or more of the Bank’s outstanding capital stock. A transaction with a company with which a Related Person is associated is deemed pre-approved where the Related Person: (1) serves only as a director of such company; (2) is only an employee (and not an executive officer) of such company; or (3) is the beneficial owner of less than 10 percent of such company’s shares.
Related Person Transactions
In accordance with the Bank’s Related Person Transaction Policy, on February 16, 2007, the Governance Committee of the Board of Directors approved Wilmington Trust Company as an authorized counterparty for Federal funds transactions with the Bank. The Governance Committee also approved Wilmington Trust as a counterparty for receiving Bank deposits on June 6, 2007. Mr. Gibson, a director of the Bank and an executive
officer of Wilmington Trust Company was not a member of the Governance Committee and did not participate in the Committee’s consideration or approval. During 2008 and through March 20, 2009, the Bank had not executed any Federal funds or deposit transactions with Wilmington Trust Company.
Beginning in 1997, the Bank began purchasing bonds issued by Pennsylvania Housing Finance Agency (PHFA). On May 14, 2007, Brian Hudson, Executive Director and Chief Executive Officer of PHFA, was appointed as a director of the Bank by the Finance Agency. On June 25, 2007, in accordance with the Related Person Transaction Policy, the Governance Committee approved the Bank’s continued purchases of PHFA bonds. In 2008, the Bank purchased $197.1 million of PHFA bonds. As of March 20, 2009, the total outstanding principal amount of PHFA bonds held by the Bank was $427.5 million. The greatest outstanding principal amount of PHFA bonds held by the Bank in 2008 was $167.2 million. In 2008, the Bank received $10.7 million in interest payments on outstanding PHFA bonds and $12.0 million in principal payments due to bond calls and redemptions.
PHFA, as the state housing finance agency for Pennsylvania, provides funding for housing for very-low- and low-income households. As a result, many of the projects that PHFA provides funding to are projects that also apply for and receive funding from the Bank’s AHP program. Consequently, on June 25, 2007, the Governance Committee also approved the Bank continuing to enter into AHP grant transactions in which PHFA participates. In 2008, the Bank approved $9.6 million in AHP grants for 23 projects in which PHFA served as a sponsor or otherwise participated. The $9.6 million in AHP grants was approved in accordance with the competitive AHP scoring regulations of the Finance Agency, including the requirement that any FHLBank director who is associated with, or whose institution is associated with, an AHP grant under consideration for approval, recuse themselves from the consideration of the grant by the Bank’s Board. See 12 C.F.R. 1291.10. The Bank followed this process in regard to its Board’s consideration and approval of the $9.6 million in AHP grants at its meetings on June 20 and December 19, 2008. Mr. Hudson did not participate in the consideration or approval of the $9.6 million in grant requests presented to the Board.
Since December 2000, as permitted under the Finance Agency’s AHP Regulations at 12 C.F.R. 1291.7 PHFA has been a party to an AHP project monitoring agreement with the Bank under which PHFA agrees to monitor the AHP compliance requirements for the Bank with respect to projects in which PHFA also monitors federal tax credit compliance. The Bank pays PHFA a fee of $225 for each AHP project monitored by PHFA during the year. In 2008, the Bank paid PHFA a total of $225 for monitoring one project. The amount of fees paid by the Bank fluctuates each year and is dependent on the number of projects the Bank identifies each year that need to be monitored for compliance with AHP requirements.
As a state housing finance agency, PHFA is eligible to apply to the Bank and be approved as a nonmember housing associate borrower from the Bank in accordance with Finance Agency Regulations. See 12 C.F.R. 926.5. The Bank approved PHFA as a housing associate borrower on December 19, 2007. With the approval of PHFA as a housing associate, the Bank has three housing associate borrowers. The terms of any Bank loans to such housing associates are ordinary course of business transactions governed by the Bank’s Member Products Policy and apply to all housing associates. Under the terms of the Bank’s Related Person Transaction Policy, provided that the loans to any related person are in accordance with the terms of the Bank’s Member Products Policy, such transactions are within the ordinary course of business of the Bank and not subject to Governance Committee approval. As of March 20, 2009, there were no outstanding loans from the Bank to PHFA.
In 2001, in furtherance of its mission to provide funding for economic development in the Bank’s district, the Bank entered into an agreement to make a capital contribution of up to $500 thousand to Mountaineer Capital, LP (Mountaineer Capital). Mountaineer Capital is a Small Business Investment Company (SBIC) which provides financing for small businesses in West Virginia. On May 14, 2007, Patrick Bond, General Partner for Mountaineer Capital, was appointed to serve as a director of the Bank. On January 23, 2007, the Bank made a capital contribution of $50 thousand to Mountaineer Capital. At year-end 2007, the total amount of Bank capital contributions was $375 thousand. On February 12, 2008, the Governance Committee approved a $50 thousand capital contribution request and granted approval for additional capital contributions to Mountaineer Capital in accordance with the terms of the Bank’s agreement, up to a total amount of $500 thousand. At year-end 2008, the Bank’s total capital contributions to Mountaineer Capital were $425 thousand.
Since approximately 2002, Chase Bank has been approved for Federal funds and other money market investment transactions with the Bank in accordance with the requirements and limits established in the Bank’s policies. During 2008, the Bank entered into overnight Federal funds transactions with Chase Bank. Chase Bank became a 5 percent or greater Bank shareholder in October 2008. On February 19, 2009, the Governance Committee ratified these transactions and approved the Bank entering into other Federal funds and money market investment transactions with Chase Bank in accordance with the Bank’s applicable investment and counterparty policy statements. The largest aggregate principal amount outstanding for such transactions with Chase during 2008 was $1.0 billion. The amount of interest paid during 2008 was $3.4 million and the amount of principal paid (representing repayment of each overnight Federal funds transaction) was $41.6 billion. There were no outstanding Federal funds transactions with Chase Bank as of March 20, 2009.
On February 19, 2009, the Governance Committee approved the Bank entering into interest-earning deposits, Federal funds, unsecured note purchase and other money market transactions with Bank members, including 5 percent or greater shareholders of the Bank and Member Directors’ institutions. All such transactions must be in accordance with the terms of the Bank’s investment and counterparty policy statements and limits. As of March 20, 2009 the Bank has not engaged in any of these transactions with Member Directors’ institutions or 5 percent or greater shareholders.
Director Independence
Under the Act, Bank management is not allowed to serve on the Bank’s Board. Consequently, all directors of the Bank are outside directors. As discussed in Item 10, directors are classified under the Act as either being a Member Director or an Independent Director. By statute, the Board cannot expand or reduce the number of directors that serve on the Board. Only the Finance Agency has the authority to determine how many seats exist on the Board. As of March 20, 2009, the Board was comprised of fifteen directors, including nine Member Directors and six Independent Directors.
The Bank’s directors are prohibited from personally owning stock in the Bank. In addition, the Bank is required to determine whether its directors are independent under two distinct director independence standards. First, the Act and Finance Agency Regulations establish independence criteria, including independence criteria for directors who serve on the Bank’s Audit Committee. Second, the SEC rules require, for disclosure purposes, that the Bank’s Board apply the independence criteria of a national securities exchange or automated quotation system in assessing the independence of its directors.
The Act and Finance Agency Regulations.
Following the enactment of the Housing Act amendments to the Act on July 30, 2008, an individual is not eligible to be an Independent Bank director if the individual serves as an officer, employee, or director of any member of the Bank, or of any recipient of loans from the Bank. During 2008 and through March 20, 2009, none of the Bank’s Independent Directors were an officer, employee or director of any member or of any institution that received advances from the Bank.
Effective on enactment of the Housing Act, the FHLBanks are required to comply with the substantive Audit Committee director independence standards under Section 10A(m) of the Exchange Act. Rule 10A-3(b)(ii)(B) implementing Section 10A(m) provides that in order to be considered to be independent, a member of an audit committee may not: (a) accept directly or indirectly a compensatory fee (other than from the issuer for service on the Board); or (b) be an affiliated person of the issuer, defined as someone who directly or indirectly controls the issuer. The SEC implementing regulations provide that a person will be deemed not to control an issuer if the person does not own directly or indirectly more than 10 percent of any class of voting equity securities. The existence of this safe harbor does not create a presumption in any way that a person exceeding the ownership requirement controls or is otherwise an affiliate of a specified person. In regard to the Bank and the other FHLBanks, this provision of the Housing Act raises an issue whether a Member Director whose institution is a 10 percent or greater Bank shareholder could be viewed as an affiliate of the Bank, rendering such Member Director ineligible to serve on the Bank’s Audit Committee. Because of the cooperative structure of the FHLBanks, the limited items on which FHLBank stockholders may vote and the statutory cap limiting the votes that any one member may cast for a
director to the state average, it is not clear that the fact that a Member Director’s institution is a 10 percent or greater Bank shareholder causes the director to be an affiliate of the Bank. Nevertheless, none of the Bank’s current Audit Committee members nor those who served during 2008 were Member Directors from institutions that were 10 percent or greater Bank shareholders.
In addition, the Finance Agency director independence standards prohibit individuals from serving as members of the Bank’s Audit Committee if they have one or more disqualifying relationships with the Bank or its management that would interfere with the exercise of that individual’s independent judgment. Disqualifying relationships considered by the Board are: (1) employment with the Bank at any time during the last five years; (2) acceptance of compensation from the Bank other than for service as a director; (3) being a consultant, advisor, promoter, underwriter or legal counsel for the Bank at any time within the last five years; and (4) being an immediate family member of an individual who is or who has been within the past five years, a Bank executive officer. As of March 20, 2009, all current members of the Audit Committee were independent under the Act and Finance Agency regulatory criteria.
SEC Rules. Pursuant to the SEC rules applicable to the Bank for disclosure purposes, the Bank’s Board has adopted the independence standards of the New York Stock Exchange (NYSE) to determine which of its directors are independent, which members of its Audit Committee are not independent and whether the Bank’s Audit Committee financial expert is independent. As the Bank is not a listed company, the NYSE director independence standards are not substantive standards that are applied to determine whether individuals can serve as members of the Bank’s Board or the Audit Committee.
After applying the NYSE independence standards, the Board determined on February 20, 2009, that for purposes of the SEC rules with respect to the Bank’s current directors, four of the Bank’s Independent Directors, Directors Cortes, D’Alessio, Darr and Peck are independent. In determining that Director Cortés was independent, the Board considered that Nueva Esperanza, the non-profit organization which Director Cortés serves as President, has received AHP grants and charitable contributions from the Bank from time to time, including when Director Cortés was not a Bank Director. None of these transactions occurred in 2008 that required consideration under the Bank’s Related Person Transaction Policy. With respect to Director Darr, the Board considered that Manna Inc., a non-profit organization on which Mr. Darr serves as a director, was approved for an AHP grant by the Bank in 2007, prior to Mr. Darr becoming a member of the Board.
With respect to the Bank’s remaining two current Independent Directors, the Board determined that in view of the historic and ongoing relationship and transactions described above, with respect to PHFA and Mountaineer Capital, Directors Hudson and Bond are not independent.
The Board was unable to affirmatively determine that there are no material relationships (as defined in the NYSE rules) between the Bank and its Member Directors, and concluded that none of the Bank’s current Member Directors was independent under the NYSE independence standards. In making this determination, the Board considered the cooperative relationship between the Bank and its Member Directors. Specifically, the Board considered the fact that each of the Bank’s Member Directors are officers or directors of a Bank member institution, and each member institution has access to, and is encouraged to use, the Bank’s products and services. Furthermore, the Board considered the appropriateness of making a determination of independence with respect to the Member Directors based on a member’s given level of business as of a particular date, when the level of each member’s business with the Bank is dynamic and the Bank’s desire as a cooperative is to increase its level of business with each of its members. As the scope and breadth of a member’s business with the Bank changes, such member’s relationship with the Bank might, at any time, constitute a disqualifying transaction or business relationship under the NYSE’s independence standards.
For Member Directors who served on the Board in 2008 but no longer serve on the Board, the Board determined on February 20, 2009, that both of those directors, Directors Curtis and Reichart, were not independent.
The Board has a standing Audit Committee. The Board determined that none of the current Member Directors serving as members of the Bank’s Audit Committee, Directors Gibson, Marshall, Milinovich and Ward are
independent under the NYSE standards for Audit Committee members and that Independent Director Hudson is also not independent. The Board determined that Independent Director Darr, who serves on the Audit Committee, is independent under the NYSE independence standards for Audit Committee members.
Item 14:
Principal Accountant Fees and Services
The following table sets forth the aggregate fees billed to the Bank for the years ended December 31, 2008 and 2007 by its independent registered public accounting firm, PricewaterhouseCoopers LLP:
Audit fees consist of fees billed for professional services rendered for the audits of the financial statements and reviews of interim financial statements for the years ended December 31, 2008 and 2007.
Audit-related fees consist of fees billed in the years ended December 31, 2008 and 2007 for assurance and related services reasonably related to the performance of the audit or review of the financial statements. Audit-related fees were primarily for accounting consultations.
The Bank is exempt from all federal, state and local income taxation with the exception of real estate property taxes. There were no tax fees paid during the years ended December 31, 2008 and 2007.
Other fees paid during the years ended December 31, 2008 and 2007 represent licensing fees associated with the use of accounting research software.
The Audit Committee approves the annual engagement letter for the Bank’s audit. All other services provided by the independent accounting firm are pre-approved by the Audit Committee. The Audit Committee delegates to the Chair of the Audit Committee the authority to pre-approve non-audit services not prohibited by law to be performed by the independent auditors, subject to any single request involving a fee of $100 thousand or higher being circulated to all Audit Committee members for their information and comment. The Chair shall report any decision to pre-approve such services to the full Audit Committee at its next meeting.
The Bank paid additional fees to PricewaterhouseCoopers, LLP in the form of assessments paid to the Office of Finance. These fees were approximately $36 thousand dollars during the year ended December 31, 2008 and were classified as Other Expense - Office of Finance on the Statement of Operations. These fees are not included in the totals above.
PART IV
­ ­
Item 15:
Exhibits and Financial Statement Schedules
(a)(1) Financial Statements
The following Financial Statements and related notes, together with the report of PricewaterhouseCoopers, LLP, appear in Item 8.
Statement of Operations for each of the years ended December 31, 2008, 2007 and 2006
Statement of Condition as of December 31, 2008 and 2007
Statement of Cash Flows for each of the years ended December 31, 2008, 2007 and 2006
Statement of Changes in Capital for each of the years ended December 31, 2008, 2007 and 2006
(2) Financial Statement Schedules
The schedules and exhibits for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission that would appear in Item 8. Financial Statements and Supplementary Data are included in the “Financial Information” section within Item 7. Management’s Discussion and Analysis.
(b)
Index of Exhibits
The following is a list of the exhibits filed with this Annual Report on Form 10-K or incorporated herein by reference:
+
Incorporated document references to filings by the registrant are to SEC File No. 000-51395.
*
Denotes management contract or compensatory plan.
GLOSSARY
­ ­
Advance: Secured loan made to a member.
Agent fee: Fee payable to a PFI by an MPF Bank in accordance with the Origination Guide, in connection with the origination of a Bank-funded mortgage.
Affordable Housing Program (AHP): Bank program that provides primarily direct grants and/or subsidized loans to assist members in meeting communities’ affordable housing needs. Each FHLBank sets aside approximately 10 percent of its net income to fund the program with a minimum $100 million annual contribution by all twelve FHLBanks.
ALCO: Asset/Liability Management Committee of the Bank.
AMA: Acquired member assets.
APBO: Accumulated Post-retirement Benefit Obligation.
Adjustable-rate mortgage: Mortgage that features predetermined adjustments of the loan interest rate at regular intervals based on an established index.
Banking On Business (BOB): Bank program that assists eligible small businesses with start-up and expansion. A small business is defined as any firm, proprietorship, partnership or corporation that has less than 50 employees and the lesser of $10 million in annual receipts or the annual receipts limits set by the Small Business Administration’s (SBA) size standards by North American Industry Classification (NAIC).
Capital plan: New capital structure for FHLBanks, required by the GLB Act, that produces a more permanent source of capital and facilitates compliance with new risk-based capital requirements.
Capital stock: The five-year redeemable stock issued by the Bank pursuant to its capital plan.
Community financial institution (CFI): Bank member that has deposits insured under the FDIC and average total assets for 2008 of less than $1 billion over the past three years and is exempt from the requirement of having at least 10 percent of total assets in residential mortgage loans.
Community investment cash advance: General framework under which the FHLBanks may offer an array of specific standards for projects, targeted beneficiaries and targeted income levels that the Finance Agency has determined support community lending.
Community Lending Program (CLP): Bank program that funds community and development projects through an $825 million noncompetitive revolving loan pool. When loans are repaid, the money is available to be lent to other projects.
Collateralized mortgage obligation: Type of bond that divides cash flows from a pool of mortgages into multiple classes with different maturities or risk profiles.
Constant Maturity Treasury (CMT): Refers to the par yield that would be paid by a U.S. Treasury bill, note or bond that matures in exactly one, two, three, five, seven, ten, 20 or 30 years.
Consolidated Obligation (CO): Bonds and discount notes that are the joint and several liability of all twelve FHLBanks and are issued and serviced through the OF. These instruments are the primary source of funds for the FHLBanks.
Committee on Uniform Securities Identification Procedures (CUSIP): CUSIP-based identifiers provide a unique name for a wide range of global financial instruments including equity and debt issues, derivatives and syndicated loans. The CUSIP consists of a combination of nine characters, both letters and numbers, which identify a company or issuer and the type of security.
Collateral: Property subject to a security interest that secures the discharge of an obligation (e.g., mortgage or debt obligation); a security interest that an FHLBank is required by statute to obtain and thereafter maintain beginning at the time of origination or renewal of a loan.
Conventional loan/mortgage: Mortgage that is neither insured nor guaranteed by the FHA, VA or any other agency of the Federal government.
Convexity: A measure of the change in price sensitivity or duration of an asset or liability for specified changes in interest rates. While all fixed income instruments have some degree of convexity, mortgage assets and callable liabilities have notable convexity characteristics because of the option components within those instruments.
Cost of funds: Estimated cost of issuing FHLBank System consolidated obligations and discount notes.
Credit enhancement fee: Fee payable monthly by an MPF Bank to a PFI in consideration of the PFI’s obligation to fund the realized loss for a Master Commitment; based on fee rate applicable to such Master Commitment and subject to terms of the Master Commitment and applicable MPF mortgage product, which may include performance and risk participation features.
Demand Deposit Account (DDA): The account each member maintains with the Bank. All incoming and outgoing wires, loan credits and debits, as well as any principal and interest payments from securities and loans are posted into the DDA.
Delivery commitment: Mandatory commitment of the parties, evidenced by a written, machine- or electronically generated transmission issued by an MPF Bank to a PFI accepting the PFI’s oral mortgage loan delivery commitment offer.
Duration: A common measure of the price sensitivity of an asset or liability to specified changes in interest rates.
EITF: Emerging Issues Task Force.
Exempt securities: Bank securities under Section 3(a)(2) of the Securities Exchange Act of 1933.
Fannie Mae, Federal National Mortgage Association (FNMA): GSE established in 1938 to expand the flow of mortgage money by creating a secondary market.
Financial Accounting Standards Board (FASB): Board created in 1973 responsible for establishing and interpreting generally accepted accounting principles and improving standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors and users of financial information.
Federal Deposit Insurance Corporation (FDIC): Federal agency established in 1933 that guarantees (with limits) funds on deposit in member banks and performs other functions such as making loans to or buying assets from member banks to facilitate mergers or prevent failures.
Federal Home Loan Bank Act (the Act): Enacted by Congress in 1932 creating the FHLBank Board, whose role was to supervise a series of discount banks across the country. The intent was to increase the supply of money available to local institutions that made home loans and to serve them as a reserve credit resource. The FHLBank Board became the Federal Housing Finance Board in 1989, which was replaced by The Federal Housing Finance Agency in 2008.
Federal Home Loan Bank’s Office of Finance (OF): FHLBank System’s centralized debt issuance facility that also prepares combined financial statements, selects/evaluates underwriters, develops/maintains the infrastructure needed to meet FHLBank System goals, and administers REFCORP and FICO funding programs.
Federal Housing Finance Agency (Finance Agency): Independent regulatory agency (established on enactment of the Housing Act) of the executive branch ensuring the FHLBanks, Federal National Mortgage Association and Federal Home Loan Mortgage corporation operate in a safe and sound manner, carry out their statutory missions and remain adequately capitalized and able to raise funds in the capital markets.
Federal Housing Administration (FHA): Government agency established in 1934 and insures lenders against loss on residential mortgages.
Financing Corporation (FICO): Mixed-ownership, government corporation in charge of servicing debt on bonds that were issued as a result of the savings and loan “bailout”. Mixed-ownership corporations are those with capital stock owned by both the United States and borrowers or other private holders.
First Front Door (FFD): Bank program developed to provide grant assistance to cover the down payment and closing costs to first-time homebuyers at or below 80 percent area median income.
First Loss Account (FLA): Notational account established by an MPF Bank for each Master Commitment based on and in the amount required under the applicable MPF mortgage product description and Master Commitment.
Freddie Mac, Federal Home Loan Mortgage Corporation (FHLMC): GSE chartered by Congress in 1970 to keep money flowing to mortgage lenders in support of homeownership and rental housing.
Generally Accepted Accounting Principles (GAAP): Accounting term that encompasses the conventions, rules, and procedures necessary to define accepted accounting practice at a particular time. GAAP includes not only broad guidelines of general application, but also detailed practices and procedures. Those conventions, rules, and procedures provide a standard by which to measure financial presentations.
Ginnie Mae, Government National Mortgage Association (GNMA): GSE established by Congress in 1968 that guarantees securities backed by a pool of mortgages.
Gramm-Leach-Bliley Act (GLB Act): Enacted in 1999 that set forth the following:
•
Banks with less than $500 million in assets may use long-term loans for loans to small businesses, small farms and small agri-businesses.
•
A new, permanent capital structure for FHLBanks is established. Two classes of stock are authorized, redeemable on six months’ and five years’ notice. FHLBanks must meet a 5 percent leverage minimum tied to total capital and a risk-based requirement tied to permanent capital.
•
Equalizes the stock purchase requirement for banks and thrifts.
•
Voluntary membership for federal savings associations took effect six months after enactment.
•
Annual $300 million funding formula for REFCORP obligations of FHLBanks is changed to 20 percent of annual net earnings.
•
Governance of the FHLBanks is decentralized from the Finance Board (the regulator at that time) to the individual FHLBanks. Changes include the election of a chairperson and vice chairperson of each FHLBank by its directors rather than the Finance Board and a statutory limit on FHLBank directors’ compensation.
Government-sponsored enterprise (GSE): A private organization with a government charter whose function is to provide liquidity for the residential loan market or another identified government purpose.
HUD: Housing and Urban Development.
Index amortizing swap: Typically a fixed to float rate interest rate swap whereby the notional principal amortizes in response to changes in the referenced index.
Internal Credit Rating (ICR): A scoring system used by the Bank to measure the financial condition of a member or housing associate and is based on quantitative and qualitative factors.
Joint and several liability: Obligation for which multiple parties are each individually and all collectively liable for payment.
London Interbank Offered Rate (LIBOR): Offer rate that a Euromarket bank demands to place a deposit at (or equivalently, make a loan to) another Euromarket bank in London. LIBOR is frequently used as the reference rate for the floating-rate coupon in interest rate swaps and option contracts such as caps and floors.
Loan level credit enhancement: Portion of the credit enhancement pertaining to the risks of an individual mortgage loan.
Master Commitment: A document executed by a PFI and an MPF Bank, which provides the terms under which the PFI will deliver mortgage loans to the MPF Bank.
Master Servicer: Financial institution that the MPF Provider has engaged to perform various master servicing duties on its behalf in connection with the MPF Program.
Maximum Borrowing Capacity (MBC): Total possible borrowing limit for an individual member. This is determined based on the type and amount of collateral each member has available to pledge as security for Bank loans to members. It is computed using specific asset balances (market and/or book values) from qualifying collateral categories, which are discounted by applicable collateral weighting percentages. The MBC is equal to the aggregate collateral value net of any pledged assets.
Mortgage-Backed securities (MBS): Investment instrument backed by mortgage loans as security.
Mortgage Partnership Finance (MPF) Program: FHLBank of Chicago program offered by select FHLBanks to their members to provide an alternative for funding mortgages through the creation of a secondary market.
Office of Federal Housing Enterprise Oversight (OFHEO): Government agency established in 1992 and responsible for ensuring the financial safety and soundness of Fannie Mae and Freddie Mac.
ORERC: Other real estate-related collateral.
Pair-off fee: A fee assessed against a PFI when the aggregate principal balance of mortgages funded or purchased under a delivery commitment falls above or below the tolerance specified.
Permanent capital: Retained earnings and capital stock.
Participating Financial Institution (PFI): Bank member participating in the MPF Program, which is legally bound to originate, sell and/or service mortgages in accordance with the PFI Agreement, which it signs with the MPF Bank of which it is a member.
Real Estate Mortgage Investment Conduit (REMIC): Multi-class bond backed by a pool of mortgage securities or mortgage loans.
Real Estate Owned (REO): Mortgaged property acquired by a servicer on behalf of the mortgagee, through foreclosure or deed in lieu of foreclosure.
Resolution Funding Corporation (REFCORP): Mixed-ownership, government corporation created by Congress in 1989 to issue “bailout” bonds and raise industry funds to finance activities of the Resolution Trust Corporation, and merge or close insolvent institutions inherited from the disbanded Federal Savings and Loan Insurance Corporation. Mixed-ownership corporations are those with capital stock owned by both the United States and borrowers or other private holders.
RHS: Rural Housing Service
RPAF: Registered Public Accounting Firm.
SERP: Supplemental Executive Retirement Plan.
Servicer: Institution approved to service mortgages funded or purchased by an MPF Bank. The term servicer refers to the institution acting in the capacity of a servicer of mortgages for an MPF Bank under a PFI Agreement.
SFAS: Statement of Financial Accounting Standard.
Standby letter of credit: Document issued by the FHLBanks on behalf of a member as a guarantee against which funds can be drawn, that is used to facilitate various types of business transactions the member may have with third parties. Standby is defined as the Bank standing by to make good on the obligation made by the member to the beneficiary.
Supplemental Mortgage Insurance (SMI) policy: Any and all supplemental or pool mortgage guarantee insurance policies applicable to mortgages delivered under the Master Commitment.
Underlying: A specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates or other variable. An underlying may be the price or rate of an asset or liability, but is not the asset or liability itself.
Veterans Affairs, Department of (VA): Federal agency with oversight for programs created for veterans of the U.S. armed forces. Mortgage loans granted by a lending institution to qualified veterans or to their surviving spouses may be guaranteed by the VA.
Weighted average coupon (WAC): Weighted average of the interest rates of loans within a pool or portfolio.
Weighted average life (WAL): The average amount of time that will elapse from the date of a security’s issuance until each dollar of principal is repaid. The WAL of mortgage loans or mortgage-backed securities is only an assumption. The average amount of time that each dollar of principal is actually outstanding is influenced by, among other factors, the rate at which principal, both scheduled and unscheduled, is paid on the mortgage loans.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this amended report to be signed on its behalf by the undersigned, thereunto duly authorized.
Federal Home Loan Bank of Pittsburgh
(Registrant)
Date: March 27, 2009
By:
/s/John R. Price
John R. Price
President and Chief Executive Officer
Item 7A:
Quantitative and Qualitative Disclosures about Market Risk
See the “Risk Management” discussion in Item 7. Management’s Discussion and Analysis in Part II of this 2008 Annual Report Form 10-K.
Item 8:
Item 8:
Financial Statements and Supplementary Financial Data
Management’s Annual Report of Internal Control over Financial Reporting
The management of the Bank is responsible for establishing and maintaining adequate internal control over financial reporting. The Bank’s internal control over financial reporting is designed by and under the supervision of the Bank’s management, including our Chief Executive Officer and Chief Financial Officer. The Bank’s internal controls over financial reporting are to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with GAAP in the United States of America.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The Bank’s management assessed the effectiveness of the Bank’s internal control over financial reporting as of December 31, 2008. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in the Internal Control-Integrated Framework. Based on its assessment, management of the Bank determined that as of December 31, 2008, the Bank’s internal control over financial reporting was effective based on those criteria.
This Annual Report does not include an attestation report of the company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the company to provide only management’s report in this annual report.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
of the Federal Home Loan Bank of Pittsburgh:
In our opinion, the accompanying statement of condition and the related statements of operations, capital, and cash flows present fairly, in all material respects, the financial position of the Federal Home Loan Bank of Pittsburgh (the “Bank”) at December 31, 2008 and 2007, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Bank’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Pittsburgh, PA
March 27, 2009
Financial Statements for the Years Ended 2008, 2007 and 2006
Federal Home Loan Bank of Pittsburgh
Statement of Operations
The accompanying notes are an integral part of these financial statements.
Federal Home Loan Bank of Pittsburgh
Statement of Condition
The accompanying notes are an integral part of these financial statements.
Federal Home Loan Bank of Pittsburgh
Statement of Cash Flows
Federal Home Loan Bank of Pittsburgh
Statement of Cash Flows - (Continued)
Note:
(1) Other
liabilities includes the net change in the REFCORP asset/liability where applicable.
The accompanying notes are an integral part of these financial statements.
Federal Home Loan Bank of Pittsburgh
Statement of Changes in Capital
The accompanying notes are an integral part of these financial statements.
Federal Home Loan Bank of Pittsburgh
Notes to Financial Statements
Note 1 -
Background Information
The Bank, a federally chartered corporation, is one of 12 district FHLBanks. The FHLBanks serve the public by enhancing the availability of credit for residential mortgages and targeted community development. The Bank provides a readily available, low-cost source of funds to its member institutions. The Bank is a cooperative, which means that current members own nearly all of the outstanding capital stock of the Bank and may receive dividends on their investment. Regulated financial depositories and insurance companies engaged in residential housing finance that maintain their principal place of business in Delaware, Pennsylvania or West Virginia may apply for membership. State and local housing associates that meet certain statutory and regulatory criteria may also borrow from the Bank. While eligible to borrow, state and local housing associates are not members of the Bank and, as such, are not required to hold capital stock.
All members must purchase stock in the Bank. The amount of capital stock members own is based on their outstanding loans, their unused borrowing capacity and the principal balance of residential mortgage loans previously sold to the Bank. See Note 18 for additional information. The Bank considers those members with capital stock outstanding in excess of ten percent of total capital stock outstanding to be related parties. See Note 20 for additional information.
The Finance Board, an independent agency in the executive branch of the United States government, supervised and regulated the FHLBanks and the OF through July 29, 2008. With the passage of the Housing Act, the Finance Agency was established and became the new independent Federal regulator of the FHLBanks, effective July 30, 2008. The OF is a joint office of the FHLBanks established to facilitate the issuance and servicing of the consolidated obligations of the FHLBanks and to prepare the combined quarterly and annual financial reports of all twelve FHLBanks. The Finance Agency’s principal purpose is to ensure that the FHLBanks operate in a safe and sound manner including maintenance of adequate capital and internal controls. In addition, the Finance Agency ensures that the operations and activities of each FHLBank foster liquid, efficient, competitive, and resilient national housing finance markets; each FHLBank complies with the title and the rules, regulations, guidelines, and orders issued under the Housing Act and the authorizing statutes; each FHLBank carries out its statutory mission only through activities that are authorized under and consistent with the Housing Act and the authorizing statutes; and the activities of each FHLBank and the manner in which such regulated entity is operated are consistent with the public interest. Each FHLBank operates as a separate entity with its own management, employees and board of directors. The Bank does not have any off-balance sheet special-purpose entities or any other type of off-balance sheet conduits.
As provided by the Act, as amended, or Finance Agency regulation, the Bank’s debt instruments, referred to as consolidated obligations, are the joint and several obligations of all the FHLBanks and are the primary source of funds for the FHLBanks. See Note 15 for additional information. Deposits, other borrowings, and capital stock issued to members provide other funds. The Bank primarily uses these funds to provide loans to members and to purchase mortgages from members through the MPF Program. See Notes 8 and 9 for additional information. The Bank also provides member institutions with correspondent services, such as wire transfer, safekeeping and settlement.
Note 2 -
Summary of Significant Accounting Policies
Use of Estimates. The preparation of financial statements in accordance with GAAP requires management to make assumptions and estimates. These assumptions and estimates affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of income and expenses. Actual results could differ from these estimates.
Interest-Earning Deposits, Securities Purchased Under Agreements to Resell and Federal Funds Sold. These investments provide short-term liquidity and are carried at cost. The Bank has the ability to purchase from or sell Federal funds to eligible counterparties. These funds are usually purchased and sold for one-day periods, but
Notes to Financial Statements (continued)
can have longer terms for up to three months. The Bank treats securities purchased under agreements to resell as collateralized financings. The Bank may invest in certificates of deposits (CDs) that are recorded at amortized cost as interest-earning deposits. The Bank also invests in certain CDs and bank notes that meet the definition of a security under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities (SFAS 115) and are recorded as investment securities.
Investment Securities. The Bank may classify certain investment securities acquired for purposes of liquidity and asset/liability management as trading and carry them at fair value. The Bank records changes in the fair value of these investment securities through “other income (loss).” However, the Bank does not participate in speculative trading practices.
The Bank classifies certain investment securities that it may sell before maturity as available-for-sale and carries them at fair value. The change in fair value of the available-for-sale securities is recorded in other comprehensive income as a “net unrealized gain (loss) on available-for-sale securities.”
The Bank classifies certain investment securities for which it has both the ability and intent to hold to maturity as held-to-maturity securities and carries them at amortized cost. These securities are adjusted for periodic principal repayments, and the amortization of premiums and accretion of discounts are calculated using the interest method.
Under SFAS 115, changes in circumstances may cause the Bank to change its intent to hold a certain security to maturity without calling into question its intent to hold other debt securities to maturity in the future. Thus, the sale or transfer of a held-to-maturity security due to certain changes in circumstances, such as evidence of significant deterioration in the issuer’s creditworthiness or changes in regulatory requirements, is not considered to be inconsistent with its original classification. Other events that are isolated, nonrecurring, and unusual for the Bank that could not have been reasonably anticipated may cause the Bank to sell or transfer a held-to-maturity security without necessarily calling into question its intent to hold other debt securities to maturity.
In addition, in accordance with SFAS 115, sales of debt securities that meet either of the following two conditions may be considered maturities for purposes of the classification of securities: 1) the sale occurs near enough (within three months) to its maturity date (or call date if exercise of the call is probable) that interest rate risk is substantially eliminated as a pricing factor and the changes in market interest rates would not have a significant effect on the security’s fair value; or 2) the sale of a security occurs after the Bank has already collected a substantial portion (at least 85 percent) of the principal outstanding at acquisition due either to prepayments on the debt security or to scheduled payments on a debt security payable in equal installments (both principal and interest) over its term.
The Bank computes the amortization and accretion of premiums and discounts on MBS and other investments using the interest method to contractual maturity of the securities. The contractual method recognizes the income effects of premiums and discounts based on the actual behavior of the underlying assets and reflects the contractual terms of the securities without regard to changes in estimated prepayments based on assumptions about future borrower behavior. Certain basis adjustments to the carrying value of investment securities are amortized or accreted to earnings using the interest method.
The Bank computes gains and losses on sales of investment securities using the specific identification method and includes these gains and losses in “other income (loss).”
The Bank evaluates its available-for-sale and held-to-maturity investment securities for other-than-temporary impairment quarterly. The Bank will conclude that a loss is other-than-temporary if it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the security. As part of this evaluation, the Bank assesses its intent and ability to hold the security until recovery of any unrealized losses, including until maturity. These evaluations are inherently subjective and consider a number of qualitative factors. In addition to monitoring the credit rating of these securities for downgrades, as well as placement on negative outlook or credit watch, the Bank’s management evaluates other factors that may be indicative of other-than-temporary impairment. These include, but are not limited to, an evaluation of the type of security, the length of time and extent to which the fair value of a security has been less than its cost, any credit enhancement or insurance, and certain other collateral-related characteristics such as loan-to-value ratios, delinquency and foreclosure rates, geographic concentrations
Notes to Financial Statements (continued)
and the security’s performance. If an FHLBank determines that an other-than-temporary impairment exists, it accounts for the investment security as if it had been purchased on the measurement date of the other-than-temporary impairment. The investment security is written down to fair value (its new cost basis) and a realized loss is recognized in noninterest income. A new accretable yield is calculated and amortized prospectively over the remaining life of the investment security based on the amount and timing of future expected cash flows.
The Bank recorded other-than-temporary impairment losses of $266.0 million for the year ended December 31, 2008 related to the Bank’s private label MBS portfolio. The other-than-temporary impairment charge is presented in the Statement of Operations in “net realized losses on available-for-sale securities” and “net realized losses on held-to-maturity securities” in “other income (loss).” See Notes 6 and 7 for more information. The Bank did not experience any other-than-temporary impairment in value of investment securities during 2007 or 2006.
Loans to Members. The Bank reports loans to members and housing associates, net of premiums and discounts and discounts on AHP loans, as discussed below. The Bank amortizes the discounts on loans to members to interest income using the interest method, which produces a constant effective yield on the net investment in the loan. The Bank credits interest on loans to members to income as earned. Following the requirements of the Act, the Bank obtains sufficient collateral on loans to members to protect it from losses. The Act limits eligible collateral to certain investment securities, residential mortgage loans, cash or deposits with the Bank, and other eligible real estate-related assets. As more fully described in Note 8, community financial institutions (CFIs) (redefined by the Housing Act to also include community development activities) are eligible to utilize expanded statutory collateral rules that include secured small business and agricultural loans, and securities representing a whole interest in such secured loans. The Bank has not incurred any credit losses on loans to members since its inception. The Bank evaluates the creditworthiness of its members and nonmember borrowers on an ongoing basis. The Bank would classify as impaired any loans to members with respect to which management believes it is probable that all principal and interest due will not be collected according to its contractual terms. If the Bank had any impaired loans to members, they would be valued using the present value of expected future cash flows discounted at the loan’s effective interest rate, the observable market price or, if collateral dependent, the fair value of the loan’s underlying collateral. If a loan to a member were ever classified as impaired, the accrual of interest would be discontinued and unpaid accrued interest would be reversed. Loans to members would not return to accrual status until they were brought current with respect to both principal and interest and if management believed future principal payments were no longer in doubt. Based upon the analysis of the credit standing of the Bank’s members, collateral held as security and the repayment history of the Bank’s loans to members, management believes that an allowance for credit losses on loans to members is unnecessary.
Mortgage Loans Held for Portfolio. The Bank participates in the MPF Program under which the Bank invests in government-guaranteed/insured residential mortgage loans (those insured or guaranteed by the Federal Housing Administration, the Department of Veterans Affairs, the Rural Housing Service of the Department of Agriculture (RHS) and/or the Department of Housing and Urban Development (HUD)) and conventional residential mortgage loans, which are purchased from participating members. The Bank manages the liquidity, interest-rate risk and optionality of the loans while the member retains the marketing and servicing activities. The Bank and the member share in the credit risk of the conventional loans with the Bank assuming the first loss obligation limited by the first loss account (FLA), and the member assuming credit losses in excess of the FLA, referred to as credit enhancement (CE), up to the amount of the credit enhancement obligation as specified in the master agreement. The Bank assumes all losses in excess of the credit enhancement.
The CE is a contractually specified obligation on the part of the PFI, which ensures the retention of a portion of the credit risk on loans it sells to the Bank. The CE obligation must be at a sufficient level to ensure that the Bank’s risk of loss is limited to losses of an investor in an “AA” rated mortgage backed security. The PFI receives a credit enhancement fee from the Bank, based upon the remaining unpaid principal balance, for managing this portion of the inherent risk in the loans. Under the MPF Program, the PFI’s credit enhancement protection level may take the form of the CE amount and/or the PFI may contract for a contingent performance-based credit enhancement fee whereby such fees are reduced by losses up to a certain amount arising under the master commitment. The required credit enhancement obligation amount may vary depending on the product alternatives selected. Under Acquired
Notes to Financial Statements (continued)
Member Asset (AMA) regulation, any portion of the CE amount that is a PFI’s direct liability must be collateralized by the PFI in the same way that loans to members are collateralized. All of the PFI’s obligations under the PFI agreement are secured under its regular loans to members agreement with the Bank. The Bank may request additional collateral to secure the PFI’s obligation.
The Bank classifies mortgage loans as held for portfolio and reports them at their principal amount outstanding net of deferred loan costs, unamortized premiums and discounts, and mark-to-market basis adjustments on loans initially classified as mortgage loan commitments. The Bank has the intent and ability to hold these mortgage loans in portfolio for the foreseeable future.
The Bank defers and amortizes mortgage loan premiums paid to and discounts received from the Bank’s participating member and basis adjustments to interest income over the contractual life of the loan using the interest method.
The Bank records credit enhancement fees paid to PFIs as a reduction to mortgage loan interest income. The Bank may receive certain non-origination fees, such as delivery commitment extension fees and pair-off fees. Delivery extension fees are received when a member requests to extend the period of the delivery commitment beyond the original stated maturity and are recorded as part of the mark-to-market of the delivery commitment derivatives, and as such, eventually become basis adjustments to the mortgage loans funded as part of the delivery commitment. Pair-off fees are received when the amount of mortgages purchased is less than or greater than the specified percentage of the delivery commitment. Pair-off fees attributable to mortgage loans delivered greater than the specified percentage of the delivery commitment amount represent purchase price adjustments and become part of the basis of the purchased mortgage loans. Pair-off fees attributable to mortgage loans not delivered are reported as other income when received.
Conventional mortgage loans are generally placed on nonaccrual status when they become 90 days or more delinquent, at which time accrued but uncollected interest is reversed against interest income. The Bank records cash payments received on nonaccrual loans as a reduction of principal. Delinquent loans that are foreclosed are removed from the loan classification and the property is initially recorded (and subsequently carried at the lower of cost or fair value less costs to sell) in other assets as real estate owned (REO). If the fair value (less costs to sell) of the REO property is lower than the carrying value of the loan then the difference, to the extent such amount is not expected to be recovered through recapture of performance-based credit enhancement fees, is recorded as a charge-off to the allowance for credit losses. A government-guaranteed/insured loan is not automatically placed on nonaccrual status when the collection of the contractual principal or interest is 90 days or more past due because of the (1) U.S. government guarantee of the loan and (2) contractual obligation of the loan servicer.
The Bank, along with several other FHLBanks, participated in a Shared Funding Program, which is administered by an unrelated third party. This program allows mortgage loans originated through the MPF Program and related credit enhancements to be sold to a third-party-sponsored trust and pooled into securities. The FHLBank of Chicago purchased the AMA-eligible securities, which are rated at least AA, and the Bank purchased a portion of the investments from FHLBank of Chicago at the original transaction closing. The investments are classified as held-to-maturity securities and are reported at amortized cost of $47.2 million and $53.1 million as of December 31, 2008 and 2007, respectively. These securities are not publicly traded or guaranteed by any of the FHLBanks. The Bank sold no mortgage loans into the third-party sponsored trust. The Bank’s involvement was as a purchaser of the AMA-eligible securities.
In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46), a new interpretation on consolidation accounting. In December 2003, the FASB issued a revision to FIN 46 (FIN 46-R) to address various technical corrections and implementation issues that had arisen since the issuance of FIN 46. Application of FIN 46-R to the Bank is limited to the MPF Shared Funding securities, which the Bank believes were issued by qualifying special purpose entities (QSPEs) that are sponsored by One Mortgage Partners Corp., a subsidiary of JP Morgan Chase. A QSPE generally can be described as an entity whose permitted activities are limited to passively holding financial assets and distributing cash flows to investors based on pre-set terms. A QSPE must meet certain criteria in SFAS 140, Accounting for
Notes to Financial Statements (continued)
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities - a replacement of FASB Statement 125, to be considered a QSPE. FIN 46-R does not require an investor to consolidate a QSPE, as long as the investor does not have the unilateral ability to liquidate the QSPE or cause it to no longer meet the QSPE criteria. The Bank meets this scope exception for QSPEs under FIN 46-R, and accordingly, does not consolidate its investments in the MPF Shared Funding securities.
Banking on Business (BOB) Loans. The Bank has offered the BOB loan program to members, which is targeted to small businesses in the Bank’s district of Delaware, Pennsylvania and West Virginia, since 2000. The program’s objective is to assist in the growth and development of small business, including both the start-up and expansion of these businesses. The Bank makes funds available to members to extend credit to an approved small business borrower, enabling small businesses to qualify for credit that would otherwise not be available. The intent of the BOB program is as a grant program to members to help facilitate community economic development; however, repayment provisions within the program require that the BOB program be accounted for as an unsecured loan program. Therefore, the accounting for the program follows the provisions of loan accounting whereby an asset (loan receivable) is recorded for disbursements to members and an allowance for credit losses is estimated and established through provision for credit losses. As the members collect directly from the borrowers, the members remit to the Bank repayment of the loans as stated in the agreements. If the business is unable to repay the loan, it may be forgiven at the member’s request, subject to the Bank’s approval. Based on the intent of the BOB program as described above, the Bank has doubt about the ultimate collection of contractual principal and interest of the BOB loans. Therefore, for accounting purposes, the BOB program is classified as a nonperforming loan portfolio and interest income is not accrued on these loans. Instead, income is recognized on a cash basis after full collection of principal.
Allowance for Credit Losses. The allowance for credit losses is a valuation allowance established by the Bank to provide for probable losses inherent in the Bank’s portfolio as of the Statement of Condition date, including mortgage loans held for portfolio, BOB loans and off-balance sheet exposure. An impairment is considered to have occurred when it is probable that all contractual principal and interest payments will not be collected as scheduled based on current information and events.
The Bank purchases government-guaranteed/insured mortgage loans and conventional fixed-rate residential mortgage loans. Because the credit risk on the government-guaranteed/insured loans is predominately assumed by other entities, only conventional mortgage loans are evaluated for an allowance for credit loss. The Bank’s conventional mortgage loan portfolio is comprised of large groups of smaller-balance homogeneous loans made to borrowers that are secured by residential real estate. The Bank collectively evaluates the homogeneous mortgage loan portfolio for impairment; therefore, it is scoped out of the provisions of SFAS 114. The allowance for credit loss methodology for mortgage loans considers loan pool specific attribute data. The calculated expected loss is compared to peer data and market trends. Peer data and market data are reviewed on a quarterly basis when available.
The allowance for credit losses for the BOB program provides a reasonable estimate of losses inherent in the BOB portfolio based on the portfolio’s characteristics. Both probability of default and loss given default are determined and used to estimate the allowance for credit losses. Loss given default is considered to be 100% due to the fact that the BOB program has no collateral or credit enhancement requirements. Probability of default is based on small business default statistics from the NRSROs as well as the Small Business Administration and trends in Gross Domestic Product. Based on the nature of the program, all of the loans in the BOB program are classified as nonperforming loans.
The allowance for credit losses for off-balance sheet exposure is recorded in other liabilities in the Statement of Condition and is mainly comprised of the reserve associated with BOB loan commitments. Because there is a high likelihood that BOB commitments will ultimately be funded, the allowance for credit losses related to the BOB loan commitments is based on the same methodology as BOB loans.
Notes to Financial Statements (continued)
The Bank has not incurred any losses on loans to members since its inception. Due to the Bank’s collateral security position and the repayment history for member loans, management believes that an allowance for credit losses for member loans is unnecessary.
Derivatives. Accounting for derivatives is addressed in SFAS 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133), and its related interpretations. All derivatives are recognized on the Statement of Condition at their fair values. Due to the application of FASB Staff Position No. FIN 39-1, Amendment of FASB Interpretation No. 39 (FSP FIN 39-1), derivative assets and derivative liabilities reported on the Statement of Condition include the net cash collateral and accrued interest from counterparties. See Note 3 for additional information.
In accordance with SFAS 133, each derivative is designated as one of the following:
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a hedge of the fair value of a recognized asset or liability or an unrecognized firm commitment (a “fair value” hedge);
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a hedge of a forecasted transaction or the variability of cash flows that are to be received or paid in connection with a recognized asset or liability (a “cash flow” hedge);
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a non-qualifying hedge of an asset or liability (an “economic” hedge) for asset/liability management purposes; or
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a non-qualifying hedge of another derivative (an “intermediation” hedge) that is offered as a product to members or used to offset other derivatives with nonmember counterparties.
Changes in the fair value of a derivative that is designated and qualifies as a fair value hedge, along with changes in the fair value of the hedged asset or liability that are attributable to the hedged risk (including changes that reflect losses or gains on firm commitments), are recorded in “other income (loss)” as “net gain (loss) on derivatives and hedging activities.”
Changes in the fair value of a derivative that is designated and qualifies as a cash flow hedge, to the extent that the hedge is effective, are recorded in other comprehensive income, a component of capital, until earnings are affected by the variability of the cash flows of the hedged transactions (i.e., until the periodic recognition of interest on a variable-rate asset or liability).
For both fair value and cash flow hedges, any hedge ineffectiveness (which represents the amount by which the change in the fair value of the derivative differs from the change in the fair value of the hedged item or the variability in the cash flows of the forecasted transaction) is recorded in “other income (loss)” as “net gain (loss) on derivatives and hedging activities.”
An economic hedge is defined as a derivative hedging specific or non-specific underlying assets, liabilities or firm commitments that does not qualify or was not designated for hedge accounting under SFAS 133 but is an acceptable hedging strategy under the Bank’s risk management program. Economic hedging strategies also comply with the Finance Agency regulatory requirements prohibiting speculative hedge transactions. An economic hedge by definition introduces the potential for earnings variability caused by the change in fair value on the derivatives that are recorded in the Bank’s income but not offset by corresponding changes in the value of the economically hedged assets, liabilities or firm commitments. As a result, the Bank recognizes only the net interest and the change in fair value of these derivatives in “other income (loss)” as “net gain (loss) on derivatives and hedging activities” with no offsetting fair value adjustments for the assets, liabilities, or firm commitments. Cash flows associated with such stand-alone derivatives (derivatives not qualifying as a hedge) are reflected as cash flows from operating activities in the Statement of Cash Flows.
The derivatives used in the intermediary activities do not qualify for SFAS 133 hedge accounting treatment and are separately marked-to-market through earnings. The net result of accounting for these derivatives does not significantly affect the operating results of the Bank. These amounts are recorded in “other income (loss)” as “net gain (loss) on derivatives and hedging activities.”
Notes to Financial Statements (continued)
The difference between accruals of interest receivables and payables on derivatives designated as fair value or cash flow hedges is recognized as adjustments to the income or expense of the designated underlying investment securities, loans to members, consolidated obligations or other financial instruments. The difference between accruals of interest receivables and payables on intermediation derivatives for members and other economic hedges are recognized in “other income (loss)” as “net gain (loss) on derivatives and hedging activities.”
The Bank routinely issues debt, makes loans to members, or purchases financial instruments in which a derivative instrument is “embedded.” Upon execution of these transactions, the Bank assesses whether the economic characteristics of the embedded derivative are clearly and closely related to the economic characteristics of the remaining component of the loan to member or debt (the host contract) and whether a separate, non-embedded instrument with the same terms as the embedded instrument would meet the definition of a derivative instrument. When the Bank determines that (1) the embedded derivative has economic characteristics that are not clearly and closely related to the economic characteristics of the host contract; and (2) a separate, stand-alone instrument with the same terms would qualify as a derivative instrument, the embedded derivative is separated from the host contract, carried at fair value, and designated as a stand-alone derivative instrument pursuant to an economic hedge. However, if the entire contract (the host contract and the embedded derivative) is to be measured at fair value, with changes in fair value reported in current period earnings (such as an investment security classified as trading under SFAS 115 as well as hybrid financial instruments accounted for under SFAS 155, Accounting for Certain Hybrid Financial Instruments, an Amendment of FASB Statements No. 133 and 140 (SFAS 155)), or if the Bank cannot reliably identify and measure the embedded derivative for purposes of separating that derivative from its host contract, the entire contract is carried on the Statement of Condition at fair value and no portion of the contract is designated as a hedging instrument. The Bank currently does not have any instruments containing embedded derivatives that are not clearly and closely related to the economic characteristics of the host contract.
If hedging relationships meet certain criteria specified in SFAS 133, they are eligible for hedge accounting and the offsetting changes in fair value of the hedged items may be recorded in earnings. The application of hedge accounting generally requires the Bank to evaluate the effectiveness of hedging relationships on an ongoing basis and to calculate the changes in fair value of the derivatives and related hedged items independently. This is known as the “long-haul” method of accounting. Transactions that meet more stringent criteria qualify for the “short-cut” method of hedge accounting in which an assumption can be made that the change in fair value of a hedged item exactly offsets the change in value of the related derivative.
Derivatives are typically executed at the same time as the hedged loans to members or consolidated obligations and the Bank designates the hedged item in a qualifying hedge relationship as of the trade date. In many hedging relationships, the Bank may designate the hedging relationship upon its commitment to disburse a loan to a member or trade a consolidated obligation in which settlement occurs within the shortest period of time possible for the type of instrument based on market settlement conventions. The Bank defines market settlement conventions for loans to members to be five business days or less and for consolidated obligations to be thirty calendar days or less, using a next business day convention. The Bank then records the changes in fair value of the derivative and the hedged item beginning on the trade date. The “short-cut” method may be utilized when the hedging relationship is designated on the trade date, the fair value of the derivative is zero on that date and the Bank meets the rest of the applicable SFAS 133 criteria of paragraph 68.
The Bank discontinues hedge accounting prospectively when: (1) it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item (including hedged items such as firm commitments or forecasted transactions); (2) the derivative and/or the hedged item expires or is sold, terminated or exercised; (3) it is no longer probable that the forecasted transaction will occur in the originally expected period; (4) a hedged firm commitment no longer meets the definition of a firm commitment; or (5) management determines that designating the derivative as a hedging instrument in accordance with SFAS 133 is no longer appropriate (i.e., de-designation).
When hedge accounting is discontinued because the Bank determines that the hedge relationship no longer qualifies as an effective fair value hedge, the Bank continues to carry the derivative on the Statement of Condition at
Notes to Financial Statements (continued)
its fair value, ceases to adjust the hedged asset or liability for changes in fair value, and amortizes the cumulative basis adjustment on the hedged item into earnings over the remaining life of the hedged item using the interest method.
When hedge accounting is discontinued because the Bank determines that the hedge relationship no longer qualifies as an effective cash flow hedge, the Bank continues to carry the derivative on the Statement of Condition at its fair value and reclassifies the cumulative other comprehensive income adjustment into earnings when earnings are affected by the existing hedge item (i.e., the original forecasted transaction).
Under limited circumstances, when the Bank discontinues cash flow hedge accounting because it is no longer probable that the forecasted transaction will occur in the originally expected period plus the following two months, but it is probable the transaction will still occur in the future, the gain or loss on the derivative remains in accumulated other comprehensive income and is recognized as earnings when the forecasted transaction affects earnings. However, if it is probable that a forecasted transaction will not ever occur, the gains and losses in accumulated other comprehensive income are recognized immediately in earnings.
When hedge accounting is discontinued because the hedged item no longer meets the definition of a firm commitment, the Bank continues to carry the derivative on the Statement of Condition at its fair value, removing from the Statement of Condition any asset or liability that was recorded to recognize the firm commitment and recording it as a gain or loss in current period earnings.
Premises, Software and Equipment. The Bank records premises, software and equipment at cost less accumulated depreciation and amortization and computes depreciation on the straight-line method over the estimated useful lives of assets, which range from one to ten years. The Bank amortizes leasehold improvements on the straight-line basis over the shorter of the estimated useful life of the improvement or the remaining term of the lease. The Bank capitalizes improvements and major renewals but expenses ordinary maintenance and repairs when incurred. The Bank includes gains and losses on the disposal of premises, software and equipment in “other income (loss).”
Costs of computer software developed or obtained for internal use are accounted for in accordance with Statement of Position No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use (SOP 98-1). SOP 98-1 requires the cost of purchased software and certain costs incurred in developing computer software for internal use to be capitalized and amortized over future periods. The Bank amortizes such costs on a straight-line basis over estimated lives ranging from three to seven years.
Mandatorily Redeemable Capital Stock. In accordance with SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity (SFAS 150), the Bank reclassifies stock subject to redemption from equity to a liability after a member provides written notice of redemption, gives notice of intention to withdraw from membership, or attains non-member status by merger, acquisition, charter termination or other involuntary termination from membership, because the member’s shares will then meet the definition of a mandatorily redeemable financial instrument. Shares meeting this definition are reclassified to a liability at fair value. Dividends declared on shares classified as a liability in accordance with SFAS 150 are accrued at the expected dividend rate and reflected as interest expense in the Statement of Operations. Once redeemed, the repayment of these mandatorily redeemable financial instruments (by repurchase or redemption of the shares) is reflected as a financing cash outflow in the Statement of Cash Flows.
If a member cancels its written notice of redemption or notice of withdrawal, the Bank will reclassify mandatorily redeemable capital stock from a liability to equity in accordance with SFAS 150. After the reclassification, dividends on the capital stock will no longer be classified as interest expense.
Prepayment Fees. The Bank charges a member a prepayment fee when the member prepays certain loans before the original maturity. Prepayment fees are determined by a formula that equates the fee owed at the time of loan prepayment to the present value of the foregone interest as compared to that of a replacement advance at prevailing market rates. Therefore, the overall effect on the loan portfolio yield and overall return on assets of recognizing such fee income equals the present value of this foregone income.
Notes to Financial Statements (continued)
In cases in which the Bank funds a new member loan concurrent with the prepayment of an existing loan or shortly thereafter, the Bank evaluates whether the restructuring represents a minor modification of an existing loan or is a new loan. Such determination is primarily based upon a comparison of the net present value of the old loan to the net present value of the new loan, along with certain qualitative factors.
If the restructuring qualifies as a minor modification of the existing loan and no derivative hedging relationship existed whereby a swap termination fee would be offset with the prepayment fee, the prepayment fee on the prepaid loan is deferred. The prepayment fee is recorded in the basis of the modified loan, and amortized over the life of the modified loan using the interest method, which produces a constant effective yield for the loan. This amortization is recorded in interest income. If the restructuring is a new loan, then the fee would be immediately recorded to interest income.
If the restructuring qualifies as a minor modification of a hedged advance that continues to be in a SFAS 133 qualifying hedge relationship, it is marked to fair value after the modification, and subsequent fair value changes are recorded in “other income (loss).”
Commitment Fees. The Bank does not currently collect commitment fees on loans to members. The Bank records commitment fees for standby letters of credit as a deferred credit when the Bank receives the fee and accretes them using the straight-line method over the term of the standby letter of credit. The Bank believes the likelihood of standby letters of credit being drawn upon is remote based on past experience.
Concessions on Consolidated Obligations. Concessions are paid to dealers in connection with the issuance of consolidated obligations. The OF pro-rates the amount of the concession to the Bank based upon the percentage of the debt issued that is assumed by the Bank. The Bank defers and amortizes concession fees using the interest method over the contractual term of the consolidated obligations. Unamortized concessions were $23.9 million and $35.4 million at December 31, 2008 and 2007 and are included in “other assets” on the Statement of Condition. Amortization of such concessions were included in interest expense and totaled $26.0 million, $14.2 million and $12.2 million in 2008, 2007 and 2006, respectively.
Discounts and Premiums on Consolidated Obligations. The Bank amortizes the discounts on consolidated obligation discount notes using the interest method over the contractual term of the related obligations. It amortizes the discounts and premiums on consolidated obligation bonds using the interest method over the term to maturity. If the consolidated obligation is called prior to maturity, the remaining discount, premium or concession is recorded to interest expense on the call date.
Finance Agency/Finance Board Expenses. The Bank is assessed for its proportionate share of the costs of operating the Finance Board, the Bank’s primary regulator until July 29, 2008 and the Finance Agency, beginning July 30, 2008. The Finance Board allocated its operating and capital expenditures among the FHLBanks based on each FHLBank’s percentage of total combined regulatory capital plus retained earnings through July 29, 2008. The portion of the Finance Agency’s expenses and working capital fund paid by the FHLBank is allocated among the FHLBanks based on the pro rata share of the annual assessments based on the ratio between each FHLBank’s minimum required regulatory capital and the aggregate minimum required regulatory capital of every FHLBank. Each FHLBank must pay an amount equal to one-half of its annual assessment twice each year.
Office of Finance (OF) Expenses. The Bank is assessed for its proportionate share of the costs of operating the OF. The OF allocates its operating and capital expenditures based on each FHLBank’s percentage of capital stock, percentage of consolidated obligations issued and percentage of consolidated obligations outstanding.
Affordable Housing Program (AHP). The Act requires each FHLBank to establish and fund an AHP. The Bank charges the required funding for AHP to earnings and establishes a liability. The AHP funds provide subsidies to members to assist in the purchase, construction, or rehabilitation of housing for very low-, low-, and moderate-income households. The requirements of the Act can be satisfied by either a grant or a loan; the Bank primarily issues grants. AHP loans would be executed at interest rates below the customary interest rate for non-subsidized loans. When the Bank makes an AHP loan, the present value of the variation in the cash flow caused by the difference in the interest rate between the AHP loan rate and the Bank’s related cost of funds for comparable
Notes to Financial Statements (continued)
maturity funding is charged against the AHP liability and recorded as a discount on the AHP loan. The discount on AHP loans is accreted to earnings using the interest method. See Note 16 for more information.
Resolution Funding Corporation (REFCORP) Assessments. Although FHLBanks are exempt from ordinary Federal, state, and local taxation except for local real estate tax, the FHLBanks are required to make quarterly payments to REFCORP to fund interest on bonds issued by the REFCORP. REFCORP is a corporation established by Congress in 1989 to provide funding for the resolution and disposition of insolvent savings institutions. Officers, employees, and agents of the OF are authorized to act for and on behalf of REFCORP to carry out the functions of REFCORP. See Note 17 for more information.
Segments. The Bank historically operated two business segments, differentiated by products. The first segment, entitled Traditional Member Finance, housed a majority of the Bank’s activities, including but not limited to, providing loans to members, investments and deposit products. The MPF Program, or Mortgage Finance segment, purchased mortgage loans from members and funded and hedged the resulting portfolio.
Over time, the Bank has experienced changes in organizational structure, management philosophy and business strategies. As a result of these changes, Bank management no longer receives or reviews results by operating segments. Therefore, management has concluded that it no longer operates the Bank as two segments differentiated by product, but operates the Bank as one operating segment.
Estimated Fair Values. Some of the Bank’s financial instruments lack an available trading market characterized by transactions between a willing buyer and a willing seller engaging in an exchange transaction. Therefore, the Bank uses a combination of third-party pricing sources and internal models to determine estimated fair value. Both employ significant assumptions in determining estimated fair values. See Note 21 for information regarding the estimated fair values of the Bank’s financial instruments.
Cash Flows. In the Statement of Cash Flows, the Bank considers cash and due from banks as cash and cash equivalents. Federal funds sold are not treated as cash equivalents for purposes of the Statement of Cash Flows, but are instead treated as short-term investments and are reflected in the investing activities section of the Statement of Cash Flows.
Earnings per Share. Basic earnings per share of capital stock is computed on the basis of weighted average number of shares of capital stock outstanding. Mandatorily redeemable capital stock is excluded from the calculation. The Bank does not have diluted earnings per share because it has no financial instruments convertible to capital stock.
Reclassifications. Certain prior period amounts have been reclassified to conform to the 2008 presentation.
Note 3 - Accounting Adjustments, Changes in Accounting Principle and Recently Issued Accounting Standards and Interpretations
Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS 157). In September 2006, the FASB issued SFAS 157 which addresses how to measure fair value. SFAS 157 provides a single definition of fair value, establishes a framework for measuring fair value, and requires expanded disclosures about fair value. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements, but does not change existing guidance as to whether or not an instrument is carried at fair value. The Bank adopted SFAS 157 on January 1, 2008. The Bank’s adoption of SFAS 157 had no impact on its Statement of Operations and Statement of Condition. See Note 21 for additional information.
Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115 (SFAS 159). On February 15, 2007, the FASB issued SFAS 159 which creates a fair value option allowing, but not requiring, an entity to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities, with changes in fair value recognized in earnings as they occur. It requires entities to separately display the fair value of those assets and liabilities for which the entity has elected the fair value option separately on the
Notes to Financial Statements (continued)
face of the balance sheet. Additionally, SFAS 159 requires an entity to provide information that would allow users to understand the effect on earnings of changes in the fair value of those instruments selected for the fair value election. The Bank adopted SFAS 159 on January 1, 2008 but did not elect the fair value option on any financial assets or liabilities under SFAS 159. Therefore, the Bank’s adoption of SFAS 159 had no impact on its Statement of Operations and Statement of Condition.
Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging Activities (SFAS 161). In March 2008, the FASB issued SFAS 161 which requires enhanced disclosures for derivative instruments. The intent of the enhanced disclosures is to assist the users of the financial statements to better understand how and why an entity uses derivative instruments and how derivative instruments and hedging activities affect the entity’s financial position, financial performance and cash flows. SFAS 161 is effective for the Bank’s fiscal year beginning January 1, 2009. The Bank’s adoption of SFAS 161 is expected to result in increased financial statement disclosure.
FASB Staff Position No. FIN 39-1, Amendment of FASB Interpretation No. 39 (FIN 39-1). In April 2007, the FASB issued FIN 39-1 which permits the fair value of receivables or payables related to cash collateral to be offset against the net fair value amount recognized for derivative instruments under the same master netting arrangement (such offset is generally required if derivative fair values by counterparty are offset). The Bank adopted FIN 39-1 on January 1, 2008 and it was applied retrospectively. The Bank’s adoption of FIN 39-1 did not impact its Statement of Operations, Statement of Cash Flows or Statement of Changes in Capital. The impact to the Bank’s December 31, 2007 Statement of Condition was as follows:
SFAS 133 Implementation Issue No. E23: Issues Involving the Application of the Shortcut Method Under Paragraph 68 (DIG E23). In December 2007, the FASB issued DIG E23, which provides two clarifications on the application of the shortcut method in accordance with paragraph 68 of SFAS 133. DIG E23 permits the use of the shortcut method if (1) interest rate swaps have a non-zero fair value at inception, provided that the non-zero fair value at inception is attributable solely to a bid-ask spread and (2) hedged items have a settlement date after the swap trade date, provided that the trade date of the asset or liability differs from its settlement date because of generally established conventions in the marketplace in which the transaction is executed. The Bank adopted DIG E23 on January 1, 2008. The Bank’s adoption of DIG E23 did not have a material impact on its Statement of Operations or Statement of Condition.
FASB Staff Position No. FAS 133-1 and FIN 45-4, Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45 (FSP 133-1 and FIN 45-4). In September 2008, the FASB issued FSP 133-1 and FIN 45-4. The purpose of FSP 133-1 and FIN 45-4 is to improve disclosures for credit derivatives and guarantees. The FSP 133-1 and FIN 45-4 also requires entities to disclose the current status of the payment/performance risk of a guarantee, which could be indicated by external credit ratings or internal risk categories. The Bank adopted FSP 133-1 and FIN 45-4 on December 31, 2008. The Bank’s adoption of FSP 133-1 and FIN 45-4 had no impact on its Statement of Operations or Statement of
Notes to Financial Statements (continued)
Condition, although it did result in additional footnote disclosures. The Bank does not issue credit derivatives and therefore is not impacted by the provisions of the FSP that specifically amend SFAS 133.
FASB Staff Position 157-3, Determining the Fair Value of a Financial Asset in a Market That is not Active (FSP 157-3). In October 2008, the FASB issued FSP 157-3 which was effective as of September 30, 2008. The purpose of FSP 157-3 was to clarify the application of SFAS 157 for determining the fair value of financial assets in an inactive market. FSP 157-3 clarifies that fair value in accordance with SFAS 157 is the price received by the holder in an active market. If a market is not active, management may evaluate the use of appropriate internal assumptions. FSP 157-3 also states that market broker quotes in an inactive market are not necessarily determinative of fair value. FSP 157-3 was adopted by the Bank on September 30, 2008. The Bank’s adoption of FSP 157-3 did not have a material impact on its Statement of Operations or Statement of Condition.
FASB Staff Position FAS 140-4 and FIN 46(R)-8, Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities (FSP 140-4 and FIN 46(R)-8). In December 2008, the FASB issued FSP 140-4 and FIN 46(R)-8 which was effective as of December 31, 2008. The FSP requires enhanced disclosures concerning transfers of financial assets, qualifying special purpose entities (QSPEs) and variable interest entities (VIEs). Specifically, FSP 140-4 and FIN 46(R)-8 requires additional disclosures regarding assets transferred to SPEs, how the SPE affects the entity’s financial statements, and the interaction of the entity and consolidated and non-consolidated VIEs. FSP 140-4 and FIN 46(R)-8 was adopted by the Bank on December 31, 2008. The Bank’s adoption of FSP 140-4 and FIN 46(R)-8 had no impact on its Statement of Operations, Statement of Condition or Notes to Financial Statements.
FASB Staff Position EITF 99-20-1, Amendments to the Impairment and Interest Income Measurement Guidance of EITF Issue No. 99-20 (FSP 99-20-1). In January 2009, the FASB issued FSP 99-20-1 which was effective as of December 31, 2008. FSP 99-20-1 was issued to reconcile differences between the impairment model under SFAS 115 and EITF 99-20. Specifically, FSP 99-20-1 removes the requirement to utilize a market participant’s assumptions about future cash flows and replaces it with management’s best estimate of future cash flows based on reasonable judgments. FSP 99-20-1 was adopted by the Bank on December 31, 2008. The Bank’s adoption of FSP 99-20-1 did not have a material impact on its Statement of Operations or Statement of Condition.
EITF Issue No. 08-5. On September 24, 2008, the FASB ratified the consensus reached by the EITF on Emerging Issues Task Force Issue No. 08-5, Issuer’s Accounting for Liabilities Measured at Fair Value with a Third-Party Credit Enhancement (EITF 08-5). The objective of EITF 08-5 is to determine the issuer’s unit of accounting for a liability that is issued with an inseparable third-party credit enhancement when it is recognized or disclosed at fair value on a recurring basis. EITF 08-5 should be applied prospectively and is effective in the first reporting period beginning on or after December 15, 2008 (January 1, 2009 for the Bank). The Bank does not believe the adoption of EITF 08-5 will have a material effect on its Statement of Condition, Statement of Operations or Statement of Cash Flows.
Certificates of Deposit. During the third quarter of 2008, on a retrospective basis, the Bank reclassified its investments in certain certificates of deposit including related interest income and cash flow activity, previously included as a component of interest-earning deposits, to held-to-maturity securities in its Statement of Condition, Statement of Operations and Statement of Cash Flows based on the definition of a security under SFAS 115. These financial instruments have been classified as held-to-maturity securities based on their short-term nature and the Bank’s history of holding them until maturity. This reclassification had no effect on total assets, total net interest income or net income. The Bank has certain other interest-earning deposits that do not meet the definition of a security; therefore, these balances, as well as related interest income and cash flow activity, will continue to be classified as interest-earning deposits on the Statement of Condition, Statement of Operations or Statement of Cash Flows.
Notes to Financial Statements (continued)
The effects of this reclassification on the Bank’s prior period Statement of Condition, Statement of Operations and Statement of Cash Flows was as follows:
Note:
(1) Or,
in the case of interest-earning deposits and total assets, as adjusted due to the adoption of FIN 39-1.
Note 4 -
Cash and Due from Banks
The Bank maintains compensating and collected cash balances with commercial banks in return for certain services. These agreements contain no legal restrictions about the withdrawal of funds. The average compensating and collected cash balances for the years ended December 31, 2008 and 2007, were approximately $15.6 million and $10.7 million, respectively.
In addition, the Bank maintained average required balances with various Federal Reserve Banks of approximately $30 thousand for the years ended December 31, 2008 and 2007. These represent average balances required to be maintained over each 14-day reporting cycle; however, the Bank may use earnings credits on these balances to pay for services received from the Federal Reserve Banks.
Pass-through Deposit Reserves. The Bank acts as a pass-through correspondent for member institutions required to deposit reserves with the Federal Reserve Banks. The amount shown as cash and due from banks includes pass-through reserves deposited with Federal Reserve Banks of approximately $11.0 million and
Notes to Financial Statements (continued)
$17.9 million as of December 31, 2008 and 2007, respectively. The Bank includes member reserve balances in noninterest-bearing deposits within liabilities on the Statement of Condition.
Note 5 -
Trading Securities
Trading securities as of December 31, 2008 and 2007 were as follows:
Note:
(1) Represents
certificates of deposit that meet the definition of a security under SFAS 115.
The mutual funds are held in a Rabbi trust created in November 2007 to generate returns that seek to offset changes in liabilities related to the notional market risk of certain deferred compensation agreements. These deferred compensation liabilities were $6.2 million and $7.6 million at December 31, 2008 and 2007, respectively. Prior to the creation of the Rabbi trust, the Bank maintained available-for-sale mutual funds for this purpose.
Net losses on trading securities were $706 thousand and $79 thousand for the years ended December 31, 2008 and 2007, respectively. There were no gains or losses on trading securities for the year ended December 31, 2006. Net interest income on trading certificates of deposits was $474 thousand for the year ended December 31, 2008. There was no interest income on trading certificates of deposit for the years ended December 31, 2007 and 2006.
Note 6 -
Available-for-Sale Securities
Available-for-sale securities as of December 31, 2008 and 2007, were as follows:
Note:
(1) Amortized
cost includes adjustments made to the cost basis of an investment for accretion and/or amortization.
Available-for-sale securities with unrealized losses had fair values of $18.1 million and $42.4 million as of December 31, 2008 and 2007, respectively. At December 31, 2008, all but one of the available-for-sale securities had been in an unrealized loss position for greater than twelve months. At December 31, 2007, all available-for-sale securities had been in an unrealized loss position for less than twelve months.
Mortgage-Backed Securities. The Bank invests in MBS which must be rated AAA at the time of purchase. Each of the securities may contain one or more forms of credit protection, including but not limited to guarantee of principal and interest, subordination, over collateralization, excess interest and insurance wrap.
Notes to Financial Statements (continued)
Credit protection/enhancements for private label MBS primarily consist of senior-subordinated features, which results in the prioritization of payments to senior classes over junior classes. The Bank primarily invests in senior classes of private label MBS. The Bank has higher exposure to the risk of loss on its investments in MBS when the loans backing the MBS exhibit high rates of delinquency and foreclosure and high losses on the sale of foreclosed properties.
Impairment Analysis on Available-for-Sale Securities. The Bank evaluates its available-for-sale investment securities for other-than-temporary impairment quarterly. The Bank will conclude that a loss is other-than-temporary if it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the security. Discussion of other-than-temporary impairment is detailed in Note 7 to the audited financial statements. The overall process is the same for both available-for-sale and held-to-maturity securities.
The Bank performed an impairment analysis of its investment portfolio at December 31, 2008 based on the securities’ underlying type of collateral, credit rating, collateral performance such as delinquency and default rates and projected cash flows of certain securities. Based on the impairment assessment, management determined that it did not have sufficient persuasive evidence to conclude that the impairment of one MBS backed by HELOCs in the available-for-sale securities portfolio was temporary. For this security, the Bank recognized other-than-temporary impairment of $2.8 million in the fourth quarter of 2008, which is included in the total reported on the Statement of Operations as “net realized losses on available-for-sale securities.” This information is detailed in the following table.
The remainder of the available-for-sale securities portfolio has experienced unrealized losses and a decrease in fair value due to interest rate volatility, illiquidity in the marketplace, and credit deterioration in the U.S. mortgage markets. However, the decline is considered temporary as the Bank currently has the intent and ability to hold these investments to maturity and expects to collect all contractual principal and interest.
Redemption Terms. The amortized cost of the Bank’s MBS classified as available-for-sale includes net discounts of $2.9 million and $10 thousand at December 31, 2008 and 2007, respectively. This increase was the result of the other-than-temporary impairment charge taken on one available-for-sale security as discussed above. Contractual maturity extends over a period exceeding ten years. Expected maturities will differ from contractual maturities because borrowers have the right to prepay obligations with or without call or prepayment fees.
Interest Rate Payment Terms. The following table details interest payment terms for available-for-sale MBS at December 31, 2008 and 2007.
Notes to Financial Statements (continued)
Note 7 - Held-to-Maturity Securities
Held-to-maturity securities as of December 31, 2008 and 2007 were as follows:
Note:
(1)
Amortized cost includes adjustments made to the cost basis of an investment for accretion and/or amortization.
(2)
Represents certificates of deposit that meet the definition of a security under SFAS 115.
(3)
Represents asset-backed commercial paper, all of which matured by January 8, 2008.
Restricted securities related to the Shared Funding Program are classified as held-to-maturity and are included in private label MBS above. The restricted securities had an amortized cost of $47.2 million and $53.1 million as of December 31, 2008 and 2007, respectively. No held-to-maturity securities were pledged as collateral at December 31, 2008 or 2007.
Notes to Financial Statements (continued)
The following tables summarize the held-to-maturity securities with unrealized losses as of December 31, 2008 and 2007. The unrealized losses are aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position.
State or Local Housing Finance Agency Obligations. Management has reviewed its investments in state or local housing finance agency obligations and has determined that the unrealized losses shown are the result of the current interest-rate environment and illiquidity in the credit markets. The Bank has determined that all unrealized losses reflected above are temporary given the creditworthiness of the issuers and the underlying collateral. Because the decline in market value is attributable to changes in interest rates and not to a deterioration in the fundamental credit quality of these obligations, and because the Bank has the ability and intent to hold these investments through to recovery, which may be maturity, the Bank does not consider these investments to be other-than-temporarily impaired at December 31, 2008.
Notes to Financial Statements (continued)
Mortgage-Backed Securities. The Bank invests in MBS, which are rated AAA at the time of purchase with the exception of one of the restricted securities related to the Shared Funding Program. This security was rated AA at the time of purchase. Each of the securities may contain one or more forms of credit protection/enhancements, including but not limited to guarantee of principal and interest, subordination, over-collateralization, and excess interest and insurance wrap.
Credit protection/enhancement for the Bank’s MBS consist primarily of either guarantee of principal and interest in the case of U.S. government-guaranteed MBS and GSE MBS, or credit enhancement for private label residential MBS. Credit enhancements for private label MBS primarily consist of senior-subordinated features, which results in the prioritization of payments to senior classes over junior classes. The Bank primarily invests in senior classes of GSE and private label MBS. The Bank has higher exposure to the risk of loss on its investments in MBS when the loans backing the MBS exhibit high rates of delinquency and foreclosure and high losses on the sale of foreclosed properties. With respect to its GSE MBS holdings, the Bank has concluded that despite the ongoing deterioration in the nation’s housing markets, the guarantee of principal and interest on the Bank’s GSE MBS by Fannie Mae and Freddie Mac is still assured, and therefore the securities are not other-than-temporarily impaired.
Impairment Analysis on Held-to-Maturity Securities. The Bank evaluates its held-to-maturity investment securities for other-than-temporary impairment quarterly. The Bank will conclude that a loss is other-than-temporary if it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the security.
The Bank performed an impairment assessment of its investment portfolio at December 31, 2008. As part of this process, the Bank considers its current intent and ability to hold each security for a sufficient time to allow for any anticipated recovery of unrealized losses, including until maturity. The current intent and ability of the Bank is demonstrated by the fact that the Bank is adequately capitalized and has ample liquidity and therefore has no need to sell these securities, nor has the Bank entered into any contractual constraints that would impact such intent and ability. To determine which individual securities are at risk for other-than-temporary impairment, the Bank considers various characteristics of each security including, but not limited to, the following: the credit rating and related outlook or status; the underlying type of collateral; the duration and level of the unrealized loss; the market price of the security; collateral-related characteristics; and collateral performance such as delinquency rates. As a result of this security level review, the Bank then identifies individual securities which are believed to be at risk for other-than-temporary impairment, which are evaluated by analyzing the security. To perform the Bank’s impairment assessment, the Bank evaluates all information, both quantitative and qualitative, about a security to conclude that a security’s impairment is other-than-temporary including estimating cash flows of certain securities. This evaluation is completed by the Bank on a security-by-security basis.
Management determined as of December 31, 2008 that it did not have sufficient persuasive evidence to conclude that the impairment of six MBS in the held-to-maturity securities portfolio and one in the AFS portfolio were temporary. For the held-to-maturity securities, the Bank recognized other-than-temporary impairment totaling $263.2 million in the fourth quarter of 2008, with a total unpaid principal balance of $594.6 million. The impairment charges are included in the total reported on the Statement of Operations as “net realized losses on held-to-maturity securities.” This information is detailed in the following tables.
The remainder of the held-to-maturity securities portfolio experienced unrealized losses and a decrease in fair value due to interest rate volatility, illiquidity in the marketplace, and credit deterioration in the U.S. mortgage
Notes to Financial Statements (continued)
markets. However, the decline is considered temporary as the Bank currently has the intent and ability to hold these investments to maturity and expects to collect all contractual principal and interest.
Redemption Terms. The amortized cost and estimated fair value of held-to-maturity securities by contractual maturity are shown below. Expected maturities of some securities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.
The amortized cost of the Bank’s mortgage-backed securities classified as held-to-maturity includes net discounts of $343.5 million and $94.8 million at December 31, 2008 and 2007, respectively. This increase was the result of the other-than-temporary impairment charges taken on certain held-to-maturity securities as discussed above.
Interest Rate Payment Terms. The following table details interest rate payment terms for held-to-maturity securities at December 31, 2008 and 2007.
Realized Gains and Losses. There were no sales of held-to-maturity securities and, therefore, no realized gains or losses on sales, for the years ended December 31, 2008, 2007 and 2006. All realized losses on held-to-maturity reflect the other-than-temporary impairment charges recorded in fourth quarter 2008.
Notes to Financial Statements (continued)
Note 8 - Loans to Members
Redemption Terms. At December 31, 2008 and 2007, the Bank had loans to members outstanding including AHP loans (see Note 16) at interest rates ranging from 0% to 8.56% as summarized below. AHP subsidized loans have interest rates ranging between 0% and 6.50%.
Index amortizing loans require repayment according to predetermined amortization schedules linked to the level of various indices. Usually, as market interest rates rise (fall), the maturity of an index amortizing loan to member extends (contracts).
The Bank offers loans to members that may be prepaid on pertinent dates (call dates) without incurring prepayment or termination fees (returnable loans). Other loans to members may only be prepaid by paying a fee (prepayment fee) to the Bank that makes the Bank financially indifferent to the prepayment of the loan. At both December 31, 2008 and 2007, the Bank had returnable loans of $3.6 billion. The following table summarizes loans to members by year of contractual maturity or next call date for returnable loans to members.
The Bank also offers convertible loans. With a convertible loan, the Bank purchases an option from the member that allows the Bank to convert the interest rate from fixed to floating by terminating the fixed loan, which the Bank normally would exercise when interest rates increase, and offering a floating-rate loan. At December 31, 2008 and 2007, the Bank had convertible loans outstanding of $7.4 billion and $9.3 billion, respectively. The
Notes to Financial Statements (continued)
following table summarizes loans to members by year of contractual maturity or next convertible date for convertible loans.
Security Terms. The Bank lends to financial institutions involved in housing finance within its district according to Federal statutes, including the Act. The Act requires the Bank to obtain sufficient collateral on loans to members to protect against losses and to accept only certain U.S. government or government agency securities, residential mortgage loans, cash or deposits in the Bank, and other eligible real estate-related assets as collateral on such loans to members. CFIs are eligible under expanded statutory collateral rules to use secured small business, small farm and small agriculture loans and securities representing a whole interest in such secured loans. The Housing Act also adds CDFIs as eligible members and includes secured loans for “community development activities” as a permitted purpose, and as eligible collateral for loans to CFIs. As additional security, the Bank has a statutory lien on each borrower’s capital in the Bank. At December 31, 2008 and 2007, the Bank had collateral with an eligible collateral value in excess of the book value of all outstanding loans to members. The estimated value of the collateral required to secure each member’s obligation is calculated by applying collateral discount or weightings. On the basis of the financial condition of the member, the type of security agreement, and other factors, the Bank requires the member and any affiliated pledgor to execute a written security agreement and imposes one of two requirements to protect the collateral secured:
(1)
Allows a member or affiliate pledgor to retain possession of the collateral pledged to the Bank, under a written security agreement that requires the member to hold such collateral for the benefit of the Bank; or
(2)
Requires the member or affiliate pledgor to deliver physical custody/grant control of the pledged collateral with the Bank or its third-party custodian.
Beyond these provisions, the Act affords any security interest granted by a member or any affiliate of the member to the Bank priority over the claims or rights of any other party. The exceptions are those claims that would be entitled to priority under otherwise applicable law and are held by bona fide purchasers for value or by secured parties with perfected security interests ahead in priority to the Bank’s.
Credit Risk. While the Bank has never experienced a loan loss on a loan to a member, the expansion of collateral for CFIs and lending to nonmember housing associates and lending to CDFIs, when implemented, provides the potential for additional credit risk for the Bank. Deterioration in real estate values in various markets, with a resulting decline in the value of certain mortgage loans and mortgage securities pledged as collateral, also pose the potential for additional risk. The management of the Bank has policies and procedures in place to manage this credit risk. Accordingly, the Bank has not provided any allowances for credit losses on loans to members.
The Bank’s potential credit risk from loans to members is concentrated in commercial banks and savings institutions. As of December 31, 2008, the Bank had loans to members of $37.6 billion outstanding to the five largest borrowers, which represented 63.2% of total loans outstanding. The interest income from these loans was $1.8 billion during the year ended December 31, 2008. Of these five, three each had outstanding loan balances in excess of 10% of the total portfolio at December 31, 2008. As of December 31, 2007, the Bank had outstanding loans of $49.0 billion to five borrowers which represented 72.3% of total loans outstanding. The interest income
Notes to Financial Statements (continued)
from these loans was $1.7 billion during the year ended December 31, 2007. Of these five, two each had outstanding loan balances in excess of 10% of the total portfolio at December 31, 2007. The Bank held sufficient collateral to secure loans to members and the Bank does not expect to incur any losses on these loans. See Note 20 for further information on transactions with related parties.
Interest Rate Payment Terms. The following table details interest rate payment terms for loans to members.
At December 31, 2008, the Bank had $30.6 billion of fixed rate loans and $6.9 billion of variable rate loans with a contractual maturity greater than one year. At December 31, 2007, these balances were $32.0 billion and $5.0 billion, respectively.
Note 9 - Mortgage Loans Held for Portfolio
Under the MPF Program, the Bank invests in mortgage loans which it purchases from its participating members. The total loans represent held-for-portfolio loans under the MPF Program whereby the Bank’s members originate, service, and credit enhance residential mortgage loans that are then sold to the Bank. The Bank has historically sold participation interests in some of its MPF Program loans to other FHLBanks and holds the rest in portfolio. On June 30, 2008, the Bank agreed to purchase up to $300 million of 100% participation interest in new MPF loans from FHLBank of Chicago. This agreement expired October 31, 2008. As of December 31, 2008, the Bank had purchased $218.0 million under the agreement. See Note 20 for further information regarding transactions with related parties.
The following table presents information as of December 31, 2008 and 2007 on mortgage loans held for portfolio:
Note:
(1)
Medium-term is defined as a term of 15 years or less. Long-term is defined as greater than 15 years.
Notes to Financial Statements (continued)
The following tables detail the par value of mortgage loans held for portfolio outstanding categorized by type and by maturity.
Note 10 - Allowance for Credit Losses
Mortgage Loans Held for Portfolio. The rollforward of the allowance for credit losses for mortgage loans held for portfolio was as follows:
At December 31, 2008 and 2007, the Bank had $38.3 million and $20.7 million, respectively, of nonaccrual mortgage loans which represent conventional loans delinquent by 90 days or more. At December 31, 2008 and 2007, the Bank’s other assets included $5.9 million and $3.2 million, respectively, of other real estate owned (REO). The REO balances are carried at the lower of cost or market.
Credit losses that are not paid by primary mortgage insurance are allocated to the Bank up to an agreed upon amount, called a First Loss Account (FLA). The FLA functions as a tracking mechanism for determining the point after which the participating member is required to cover losses. The FLA can be either an account which builds over time or an amount equal to an agreed-upon percentage of the aggregate balance of the mortgage loans purchased, depending on the MPF Program product. The Bank pays the participating member a fee, a portion of which may be based on the credit performance of the mortgage loans, in exchange for absorbing the second layer of losses up to an agreed-upon CE amount. Performance-based fees may be withheld to cover losses allocated to the Bank under the FLA. At December 31, 2008 and 2007, the Bank’s exposure under the FLA, excluding amounts that may be recovered through withholding of performance-based CE fees, was $44.0 million and $44.4 million, respectively. This exposure includes both accrual and nonaccrual loans.
The Bank records CE fees as a reduction to mortgage loan interest income. CE fees totaled $7.1 million, $7.7 million and $8.5 million for the years ended December 31, 2008, 2007 and 2006, respectively.
Notes to Financial Statements (continued)
Banking on Business Loans. The rollforward of the allowance for credit losses for BOB loans was as follows:
The Bank determined that $0.3 million and $1.6 million of BOB loans were in default and charged them off during the years ended December 31, 2008 and 2007, respectively.
At December 31, 2008 and 2007, the Bank had $21.1 million and $19.6 million, respectively, of gross nonaccrual BOB loans, before allowance for credit losses.
The amount of forgone interest income on nonaccrual BOB loans for the periods presented was less than $1 million. The Bank recorded $68 thousand, $103 thousand and $114 thousand of cash basis interest income during the years ended December 31, 2008, 2007 and 2006, respectively.
Off-Balance Sheet Credit Risk. The rollforward of the allowance for off-balance sheet credit risk was as follows:
The off-balance sheet credit risk is associated with BOB loan commitments and standby letters of credit.
See Note 2 to the audited financial statements regarding the methodologies for the allowance for credit losses on mortgage loans held for portfolio, BOB loans and off-balance sheet credit risk.
Note 11 -
Derivatives and Hedging Activities
The Bank may enter into interest rate swaps (including callable and putable swaps), swaptions, interest rate cap and floor agreements, and forward contracts (collectively, derivatives) to manage its exposure to changes in interest rates. Through derivatives, the Bank may adjust the effective maturity, repricing frequency or option characteristics of financial instruments to achieve risk management objectives. The Bank uses derivatives in several ways: (1) by designating them as either a fair value or cash flow hedge of an underlying financial instrument, a firm commitment or a forecasted transaction; (2) by acting as an intermediary; or (3) in asset/liability management (i.e., an economic hedge). For example, the Bank uses derivatives in its overall interest rate risk management to adjust the interest rate sensitivity of consolidated obligations to approximate more closely the interest rate sensitivity of assets (loans to members, investment securities, and mortgage loans), and/or to adjust the interest rate sensitivity of loans to members, investment securities, or mortgage loans to approximate more closely the interest rate sensitivity of liabilities. In addition to using derivatives to manage mismatches of interest rates between assets and liabilities, the Bank also uses derivatives as follows: (1) to manage embedded options in assets and liabilities; (2) to hedge the market value of existing assets and liabilities and anticipated transactions; (3) to hedge the duration risk of prepayable instruments; (4) to exactly offset other derivatives executed with members (the Bank serves as an intermediary); and (5) to reduce funding costs.
Consistent with Finance Agency regulation, the Bank enters into derivatives to manage the interest rate risk exposures inherent in otherwise unhedged assets and funding positions, to achieve the Bank’s risk management
Notes to Financial Statements (continued)
objectives or to act as an intermediary between its members and counterparties. Bank management uses derivatives when they are considered to be the most cost-effective alternative to achieve the Bank’s financial and risk management objectives. Accordingly, the Bank may enter into derivatives that do not necessarily qualify for hedge accounting (economic hedges).
The components of net gain (loss) on derivatives and hedging activities for the years ended December 31, 2008, 2007 and 2006 are presented in the following table.
Net Gains (Losses) on Derivatives and Hedging Activities
On September 15, 2008, Lehman Brothers Holding, Inc. (Lehman) filed for bankruptcy. At that time, Lehman’s subsidiary, Lehman Brothers Special Financing, Inc. (LBSF) was the Bank’s largest derivatives counterparty, with a total of 595 outstanding derivative trades having a total notional value of $16.3 billion. Lehman was a guarantor under the Bank’s agreement with LBSF such that Lehman’s bankruptcy filing triggered an event of default. Substantially all of these derivatives were in fair value hedging relationships under SFAS 133. As a result of the bankruptcy filing, the Bank evaluated the outstanding trades it had with LBSF to assess which individual derivatives were most important to the Bank’s overall risk position. Of the 595 trades, 63 represented approximately half of the total LBSF notional value and almost 100% of the base case duration impact of the LBSF portfolio. Therefore, the Bank elected to enter into 63 identical new trades with different counterparties on September 18, 2008. The fair value hedging relationships associated with the 63 LBSF trades were de-designated with the respective hedged items being simultaneously re-designated in new hedging relationships with the new derivatives traded on September 18, 2008. Management determined that it was in the Bank’s best interest to declare an event of default and designate September 19, 2008 as the early termination date of the Bank’s agreement with LBSF. Accordingly, all LBSF derivatives were legally terminated at that time and the Bank began the process of obtaining third party quotes for all of the derivatives in order to settle its position with LBSF in accordance with the International Swaps Dealers Association, Inc. (ISDA) Master Agreement. On September 22, 2008, the Bank replaced additional LBSF derivatives by trading 40 derivatives identical to certain LBSF derivatives that were terminated on September 19, 2008. The Bank was unable to place these 40 replacement derivatives into SFAS 133 fair value hedge relationships until October 10, 2008.
The above Lehman-related transactions had a material impact on the components of net gain (loss) on derivatives and hedging activities for the twelve months ended December 31, 2008 as detailed in the table above. Fair value hedge ineffectiveness for the twelve months ended December 31, 2008, includes a loss of $10.9 million resulting from the replacement of the 63 LBSF derivatives described above that were in fair value hedging relationship with certain loans to members. For the twelve months ended December 31, 2008, gains (losses) associated with economic hedges include a $69.0 million gain associated with 63 replaced LBSF derivatives that remained as economic hedges for a one day period after they were replaced. The gains (losses) associated with economic hedges for the twelve months ended December 31, 2008 also include a gain of $0.2 million associated with the 40 additional replacement derivatives. For the twelve months ended December 31, 2008, other gains (losses) on derivatives and hedging activities includes a gain of $11.8 million associated with the termination of the LBSF derivatives.
The remaining fluctuations in the various gain (loss) categories were primarily due to changes in interest rates. There were no material amounts for the years ended December 31, 2008, 2007 and 2006 that were reclassified into
Notes to Financial Statements (continued)
earnings as a result of the discontinuance of cash flow hedges because it became probable that the original forecasted transactions would not occur by the end of the originally specified time period or within a two month period thereafter. As of December 31, 2008, the deferred net gains on derivative instruments accumulated in other comprehensive income expected to be reclassified to earnings during the next twelve months was $0.3 million. Normally, the maximum length of time over which the Bank hedges its exposure to the variability in future cash flows for forecasted transactions, excluding those forecasted transactions related to the payment of variable interest on existing financial instruments, is 45 days or less. The Bank did not have any hedges related to the exposure to the variability in future cash flows for forecasted transactions at December 31, 2008.
The following table represents outstanding notional balances and estimated fair values of the derivatives outstanding at December 31, 2008 and 2007.
Note:
December 31, 2007 balances reflect the Bank’s adoption retrospectively of FIN 39-1. See Note 3 for further information on FIN 39-1.
The Bank enters into master netting arrangements which allow the Bank to net derivative gain or loss position by derivative counterparty. Based on the net derivative position with each derivative counterparty, the Bank may receive (post) cash collateral from (to) the counterparty. In accordance with FIN 39-1, the Bank has offset cash collateral and related accrued interest against the net fair value of derivatives.
Notes to Financial Statements (continued)
Hedge Documentation and Effectiveness. At hedge inception, the Bank formally documents all relationships between derivatives designated as hedging instruments and hedged items, its risk management objectives and strategies for undertaking various hedge transactions, and its method of assessing effectiveness. This process includes linking all derivatives that are designated as fair value or cash flow hedges to: (1) assets and liabilities on the Statement of Condition; (2) firm commitments; or (3) forecasted transactions. The Bank also formally assesses (both at the hedge’s inception and monthly on an ongoing basis) whether the derivatives that are used in hedging transactions have been effective in offsetting changes in the fair value or cash flows of hedged items and whether those derivatives may be expected to remain effective in future periods. The Bank uses regression analyses to assess the effectiveness of its hedges.
The Bank is not a derivative dealer and thus does not trade derivatives for short-term profit.
Investment Securities. The Bank invests in U.S. agency obligations, government-sponsored enterprise obligations, mortgage-backed securities and the taxable portion of state or local agency obligations, which may be classified as held-to-maturity, available-for-sale or trading securities. The interest rate and prepayment risk associated with these investment securities is managed through a combination of debt issuance and derivatives. The Bank may manage the prepayment and interest rate risk by funding investment securities with consolidated obligations that have call features or by economically hedging the prepayment risk with caps or floors, callable swaps or swaptions.
The Bank may also manage the risk arising from changing market prices or cash flows of investment securities classified as trading by entering into derivatives (economic hedges) that offset the changes in fair value or cash flows of the securities. The market value changes of both the trading securities and the associated derivatives are included in other income in the Statement of Operations and presented as part of the “net gains (loss) on trading securities” and “net gain (loss) on derivatives and hedging activities.”
Loans to Members. The Bank offers a wide array of loan to member structures to meet members’ funding needs. These loans to members may have maturities up to 30 years with variable or fixed rates and may include early termination features or options. The Bank may use derivatives to adjust the repricing and/or options characteristics of loans to members in order to more closely match the characteristics of the Bank’s funding liabilities. In general, whenever a member executes a fixed-rate loan to member or a variable-rate loan to member with embedded options, the Bank may simultaneously execute a derivative with terms that offset the terms and embedded options, if any, in the loan to member. For example, the Bank may hedge a fixed-rate loan to member with an interest-rate swap where the Bank pays a fixed-rate coupon and receives a floating-rate coupon, effectively converting the fixed-rate loan to member to a floating-rate loan to member. This type of hedge is treated as a fair-value hedge under SFAS 133.
Mortgage Loans Held for Portfolio. The Bank invests in fixed-rate mortgage loans. The prepayment options embedded in mortgage loans can result in extensions or contractions in the expected repayment of these loans, depending on changes in estimated prepayment speeds. The Bank manages the interest rate and prepayment risk associated with mortgages through a combination of debt issuance and derivatives. The Bank issues both callable and non-callable debt and prepayment linked consolidated obligations to achieve cash flow patterns and liability durations similar to those expected on the mortgage loans.
The Bank may also purchase interest rate caps and floors, swaptions and callable swaps to minimize the prepayment risk embedded in the mortgage loans. Although these derivatives are valid economic hedges against the prepayment risk of the loans, they are not specifically linked to individual loans and, therefore, do not receive either fair value or cash flow hedge accounting. The derivatives are marked-to-market through current period earnings.
Consolidated Obligations. While consolidated obligations are the joint and several obligations of the FHLBanks, each FHLBank has consolidated obligations for which it is the primary obligor. The Bank enters into derivatives to hedge the interest rate risk associated with its specific debt issuances.
For instance, in a typical transaction, fixed-rate consolidated obligations are issued for one or more FHLBanks and the Bank simultaneously enters into a matching derivative in which the counterparty pays fixed cash flows to the Bank designed to mirror in timing and amount the cash outflows the Bank pays on the consolidated obligation. The
Notes to Financial Statements (continued)
Bank pays a variable cash flow that closely matches the interest payments it receives on short-term or variable-rate loans to members, typically three-month LIBOR. These transactions are treated as fair-value hedges under SFAS 133. The Bank may issue variable-rate consolidated obligations - bonds indexed to LIBOR, the U.S. Prime rate, or federal funds rate and simultaneously execute interest-rate swaps to hedge the basis risk of the variable rate debt. This intermediation between the capital and derivative markets permits the Bank to raise funds at lower costs than would otherwise be available through the issuance of simple fixed- or floating-rate consolidated obligations in the capital markets.
Anticipated Streams of Future Cash Flows. The Bank may enter into an option to hedge a specified future variable cash stream as a result of rolling over short-term, fixed-rate financial instruments such as consolidated obligation discount notes. The option will effectively cap the variable cash stream at a predetermined target rate. At December 31, 2008 and 2007, the Bank did not have a position in these types of options.
Firm Commitment Strategies. In accordance with SFAS 149, certain mortgage purchase commitments entered into after June 30, 2003, are considered derivatives. The Bank normally hedges these commitments by selling TBA MBS or other derivatives for forward settlement. A TBA represents a forward contract for the sale of MBS at a future agreed upon date for an established price. The mortgage purchase commitment and the TBA used in the firm commitment hedge strategy (economic hedge) are recorded as a derivative asset and derivative liability at fair value, with changes in fair value recognized in current-period earnings. When the mortgage purchase commitment derivative settles, the current market value of the commitment is included with the basis of the mortgage loan and amortized accordingly.
The Bank may also fair value hedge an unrecognized firm commitment to provide a forward starting loan to a member through the use of an interest rate swap. For firm commitments that are not considered regular way trades, the swap will function as the hedging instrument for both the unrecognized firm commitment and the subsequent loan to member in separately designated qualifying hedging relationships.
Anticipated Debt Issuance. The Bank may enter into interest rate swaps for the anticipated issuance of fixed-rate consolidated obligation bonds to lock in the cost of funding. The interest rate swap is terminated upon issuance of the fixed-rate bond, with the realized gain or loss on the interest rate swap recorded in other comprehensive income. Realized gains and losses reported in accumulated other comprehensive income (loss) are recognized as earnings in the periods in which earnings are affected by the cash flows of the fixed-rate bonds. The Bank did not enter into any such transactions during the years ended December 31, 2008, 2007 and 2006.
Intermediation. To assist our members in meeting their hedging needs, the Bank may act as an intermediary between the members and other counterparties by entering into offsetting derivatives. This intermediation allows smaller members indirect access to the derivatives market. Derivatives in which the Bank is an intermediary arise when the Bank (1) enters into derivatives with members and offsetting derivatives with other counterparties to meet the needs of members and (2) enters into derivatives to offset the economic effect of other derivatives that are no longer designated to either loans to members, investments, or consolidated obligations.
The notional principal of derivatives in which the Bank was an intermediary was $2.8 million and $7.6 million at December 31, 2008 and 2007, respectively.
Credit Risk. The Bank is subject to credit risk due to the risk of nonperformance by counterparties to the derivative agreements. The degree of counterparty risk depends on the extent to which master netting arrangements are included in such contracts to mitigate the risk. The Bank manages counterparty credit risk through credit analysis, collateral requirements and adherence to the requirements set forth in the Board’s policy and Finance Board regulations. Based on credit analyses and collateral requirements, the management of the Bank does not anticipate any material credit losses on its derivative agreements.
The contractual or notional amount of derivatives reflects the involvement of the Bank in the various classes of financial instruments. The notional amount of derivatives does not measure the credit risk exposure of the Bank, and the maximum credit exposure of the Bank is substantially less than the notional amount. The Bank requires collateral agreements on all derivatives that establish collateral delivery thresholds. The maximum credit risk is the
Notes to Financial Statements (continued)
estimated fair value (i.e., carrying value) of the derivative contracts that have a net positive market value if the counterparty defaults, and the related collateral, if any, is of no value to the Bank. At December 31, 2008 and 2007, the Bank’s maximum credit risk, as defined above, was approximately $38.7 million and $240.6 million, respectively. These totals include $10.2 million and $72.0 million, respectively, of net accrued interest receivable. In determining maximum credit risk, the Bank considers accrued interest receivables and payables, and the legal right to offset derivative assets and liabilities by counterparty. The Bank held cash of $9.8 million and $192.9 million as collateral as of December 31, 2008 and 2007, respectively. Four counterparties comprise 91.0% of the Bank’s total credit risk when measured after consideration for related collateral as of December 31, 2008. Additionally, collateral with respect to derivatives with member institutions includes collateral assigned to the Bank, as evidenced by a written security agreement and held by the member institution for the benefit of the Bank.
The Bank transacts most of its derivatives with large banks and major broker-dealers. Some of these banks and broker-dealers or their affiliates buy, sell, and distribute consolidated obligations. See Note 22 for further discussion regarding assets pledged by the Bank to these counterparties.
Note 12 -
Premises, Software and Equipment
Depreciation and amortization expense was $5.1 million, $5.1 million and $3.4 million for the years ended December 31, 2008, 2007 and 2006, respectively. Gains and losses on disposal of premises and equipment are included in “other income (loss)” on the Statement of Operations. There was no net realized gain (loss) on disposal of premises and equipment for the years ended December 31, 2008, 2007 and 2006.
Software amortization expense was $3.7 million, $3.6 million and $2.2 million for the years ended December 31, 2008, 2007 and 2006, respectively. The unamortized software balance was $19.5 million and $20.5 million at December 31, 2008 and 2007, respectively.
During the years ended December 31, 2008 and 2007, the Bank capitalized $3.0 million and $6.4 million, respectively, in costs associated with computer software being developed for internal use.
Note 13 -
Deposits
The Bank offers demand and overnight deposits to both members and qualifying nonmembers and term deposits to members. Noninterest-bearing demand and overnight deposits are comprised of funds collected by members pending disbursement to the mortgage loan holders, as well as member funds deposited at the Federal Reserve Bank.
Interest-bearing deposits classified as demand and overnight pay interest based on a daily interest rate. Term deposits pay interest based on a fixed rate determined at the issuance of the deposit. The average interest rates paid
Notes to Financial Statements (continued)
on average deposits during 2008 and 2007 were 1.87% and 4.93%, respectively. The following table details interest-bearing and noninterest-bearing deposits as of December 31, 2008 and 2007.
The aggregate amount of time deposits with a denomination of $100 thousand or more was $15.7 million and $200 thousand as of December 31, 2008 and 2007, respectively.
Note 14 -
Borrowings
Securities Sold Under Agreements to Repurchase. Historically, the Bank has sold securities under repurchase agreements. The amounts received under these agreements represent short-term borrowings and are classified as liabilities on the Statement of Condition. The Bank has delivered securities sold under agreements to repurchase to the primary dealer. Should the market value of the underlying securities fall below the market value required as collateral, the Bank may be required to deliver additional securities to the dealer. The Bank had no securities sold under agreements to repurchase at December 31, 2008 and 2007.
Loans from Other FHLBanks. There were no loans from other FHLBanks outstanding at December 31, 2008 and 2007.
Note 15 -
Consolidated Obligations
Consolidated obligations consist of consolidated bonds and discount notes, and as provided by the Act or Finance Agency regulation, are backed only by the financial resources of the FHLBanks. The FHLBanks issue consolidated obligations through the OF as their agent. In connection with each debt issuance, each FHLBank specifies the amount of debt it wants to be issued on its behalf. The OF tracks the amount of debt issued on behalf of each FHLBank. In addition, the Bank separately tracks and records as a liability its specific portion of consolidated obligations for which it is the primary obligor. The Finance Agency and the U.S. Secretary of the Treasury have oversight over the issuance of FHLBank debt through the OF. Consolidated bonds are issued primarily to raise intermediate and long-term funds for the FHLBanks and are not subject to any statutory or regulatory limits on their maturity. Consolidated discount notes are issued primarily to raise short-term funds. These notes sell at less than their face amount and are redeemed at par value when they mature.
Although the Bank is primarily liable for its portion of consolidated obligations (i.e., those issued on its behalf), the Bank is also jointly and severally liable with the other eleven FHLBanks for the payment of principal and interest on all consolidated obligations of each of the FHLBanks. The Finance Agency, at its discretion, may require any FHLBank to make principal or interest payments due on any consolidated obligations whether or not the consolidated obligation represents a primary liability of such FHLBank. Although it has never occurred, to the extent that an FHLBank makes any payment on a consolidated obligation on behalf of another FHLBank that is primarily liable for such consolidated obligation, Finance Agency regulations provide that the paying FHLBank is entitled to reimbursement from the non-complying FHLBank for any payments made on its behalf and other associated costs (including interest to be determined by the Finance Agency). However, if the Finance Agency determines that the non-complying FHLBank is unable to satisfy its repayment obligations, then the Finance
Notes to Financial Statements (continued)
Agency may allocate the outstanding liabilities of the non-complying FHLBank among the remaining FHLBanks on a pro rata basis in proportion to each FHLBank’s participation in all consolidated obligations outstanding. The Finance Agency reserves the right to allocate the outstanding liabilities for the consolidated obligations between the FHLBanks in any other manner it may determine to ensure that the FHLBanks operate in a safe and sound manner.
The par amounts of the 12 FHLBanks’ outstanding consolidated obligations, including consolidated obligations held by other FHLBanks, were $1.3 trillion and $1.2 trillion at December 31, 2008 and 2007, respectively. Regulations require the Bank to maintain unpledged qualifying assets equal to its participation of the consolidated obligations outstanding. Qualifying assets are defined as cash; secured loans to members; assets with an assessment or rating at least equivalent to the current assessment or rating of the consolidated obligations; obligations of or fully guaranteed by the United States, obligations, participations, or other instruments of or issued by Fannie Mae or Ginnie Mae; mortgages, obligations or other securities which are or have ever been sold by Freddie Mac under the Act; and such securities as fiduciary and trust funds may invest in under the laws of the state in which the Bank is located. Any assets subject to a lien or pledge for the benefit of holders of any issue of consolidated obligations are treated as if they are free from lien or pledge for purposes of compliance with these regulations.
To provide the holders of consolidated obligations issued before January 29, 1993 (prior bondholders), the protection equivalent to that provided under the FHLBanks’ previous leverage limit of twelve times the FHLBanks’ capital stock, prior bondholders have a claim on a certain amount of the qualifying assets, referred to as the Special Asset Account (SAA), if regulatory capital stock is less than 8.33% of consolidated obligations. Mandatorily redeemable capital stock is considered capital stock for determining the FHLBanks’ compliance with this requirement. At December 31, 2008 and 2007, the FHLBanks’ regulatory capital stock was 4.4% and 4.3%, respectively, of the par value of consolidated obligations outstanding. Further, the regulations require each FHLBank to transfer qualifying assets in the amount of its allocated share of the FHLBanks’ SAA to a trust for the benefit of the prior bondholders if its capital-to-assets ratio falls below 2.0%. As of December 31, 2008 and 2007, no FHLBank had a capital-to-assets ratio less than 2.0%; therefore, no assets were being held in a trust. In addition, no trust has ever been established as a result of this regulation because the ratio has never fallen below 2.0%.
General Terms. Consolidated obligations are issued with either fixed-rate coupon payment terms or variable-rate coupon payment terms that use a variety of indices for interest rate resets including LIBOR, Constant Maturity Treasury (CMT), Treasury Bills (T-Bills), the Prime rate, 11th District Cost of Funds Index (COFI) and others. To meet the expected specific needs of certain investors in consolidated obligations, both fixed-rate bonds and variable-rate bonds may contain features, which may result in complex coupon payment terms and call options. When such consolidated obligations are issued, the Bank may enter into derivatives containing offsetting features that effectively convert the terms of the bond to those of a simple variable-rate bond or a fixed-rate bond. The Bank has no outstanding consolidated obligations denominated in currencies other than U.S. dollars.
These consolidated obligations, beyond having fixed-rate or simple variable-rate coupon payment terms, may also have the following broad terms regarding either principal repayment or coupon payment terms:
Indexed Principal Redemption Bonds (index amortizing notes) repay principal according to predetermined amortization schedules that are linked to the level of a certain index. A form of an indexed principal redemption bond that is common to the Bank is an Amortizing Prepayment Linked Security (APLS). The APLS redeems based on the prepayments of Fannie Mae, Freddie Mac, Ginnie Mae or private label reference pools. As of December 31, 2008 and 2007, most of the index amortizing notes had fixed-rate coupon payment terms. Usually, as market interest rates rise (fall), the average life of the index amortizing notes extends (contracts).
Optional Principal Redemption Bonds (callable bonds) that the Bank may redeem in whole or in part at its discretion on predetermined call dates according to the terms of the bond offerings.
Notes to Financial Statements (continued)
Interest Rate Payment Terms. With respect to interest payments, consolidated obligation bonds may also have the following terms:
Step-up Bonds generally pay interest at increasing fixed rates at specified intervals over the life of the bond. These bonds generally contain provisions enabling the Bank to call bonds at its option on the step-up dates;
Inverse Floating Bonds have coupons that increase as an index declines and decrease as an index rises;
Conversion Bonds have coupons that the Bank may convert from fixed to floating, or floating to fixed, or from one U.S. or other currency index to another, at its discretion on predetermined dates according to the terms of the bond offerings;
Range Bonds pay interest at fixed or variable rates provided a specified index is within a specified range. The computation of the variable interest rate differs for each bond issue, but the bond generally pays zero interest or a minimal rate of interest if the specified index is outside the specified range;
Zero-Coupon Bonds are long-term discounted instruments that earn a fixed yield to maturity or the optional principal redemption date. All principal and interest are paid at maturity or on the optional principal redemption date, if exercised prior to maturity. The par value of the zero-coupon bonds in the following tables represents the principal due at maturity as opposed to the optional principal redemption values.
The following table details interest rate payment terms for consolidated obligation bonds.
Maturity Terms. The following is a summary of the Bank’s participation in consolidated obligation bonds outstanding by year of contractual maturity.
Notes to Financial Statements (continued)
The Bank’s consolidated obligation bonds included:
The following table summarizes consolidated obligation bonds outstanding by year of contractual maturity or next call date.
Consolidated Discount Notes. Consolidated discount notes are issued to raise short-term funds. Discount notes are consolidated obligations with original maturities up to 365 days. These notes are issued at less than their face amount and redeemed at par value when they mature. The Bank’s participation in consolidated discount notes, all of which are due within one year, was as follows:
See Note 22 for discussion regarding the Bank’s Lending Agreement with the U.S. Treasury.
Notes to Financial Statements (continued)
Note 16 - Affordable Housing Program
Section 10(j) of the Act requires each Bank to establish an AHP. Each FHLBank provides subsidies in the form of direct grants and/or below-market interest rate loans to members who use the funds to assist in the purchase, construction or rehabilitation of housing for very low-, low-, and moderate-income households. Annually, the FHLBanks must set aside for the AHP the greater of $100 million or ten percent of regulatory income. Regulatory income is defined as income under GAAP before interest expense related to mandatorily redeemable capital stock under SFAS 150 and the assessment for AHP, but after the assessment for REFCORP. The exclusion of interest expense related to mandatorily redeemable capital stock is based on an advisory bulletin issued by the regulators. The AHP and REFCORP assessments are calculated simultaneously because of their interdependence on each other. The Bank accrues this expense monthly based on income before assessments. The Bank reduces the AHP liability as members use subsidies. The calculation of the REFCORP assessment is discussed in Note 17.
If the Bank experienced a net regulatory loss during a quarter, but still had net regulatory income for the year, the Bank’s obligation to the AHP would be calculated based on the Bank’s year-to-date net regulatory income. If the Bank had regulatory income in subsequent quarters, it would be required to contribute additional amounts to meet its calculated annual obligation. If the Bank experienced a regulatory loss for a full year, the Bank would have no obligation to the AHP for the year since each FHLBank’s required annual AHP contribution is limited to its annual net earnings. If the aggregate ten percent calculation described above was less than $100 million for all twelve FHLBanks, each FHLBank would be required to assure that the aggregate contributions of the FHLBanks equal $100 million. The proration would be made on the basis of an FHLBank’s income in relation to the income of all FHLBanks for the previous year. Each FHLBank’s required annual AHP contribution is limited to its annual net income. There was no shortfall in 2008, 2007 or 2006. If an FHLBank finds that its required contributions are contributing to the financial instability of that FHLBank, it may apply to the Finance Agency for a temporary suspension of its contributions. The Bank did not make such an application in 2008, 2007 or 2006. The Bank had outstanding principal in AHP-related loans to members of $9.6 million and $10.0 million at December 31, 2008 and 2007, respectively.
For the years ended December 31, 2008 and 2007, the Bank added $2.2 million and $26.4 million, respectively, to its AHP liability as a result of annual assessments. Also, during the years ended December 31, 2008 and 2007, the Bank expended $18.7 million and $15.8 million, respectively, for qualifying AHP subsidies on a net basis. Further detail regarding Bank-specific AHP programs is provided in the following rollforward table.
Rollforward of the AHP Liability
Notes:
(1)
First Front Door - The Bank allocates a portion of the AHP subsidy pool on an annual basis to this program, which benefits qualifying first-time homebuyers.
(2)
Home Rehabilitation Program - A pilot program for 2007, which provides housing repair and rehabilitation assistance to homeowners with income at or below 80% of the area median income.
Notes to Financial Statements (continued)
(3)
Outstanding commitments for approved projects were $40.5 million and $31.5 million at December 31, 2008 and 2007, respectively.
Note 17 - Resolution Funding Corporation (REFCORP)
Each FHLBank is required to pay quarterly to the REFCORP twenty percent of income calculated in accordance with GAAP after the assessment for AHP, but before the assessment for REFCORP. The AHP and REFCORP assessments are calculated simultaneously because of their interdependence on each other. The Bank accrues its REFCORP assessment on a monthly basis. Calculation of the AHP assessment is discussed in Note 16. The Resolution Funding Corporation has been designated as the calculation agent for AHP and REFCORP assessments. Each FHLBank provides their net income before AHP and REFCORP to the Resolution Funding Corporation, who then performs the calculations for each quarter-end.
The FHLBanks will continue to be obligated to these amounts until the aggregate amounts actually paid by all twelve FHLBanks are equivalent to a $300 million annual annuity (or a scheduled benchmark payment of $75 million per quarter) whose final maturity date is April 15, 2030, at which point the required payment of each FHLBank to REFCORP will be fully satisfied. The cumulative amount to be paid to REFCORP by the Bank is not determinable at this time because it depends on the future earnings of all FHLBanks and interest rates. If the Bank experienced a net loss during a quarter, but still had net income for the year, the Bank’s obligation to the REFCORP would be calculated based on the Bank’s year-to-date GAAP net income. The Bank would be entitled to use the overpayment of amounts paid for the full year that were in excess of its calculated annual obligation as a credit against future REFCORP assessments. If the Bank experienced a net loss for a full year, the Bank would have no obligation to the REFCORP for the year. The Finance Agency is required to extend the term of the FHLBanks’ obligation to the REFCORP for each calendar quarter in which there is a deficit quarterly payment. A deficit quarterly payment is the amount by which the actual quarterly payment falls short of $75 million.
The FHLBanks’ aggregate payments through 2008 exceeded the scheduled payments, effectively accelerating payment of the REFCORP obligation and shortening its expected remaining term to April 15, 2013, effective December 31, 2008. The FHLBanks’ aggregate payments through 2008 have satisfied $42.5 million of the $75.0 million scheduled payment due on April 15, 2013 and all scheduled payments thereafter. This date assumes that the FHLBanks will pay exactly $300 million annually after December 31, 2008 until the annuity is satisfied.
The benchmark payments or portions of the payments could be reinstated if the actual REFCORP payments of the FHLBanks fall short of $75 million in a quarter. The maturity date of the REFCORP obligation may be extended beyond April 15, 2030, if such extension is necessary to ensure that the value of the aggregate amounts paid by the FHLBanks exactly equals a $300 million annual annuity. Any payment beyond April 15, 2030, will be paid to the U.S. Department of Treasury.
In 2008, the Bank overpaid its 2008 REFCORP assessment as a result of the loss recognized in fourth quarter 2008. As instructed by the U.S. Treasury, the Bank will use its overpayment as a credit against future REFCORP assessments (to the extent the Bank has positive net income in the future) over an indefinite period of time. This overpayment was recorded as deferred assets by the Bank and reported as “prepaid REFCORP assessment” on the Statement of Condition at December 31, 2008. Over time, as the Bank uses this credit against its future REFCORP assessments, the deferred asset will be reduced until the deferred asset has been exhausted. If any amount of the deferred asset still remains at the time that the REFCORP obligation for the FHLBank System as a whole is fully satisfied, REFCORP, in consultation with the U.S. Treasury, will implement a procedure so that the Bank would be able to collect on its remaining deferred asset. The Bank’s prepaid REFCORP assessment balance at December 31, 2008 was $39.6 million.
Note 18 - Capital
The Bank is subject to three capital requirements under the current capital plan structure. The Bank shall maintain at all times permanent capital in an amount at least equal to the sum of its credit risk, market risk and
Notes to Financial Statements (continued)
operations risk capital requirements, calculated in accordance with the Finance Agency regulations. Only permanent capital, defined as retained earnings plus capital stock, satisfies the risk-based capital requirement. The Finance Agency may require the Bank to maintain a greater amount of permanent capital than is required by the risk-based capital requirements, as defined. In addition, the GLB Act requires the Bank to maintain at all times at least a 4.0% capital-to-asset ratio and at least a 5.0% leverage ratio, defined as the sum of permanent capital weighted 1.5 times plus loan loss reserves divided by total assets.
The following table demonstrates the Bank’s compliance with these capital requirements at December 31, 2008 and 2007:
Under the capital plan, member institutions are required to maintain holdings of capital stock in the Bank in an amount equal to no less than the sum of three amounts: (1) a specified percentage of their outstanding loans from the Bank; (2) a specified percentage of their unused borrowing capacity (defined generally as the remaining collateral value that can be borrowed against) with the Bank; and (3) a specified percentage of the principal balance of residential mortgage loans previously sold to the Bank and still held by the Bank (any increase in this percentage will be applied on a prospective basis only). These specified percentages may be adjusted by the Bank’s Board within pre-established ranges as contained in the capital plan.
The stock purchase requirement for unused borrowing capacity is referred to as the membership capital stock purchase requirement because it applies to all members. The other two stock purchase requirements are referred to as activity-based requirements. The Bank determines membership capital stock purchase requirements by considering the aggregate amount of capital necessary to prudently capitalize the Bank’s business activities. The amount of capital is dependent upon the size of the current balance sheet, expected members’ borrowing requirements and other forecasted balance sheet changes.
The GLB Act made membership voluntary for all members. The Bank issues stock that may be redeemed subject to certain restrictions by giving five years’ notice. The Bank is not required to redeem activity-based stock until the latter of the expiration of the notice of redemption or the activity no longer remains outstanding. Activity-based stock becomes excess stock when the associated activity no longer remains outstanding. In addition to capital stock redemptions, the Bank may also, in its discretion, repurchase excess capital stock from members from time to time. On December 23, 2008, the Bank announced that it had suspended excess capital stock repurchases until further notice. Before being readmitted to membership in any FHLBank, a member that withdraws from membership must wait five years from the divestiture date for all capital stock that is held as a condition of membership, as that requirement is set out in the Bank’s capital plan. A member may cancel or revoke its written notice of redemption or its notice of withdrawal from membership prior to the end of the five-year redemption period. The Bank’s capital plan provides that the Bank may charge the member a cancellation fee. The Board may change the cancellation fee with prior written notice to members.
Notes to Financial Statements (continued)
Capital Concentrations. The following table presents member holdings of ten percent or more of the Bank’s total capital stock including mandatorily redeemable capital stock outstanding as of December 31, 2008 and 2007.
Mandatorily Redeemable Capital Stock. Once a member exercises a written redemption right, gives notice of intent to withdraw from membership, or attains nonmember status by merger or acquisition, charter termination, or involuntary termination from membership, the Bank reclassifies the stock subject to mandatory redemption from equity to liability at fair value. Dividends related to capital stock classified as a liability are accrued at the expected dividend rate and reported as interest expense in the Statement of Operations. The repayment of these mandatorily redeemable financial instruments is reflected as a cash outflow in the financing activities section of the Statement of Cash Flows. If a member cancels its written notice of redemption or notice of withdrawal, the Bank reclassifies mandatorily redeemable capital stock from a liability to equity in compliance with SFAS 150. After the reclassification, dividends on the capital stock are no longer classified as interest expense.
The Finance Agency has confirmed that the liability accounting treatment for certain shares of its capital stock does not affect the definition of total capital for purposes of determining the Bank’s compliance with its regulatory capital requirements, calculating its mortgage securities investment authority (300% of total capital), calculating its unsecured credit exposure limit to other government-sponsored enterprises (100% of total capital), or calculating its unsecured credit limits to other counterparties (various percentages of total capital depending on the rating of the counterparty).
At December 31, 2008 and 2007 the Bank had $4.7 million and $3.9 million in capital stock subject to mandatory redemption with payment subject to a five-year waiting period and the Bank meeting its minimum regulatory capital requirements. For the years ended December 31, 2008, 2007 and 2006, dividends on mandatorily redeemable capital stock in the amount of $148 thousand, $393 thousand and $1.4 million, respectively, were recorded as interest expense. There have been no reclassifications of mandatorily redeemable capital stock back into capital.
As of December 31, 2008, the total mandatorily redeemable capital stock reflected balances for five institutions. One institution was in receivership and one had notified the Bank to voluntarily redeem their capital stock and withdraw from membership. In addition, one other institution was taken over by the FDIC and its charter was dissolved. The remaining two institutions were merged out of district and are considered nonmembers. These redemptions were not complete as of December 31, 2008. The following table shows the amount of mandatorily redeemable capital stock by contractual year of redemption.
Notes to Financial Statements (continued)
The year of redemption in the table above is the later of the end of the five-year redemption period or the maturity date of the activity the stock is related to, if the capital stock represents the activity-based stock purchase requirement of a nonmember (former member that withdrew from membership, merged into a nonmember or was otherwise acquired by a nonmember).
In 2008 and 2007, the Bank repurchased $53.7 million and $9.3 million of capital stock related to out-of-district mergers. As noted above, effective December 23, 2008, repurchases of excess capital stock have been suspended until further notice.
The following table provides the number of stockholders and the related dollar amounts for activities recorded in mandatorily redeemable stock during 2008, 2007 and 2006.
Dividends and Retained Earnings. At December 31, 2008, retained earnings stood at $170.5 million, representing a decrease of $125.8 million, or 42.5%, from December 31, 2007.
The Finance Agency has issued regulatory guidance to the FHLBanks relating to capital management and retained earnings. The guidance directs each FHLBank to assess, at least annually, the adequacy of its retained earnings with consideration given to future possible financial and economic scenarios. The guidance also outlines the considerations that each FHLBank should undertake in assessing the adequacy of the Bank’s retained earnings.
All dividend payments are subject to Board approval. Dividends may be paid in either capital stock or cash; historically, the Bank has paid cash dividends only. In September 2008, the Bank revised its retained earnings policy and added a new capital adequacy metric, including a floor and target for this metric and a requirement to establish an implementation plan to reach the target and restrict dividend payments during the period the plan is in place. As announced on December 23, 2008, the Bank has suspended dividend payments at this point.
Statutory and Regulatory Restrictions on Capital Stock Redemption. In accordance with the GLB Act, Bank stock is considered putable with restrictions given the significant restrictions on the obligation/right to redeem and the limitation of the redemption privilege to a small fraction of outstanding stock. Statutory and regulatory restrictions on the redemption of Bank stock include the following:
•
In no case may the Bank redeem any capital stock if, following such redemption, the Bank would fail to satisfy its minimum capital requirements (i.e., a statutory capital/asset ratio requirement, established by the GLB Act, and a regulatory risk-based capital-to-asset ratio requirement established by the Finance Agency). By law, all member holdings of Bank stock immediately become non-redeemable if the Bank becomes undercapitalized and only a minimal portion of outstanding stock qualifies for redemption consideration.
•
In no case may the Bank redeem any capital stock if either its Board or the Finance Agency determine that it has incurred, or is likely to incur, losses resulting, or expected to result, in a charge against capital while such charges are continuing or expected to continue.
Notes to Financial Statements (continued)
•
The Board has a statutory obligation to review and adjust member capital stock requirements in order to comply with the Bank’s minimum capital requirements, and each member must comply promptly with any such requirement.
•
In addition to possessing the authority to prohibit stock redemptions, the Bank’s Board has a right to call for additional capital stock purchases by its members as a condition of membership, as needed to satisfy statutory and regulatory capital requirements under the GLB Act.
•
If, during the period between receipt of a stock redemption notification from a member and the actual redemption (which may last indefinitely if the Bank is undercapitalized, does not have the required credit rating, etc.), the Bank becomes insolvent and is either liquidated or forced to merge with another FHLBank, the redemption value of the stock will be established through the liquidation process or through negotiation with the merger partner.
•
The GLB Act states that the Bank may repurchase, in its sole discretion, stock investments which exceed the required minimum amount.
•
In no case may the Bank redeem or repurchase any capital stock if the principal or interest payment due on any consolidated obligation issued by the OF has not been paid in full.
•
In no case may the Bank redeem or repurchase any capital stock if the Bank has failed to provide the Finance Agency with the necessary quarterly certification required by Section 966.9(b)(1) of the Finance Agency’s regulations prior to declaring or paying dividends for a quarter.
•
In no case may the Bank redeem or repurchase any capital stock if the Bank is unable to provide the required certification, projects that it will fail to comply with statutory or regulatory liquidity requirements or will be unable to timely and fully meet all of its current obligations, actually fails to satisfy these requirements or obligations, or negotiates to enter or enters into an agreement with another Bank to obtain financial assistance to meet its current obligations.
On January 30, 2009, the Finance Agency issued an Interim Final Regulation implementing provisions of the Housing Act requiring the establishment of a minimum critical capital level for the FHLBanks and prompt corrective action mechanisms by the Finance Agency for an FHLBank that fails to meet the minimum capital requirements. The Interim Final Regulation does not change the existing risk-based, leverage and total capital requirements. See “Legislative and Regulatory Developments” in Item 7. Management’s Discussion and Analysis for additional details.
Note 19 - Employee Retirement Plans
The Bank participates in the Pentegra Defined Benefit Plan for Financial Institutions (Pentegra Defined Benefit Plan), a tax qualified defined benefit pension plan. The plan covers substantially all officers and employees of the Bank. Funding and administrative costs of the Pentegra Defined Benefit Plan charged to other operating expense were $3.4 million, $4.2 million, and $4.0 million for the years ended December 31, 2008, 2007, and 2006, respectively. The Pentegra Defined Benefit Plan is a multi-employer plan in which assets contributed by one participating employer may be used to provide benefits to employees of other participating employers since assets contributed by an employer are not segregated in a separate account or restricted to provide benefits only to employees of that employer. As a result, disclosure and accounting of the accumulated benefit obligations, plan assets, and the components of annual pension expense attributable to the Bank cannot be made.
The Bank also participates in the Pentegra Defined Contribution Plan for Financial Institutions, a tax qualified defined contribution pension plan. The Bank’s contributions consist of a matching contribution equal to a percentage of voluntary employee contributions, subject to certain limitations. The Bank contributed $900 thousand, $824 thousand and $728 thousand for the years ended December 31, 2008, 2007, and 2006, respectively.
Notes to Financial Statements (continued)
In addition, the Bank maintains nonqualified deferred compensation plans, available to select employees and directors, which are, in substance, unfunded supplemental defined contribution retirement plans. The plans’ liabilities consist of the accumulated compensation deferrals and accrued earnings (losses) on the deferrals. The Bank’s minimum obligation from these plans was $6.6 million and $8.3 million at December 31, 2008 and 2007, respectively. Operating expense includes deferred compensation and accrued earnings (losses) of $(493) thousand, $1.8 million and $1.8 million for the years ended December 31, 2008, 2007 and 2006, respectively. The Bank owns mutual funds held in a Rabbi Trust to offset the earnings (losses) of certain deferred compensation agreements. See Note 5 for more information.
Postretirement Benefits. The Bank sponsors a retiree benefits program that includes health care and life insurance benefits for eligible retirees. Employees who retired prior to January 1, 1992, receive health care benefits at the Bank’s expense after age 65. Employees retiring after January 1, 1992, are required to contribute toward the cost of health care benefits above the established expense caps after attaining age 65. A limited life insurance benefit is provided at the Bank’s expense for all retirees. Those employees retiring after January 1, 1992, are also required to meet specific eligibility requirements of age 60 with ten years of service at the time of retirement to be eligible for retiree health and life insurance benefits. The approximate Accumulated Postretirement Benefit Obligation (APBO) as of December 31, 2008 and 2007 was $2.8 million and $2.3 million, respectively.
Supplemental Retirement Plan. The Bank also maintains a Supplemental Retirement Plan, a nonqualified defined benefit retirement plan, for certain executives. The plan ensures, among other things, that participants receive the full amount of benefits to which they would have been entitled under the qualified defined benefit pension plan in the absence of limits on benefits levels imposed by the Internal Revenue Service. The accumulated benefit obligation for the supplemental retirement plan was $2.7 million and $3.3 million at December 31, 2008 and 2007, respectively.
The Bank does not have any plan assets or any unrecognized transitional obligation. The following table sets forth the changes in benefit obligation associated with these defined benefit plans:
Notes to Financial Statements (continued)
Amounts recognized in the Statement of Condition at December 31, 2008 and 2007 consist of:
Amounts recognized in accumulated other comprehensive income at December 31, 2008 and 2007 consist of:
Components of the net periodic benefit cost and other amounts recognized in other comprehensive income for the Bank’s supplemental retirement plan and postretirement health plan for the years ended December 31, 2008, 2007 and 2006, were as follows:
Activity presented in other comprehensive income above began when the Bank adopted SFAS 158 on December 31, 2006. Therefore, only amounts related to 2007 and 2008 are applicable. Prior to adoption, the activity in other comprehensive income attributable to the Supplemental Retirement Plan and the Postretirement Health Benefit Plan were adjustments to the minimum liability; this activity is reported on the Statement of Changes in Capital under the caption “other” for 2006.
Notes to Financial Statements (continued)
The estimated net actuarial loss (gain), prior service cost (benefit) and transition obligation that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year are:
The measurement date used to determine the current year’s benefit obligations was December 31, 2008. Key assumptions used for the actuarial calculation to determine benefit obligations and net periodic benefit cost for the Bank’s supplemental retirement plan and postretirement health benefit plan for the years ended December 31, 2008 and 2007 are presented in the tables below. The discount rate for both plans as of December 31, 2008 was determined by using a discounted cash-flow approach, which incorporates the timing of each expected future benefit payment. The estimate of the future benefit payments is based on the plan’s census data, benefit formula and provisions, and valuation assumptions reflecting the probability of decrement and survival. The present value of the future benefit payments is then determined by using duration based interest rate yields from the Citibank Pension Liability Index as of December 31, 2008 and solving for the single discount rate that produces the same present value.
Assumed health care cost trend rates for the Bank’s postretirement health benefit plan at December 31, 2008 and 2007 are presented in the table below.
The effect of a percentage point increase in the assumed healthcare trend rates would be an increase in postretirement benefit expense of $35 thousand and in APBO of $246 thousand. The effect of a percentage point decrease in the assumed healthcare trend rates would be a decrease in postretirement benefit expense of $29 thousand and in APBO of $210 thousand.
Notes to Financial Statements (continued)
The supplemental retirement plan and postretirement health plan are not funded. Estimated future benefits payments reflecting expected future services for the years ending after December 31, 2008 were as follows:
Note 20 - Transactions with Related Parties
The Bank is a cooperative whose member institutions own the capital stock of the Bank and may receive dividends on their investments. In addition, certain former members that still have outstanding transactions are also required to maintain their investment in Bank capital stock until the transactions mature or are paid off. All loans, including BOB loans, are issued to members and all mortgage loans held for portfolio are purchased from members. The Bank also maintains demand deposit accounts for members primarily to facilitate settlement activities that are directly related to loans to members and mortgage loan purchases. All transactions with members are entered into in the normal course of business. In instances where the member also has an officer or a director who is a director of the Bank, those transactions are subject to the same eligibility and credit criteria, as well as the same terms and conditions, as all other transactions. In accordance with Statement of Financial Accounting Standards No. 57, Related Party Disclosures, the Bank defines related parties as those parties meeting any one of the following criteria: (1) other FHLBanks in the System; (2) members with capital stock outstanding in excess of 10% of total capital stock outstanding; or (3) members and non-member borrowers that have an officer or director who is a director of the Bank.
The following table includes significant outstanding related party member balances.
The following table includes the MPF activity of the related party members.
The following table summarizes the Statement of Operations effects corresponding to the above related party member balances.
Notes to Financial Statements (continued)
Note:
(1)
Reflects balances related to the Bank’s investment in Pennsylvania Housing Finance Agency (PHFA), of which one of the Bank’s elected Independent Directors is the CEO. The Bank owned this investment in 2006; however, it was not considered a related party transaction until PHFA’s CEO joined the Board in 2007. The Bank made additional purchases from PHFA in 2008 and 2007.
Prior to May 1, 2006, the Bank regularly sold participation interests in the mortgage loans purchased from members to the FHLBank of Chicago. Upon execution of the service agreement, which became effective May 1, 2006, both parties agreed to discontinue the practice and a transaction services fee is now being paid to the FHLBank Chicago in lieu of the participation. A new service agreement was executed on August 31, 2007 under which the Bank pays transaction services fees to FHLBank of Chicago. A minimum level of annual transaction service fees was established by FHLBank of Chicago; the Bank exceeded this minimum in 2008. On June 30, 2008, the Bank agreed to purchase up to $300 million of 100% participation interest in new MPF loans from FHLBank of Chicago. The agreement expired October 31, 2008; the Bank purchased $218.0 million of commitments as of October 31, 2008 and all were funded as of December 31, 2008.
The following table summarizes the effect of the MPF activities with FHLBank of Chicago.
From time to time, the Bank may borrow from or lend to other FHLBanks on a short-term uncollateralized basis. See Note 14 for further information. The following table includes gross amounts transacted under these arrangements for the years ended December 31, 2008, 2007 and 2006. As of December 31, 2007, the Bank had $500 million reported as Loans to Other FHLBanks on the Statement of Condition. This balance was repaid on January 2, 2008.
On occasion, two FHLBanks may agree to sell at fair value its primary debt obligations to another FHLBank, which becomes the primary obligor on the transferred debt upon completion of the transfer. During the year ended December 31, 2008, the Bank purchased the debt of other FHLBanks having a total par value of $300.0 million and a total fair value of $314.0 million. During the years ended December 31, 2006 and 2007, there were no sales of debt between the Bank and another FHLBank.
From time to time, a member of one FHLBank may be acquired by a member of another FHLBank. When such an acquisition occurs, the two FHLBanks may agree to transfer at fair value the loans of the acquired member to the FHLBank of the surviving member. The FHLBanks may also agree to the purchase and sale of any related hedging instrument. The Bank had no such activity during 2008, 2007 or 2006.
Notes to Financial Statements (continued)
Note 21 - Estimated Fair Values
As discussed in Note 2 to the financial statements, the Bank adopted SFAS 157 and SFAS 159 on January 1, 2008. SFAS 157 provides a single definition of fair value, establishes a framework for measuring fair value, and requires expanded disclosures about fair value. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements, but does not change existing guidance as to whether or not an instrument is carried at fair value. SFAS 159 provides companies with an option to elect fair value as an alternative measurement for selected financial assets, financial liabilities, unrecognized firm commitments, and written loan commitments not previously carried at fair value. It requires entities to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. Under SFAS 159, fair value is used for both the initial and subsequent measurement of the designated assets, liabilities and commitments, with the changes in fair value recognized in net income. The Bank has not elected the fair value option on any financial assets or liabilities under SFAS 159.
According to SFAS 157, fair value is defined as the price that would be received to sell an asset, or paid to transfer a liability, (i.e., an exit price) in an orderly transaction between market participants at the measurement date in the principal (or most advantageous) market for the asset or liability. SFAS 157 established a fair value hierarchy to prioritize the inputs of valuation techniques used to measure fair value. The inputs are evaluated and an overall level for the measurement is determined. This overall level is an indication of how market observable the fair value measurement is and defines the level of required disclosures.
On a recurring basis, the Bank carries derivatives as well as trading and available-for-sale securities at fair value on the Statement of Condition. Outlined below is the application of the fair value hierarchy established by SFAS 157 to the Bank’s financial assets and financial liabilities that are carried at fair value.
Level 1 - defined as those instruments for which inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. An active market for the asset or liability is a market in which the transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. Certain of the Bank’s trading securities, which consist of publicly traded mutual funds, are considered Level 1 instruments.
Level 2 - defined as those instruments for which inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. The Bank’s derivative instruments and certificates of deposit classified as trading securities are generally considered Level 2 instruments based on the inputs utilized to derive fair value.
Level 3 - defined as those instruments for which inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs are those supported by little or no market activity or by the entity’s own assumptions. As a result of the current market conditions and the use of significant unobservable inputs, the securities in the Bank’s available-for-sale portfolio, which the Bank measures at fair value on a recurring basis, are considered Level 3 instruments.
The Bank utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs.
Notes to Financial Statements (continued)
Fair Value on a Recurring Basis. The following table presents for each SFAS 157 hierarchy level, the Bank’s assets and liabilities that are measured at fair value on a recurring basis on its Statement of Condition at December 31, 2008.
Note:
(1)
Amounts represent the effect of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions and also cash collateral held or placed with the same counterparties.
For instruments carried at fair value, the Bank reviews the fair value hierarchy classifications on a quarterly basis. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities. Such reclassifications are reported as transfers in/out of Level 3 at fair value in the quarter in which the changes occur. The following tables present a reconciliation of all assets and liabilities that are measured at fair value on the Statement of Condition using significant unobservable inputs (Level 3) for the year ended December 31, 2008.
Fair Value on a Nonrecurring Basis. The Bank measures certain held-to-maturity securities at fair value on a nonrecurring basis. These assets are not measured at fair value on an ongoing basis, but are subject to fair value adjustments in certain circumstances (i.e., when there is other-than-temporary impairment).
As presented in Note 7, the Bank recognized other-than-temporary impairment charges during the year ended December 31, 2008. Held-to-maturity securities with a carrying amount of $593.7 million were written down to their fair value of $330.5 million, resulting in an other-than-temporary impairment charge of $263.2 million, which was included in “other income (loss)” on the Statement of Operations for the year ended December 31, 2008. As a result of current market conditions and the use of significant unobservable inputs, these securities are considered Level 3 instruments.
Notes to Financial Statements (continued)
The following table presents these investment securities by level within the SFAS 157 valuation hierarchy, for which a nonrecurring change in fair value has been recorded and the total change in value of these assets for which a fair value adjustment has been included in the Statement of Operations for the year ended December 31, 2008.
Estimated Fair Values. The following estimated fair value amounts have been determined by the Bank using available market information and the Bank’s best judgment of appropriate valuation methods. These estimates are based on pertinent information available to the Bank as of December 31, 2008 and 2007. Although the Bank uses its best judgment in estimating the fair value of these financial instruments, there are inherent limitations in any estimation technique or valuation methodology. For example, because an active secondary market does not exist for a majority of the Bank’s financial instruments, in certain cases fair values are not subject to precise quantification or verification and may change as economic and market factors and evaluation of those factors change. Therefore, these estimated fair values are not necessarily indicative of the amounts that would be realized in current market transactions, although they do reflect the Bank’s judgment of how a market participant would estimate the fair values. In addition to these estimated fair value limitations on specific assets and liabilities, no value has been ascribed to the future business opportunities of the Bank which would be included in an overall valuation of the Bank as a going concern.
Subjectivity of estimates. Estimates of the fair value of advances with options, mortgage instruments, derivatives with embedded options and consolidated obligations bonds with options using the methods described below and other methods are highly subjective and require judgments regarding significant matters such as the amount and timing of future cash flows, prepayment speed assumptions, expected interest rate volatility, methods to determine possible distributions of future interest rates used to value options, and the selection of discount rates that appropriately reflect market and credit risks. Changes in these judgments often have a material effect on the fair value estimates. Since these estimates are made as of a specific point in time, they are susceptible to material near term changes.
Cash and Due From Banks. The estimated fair value approximates the recorded book balance.
Interest-Earning Deposits and Investment Securities. The estimated fair value of non-mortgage-related securities and interest earning deposits is determined based on quoted market prices, when available. When quoted market prices are not available, the Bank estimates the fair value of these instruments by calculating the present value of the expected future cash flows and reducing the amount for accrued interest receivable.
The Bank obtains prices for mortgage-related securities from three third-party pricing services. Typically, these prices are derived using a modified matrix pricing approach. The valuation inputs for matrix pricing basically consist of transaction data relating to other securities whose prices are more readily ascertainable in the market which is used to produce a hypothetical value based on the estimated spread relationship between the securities. In some instances, the fair value of certain securities cannot be determined solely through the use of matrix pricing due to the lack of relevant market data. As a result, the use of unobservable inputs and other qualitative factors is necessary in determining the fair value of these securities. Using the prices received from the third-party pricing services, and in some cases, other available information, the Bank follows an established framework of criteria to determine and validate the fair values. In certain limited instances (e.g., not all third party services provide a price, etc.), the Bank may derive an internally modeled price that is deemed appropriate after consideration of all relevant facts and circumstances.
Federal Funds Sold and Loans to Other FHLBanks. The estimated fair value is determined by calculating the present value of the expected future cash flows. The discount rates used in these calculations are the rates for instruments with similar terms.
Notes to Financial Statements (continued)
Trading Securities. Fair values for publicly traded mutual funds are based on quoted market prices. The estimated fair value of certificates of deposit is determined by calculating the present value of the expected future cash flows. The discount rates used in these calculations are the rates for instruments with similar terms.
Loans to Members. The Bank determines the estimated fair value of loans to members by calculating the present value of expected future cash flows from the loans and excluding the amount for accrued interest receivable. The discount rates used in these calculations are the replacement loan rates for loans to members with similar terms. Under Finance Agency regulations, loans to members with a maturity or repricing period greater than six months require a prepayment fee sufficient to make the Bank financially indifferent to the borrower’s decision to prepay the loans. Therefore, the estimated fair value of loans to members does not assign a value to the ability of the member to prepay the advance.
Mortgage Loans Held For Portfolio. The estimated fair values for mortgage loans are determined based on quoted market prices of similar mortgage instruments. These prices, however, can change rapidly based upon market conditions.
Accrued Interest Receivable and Payable. The estimated fair value approximates the recorded book value. Derivative accrued interest receivable and payable are excluded and are valued as described below.
Derivative Asset/Liabilities. The Bank bases the estimated fair values of derivatives with similar terms on available market prices including derivative accrued interest receivable and payable. However, active markets do not exist for many types of financial instruments. Consequently, fair values for these instruments must be estimated using techniques such as discounted cash flow analysis and comparisons to similar instruments. Estimates developed using these methods are highly subjective and require judgment regarding significant matters such as the amount and timing of future cash flows, volatility of interest rates and the selection of discount rates that appropriately reflect market and credit risks. Changes in these judgments often have a material effect on the fair value estimates. Because these estimates are made as of a specific point in time, they are susceptible to material near-term changes. The Bank is subject to credit risk in derivatives transactions due to potential nonperformance by the derivatives counterparties. To mitigate this risk, the Bank enters into master-netting agreements for interest-rate-exchange agreements with highly-rated institutions. In addition, the Bank has entered into bilateral security agreements with all active derivatives dealer counterparties that provide for delivery of collateral at specified levels tied to counterparty credit ratings to limit the Banks’ net unsecured credit exposure to these counterparties. The Bank has evaluated the potential for the fair value of the instruments to be impacted by counterparty credit risk and has determined that no adjustments were significant or necessary to the overall fair value measurements. If these netted amounts are positive, they are classified as an asset and if negative, a liability.
BOB Loans. The estimated fair value approximates the carrying value.
Deposits. The Bank determines estimated fair values of Bank deposits by calculating the present value of expected future cash flows from the deposits and reducing this amount for accrued interest payable. The discount rates used in these calculations are the cost of deposits with similar terms.
Borrowings. The Bank determines the estimated fair value of borrowings by calculating the present value of expected future cash flows from the borrowings and reducing this amount for accrued interest payable. The discount rates used in these calculations are the cost of borrowings with similar terms.
Consolidated Obligations. The Bank’s internal valuation model determines fair values of consolidated obligations bonds and discount notes by calculating the present value of expected cash flows using market-based yield curves. Adjustments may be necessary to reflect the FHLBanks’ credit quality when valuing consolidated obligations bonds measured at fair value. Due to the joint and several liability of consolidated obligations, the Bank monitors its own creditworthiness and the creditworthiness of the other FHLBanks to determine whether any credit adjustments are necessary in its fair value measurement of consolidated obligations - bonds. The credit ratings of the FHLBanks and any changes to these credit ratings are the basis for the Bank to determine whether the fair values of consolidated obligations bonds have been significantly affected during the reporting period by changes in the
Notes to Financial Statements (continued)
instrument-specific credit risk. Either no adjustment or an immaterial adjustment was made during the year ended December 31, 2008, as deemed appropriate by the Bank.
Mandatorily Redeemable Capital Stock. The fair value of capital stock subject to mandatory redemption is generally equal to par value. Capital stock can be acquired by members only at par value and may be redeemed or repurchased at par value. Capital stock is not traded and no market mechanism exists for the exchange of stock outside the cooperative structure of the Bank.
Commitments. The estimated fair value of the Bank’s unrecognized commitments to extend credit, including standby letters of credit, was immaterial at December 31, 2008 and 2007. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The estimated fair value of standby letters of credit is based on the present value of fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties.
Commitments to Extend Credit for Mortgage Loans. Certain mortgage loan purchase commitments are recorded as derivatives at their fair value.
The carrying value and estimated fair values of the Bank’s financial instruments at December 31, 2008 and 2007 are presented in the tables below.
2008 Fair Value Summary Table
Notes to Financial Statements (continued)
2007 Fair Value Summary Table
Note 22 -
Commitments and Contingencies
As described in Note 15, the twelve FHLBanks have joint and several liability for all the consolidated obligations issued on their behalf. Accordingly, should one or more of the FHLBanks be unable to repay its participation in the consolidated obligations, each of the other FHLBanks could be called upon to repay all or part of such obligations, as determined or approved by the Finance Agency. The Finance Agency, in its discretion and notwithstanding any other provision, may at any time order any FHLBank to make principal or interest payments due on any consolidated obligation, even in the absence of default by the primary obligor. No FHLBank has ever been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank, and as of December 31, 2008 and through the filing date of this report, the Bank does not believe that it is probable that they will be asked to do so.
The FHLBanks considered the guidance under FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FASB Interpretation No. 34 (FIN 45), and determined it was not necessary to recognize the fair value of the FHLBanks’ joint and several liability for all of the consolidated obligations. The Bank considers the joint and several liability as a related party guarantee. Related party guarantees meet the recognition scope exceptions in FIN 45. Accordingly, the Bank has not recognized a liability for its joint and several obligation related to other FHLBanks’ consolidated obligations at December 31, 2008 and 2007. The par amounts of the FHLBanks’ consolidated obligations for which the Bank is jointly and severally liable were approximately $1.3 trillion and $1.2 trillion at December 31, 2008 and 2007, respectively.
Notes to Financial Statements (continued)
During the third quarter of 2008, the Bank entered into a Lending Agreement with the U.S. Treasury in connection with the U.S. Treasury’s establishment of the Government Sponsored Enterprise Credit Facility (GSECF), as authorized by the Housing Act. The GSECF is designed to serve as a contingent source of liquidity for the housing GSEs, including each of the 12 FHLBanks. Any borrowings by one or more of the FHLBanks under GSECF are considered consolidated obligations with the same joint and several liability as all other consolidated obligations. The terms of any borrowings are agreed to at the time of issuance. Loans under the Lending Agreement are to be secured by collateral acceptable to the U.S. Treasury, which consists of Bank loans to members that have been collateralized in accordance with regulatory standards and mortgage-backed securities issued by the Fannie Mae or Freddie Mac. The Bank is required to submit to the Federal Reserve Bank of New York, acting as fiscal agent of the U.S. Treasury, a list of eligible collateral, updated on a weekly basis. As of December 31, 2008, the Bank had provided the U.S. Treasury with listings of loans to members collateral amounting to $19.3 billion, which provides for maximum borrowings of $16.8 billion. The amount of collateral can be increased or decreased (subject to the approval of the U.S. Treasury) at any time through the delivery of an updated listing of collateral. As of December 31, 2008, the Bank has not drawn on this available source of liquidity and has no immediate plans to do so.
Commitments that legally bind and unconditionally obligate the Bank for additional loans to members, including BOB loans, totaled approximately $4.4 million and $2.1 billion at December 31, 2008 and 2007, respectively. Commitments can be for periods of up to twelve months. Standby letters of credit are executed for members for a fee. A standby letter of credit is generally a short-term financing arrangement between the Bank and its member. If the Bank is required to make payment for a beneficiary’s draw, these amounts are converted into a collateralized loan to the member. Outstanding standby letters of credit were as follows:
The Bank monitors the creditworthiness of its standby letters of credit based on an evaluation of the guaranteed entity. The Bank has established parameters for the review, assessment, monitoring and measurement of credit risk related to these standby letters of credit.
Based on management’s credit analyses, collateral requirements, and adherence to the requirements set forth in Bank policy and Finance Agency regulations, the Bank has not recorded any liability on these commitments and standby letters of credit. Excluding BOB, commitments and standby letters of credit are collateralized at the time of issuance.
Commitments that unconditionally obligate the Bank to purchase mortgage loans totaled $31.2 million and $6.6 million at December 31, 2008 and 2007, respectively. Master Commitments are generally for periods not to exceed 365 days. In accordance with Statement of Financial Accounting Standards No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (SFAS 149), such commitments entered into after June 30, 2003, are recorded as derivatives at their fair value.
The Bank generally executes derivatives with major banks and broker-dealers and generally enters into bilateral collateral agreements. The Bank had pledged, as collateral, cash and securities to counterparties that have market risk exposure from the Bank related to derivative agreements. The Bank had $1.4 billion cash pledged at December 31, 2008 and $60.6 million cash pledged at December 31, 2007. There were no securities pledged as of December 31, 2008 or 2007.
The Bank had committed to issue or purchase consolidated obligations totaling $635.0 million and $960.0 million at December 31, 2008 and 2007, respectively.
The Bank terminated its previous lease and signed a new lease, effective May 1, 2008, to remain at its existing location, 601 Grant Street. The lease has a term of 17 years, expiring April 30, 2025, with the option for two
Notes to Financial Statements (continued)
additional renewal terms of five years each at 90% of market terms. However, the Bank also has the right to terminate the lease, after 10, 12 and 14 years at a cost estimated to be less than $1.0 million. The Bank charged to operating expense net rental costs of approximately $2.2 million, $2.6 million and $2.5 million for the years ended December 31, 2008, 2007 and 2006, respectively. Lease agreements for Bank premises generally provide for increases in the basic rentals resulting from increases in property taxes and maintenance expenses. Such increases are not expected to have a material effect on the Bank.
Future minimum rentals at December 31, 2008, are presented below.
As discussed in Note 11, the Bank has terminated all of its derivative contracts with LBSF. Related to the termination of these contracts, the Bank has a receivable due from LBSF in the amount of $41.5 million as of December 31, 2008. The receivable from LBSF is recorded in the Bank’s Statement of Condition within Other Assets. Management believes it is probable that a loss has been incurred with respect to this receivable as of December 31, 2008. However, the Bank has not recorded a reserve with respect to the receivable from LBSF as of December 31, 2008 because, at this time, the Bank is unable to reasonably estimate the amount of loss that has been incurred. The Bank has filed an adversary proceeding against LBSF and J.P. Morgan Chase Bank, N.A. (JP Morgan) to return the cash collateral posted by the Bank associated with the derivative contracts. See discussion within Item 3. Legal Proceedings for more information with respect to the proceeding.
Notes 2, 8, 11, 15, 16, 17, 18, 19 and 20 also discuss other commitments and contingencies.
Supplementary Data
In addition to the Financial Statements and related notes and the report of PricewaterhouseCoopers, LLP; the schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission that would appear in Item 8. Financial Statements and Supplementary Data are included in the “Financial Information” section in Item 7. Management’s Discussion and Analysis.
Item 9:
Item 9:
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A:
Item 9A:
Controls and Procedures
Disclosure Controls and Procedures
Under the supervision and with the participation of the Bank’s management, including the chief executive officer and chief financial officer, the Bank conducted an evaluation of its disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based on this evaluation, the Bank’s chief executive officer and chief financial officer concluded that the Bank’s disclosure controls and procedures were effective as of December 31, 2008.
Management’s Report on Internal Control Over Financial Reporting
See “Item 8. Financial Statements and Supplementary Financial Data - Management’s Annual Report of Internal Control over Financial Reporting.”
Changes in Internal Control Over Financial Reporting
There have been no changes in internal control over financial reporting that occurred during the fourth quarter of 2008 that have materially affected, or are reasonably likely to materially affect, the Bank’s internal control over financial reporting.
Item 9B:
Item 9B:
Other Information
None
PART III
Item 10:
Item 10:
Directors, Executive Officers and Corporate Governance
Directors
Following enactment of the Housing Act, the Bank’s Board is comprised of a combination of industry directors elected by the Bank’s member institutions (Member Directors) on a state-by-state basis and independent directors elected by a plurality of the Bank’s members (Independent Directors). Prior to enactment of the Housing Act, the Bank’s Board was comprised of a combination of directors elected by the members and public interest directors appointed by the Finance Agency. No member of the Bank’s management may serve as a director of an FHLBank. The Bank’s Board currently includes nine Member Directors and six Independent Directors. As a result of the Housing Act, the procedures for nominating Independent Directors have changed over the past year. See Item 4. Submission of Matters to a Vote of Security Holders in this 2008 Annual Report filed on Form 10-K for details.
The following table sets forth certain information (ages as of February 28, 2009) regarding each of the Bank’s directors. No director of the Bank is related to any other director or executive officer of the Bank by blood, marriage, or adoption.
(a)
Member of Audit Committee
(b)
Member of Finance and Risk Management Committee
(c)
Member of Human Resources Committee
(d)
Member of Governance Committee
(e)
Member of Community Investment and Public Policy Committee
(f)
Member of Products & Services Committee
(g)
Member of Executive Committee
(*)
Rev. Cortés served a previous term from 2002 to 2004 as an appointed director.
(**)
Mr. Molnar served a previous term from 1982 to 1988 as an elected director.
(***)
Ms. Peck served a previous term from 1997 to 2002 as an appointed director.
(****)
Mr. Mason was appointed by the Board to fill a vacant non-guaranteed stock Member Director seat.
Dennis S. Marlo (Chair)
Dennis Marlo has served on the Board of Directors of the Bank since November 2002. Mr. Marlo is currently Managing Director of Sanctuary Group LTD, a financial and executive advisory firm located in Malvern, Pennsylvania. In addition, he is an Executive Vice President of Sovereign Bank, representing the Bank in various community, bank industry and Bank related activities. Mr. Marlo serves as a Director on the Board of NOVA Bank as well. Formerly, Mr. Marlo served as the Chief Risk Management Officer, Chief Financial Officer, Treasurer and President of the Pennsylvania Retail Banking Division of Sovereign Bancorp, Inc. (SOV - NYSE) and its wholly owned subsidiary, Sovereign Bank from 1998 to 2004. He came to Sovereign in 1998 through a merger with ML Bancorp, Inc. Previously, Mr. Marlo served as the President and Chief Executive Officer of ML Bancorp, Inc. (MLBC - NASDAQ) and its wholly owned subsidiary, Main Line Bank, as well as Chief Financial Officer from 1989 to 1998. Prior to his association with ML Bancorp, he was employed for 25 years at KPMG Peat Marwick and its predecessor organizations, where he retired as a partner in the firm. A graduate of LaSalle University and a Certified Public Accountant (CPA), Mr. Marlo also completed studies at the Graduate School of Community Bank Management, University of Texas/Austin. He is currently a member of the Board of Trustees of Harcum College in Bryn Mawr, Pennsylvania; the Board of Directors of EnerSys (ENS-NYSE) in Reading, Pennsylvania; the Board of Directors of Main Line Health Real Estate, LP; the Lankenau Hospital Foundation Board of Trustees in Wynnewood, Pennsylvania; and a member of the Council of President’s Associates of LaSalle University in Philadelphia. He is also a member of both the American and Pennsylvania Institutes of Certified Public Accountants and the Financial Managers Society, having served on its national board of directors. He is an active licensed Certified Public Accountant in the Commonwealth of Pennsylvania.
H. Charles Maddy, III (Vice Chair)
H. Charles Maddy, III joined the Board of Directors of the Bank in January 2002. Mr. Maddy is president and chief executive officer of Summit Financial Group, Inc. in Moorefield, West Virginia. He is also a member of the boards of directors for Summit Financial Group and its banking subsidiary Summit Community Bank. Mr. Maddy is also a director for the West Virginia Bankers Association and the Hardy County Child Care Center. He is a past president and past director of the West Virginia Association of Community Bankers, and a CPA certified by the West Virginia Board of Accountancy. Mr. Maddy graduated magna cum laude from Concord College in Athens, West Virginia, earning a bachelor of science degree in business administration with a concentration in accounting.
Patrick A. Bond
Patrick Bond joined the Board of Directors of the Bank in May 2007. He is a Founding General Partner of Mountaineer Capital, LP in Charleston, West Virginia. He graduated with a BS in Industrial Engineering and an MS in Industrial Engineering from West Virginia University. He is President of the West Virginia Symphony Orchestra, a member of the Board of Charleston Area Alliance, a member of the Board of Clay Center for the Arts and Sciences of West Virginia, a former President of Charleston Renaissance Corporation and a former member of the FHLBank Pittsburgh’s Affordable Housing Advisory Council.
Luis A. Cortés
Luis Cortés joined the Board of Directors of the Bank in April 2007. Reverend Cortés has served as the President and CEO of Nueva Esperanza since its inception in 1986. Esperanza, is the largest Hispanic faith-based organization in the country. The not-for-profit corporation has over 250 employees and manages an $18 million budget. The organization is networked with over ten thousand Latino congregations in the United States. He is also President Emeritus of Hispanic Clergy of Philadelphia, a religious organization. He has served as a board member of the FHLBank Pittsburgh from 2002-2004, which included his serving as vice chairman of the Board. He also serves on the board of The Cancer Treatment Centers of America, a privately held cancer hospital, as well as on the board of the Institute for the Study of Civic Values, a nonprofit in Pennsylvania, since 1993.
Walter D’Alessio
Walter D’Alessio joined the Board of Directors of the Bank in January 2008. A leader in the area of economic development in Greater Philadelphia, Mr. D’Alessio joined NorthMarq Capital in 2003. He is currently NorthMarq’s vice chairman, and a member of its board of directors; he also serves as president of the firm’s real estate consulting group. As chairman of the board of the Philadelphia Industrial Development Corporation (PIDC), Mr. D’Alessio has played a key role in building that organization’s international reputation. As a nonprofit partnership between the City of Philadelphia and the Chamber of Commerce, PIDC administers financing programs, land development and project management targeted to economic growth. During his time with the City’s Redevelopment Authority and at PIDC, Mr. D’Alessio has been involved in numerous large-scale projects including Market Street East, Penn’s Landing, Franklin Town and the development and expansion of the University of Pennsylvania, Temple University and Drexel University. Mr. D’Alessio has served on a wide array of corporate and nonprofit boards including Brandywine Realty Trust, the American Red Cross, the World Affairs Council and Independence Seaport Museum. He has been recognized locally and nationally with numerous awards.
John K. Darr
John Darr joined the Board of Directors of the Bank in January 2008. Mr. Darr, who retired from FHLBanks’ Office of Finance at the end of 2007 and resides in Delaware, served as managing director of the Office of Finance for 15 years. He had been responsible for issuing debt in the global capital markets on behalf of the twelve FHLBanks, consistent with their mission of providing low-cost liquidity to their respective member-owner financial institutions. He was also responsible for issuing the FHLBank System’s Combined Financial Statements and was intimately involved in the System’s SEC Registration process. Mr. Darr has a total of 35 years of business experience, including several years as Treasurer of FHLBank-San Francisco and as a director at Mortgage IT, a mortgage banking real estate investment trust. As a director of Manna, Inc. for more than ten years, Mr. Darr has served as chair of the board’s Audit and Finance Committee, as co-chair of its Leadership Committee and as a fund raiser for the $12 million organization. Manna, Inc., a faith-based institution, is devoted to building or rehabilitating very low-and low-income housing in the nation’s capital as well as providing homeownership counseling, mortgage brokerage and post-ownership support to project residents. It is credited with having provided more than 1,000 units of affordable housing over the past 25 years as well as counseling hundreds of homebuyers.
David R. Gibson
David Gibson was elected to the Board of Directors of the Bank and began his term January 1, 2007. Mr. Gibson, who has served Wilmington Trust for more than 20 years, was named its chief financial officer in 1996. He holds an MBA in Finance and Accounting from Vanderbilt University and earned his undergraduate degree from the University of Delaware. Mr. Gibson is a member of the finance committee of the board of Christiana Care Health Systems and a former member of the boards of the Delaware Workforce Investment Board, St. Edmond’s Academy and Junior Achievement of Delaware. He is a member of the Financial Executives Institute and the National Association of Accountants.
Brian A. Hudson
Brian Hudson joined the Board of Directors of the Bank in May 2007. Mr. Hudson is currently the Executive Director and Chief Executive Officer, Pennsylvania Housing Finance Agency (PHFA) in Harrisburg, Pennsylvania. He has a BA from Pennsylvania State University. He is a CPA and a Certified Treasury Professional (CTP). He is a member of the Board of National Council of State Housing Agencies, a member of the Board of Lackawanna College, Chair of Commonwealth Cornerstone Group and a former Chair of the Harrisburg Public School Foundation.
Glenn B. Marshall
Glenn Marshall was elected to the Board of Directors of the Bank and began his term January 1, 2008. Mr. Marshall is President and Chief Executive Officer of First Resource Bank, Exton, Pennsylvania. He has more than 25 years of banking experience. Mr. Marshall graduated from Drexel University with a bachelor’s degree in
Accounting and Marketing. He also holds a Master’s degree from St. Joseph’s University with a concentration in Finance and Banking. Mr. Marshall is the Chairman of the Audit Committee of West Whiteland Township, is a member of the Pension Board of West Whiteland Township and is a member of the Radnor Hunt Foundation.
John C. Mason
John Mason was appointed by the Bank’s Board to fill a vacant non-guaranteed stock seat on the Board and began his term January 1, 2009. Mr. Mason is ING Bank, FSB’s (ING DIRECT USA) Chief Investment Officer and Treasurer. Mr. Mason joined ING in June 2004. Mr. Mason has over 30 years of experience in the financial services industry. Mr. Mason graduated from Indiana University in Bloomington, Indiana with a Bachelor’s of Science degree in Business Economics. Mr. Mason is a participant in the Junior Achievement Titan and Economics for Success Programs.
John S. Milinovich
John Milinovich was elected to the Board of Directors of the Bank and began his term January 1, 2009. Mr. Milinovich is Executive Vice President, Treasurer and CFO of Washington Federal Savings Bank. Mr. Milinovich has 35 year’s experience including 10 years banking experience and 25 years of public accounting experience. Mr. Milinovich holds a Bachelor of Science degree in Accounting from Duquesne University and has continuously maintained his CPA license in Pennsylvania from 1976 to present. He has completed the graduate-level America’s Community Bankers - National School of Banking program at Fairfield University, where he received the prestigious Chairman’s Award for leadership ability and academic excellence. Mr. Milinovich serves on the Washington County Chamber of Commerce’s Board and Executive Committee, holding the office of Past Chairman. Mr. Milinovich has served on the Steering Committee of the Southwestern PA Growth Alliance, the Board of Directors of the Southwest Corner Workforce Investment Board, the Board of Governors of the Pennsylvania Economy League - Western Division, as Chairman of the Washington County Branch of the Pennsylvania Economy League, as Treasurer and Board Member of the United Way of Washington County, as Chairman of the PICPA State Continuing Professional Education Committee and as a Committee member of the PICPA State Education Committee.
Edward J. Molnar
Edward Molnar has served on the Board of Directors of the Bank since 2004. Mr. Molnar is Chairman of both Harleysville Savings Financial Corporation and Harleysville Savings Bank. With over 45 years’ experience in banking, Mr. Molnar is a past member of the board of directors of Americas’ Community Bankers, past chairman of the Pennsylvania Association of Community Bankers and past chairman of the bank advisory counsel of the Federal Reserve Bank of Philadelphia. Mr. Molnar also served as a member of the Thrift Advisory Council of the Federal Reserve Board.
Sarah E. Peck
Sarah Peck joined the Board of Directors of the Bank in April 2007. Ms. Peck is President and owner of Progressive Housing Ventures, LLC, Malvern, Pennsylvania. Her career includes thirty years of experience in real estate economics and development. She has a BA from Yale University and an MS from the London School of Economics. She is a former member and committee chair of the Board of Directors of FHLBank Pittsburgh; co-founder and member of the Commercial Real Estate Women; member, Planning Commission of Charlestown Township, Chester County; co-founder and member, Charlestown Citizens Forum; Director and Building Committee chair, Beth Chaim Reform Congregation; member, National Association of Homebuilders, Multifamily Council; member, Urban Land Institute; past president and co-founder, Housing Partnership of Chester County; past Marketing Committee chair and Board member, Chester County Fund for Women and Girls; and past member, Young President’s Organization. She has been honored with awards such as National Builder of the Year, Professional Builder Magazine; Woman of Distinction, Philadelphia Business Journal; Woman of Achievement and Business, March of Dimes; and Businesswoman of the Year, Great Valley Chamber of Commerce. Ms. Peck was also the recipient of the 2008 Pennsylvania Building Innovation Award by the PA Association of Homebuilders.
Patrick J. Ward
Patrick Ward has served on the Board of Directors of the Bank since January 2007. Mr. Ward is currently chairman and chief executive officer of Penn Liberty Bank. Mr. Ward has more than 20 years of experience in the banking industry, including executive experience with Citizens Bank of Pennsylvania and Commonwealth Bancorp in Malvern, Pennsylvania. He also held a variety of positions at Mellon Bank. Mr. Ward is a graduate of Carnegie Mellon University with a degree in Economics and earned his MBA at The University of Notre Dame. He serves on the boards of directors of the Philadelphia Police Athletic League, Phoenixville Area YMCA, EconomicsPennsylvania and the Chester County Chamber of Commerce.
Robert W. White
Robert White was elected to the Board of Directors of the Bank and began his term January 1, 2009. Mr. White began his banking career in 1970 after serving as a First Lieutenant in the United States Army from 1966 to 1969, including a tour of duty in Vietnam. He joined Abington Bank in 1974. In 1991, he was appointed President and subsequently became CEO and Chairman of the Board in 1994. Mr. White also served as Chairman of the Board, President and CEO of Abington Community Bancorp, Inc., after the Bank’s conversion to mutual holding company form in June 2004, and has served as Chairman of the Board, President and CEO of Abington Bancorp, Inc. (Nasdaq: ABBC), since the bank’s conversion to a full stock public company in June 2007.
Audit Committee
The Audit Committee has a written charter adopted by the Bank’s Board. The Audit Committee is directly responsible for the appointment, compensation and oversight of the Bank’s independent Registered Public Accounting Firm (RPAF) and Chief Internal Auditor. The Audit Committee is also responsible for approving all audit engagement fees, as well as any permitted non-audit services with the independent RPAF. The Audit Committee preapproves all auditing services and permitted non-audit services to be performed for the Bank by the independent RPAF. The independent RPAF reports directly to the Audit Committee. The Bank’s Chief Internal Auditor also reports directly to the Committee.
The Audit Committee assists the Board in fulfilling its responsibilities for general oversight of:
•
The Bank’s financial reporting processes and the audit of the Bank’s financial statements, including the integrity of the Bank’s financial statements;
•
the Bank’s administrative, operating, and internal accounting controls;
•
the Bank’s compliance with legal and regulatory requirements;
•
the independent auditors’ qualifications and independence; and
•
the performance of the Bank’s internal audit function and independent auditors.
As of February 28, 2009, the Audit Committee was composed of Messrs. Hudson (Chair), Ward, Darr, Gibson, Marshall and Milinovich. The Audit Committee regularly holds separate sessions with the Bank’s management, internal auditors, and independent RPAF.
The Board has determined that Messrs. Hudson, Ward, Darr, Gibson and Milinovich are each an “audit committee financial expert” within the meaning of the SEC rules. The Bank is required for the purposes of SEC rules regarding disclosure to use a definition of independence of a national securities exchange or a national securities association and to disclose whether each “audit committee financial expert” is “independent” under that definition. The Board has elected to use the New York Stock Exchange definition of independence, and under that definition, Messrs. Hudson, Ward, Gibson and Milinovich are not independent. Mr. Darr is independent. Messrs. Hudson, Ward, Gibson and Milinovich are independent according to the Finance Agency rules applicable to members of the audit committees of the boards of directors of the FHLBanks.
Executive Officers
The following table sets forth certain information (ages as of February 28, 2009) regarding the executive officers of the Bank.
John R. Price became President and Chief Executive Officer of the Bank on January 2, 2006. Prior to joining the Bank, Mr. Price was a senior advisor to the Institute of International Finance. Mr. Price also held several senior-level positions at JP Morgan Chase & Co. in New York (formerly Manufacturers Hanover Trust Co. which later merged into Chemical Bank and Chase Manhattan Bank). Mr. Price was responsible for the mortgage banking and consumer finance subsidiaries, led the team advising the U.S. government on the securitization on $5 billion of community development and rural low-income housing loans, and earlier served as corporate secretary. Mr. Price graduated from Grinnell College in Iowa, was named a Rhodes Scholar, earned advanced degrees in Development Economics and Diplomatic History from Queens College at Oxford University and received his law degree from Harvard Law School. Mr. Price was a member of the Board and chair of the Audit Committee of the Principal Financial Corporation, is a life trustee of Grinnell College and was the founding chairman of Americans for Oxford. Mr. Price also served as president of the Bankers Association for Finance and Trade.
Marshal S. Auron was named Chief Risk Officer in March, 2008. Between 2003 and 2008, he had been responsible for the Bank’s research, assessment and development of new product lines and business ideas. For the seven years prior to that, he was head of the Risk Management Department, responsible for measuring, modeling and assisting in managing the Bank’s interest rate risk profile. Prior to his time in Risk Management, Mr. Auron served as one of the Bank’s Credit Product Development Managers. Mr. Auron joined the Bank in 1992 from Pittsburgh National Bank (currently PNC Bank, NA), where he was a Vice President and Senior Portfolio Manager in the Asset and Liability Management Division. He is a graduate of the University of Pittsburgh where he received an MBA in Finance and he has a Bachelor of Science degree in Political Science and Economics from American University.
John J. Bendel joined the Bank in 1995 and is the Director of Community Investment. Mr. Bendel previously worked for Mullin & Lonergan Associates, an affordable housing and community development consulting firm based in Philadelphia. Mr. Bendel received a Master of Science degree in Public Administration from the University of Pittsburgh and a Bachelor of Science degree in Business Administration from St. Vincent College. Active in the community, Mr. Bendel serves as Chairman of the Board for Residential Resources, Inc., and is a Board member of the Pittsburgh Partnership for Neighborhood Development, Pennsylvania Rural Development Council and the Commonwealth Cornerstone Group. He also serves as Chairman of Rural Local Initiatives Support Corporation’s Pennsylvania Steering Committee and as a member of the West Virginia Interagency Housing Council.
Dale N. D’Alessandro joined the Bank in 2008 as the Managing Director of Human Resources. Prior to joining the Bank, Mr. D’Alessandro was the Vice President - Human Resources for Mylan Pharmaceuticals from 2003 to 2005. Before joining Mylan, Mr. D’Alessandro spent 27 years at Dominion Resources’ Pittsburgh office where he served in a variety of capacities. Mr. D’Alessandro earned a bachelor degree in Human Resource Management from Geneva College, and attended St. Francis University for a Masters degree in Human Resources and Industrial Relations. Mr. D’Alessandro is a member of the Pittsburgh Human Resources Association, Society of Human Resources Management and Leadership Pittsburgh.
Paul H. Dimmick joined the Bank in 2003, with the formation of the Mortgage Finance department. In December 2004, he was named Managing Director of Capital Markets, a newly formed group comprised of the Treasury and Mortgage Finance departments. Prior to joining the Bank, Mr. Dimmick held various senior management positions at Mellon Bank including Executive Vice President of Capital Markets. Mr. Dimmick was also a Senior Managing Director with Chemical Bank and its predecessor, Manufacturers Hanover Trust Co. Mr. Dimmick started his banking career as a bank examiner for the Federal Reserve Bank of New York. Mr. Dimmick holds a Bachelors degree in Economics and Business from Lafayette College and an MBA from the University of Pennsylvania’s Wharton School.
Teresa M. Donatelli joined the Bank in 1992, and held several managerial positions in Administration and Information Technology prior to assuming the position of Chief Information Officer in May 2004. Prior to joining the Bank, Ms. Donatelli held a variety of technical and managerial positions at Alcoa, Deloitte & Touche and Mellon Bank. Ms. Donatelli has a Bachelor of Arts degree in English from Duquesne University and a Masters degree in Business Administration from the University of Pittsburgh.
Craig C. Howie joined the Bank in 1990, and is the Group Director of the Bank’s Member Services department which includes Member Money Desk, Sales and Marketing, Mortgage Partnership Finance, Bank4Banks and Safekeeping. Before joining the Bank, Mr. Howie worked for Chemical Bank in New York as an Assistant Vice President in Mortgage Capital Markets. Prior to that, Mr. Howie worked for GMAC as an Assistant Vice President in Secondary Marketing. Mr. Howie received a Bachelors degree in Finance and Marketing from Susquehanna University and a Masters degree in Business Administration with a concentration in Finance from Drexel University.
Kristina K. Williams joined the Bank on December 31, 2004 as Chief Accounting Officer. Ms. Williams became Chief Financial Officer February 1, 2006. Ms. Williams most recently was the Chief Financial Officer of Wholesale Banking for PNC Financial Services Group. Ms. Williams also spent time in SEC and Regulatory Reporting and served as Director of Accounting Policy for PNC. Ms. Williams previously spent several years in public accounting with PricewaterhouseCoopers and Deloitte & Touche. Ms. Williams graduated magna cum laude from West Liberty State College and received her Masters in Professional Accountancy from West Virginia University. Ms. Williams is a CPA and a member of the American Institute of Certified Public Accountants, Pennsylvania Institute of Certified Public Accountants and is the audit committee chairperson on the board of directors for the West Liberty State College Foundation.
Dana A. Yealy joined the Bank in 1986, and has served as General Counsel since August 1991. Mr. Yealy is responsible for the legal, government relations, corporate secretary and ethics functions of the Bank. Prior to joining the Bank, he was an attorney with the Federal Home Loan Bank of Dallas. Mr. Yealy earned his Bachelors degree in Economics from Westminster College, his Juris Doctorate from the Dickinson School of Law, and his LL.M in Banking Law from the Boston University School of Law. Mr. Yealy is a member of the Association of Corporate Counsel, the Society of Corporate Secretaries & Governance Professionals, and the Society of Corporate Compliance and Ethics. Mr. Yealy is also a member of the American, Pennsylvania and Allegheny County Bar Associations.
Each executive officer serves at the pleasure of the Board of Directors.
Code of Conduct
The Bank has adopted a code of ethics for all of its employees and directors, including its chief executive officer, chief financial officer, controller, and those individuals who perform similar functions. A copy of the code of ethics is on the Bank’s public website, www.fhlb-pgh.com, and will be provided without charge upon written request to the Legal Department of the Bank at 601 Grant Street, Pittsburgh, PA 15219, Attention: General Counsel. Any amendments to the Bank’s Code of Conduct are posted to the Bank’s public website, www.fhlb-pgh.com.
Item 11:
Item 11:
Executive Compensation
Compensation Discussion and Analysis
Executive Summary
This Compensation Discussion and Analysis (CD&A) presents information related to the Bank’s compensation program provided to its Principal Executive Officer (the CEO) and other Named Executive Officers (other Executives). The information includes, among other things, the objectives of the Bank’s compensation program and the elements of compensation the Bank provides to its CEO and other Executives.
The Bank’s Board has determined that in order to make executive compensation decisions in a comprehensive manner it is necessary to consider the nature and level of all elements of the Bank’s compensation and benefits program in order to establish each element of the program at the appropriate level.
Compensation Philosophy
The Bank’s Total Compensation Program is designed to:
•
Attract, motivate and retain staff critical to the Bank’s long-term success; and, thereby,
•
Enable the Bank to meet its public policy mission while balancing the evolving needs of customers and shareholders.
In 2008, the Bank’s CEO and other Executives were compensated through a mix of base salary, eligibility for incentive compensation awards, benefits and perquisites, with base salary as the core component of the total compensation package. The Bank’s compensation plan for the CEO and other Executives establishes each component of compensation to be competitive within the Federal Home Loan Bank System (FHLBank System). The salary range data for comparable positions at the other FHLBanks serves as the primary benchmark for the CEO and the other Executives with the Bank targeting to pay the median of such salary range. A periodic review of the financial services market survey data (defined as those institutions with assets less than $25 billion) is conducted at least annually, as well as on an interim basis should variations arise or if the data indicates a need to differ from this benchmarking approach. Although the Bank had assets of $91.0 billion at December 31, 2008, for compensation purposes the Board has considered institutions with assets less than $25 billion to be comparable to the Bank in terms of the relative complexity of the business. As the Bank is a cooperative, it does not offer equity-based compensation as is typically offered in publicly-traded financial services institutions; however, the Bank’s incentive compensation and enhanced retirement benefits for the CEO and other Executives together are intended to provide a competitive compensation package.
Human Resources Committee’s Role and Responsibilities
The Board’s Human Resources Committee (HR Committee) is responsible for the establishment and oversight of the CEO’s compensation and oversight of other Executives’ compensation. This includes setting the objectives of and reviewing performance under the Bank’s compensation, benefits and perquisites programs for the CEO and other Executives.
Additionally, the HR Committee has adopted the practice of periodically retaining compensation and benefit consultants and other advisors, as well as reviewing analysis from the Bank’s Human Resources Department (HR Department), to assist in performing its duties in regard to the CEO’s and other Executives’ compensation. A comprehensive total compensation study was conducted in 2007.
Role of the Federal Housing Finance Agency
Under the Housing Act, which became effective July 30, 2008, the FHLBanks’ regulator, the Finance Agency, has been granted certain authority over executive compensation. Specifically under the Housing Act the Director of the Finance Agency is: a) authorized to prohibit executive compensation that is not reasonable and comparable with compensation in similar businesses and b) if an FHLBank is undercapitalized, the Finance Agency Director may also restrict executive compensation. Additionally, until December 31, 2009, the Finance Agency Director has
additional authority to approve, disapprove or modify executive compensation. The Finance Agency has directed the Bank and all the FHLBanks to submit to the Agency at least four (4) weeks prior to action by the Bank’s board, all proposed compensation and benefits actions in regard to the CEO or other Executives that require approval by the Bank’s Board. Effective January 29, 2009, the Finance Agency issued a final regulation regarding prohibitions on golden parachute payments.
Determining the CEO’s Cash Compensation
Consistent with 2007, in 2008 the HR Committee used the FHLBanks as the peer group for benchmarking the CEO’s cash compensation. The Board determined that the chief executive officer positions at the other FHLBanks were the best comparison. The CEO’s cash compensation (including both base salary and incentive compensation) was compared to the median for all FHLBanks’ chief executive officers. The HR Committee considered the benchmark data, length of service in the position and job performance when determining the CEO’s cash compensation.
For 2009, the HR Department presented the data on CEO cash compensation at the other FHLBanks to the HR Committee and the HR Committee considered this information in determining the CEO’s cash compensation. However, in view of the Bank’s financial performance, the CEO recommended and the Board agreed to forego a 2009 base salary increase for the CEO.
Determining Other Executives’ Cash Compensation
For 2008, with respect to other Executives’ base salaries and incentive compensation, the HR department used the FHLBanks’ survey data to determine competitive cash compensation. The base salary range midpoint for other Executives was based on the median of the FHLBank System survey data. A review of the financial services industry survey data reflecting institutions with asset size of $25 billion or less was also used to determine consistency with FHLBank System survey data. Actual annual base salary and incentive compensation payout levels were determined based on review of the FHLBank survey data, length of service in the position, and job performance.
For 2009, the CEO’s recommendations for any adjustments to other Executives’ cash compensation were reviewed and approved by the HR Committee which, in turn, then recommended any adjustments to the full Board for final approval. Management recommended and the Board agreed to forego 2009 base salary increases for other Executives.
Variable Incentive Plan (VIP)
The Board has established VIP compensation award opportunities based upon the achievement of specific annual performance objectives that support the Bank’s operating and profitability goals. The VIP is designed to reward the CEO and other Executives for achievement of Bank and/or individual performance goals. These goals were both quantitative and qualitative as approved by the HR Committee and the Board. Award levels were generally set at threshold, target and maximum percentages of base salary; awards could also be paid for performance achievement at points in between these levels.
Additional key components of the VIP include the following:
•
As a retention strategy, 20 percent of each award to the CEO and other Executives is retained and subject to forfeiture if employment terminates within three years (other than in the case of involuntary termination other than cause, retirement, death, disability); and
•
No award payments shall be made under the VIP if the Bank’s Member Value Focus goal (as described below) has not been achieved at the threshold level for the plan year. In 2008, in determining payouts above the threshold level, the Bank’s performance as compared to its peers was required to be considered by the Board.
The Board has the discretion to determine whether or not to pay out awards, increase awards or reduce awards. This includes cases in which the goals may or may not have been met. In 2006, 2007, and 2008, the Board did not exercise the discretion to increase, decrease or eliminate award payouts.
CEO’s VIP Goals. In its adoption of the VIP, the Board determined that higher level positions within the organization should have a greater impact on the achievement of Bank goals. Therefore, 90 percent of the VIP award opportunity for the CEO in 2008 was based on achievement of the following three Bank goals:
Bank Goals
•
Member Value Focus - 30 percent. As the Bank’s financial performance, indicated by the earned dividend rate, is a key measure of the Bank’s success, achieve a dividend rate that exceeds the Bank’s Operating Plan and provides shareholders an appropriate yield given market conditions.
•
Customer Focus - 30 percent. Complete at least six of the following eight specific objectives related to the Bank’s core businesses: increase loans to members volume, increase loans to members penetration, implement new loan products, implementation of new capital plan amendment to create a subclass of capital stock to allow for payment of patronage dividend based on member loan volume, increase maximum borrowing capacity growth, MPF risk transfer mechanism proposal submission to the Finance Agency, new member recruitment, and recruiting new PFIs
•
Community and Economic Development Initiative Focus - 30 percent. Develop initiatives to promote quality community and economic development and support infrastructure finance opportunities as well as expand profits through new opportunities.
Individual Goal
The remaining 10 percent of the CEO’s VIP award opportunity was based on implementing a new governance process at the CEO level within the FHLBank System that provided for more effective administration of FHLBank System issues and information sharing.
Other Executives’ VIP Goals. The weighting of the other Executives’ Bank goals was established at 70-75 percent of each other Executives’ total award opportunity. The remaining annual award opportunities were weighted toward individual performance goals. See the Summary Compensation Table and accompanying narrative for additional information.
Status reports on all of the incentive goals were reviewed with the Committee at least once during the year and the goals were modified as appropriate.
VIP Award Opportunity. The award opportunity levels in 2008, expressed as a percentage of base salary were:
The results of the performance goals are detailed in the Summary Compensation Table and accompanying narrative.
Additional Incentives
From time to time, the CEO has recommended, and the Board has approved, additional incentive awards in connection with specific projects or other objectives of a unique, challenging and time sensitive nature. There were no additional incentive awards granted in 2008.
Perquisites and other Benefits
The Board views the perquisites afforded to the CEO and other Executives as an element of the total compensation program, provided primarily as a benefit associated with their overall position duties and responsibilities. Examples of perquisites for the CEO and/or other Executives may include the following:
•
Personal use of a Bank-owned automobile;
•
Financial and tax planning;
•
Relocation; and
•
Business club membership.
Additionally, the Bank provides a tax gross-up for some of the perquisites offered, including relocation benefits. Perquisites for the CEO and other Executives are detailed on the Summary Compensation Table and accompanying narrative, where aggregate perquisites exceeded $10,000 in 2008.
Employee Benefits
The Board and Bank management are committed to providing competitive, high-quality benefits designed to promote health, well-being and income protection for all employees. As described above, the Bank has benchmarked the level of benefits provided to the CEO and other Executives to the other FHLBanks and financial services firms. The Bank offers all employees a core level of benefits and the opportunity to choose from a variety of optional benefits. Core and optional benefits offered include, but are not limited to, medical, dental, prescription drug, vision, long-term disability, short-term disability, flexible spending accounts, parking or transportation subsidy, worker’s compensation insurance, and life and accident insurance. The CEO and other Executives participate in these benefits on the same basis as all other full-time employees.
Qualified and Nonqualified Defined Benefit Plans
The Bank participates in the Pentegra Defined Benefit Plan for Financial Institutions (PDBP), a tax-qualified, multiple-employer defined-benefit plan. The PDBP is a funded, noncontributory plan that covers all eligible employees. For all employees hired prior to January 1, 2008, including the CEO and all other Executives, benefits under the plan are based upon a 2 percent accrual rate, the employees’ years of service and highest average base salary for a consecutive three-year period. Employees are not fully vested until they have completed five years of employment. The regular form of retirement benefits provides a single life annuity, with a guaranteed 12-year payment; a lump-sum payment or other additional payment options are also available. The benefits are not subject to offset for Social Security or any other retirement benefits received.
The CEO and other Executives also participate in a Supplemental Executive Retirement Plan (SERP). The SERP provides the CEO and other Executives with a retirement benefit that the Bank is unable to offer under the qualified PDBP due to Internal Revenue Code (IRC) and qualified PDBP limitations, including the IRC limitations on qualified pension plan benefits for employees earning $230,000 or more for 2008.
As a nonqualified plan, the benefits do not receive the same tax treatment and funding protection as the qualified plan, and the Bank’s obligations under the SERP are a general obligation of the Bank. The terms of the SERP provide for distributions from the SERP upon termination of employment with the Bank or in the event of the death or disability of the employee. Payment options under the SERP include annuity options as well as a lump-sum distribution option.
At the normal retirement age of 65, the CEO and other Executives are eligible for a retirement benefit equal to 2 percent times years of benefit service times their high three-year average salary and VIP compensation. If the CEO or other Executives select the early retirement benefit, payments may commence as early as age 45 but are reduced by an early retirement factor of 3 percent per year.
The portion of the VIP award percentages that are included in determining the CEO’s and other Executives’ SERP benefit is limited to no more than the amount of the incentive award that was included in the SERP calculation under the former Short-Term Incentive Compensation Plan (STI).
In 2009, the Bank will be changing the security vehicle for the SERP to a Rabbi trust.
Qualified and Nonqualified Defined Contribution Plans
All employees have the option to participate in the Financial Institutions Thrift Plan (Thrift Plan), a qualified defined contribution plan under the IRC. Subject to IRC and Thrift Plan limitations, employees can contribute up to 50 percent of their base salary in the Thrift Plan. The Bank matches employee contributions based on their length of service and the amount of employee contribution as follows:
In addition to the Thrift Plan, the CEO and other Executives are also eligible to participate in the Supplemental Thrift Plan, an unfunded nonqualified defined contribution plan that, in many respects, mirrors the Thrift Plan. The Supplemental Thrift Plan ensures, among other things, that the CEO and other Executives whose benefits under the Thrift Plan would otherwise be restricted by certain provisions of the IRC or limitations in the Thrift Plan are able to make elective pretax deferrals and receive the Bank matching contributions on those deferrals. In addition, the Supplemental Thrift Plan permits deferrals of and Bank matching contributions on the VIP compensation awards, subject to the limits on deferrals of compensation under the Supplemental Thrift Plan.
Thirty days prior to the beginning of the calendar year in which the compensation is to be earned and paid, the CEO and other Executives may elect to defer a percentage of their cash compensation. The CEO and other Executives may defer up to 80 percent of their total cash compensation, less their contributions to the Qualified Thrift Plan. The 20 percent retained portion of each VIP award is not eligible for deferral under the Supplemental Thrift Plan.
For each deferral period in the Supplemental Thrift Plan, the Bank credits a matching contribution equal to:
•
200 percent match on up to 3 percent of the CEO’s or other Executives’ base salary and annual incentive compensation irrespective of their years of service; less
•
The Bank’s matching contribution to the Qualified Thrift Plan.
The terms of the Supplemental Thrift Plan provide for distributions upon termination of employment with the Bank, in the event of the death of the employee or upon disability, at the discretion of the Human Resources Committee and in accordance with applicable IRC and other applicable requirements. Payment options under the Supplemental Thrift Plan include a lump-sum payment and annual installments for up to 10 years. No loans are permitted from the Supplemental Thrift Plan.
The portion of the VIP award that is eligible for a Bank matching contribution under the Supplemental Thrift Plan is limited to the percentage of each incentive award under the former STI plan that was eligible for Bank match for each such participant. In 2007, the Bank established a Trust for the Supplemental Thrift Plan (Rabbi trust). Notional investment options available to participants in the Supplemental Thrift Plan are the investments offered by The Principal Financial Group, (the administrator of the Rabbi Trust), which are substantially equivalent to those available under the Bank’s qualified defined contribution plan. See the “Nonqualified Deferred Compensation Table” and accompanying narrative below for more information.
Additional Retirement Benefits
The Bank currently provides post-retirement medical and life insurance benefits for its employees, including the CEO and other Executives who retire at age 60 or older with 10 years of service. Retirees and their spouses age 65 and older pay 60 percent of the medical premium for the retirees’ coverage and 80 percent of the premium for coverage for their spouse.
The Bank also provides $5,000 in term life insurance for all retirees, including the CEO and other Executives. The employees can purchase an additional $15,000 of coverage at group rates. The employee’s spouse is not eligible for the life insurance benefit.
Severance Policy (excluding change in control)
The Bank provides severance benefits to the CEO and other Executives. These benefits reflect the potential difficulty employees may encounter in their search for comparable employment within a short period of time. The Bank’s severance policy is designed to help bridge this gap in employment.
The Board provided a separate severance agreement as part of the initial employment offer letter for the CEO, which is more fully described in the post-termination compensation table. The Board determined that such severance arrangements for CEOs are a common practice in the marketplace.
The policy provides the following for other Executives:
•
Four weeks’ base salary continuation per year of service, with a minimum of 26 weeks and a maximum of 52 weeks;
•
Medical coverage, based on current enrollment selections, for the length of the salary continuation; and
•
Individualized outplacement service for a maximum of 12 months.
Change-in-Control (CIC) Agreements
The Bank has entered into CIC agreements with the CEO and other Executives. In 2007, the Board determined that CIC agreements are an important recruitment and retention tool and that having such agreements in place enables the CEO and other Executives to effectively perform and meet their obligations to the Bank if faced with the possibility of consolidation with another FHLBank. Several FHLBanks have such agreements in place with their executives. These agreements are a common practice in the financial services market.
In the event of a merger of the Bank with another FHLBank, where the merger results in the termination of employment (including resignation for “good reason” as defined under the CIC agreement) for the CEO or any other Executives, each such individual(s) is (are) eligible for severance payments under his/her CIC Agreement. Such severance is in lieu of severance under the Severance Policy discussed above. The Severance Policy (and in the case of the CEO, his separate severance agreement) continues to apply to employment terminations of the other Executives, other than those resulting from a Bank merger.
Benefits under the CIC Agreement for the CEO and other Executives are as follows:
•
Two years base salary;
•
Two times the VIP award payout eligibility at target in the year of separation from service;
•
Bank contributions for medical insurance for the benefits continuation period of 18 months at the same level that the Bank contributes to medical insurance for its then-active employees; and
•
Individualized outplacement for up to 12 months.
In addition, under his CIC Agreement, the CEO also receives a payment equal to:
•
The additional benefit amount that the CEO would receive for 2 additional years of credited service under the qualified and nonqualified defined benefit plans; and
•
Two times 6 percent of his annual compensation (as defined in the Supplement Thrift Plan as annual base salary and a portion of the annual VIP award) in the year of separation from service. This amount is intended to replace the Bank matching contribution under the Bank’s qualified and nonqualified defined contribution plans.
The CIC agreements were executed in November 2007. See Exhibits 10.9 and 10.9.1 to this 2008 Annual Report on Form 10-K for more information.
Compensation Committee Report
The HR Committee of the Bank’s Board has reviewed and discussed the CD&A with management. Based on its review and discussions with management, the HR Committee has recommended to the Board that the CD&A be included in the Bank’s 2008 Annual Report filed on Form 10-K.
The Human Resources Committee
of the Board of Directors
Edward J. Molnar, Chairman
Patrick A. Bond
Luis A. Cortés, Jr.
Walter D’Alessio
David R. Gibson
John C. Mason
Sarah E. Peck
Summary Compensation Table (SCT)
(1)
For 2008, Mr. Price’s non-equity incentive plan compensation is the VIP described below. All other compensation includes employer contributions to defined contribution plans of $49,005, and perquisites totaling $10,782. Perquisites include parking benefits, spousal travel and child care expenses, personal miles on a company vehicle, financial planning/tax preparation benefits, and non-business travel expenses. For 2007, Mr. Price’s non-equity incentive plan compensation is the short-term and long-term incentive plan awards described in the Bank’s 2007 Annual Report filed on Form 10-K. All other compensation includes employer contributions to defined contribution plans of $48,000. For 2006, Mr. Price’s non-equity incentive plan compensation is the annual incentive plan award as described in the Bank’s 2006 Annual Report filed on Form 10-K, as amended. All other compensation includes a $201,732 tax gross-up on relocation expenses, employer contributions to defined contribution plans of $30,000, and perquisites totaling $267,261. Perquisites include a relocation payment of $258,000, parking benefits, club memberships, spousal travel and child care expenses, personal miles on a company vehicle, and non-business travel expenses.
(2)
For 2008, Ms. Williams’ non-equity incentive plan compensation is the VIP described below. All other compensation includes employer contributions to defined contribution plans of $23,301. For 2007, Ms. Williams’ non-equity incentive plan compensation is the short-term and long-term incentive plan awards as described in the Bank’s 2007 Annual Report filed on Form 10-K. All other compensation includes employer contributions to defined contribution plans of $22,224. For 2006, Ms. Williams received a $25,000 increase in base salary in February when she was promoted to CFO. Ms. Williams was paid a $45,000 special additional award reflecting the magnitude of restating the Bank’s financials from 2001 to 2005 which was unplanned and which occurred concurrent with the SEC registration process. Non-equity incentive plan compensation is the annual incentive plan award as described in the Bank’s 2006 Annual Report filed on Form 10-K, as amended. All other compensation includes employer contributions to defined contribution plans of $20,247.
(3)
For 2008, Mr. Dimmick’s non-equity incentive plan compensation is the VIP described below. All other compensation includes employer contributions to defined contribution plans of $22,105. For 2007, Mr. Dimmick’s non-equity incentive plan compensation is the short-term and long-term incentive plan awards as described in the Bank’s 2007 Annual Report filed on Form 10-K. All other compensation includes employer contributions to defined contribution plans of $21,384. For 2006, Mr. Dimmick received a $15,000 salary adjustment in February to bring his base salary to a level comparable with other executives. Non-equity incentive plan compensation is the annual incentive plan award as described in the Bank’s 2006 Annual Report filed on Form 10-K, as amended. All other compensation includes employer contributions to defined contribution plans of $20,257.
(4)
For 2008, Mr. Howie’s non-equity incentive plan compensation is the VIP described below. All other compensation includes employer contributions to defined contribution plans of $20,257. For 2007, Mr. Howie’s non-equity incentive plan compensation is the short-term and long-term incentive plan awards as described in the Bank’s 2007 Annual Report filed on Form 10-K. All other compensation includes employer contributions to defined contribution plans of $19,114. Mr. Howie was an executive officer in 2006; however, he was not considered a named executive officer in 2006.
(5)
For 2008, Mr. Yealy’s non-equity incentive plan compensation is the VIP described below. All other compensation includes employer contributions to defined contribution plans of $19,980. Mr. Yealy was an executive officer in 2007; however, he was not considered a named executive officer in 2007. For 2006, Mr. Yealy’s non-equity incentive plan compensation is the annual incentive plan award as described in the Bank’s 2006 Annual Report filed on Form 10-K, as amended. All other compensation includes employer contributions to defined contribution plans of $17,498.
(6)
Mr. Batz was the Bank’s former Chief Operating Officer. His position was eliminated and his employment was terminated on May 31, 2008. Mr. Batz executed a severance agreement which provided payments equal to 12 months base salary, or $428,722, payable in installments from June 13, 2008 through May 29, 2009; a lump sum payment of $237,000; coverage under the group medical program through May 31, 2009; and $20,000 in outplacement assistance. Mr. Batz’s change in pension value reflects receipt of lump sum payments for qualified and nonqualified defined benefit plan benefits for 2008 (see Pension Table). As a result of the lump sum payments, the present value of his accumulated benefits at December 31, 2008 was $0. All other compensation includes the previously described severance payments of $665,722; tax gross-ups of $4,810; employer contributions to defined contribution plans of $21,279; medical insurance premiums paid during the severance period of $8,562; payment for accrued and unused vacation at termination; and perquisites totaling $15,662. Perquisites include parking benefits, retirement gifts, personal miles on a company vehicle, and financial planning/tax preparation benefits. For 2007, Mr. Batz’s non-equity incentive plan compensation is the short-term and long-term incentive plan awards as described as described in the Bank’s 2007 Annual Report filed on Form 10-K. All other compensation includes employer contributions to defined contribution plans of $35,089, and perquisites totaling $10,984. Perquisites include parking benefits, spousal travel, personal miles on a company vehicle, and financial planning/tax preparation. For 2006, Mr. Batz received a $50,000 increase in base salary in January. Mr. Batz had more than 17 years experience at the Bank at that point; therefore, in conjunction with the hiring of the new CEO, the Board determined that it would create a void if the top two positions turned over at approximately the same time. The Board entered into a retention agreement with Mr. Batz in which he would receive a payment of $200,000 if he remained a part of the Bank’s executive team through January 2, 2007. Non-equity incentive plan compensation is the annual incentive plan award as described in the Bank’s 2006 Annual Report filed on Form 10-K, as amended. All other compensation includes employer contributions to defined contribution plans of $30,996.
Non-Equity Incentive Plan Compensation:
VIP
The CEO and all other Executives shared three goals related to the Bank’s earned dividend rate, customer-centric objectives, and community and economic development initiatives with performance measures at threshold, target and maximum as outlined below:
Member Value Focus - The specific performance measure at maximum was to achieve an earned dividend rate that provides an attractive spread to 3-month LIBOR which at maximum will be based on exceeding the best case scenario identified through sensitivity analysis prepared in developing the Bank’s Operating Plan. As a result of the Bank’s other-than-temporary impairment charge taken in fourth quarter 2008 and the instability of the economic environment, the Member Value Focus goal was not achieved at threshold.
Customer Focus - The specific performance measure at maximum was to complete six objectives, including item 6, from the following:
1. Meet set full-year average balance of core advances.
2. Meet set target percentage of members initiating an advance.
3. Introduce two (2) new loans to members products or significant loans to members portfolio enhancements that are each implemented within a time frame of four (4) weeks or less.
4. Implement new Capital Plan Amendment within 90 days after FHFB approval.
5. Grow Maximum Borrowing Capacity (MBC) through collateral expansion initiatives.
6. Submit a proposal to the Finance Board for an MPF “risk transfer” mechanism.
7. Recruit ten (10) new members, of which three (3) are insurance companies.
8. Recruit twenty (20) new Participating Financial Institutions (PFIs).
The Customer Focus goal was achieved at threshold with completion of items 1, 2 and 8 from the objectives above.
Community and Economic Development Focus - The specific performance measure at maximum was to complete three objectives from the following:
1. Implement or participate in an initiative that addresses the foreclosure issue in the Bank’s district.
2. Increase number of community banks that have enrolled in or applied for community investment products or initiatives during 2006-2008 Strategic Planning Cycle.
3. Complete a new public finance negotiated transaction.
4. Research and present opportunities to the Board in: (i) community, economic development finance, and/or (ii) infrastructure finance that can be developed and implemented as a “for profit” product in 2009.
The Community and Economic Development Focus goal was achieved at target with completion of items 1 and 2 from the objectives listed above.
In addition to the three shared goals, the CEO and each other Executive also had one individual/department goal, as described below, which included performance measures at threshold, target and maximum.
Mr. Price and Mr. Yealy:
New Governance Processes - The specific performance measure at maximum was to gain the approval of the Bank Presidents’ Council or the Council of FHLBanks to adopt a plan for more effective information sharing between the FHLBanks. Actual performance was achieved at maximum.
Ms. Williams, Mr. Dimmick and Mr. Batz:
Market Risk - The specific performance measure at maximum was to design and implement a plan and timeline for new or improved measures for market value of equity and long-term earnings at risk. Actual performance was achieved at target.
Mr. Howie:
Upgrade Collateral Management Practices - The specific performance at maximum was to implement a new collateral management policy including the delivery of securities, implementing a comprehensive mortgage loan level listing program, and upgrading the Maximum Borrowing Capacity calculation process. Actual performance was achieved at maximum.
Based on the terms of the VIP, no award payment shall be made if the Bank Member Value Focus goal has not been achieved at the threshold level for the plan year. Therefore, no VIP payouts were awarded for 2008.
Change in Pension Value:
The qualified defined benefit plan, as described in the CD&A, provides a normal retirement benefit of 2% of a participant’s highest three-year average salary, multiplied by the participant’s years of benefit service. Earnings are defined as base salary, subject to an annual IRS limit of $230,000 on earnings for 2008. Annual benefits provided under the qualified plan also are subject to IRS limits, which vary by age and benefit payment type. The participant’s accrued benefits are calculated as of December 31, 2007 and December 31, 2008. The present value is calculated using the accrued benefit at each date valued multiplied by a present value factor based on an assumed age 65 retirement date, 6.70% interest and 50% of benefit valued using the 2000 RP Mortality table (static mortality table for lump sums) and 50% of benefit valued using the 2000 RP Mortality table (generational mortality table for annuities). The difference between the present value of the December 31, 2008 accrued benefit and the present value of the December 31, 2007 accrued benefit is the “change in pension value” for the qualified plan.
The nonqualified defined benefit plan, as described in the CD&A, provides benefits under the same terms and conditions as the qualified plan, except that earnings are defined as base salary plus VIP. Benefits provided under the qualified plan are an offset to the benefits provided under the nonqualified plan. The participants’ benefits are calculated as of December 31, 2007 and December 31, 2008. The present value is calculated using the accrued benefit at each date valued multiplied by a present value factor based on an assumed age 65 retirement date, 6.00% interest and the 2000 RP Mortality table (generational mortality table). The difference between the present value of the December 31, 2008 accrued benefit and the present value of the December 31, 2007 accrued benefit is the “change in pension value” for the nonqualified plan.
The total “Change in Pension Value” included in the Summary Compensation Table is the sum of the change in the qualified plan and the change in the nonqualified plan.
Grants of Plan-Based Awards
The following table shows the potential value of non-equity incentive plan awards granted to the named officers in 2008.
All are as described in the VIP section of the CD&A. Note that payment of 80 percent of any awarded amount will be made in 2010 and 20 percent of any award will accrue interest and be paid in 2013 as described in the VIP document. See Exhibit 10.10 to this 2008 Annual Report filed on Form 10-K. Payouts will be subject to achievement of performance goals established under the plan.
VIP
VIP Compensation for January 1, 2009, through December 31, 2009, and payouts are based on a percentage of the executive’s base salary as of December 31, 2009. Estimated future payouts were calculated based on executives’ salary on January 1, 2009, which reflects no annual merit increase above 2008 base salary as reported in the Summary Compensation Table.
Mr. Price’s VIP payout is 32.5% at threshold, 55% at target, and 100% at maximum. All of the other Executives have a variable incentive payout of 28.75% at threshold, 40% at target, and 77.5% at maximum.
The CEO and all other Executives share three goals related to the Bank’s financial performance (member value), community economic development, and customer centric performance with performance measures at threshold, target and maximum as outlined below:
Member Value - The specific performance measure at maximum is to achieve an earned dividend spread over 3-month LIBOR which at maximum will exceed best case scenario based on sensitivity analysis prepared in development of the Bank’s Operating Plan. In determining payouts above threshold, consideration will be given to the Bank’s performance in comparison to the other FHLBanks.
Community Economic Development - The specific performance measure at maximum is to increase the use of Letters of Credit to support bond issues.
Customer Centric - The specific performance measure at maximum is to increase the full-year average balance of core advances as outlined in the Bank’s Operating Plan.
The HR Committee is considering changes to the terms of the VIP for 2009 and is considering the 2009 goals. Changes to the VIP and approval of the goals are subject to a four-week regulatory review period by the Finance Agency and would then become effective following expiration of the regulatory review period and final ratification or approval (as applicable) by the Board.
Pension Benefits
The description of the Pentegra Defined Benefit Plan contained in the Summary Plan Description for the Financial Institutions Retirement Fund and the description of the SERP contained in the Supplemental Executive Retirement Plan are filed as Exhibits 10.13 and 10.6.1 to this 2008 Annual Report filed on Form 10-K and are incorporated herein by reference.
This table represents an estimate of retirement benefits payable at normal retirement age in the form of the actuarial present value of the accumulated benefit. The amounts were computed as of the same plan measurement date that the Bank uses for financial statement reporting purposes. The same assumptions were used that the Bank uses to derive amounts for disclosure for financial reporting, except the above information assumed normal retirement age as defined in the plan. See narrative discussion of the “Change in Pension Value” column in the Summary Compensation Table.
Compensation used in calculating the benefit for the Pentegra Defined Benefit Plan includes base salary only. Compensation used in calculating the benefit for the SERP includes base salary plus the VIP award limited to no more than the amount of the incentive award that was included in the SERP calculation under the former STI plan.
Benefits under the SERP vest after completion of 5 years of employment (the vesting requirement under the qualified plan) subject to forfeiture for cause provisions of the SERP.
Normal Retirement: Upon termination of employment at or after age 65 where an executive has met the vesting requirement of completing 5 years of employment, the executive is entitled to a normal retirement benefit under the Pentegra Defined Benefit Plan equal to: 2% of his/her highest three-year average salary multiplied by his/her years’ of benefit service. Under the SERP normal retirement benefit, the executive also would receive 2% of his/her highest three-year average short-term incentive payment for such same three-year period multiplied by his/her years’ of benefit service.
Early Retirement: Upon termination of employment prior to age 65, executives meeting the 5 year vesting and age 45 early retirement eligibility criteria are entitled to an early retirement benefit. The early retirement benefit amount is calculated by taking the normal retirement benefit amount and reducing it by 3% times the difference between the age of the early retiree and age 65. For example, if an individual retires at age 61, the early retirement benefit amount would be 88% of the normal retirement benefit amount, a total reduction of 12%. At December 31, 2008, Mr. Dimmick, Mr. Howie and Mr. Yealy were eligible for early retirement benefits. Mr. Batz was eligible for and received early retirement benefits following his employment termination on May 31, 2008. The amounts set forth above reflect the qualified and nonqualified pension plan payments made to him in 2008.
Nonqualified Deferred Compensation
See descriptions in the Qualified and Nonqualified Defined Contribution Plans section of the CD&A. A description of the Supplemental Thrift Plan is also contained in the Supplemental Thrift Plan filed as Exhibit 10.7.2 to this 2008 Annual Report filed on Form 10-K and incorporated herein by reference.
Amounts shown as “Executive Contributions in 2008” were deferred and reported as “Salary” in the Summary Compensation Table. Amounts shown as “Registrant Contributions in 2008” are reported as “All Other Compensation” in the Summary Compensation Table.
The CEO and other Executives may defer up to 80% of their total cash compensation (base salary and VIP compensation), less their contributions to the qualified thrift plan. VIP compensation is limited to no more than the maximum amount of incentive compensation that would have been included under the Bank’s former STI plan . All benefits are fully vested at all times subject to the forfeiture for cause provisions of the Supplemental Thrift Plan.
The investment options available under the nonqualified deferred compensation plan are closely matched to those available under the qualified defined contribution plan. Investment options include stock funds, bond funds, money market funds and target retirement funds.
Post-Termination Compensation
The CEO and other Executives would have received the benefits below in accordance with the Bank’s severance policy if their employment had been severed without cause during 2008.
Post-Termination Compensation - Severance (Excluding Change-In-Control)
Under the CIC Agreements, in the event of employment termination other than for cause (including constructive discharge) following a change in control event, in place of the severance benefits above, the CEO and all other executives would instead receive the following:
Post-Termination Compensation - Change-In-Control
n/a-not applicable
*
Estimated cost
**
Includes both qualified and nonqualified plans.
Notes:
(1)
CIC agreements stipulate two years of base salary for eligible participants.
(2)
CIC agreements stipulate two years of VIP award payout amount for eligible participants.
(3)
1CIC agreements stipulate 18 months of medical insurance coverage for eligible participants.
(4)
CIC agreements stipulate 12 months of outplacement services for eligible participants.
(5)
CIC agreement for CEO stipulates additional severance in an amount equivalent to the increase in the amount of the benefits that would be paid under the defined benefit plans with two years of additional defined benefit credit service.
(6)
CIC agreement for CEO stipulates additional severance in an amount equivalent to two years of defined contribution match.
Director Compensation
The Bank’s directors were compensated in accordance with the 2008 Directors’ Fee Policy. Since the passage of the GLB Act up until the adoption of the Housing Act on July 30, 2008, the total annual fees paid could not exceed the annual compensation limits set forth in the Federal Home Loan Bank Act as adjusted by the Federal Housing Finance Board annually to reflect changes in the preceding year’s Consumer Price Index (CPI). The 2008 limits on annual compensation were: $31,232 for the Chair; $24,986 for the Vice Chair; and $18,739 for all other directors. No retainer fees are paid. Fees paid for Board meeting attendance as follows: (a) Chair $1,500 per meeting; (b) Vice Chair $1,250 per meeting; and (c) All other directors, $1,000 per meeting. Board meeting fees are paid per meeting day. Additional fees paid for Board Committee meeting attendance: $1,000 per Committee meeting day to each director attending. The amount of the fee paid does not vary among the directors in attendance. No Committee meeting fees are paid if a Board meeting fee is paid for the same day. Committee meeting fees are paid per meeting day not per Committee meeting. An additional per meeting day attendance fee of $1,000 is also paid for: (a) special Committee meetings, task force or ad hoc Committee meetings; (b) FHLBank System meetings; (c) Advisory Council meetings; and (d) otherwise serving the Bank on official business. The amount of the fee paid did not vary among directors and such meeting fees are paid on a per meeting day basis.
*
Fees Earned or Paid in Cash are the aggregate of the following: (1) the fees paid by the Bank during the portion of the year during which Mr. Curtis served as an Advisory Board consultant and (2) the fees paid during the portion of the year he served as a director.
“Total Compensation” does not include previously deferred director fees for prior years’ service and earnings on such fees for those directors participating in the Bank’s nonqualified deferred compensation deferred fees plan for directors. The plan allows directors to defer their fees and receive earnings based on returns available under or comparable to certain publicly available mutual funds, including equity funds and money market funds. No Bank matching contributions are made under the plan.
“All Other Compensation” for each includes $24 per director annual premium for director travel and accident insurance.
The Bank also reimburses directors and pays for travel and related expenses associated with meeting attendance in accordance with its Travel & Expense Policy. Total expenses paid under that policy in 2008 were $123,171
With the enactment of the Housing Act, the statutory caps on director fees were removed. Director compensation levels are now established by each FHLBank’s board of directors. In connection with setting director compensation for 2009, the Bank participated in an FHLBank System review of director compensation,
which included a director compensation study prepared by McLagan Partners. The McLagan study included separate analysis of director compensation for small asset size commercial banks, farm credit banks and S&P 1500 firms. The Bank’s Board considered this study in establishing the Bank’s 2009 director fees and the 2009 director fees are relatively consistent with those at the other FHLBanks. For 2009, the Bank’s Board has adopted the 2009 Directors’ Fee Policy (2009 Fee Policy). Under the 2009 Fee Policy, the total annual director fees are paid as a combination of a quarterly retainer fee and per meeting fees. The following table sets forth the maximum fees that our directors can earn in 2009:
The 2009 Fee Policy is attached as Exhibit 10.5.1 to this 2008 Annual Report filed on Form 10-K. The Finance Agency has determined that the payment of director compensation is subject to Finance Agency review.
Item 12:
Item 12:
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Generally, the Bank may issue capital stock only to members. As a result, the Bank does not offer any compensation plan under which equity securities of the Bank are authorized for issuance.
Member Institutions Holding 5% or More of Outstanding Capital Stock
as of February 28, 2009
(a)
Formerly known as GMAC Automotive Bank. For Bank membership purposes, principal place of business is Horsham, PA.
Additionally, due to the fact that a majority of the Board of the Bank is elected from the membership of the Bank, these elected directors are officers and/or directors of member institutions that own the Bank’s capital stock. These institutions are provided in the following table.
Capital Stock Outstanding to Member Institutions
Whose Officers and/or Directors Served as a Director of the Bank
as of February 28, 2009
*
Less than 0.1%.
Note:
In accordance with Section 10(c) of the Act and the terms of the Bank’s security agreement with each member, the capital stock held by each member is pledged to the Bank as additional collateral to secure that member’s loans from and other indebtedness to the Bank.
Item 13:
Item 13:
Certain Relationships and Related Transactions and Director Independence
Corporate Governance Guidelines
The Bank has adopted corporate governance guidelines titled “Governance Principles” which are available at www.fhlb-pgh.com by first clicking “Investor Relations” and then “Governance.” The Governance Principles are also available in print to any member upon written request to the Bank, 601 Grant Street, Pittsburgh, PA 15219, Attention: General Counsel. These principles were adopted by the Board to best ensure that the Board is independent from management, that the Board adequately performs its function as the overseer of management and to help ensure that the interests of the Board and management align with the interests of the Bank’s members.
On an annual basis, each director and executive officer is obligated to complete a director and officer questionnaire which requires disclosure of any transactions with the Bank in which the director or executive officer, or any member of his or her immediate family, have a direct or indirect material interest. All directors must adhere to the Bank’s Code of Conduct which addresses conflicts of interest. Under the Code of Conduct, only the Board can grant a waiver of the Code’s requirements in regard to a director or executive officer.
Bank’s Cooperative Structure
All members are required by law to purchase capital stock in the Bank. The capital stock of the Bank can be purchased only by members. As a cooperative, the Bank’s products and services are provided almost exclusively to its members. In the ordinary course of business, transactions between the Bank and its members are carried out on terms that are established by the Bank, including pricing and collateralization terms that treat all similarly situated members on a nondiscriminatory basis. Loans included in such transactions did not involve more than the normal risk of collectibility or present other unfavorable terms. Currently, nine of the Bank’s fifteen directors are officers or directors of members. In recognition of the Bank’s status as a cooperative, in correspondence from the Office of Chief Counsel of the Division of Corporate Finance of the SEC, dated September 28, 2005, transactions in the ordinary course of the Bank’s business with member institutions are excluded from SEC Related Person Transaction disclosure requirements. No individual director or executive officer of the Bank or any of their immediate family members has been indebted to the Bank at any time.
Related Person Transaction Policy
In addition to the Bank’s Code of Conduct, which continues to govern potential director and executive officer conflicts of interest, effective January 31, 2007, the Bank adopted a Related Person Transaction Policy, which is in writing. (The Policy is subject to annual review and approval and was most recently approved by the Board in February, 2009 without change.) In accordance with the terms of the Policy, the Bank will enter into Related Person Transactions that are not in the ordinary course of Bank business only when the Governance Committee of the Board determines that the Related Person Transaction is in the best interests of the Bank and its investors. Ordinary course of Bank business is defined as providing the Bank’s products and services, including affordable housing products, to member institutions on terms no more favorable than the terms of comparable transactions with similarly situated members. A Related Person Transaction is a transaction, arrangement or relationship (or a series of transactions, arrangements or relationships) in which the Bank was, is or will be a participant, the amount involved exceeds $60 thousand and in which a Related Person had, has or will have a direct or indirect material interest. A Related Person is any director or executive officer of the Bank, any member of their immediate families or any holder of 5 percent or more of the Bank’s outstanding capital stock. A transaction with a company with which a Related Person is associated is deemed pre-approved where the Related Person: (1) serves only as a director of such company; (2) is only an employee (and not an executive officer) of such company; or (3) is the beneficial owner of less than 10 percent of such company’s shares.
Related Person Transactions
In accordance with the Bank’s Related Person Transaction Policy, on February 16, 2007, the Governance Committee of the Board of Directors approved Wilmington Trust Company as an authorized counterparty for Federal funds transactions with the Bank. The Governance Committee also approved Wilmington Trust as a counterparty for receiving Bank deposits on June 6, 2007. Mr. Gibson, a director of the Bank and an executive
officer of Wilmington Trust Company was not a member of the Governance Committee and did not participate in the Committee’s consideration or approval. During 2008 and through March 20, 2009, the Bank had not executed any Federal funds or deposit transactions with Wilmington Trust Company.
Beginning in 1997, the Bank began purchasing bonds issued by Pennsylvania Housing Finance Agency (PHFA). On May 14, 2007, Brian Hudson, Executive Director and Chief Executive Officer of PHFA, was appointed as a director of the Bank by the Finance Agency. On June 25, 2007, in accordance with the Related Person Transaction Policy, the Governance Committee approved the Bank’s continued purchases of PHFA bonds. In 2008, the Bank purchased $197.1 million of PHFA bonds. As of March 20, 2009, the total outstanding principal amount of PHFA bonds held by the Bank was $427.5 million. The greatest outstanding principal amount of PHFA bonds held by the Bank in 2008 was $167.2 million. In 2008, the Bank received $10.7 million in interest payments on outstanding PHFA bonds and $12.0 million in principal payments due to bond calls and redemptions.
PHFA, as the state housing finance agency for Pennsylvania, provides funding for housing for very-low- and low-income households. As a result, many of the projects that PHFA provides funding to are projects that also apply for and receive funding from the Bank’s AHP program. Consequently, on June 25, 2007, the Governance Committee also approved the Bank continuing to enter into AHP grant transactions in which PHFA participates. In 2008, the Bank approved $9.6 million in AHP grants for 23 projects in which PHFA served as a sponsor or otherwise participated. The $9.6 million in AHP grants was approved in accordance with the competitive AHP scoring regulations of the Finance Agency, including the requirement that any FHLBank director who is associated with, or whose institution is associated with, an AHP grant under consideration for approval, recuse themselves from the consideration of the grant by the Bank’s Board. See 12 C.F.R. 1291.10. The Bank followed this process in regard to its Board’s consideration and approval of the $9.6 million in AHP grants at its meetings on June 20 and December 19, 2008. Mr. Hudson did not participate in the consideration or approval of the $9.6 million in grant requests presented to the Board.
Since December 2000, as permitted under the Finance Agency’s AHP Regulations at 12 C.F.R. 1291.7 PHFA has been a party to an AHP project monitoring agreement with the Bank under which PHFA agrees to monitor the AHP compliance requirements for the Bank with respect to projects in which PHFA also monitors federal tax credit compliance. The Bank pays PHFA a fee of $225 for each AHP project monitored by PHFA during the year. In 2008, the Bank paid PHFA a total of $225 for monitoring one project. The amount of fees paid by the Bank fluctuates each year and is dependent on the number of projects the Bank identifies each year that need to be monitored for compliance with AHP requirements.
As a state housing finance agency, PHFA is eligible to apply to the Bank and be approved as a nonmember housing associate borrower from the Bank in accordance with Finance Agency Regulations. See 12 C.F.R. 926.5. The Bank approved PHFA as a housing associate borrower on December 19, 2007. With the approval of PHFA as a housing associate, the Bank has three housing associate borrowers. The terms of any Bank loans to such housing associates are ordinary course of business transactions governed by the Bank’s Member Products Policy and apply to all housing associates. Under the terms of the Bank’s Related Person Transaction Policy, provided that the loans to any related person are in accordance with the terms of the Bank’s Member Products Policy, such transactions are within the ordinary course of business of the Bank and not subject to Governance Committee approval. As of March 20, 2009, there were no outstanding loans from the Bank to PHFA.
In 2001, in furtherance of its mission to provide funding for economic development in the Bank’s district, the Bank entered into an agreement to make a capital contribution of up to $500 thousand to Mountaineer Capital, LP (Mountaineer Capital). Mountaineer Capital is a Small Business Investment Company (SBIC) which provides financing for small businesses in West Virginia. On May 14, 2007, Patrick Bond, General Partner for Mountaineer Capital, was appointed to serve as a director of the Bank. On January 23, 2007, the Bank made a capital contribution of $50 thousand to Mountaineer Capital. At year-end 2007, the total amount of Bank capital contributions was $375 thousand. On February 12, 2008, the Governance Committee approved a $50 thousand capital contribution request and granted approval for additional capital contributions to Mountaineer Capital in accordance with the terms of the Bank’s agreement, up to a total amount of $500 thousand. At year-end 2008, the Bank’s total capital contributions to Mountaineer Capital were $425 thousand.
Since approximately 2002, Chase Bank has been approved for Federal funds and other money market investment transactions with the Bank in accordance with the requirements and limits established in the Bank’s policies. During 2008, the Bank entered into overnight Federal funds transactions with Chase Bank. Chase Bank became a 5 percent or greater Bank shareholder in October 2008. On February 19, 2009, the Governance Committee ratified these transactions and approved the Bank entering into other Federal funds and money market investment transactions with Chase Bank in accordance with the Bank’s applicable investment and counterparty policy statements. The largest aggregate principal amount outstanding for such transactions with Chase during 2008 was $1.0 billion. The amount of interest paid during 2008 was $3.4 million and the amount of principal paid (representing repayment of each overnight Federal funds transaction) was $41.6 billion. There were no outstanding Federal funds transactions with Chase Bank as of March 20, 2009.
On February 19, 2009, the Governance Committee approved the Bank entering into interest-earning deposits, Federal funds, unsecured note purchase and other money market transactions with Bank members, including 5 percent or greater shareholders of the Bank and Member Directors’ institutions. All such transactions must be in accordance with the terms of the Bank’s investment and counterparty policy statements and limits. As of March 20, 2009 the Bank has not engaged in any of these transactions with Member Directors’ institutions or 5 percent or greater shareholders.
Director Independence
Under the Act, Bank management is not allowed to serve on the Bank’s Board. Consequently, all directors of the Bank are outside directors. As discussed in Item 10, directors are classified under the Act as either being a Member Director or an Independent Director. By statute, the Board cannot expand or reduce the number of directors that serve on the Board. Only the Finance Agency has the authority to determine how many seats exist on the Board. As of March 20, 2009, the Board was comprised of fifteen directors, including nine Member Directors and six Independent Directors.
The Bank’s directors are prohibited from personally owning stock in the Bank. In addition, the Bank is required to determine whether its directors are independent under two distinct director independence standards. First, the Act and Finance Agency Regulations establish independence criteria, including independence criteria for directors who serve on the Bank’s Audit Committee. Second, the SEC rules require, for disclosure purposes, that the Bank’s Board apply the independence criteria of a national securities exchange or automated quotation system in assessing the independence of its directors.
The Act and Finance Agency Regulations.
Following the enactment of the Housing Act amendments to the Act on July 30, 2008, an individual is not eligible to be an Independent Bank director if the individual serves as an officer, employee, or director of any member of the Bank, or of any recipient of loans from the Bank. During 2008 and through March 20, 2009, none of the Bank’s Independent Directors were an officer, employee or director of any member or of any institution that received advances from the Bank.
Effective on enactment of the Housing Act, the FHLBanks are required to comply with the substantive Audit Committee director independence standards under Section 10A(m) of the Exchange Act. Rule 10A-3(b)(ii)(B) implementing Section 10A(m) provides that in order to be considered to be independent, a member of an audit committee may not: (a) accept directly or indirectly a compensatory fee (other than from the issuer for service on the Board); or (b) be an affiliated person of the issuer, defined as someone who directly or indirectly controls the issuer. The SEC implementing regulations provide that a person will be deemed not to control an issuer if the person does not own directly or indirectly more than 10 percent of any class of voting equity securities. The existence of this safe harbor does not create a presumption in any way that a person exceeding the ownership requirement controls or is otherwise an affiliate of a specified person. In regard to the Bank and the other FHLBanks, this provision of the Housing Act raises an issue whether a Member Director whose institution is a 10 percent or greater Bank shareholder could be viewed as an affiliate of the Bank, rendering such Member Director ineligible to serve on the Bank’s Audit Committee. Because of the cooperative structure of the FHLBanks, the limited items on which FHLBank stockholders may vote and the statutory cap limiting the votes that any one member may cast for a
director to the state average, it is not clear that the fact that a Member Director’s institution is a 10 percent or greater Bank shareholder causes the director to be an affiliate of the Bank. Nevertheless, none of the Bank’s current Audit Committee members nor those who served during 2008 were Member Directors from institutions that were 10 percent or greater Bank shareholders.
In addition, the Finance Agency director independence standards prohibit individuals from serving as members of the Bank’s Audit Committee if they have one or more disqualifying relationships with the Bank or its management that would interfere with the exercise of that individual’s independent judgment. Disqualifying relationships considered by the Board are: (1) employment with the Bank at any time during the last five years; (2) acceptance of compensation from the Bank other than for service as a director; (3) being a consultant, advisor, promoter, underwriter or legal counsel for the Bank at any time within the last five years; and (4) being an immediate family member of an individual who is or who has been within the past five years, a Bank executive officer. As of March 20, 2009, all current members of the Audit Committee were independent under the Act and Finance Agency regulatory criteria.
SEC Rules. Pursuant to the SEC rules applicable to the Bank for disclosure purposes, the Bank’s Board has adopted the independence standards of the New York Stock Exchange (NYSE) to determine which of its directors are independent, which members of its Audit Committee are not independent and whether the Bank’s Audit Committee financial expert is independent. As the Bank is not a listed company, the NYSE director independence standards are not substantive standards that are applied to determine whether individuals can serve as members of the Bank’s Board or the Audit Committee.
After applying the NYSE independence standards, the Board determined on February 20, 2009, that for purposes of the SEC rules with respect to the Bank’s current directors, four of the Bank’s Independent Directors, Directors Cortes, D’Alessio, Darr and Peck are independent. In determining that Director Cortés was independent, the Board considered that Nueva Esperanza, the non-profit organization which Director Cortés serves as President, has received AHP grants and charitable contributions from the Bank from time to time, including when Director Cortés was not a Bank Director. None of these transactions occurred in 2008 that required consideration under the Bank’s Related Person Transaction Policy. With respect to Director Darr, the Board considered that Manna Inc., a non-profit organization on which Mr. Darr serves as a director, was approved for an AHP grant by the Bank in 2007, prior to Mr. Darr becoming a member of the Board.
With respect to the Bank’s remaining two current Independent Directors, the Board determined that in view of the historic and ongoing relationship and transactions described above, with respect to PHFA and Mountaineer Capital, Directors Hudson and Bond are not independent.
The Board was unable to affirmatively determine that there are no material relationships (as defined in the NYSE rules) between the Bank and its Member Directors, and concluded that none of the Bank’s current Member Directors was independent under the NYSE independence standards. In making this determination, the Board considered the cooperative relationship between the Bank and its Member Directors. Specifically, the Board considered the fact that each of the Bank’s Member Directors are officers or directors of a Bank member institution, and each member institution has access to, and is encouraged to use, the Bank’s products and services. Furthermore, the Board considered the appropriateness of making a determination of independence with respect to the Member Directors based on a member’s given level of business as of a particular date, when the level of each member’s business with the Bank is dynamic and the Bank’s desire as a cooperative is to increase its level of business with each of its members. As the scope and breadth of a member’s business with the Bank changes, such member’s relationship with the Bank might, at any time, constitute a disqualifying transaction or business relationship under the NYSE’s independence standards.
For Member Directors who served on the Board in 2008 but no longer serve on the Board, the Board determined on February 20, 2009, that both of those directors, Directors Curtis and Reichart, were not independent.
The Board has a standing Audit Committee. The Board determined that none of the current Member Directors serving as members of the Bank’s Audit Committee, Directors Gibson, Marshall, Milinovich and Ward are
independent under the NYSE standards for Audit Committee members and that Independent Director Hudson is also not independent. The Board determined that Independent Director Darr, who serves on the Audit Committee, is independent under the NYSE independence standards for Audit Committee members.
Item 14:
Item 14:
Principal Accountant Fees and Services
The following table sets forth the aggregate fees billed to the Bank for the years ended December 31, 2008 and 2007 by its independent registered public accounting firm, PricewaterhouseCoopers LLP:
Audit fees consist of fees billed for professional services rendered for the audits of the financial statements and reviews of interim financial statements for the years ended December 31, 2008 and 2007.
Audit-related fees consist of fees billed in the years ended December 31, 2008 and 2007 for assurance and related services reasonably related to the performance of the audit or review of the financial statements. Audit-related fees were primarily for accounting consultations.
The Bank is exempt from all federal, state and local income taxation with the exception of real estate property taxes. There were no tax fees paid during the years ended December 31, 2008 and 2007.
Other fees paid during the years ended December 31, 2008 and 2007 represent licensing fees associated with the use of accounting research software.
The Audit Committee approves the annual engagement letter for the Bank’s audit. All other services provided by the independent accounting firm are pre-approved by the Audit Committee. The Audit Committee delegates to the Chair of the Audit Committee the authority to pre-approve non-audit services not prohibited by law to be performed by the independent auditors, subject to any single request involving a fee of $100 thousand or higher being circulated to all Audit Committee members for their information and comment. The Chair shall report any decision to pre-approve such services to the full Audit Committee at its next meeting.
The Bank paid additional fees to PricewaterhouseCoopers, LLP in the form of assessments paid to the Office of Finance. These fees were approximately $36 thousand dollars during the year ended December 31, 2008 and were classified as Other Expense - Office of Finance on the Statement of Operations. These fees are not included in the totals above.
PART IV
­ ­
Item 15:
Item 15:
Exhibits and Financial Statement Schedules
(a)(1) Financial Statements
The following Financial Statements and related notes, together with the report of PricewaterhouseCoopers, LLP, appear in Item 8.
Statement of Operations for each of the years ended December 31, 2008, 2007 and 2006
Statement of Condition as of December 31, 2008 and 2007
Statement of Cash Flows for each of the years ended December 31, 2008, 2007 and 2006
Statement of Changes in Capital for each of the years ended December 31, 2008, 2007 and 2006
(2) Financial Statement Schedules
The schedules and exhibits for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission that would appear in Item 8. Financial Statements and Supplementary Data are included in the “Financial Information” section within Item 7. Management’s Discussion and Analysis.
(b)
Index of Exhibits
The following is a list of the exhibits filed with this Annual Report on Form 10-K or incorporated herein by reference:
+
Incorporated document references to filings by the registrant are to SEC File No. 000-51395.
*
Denotes management contract or compensatory plan.
GLOSSARY
­ ­
Advance: Secured loan made to a member.
Agent fee: Fee payable to a PFI by an MPF Bank in accordance with the Origination Guide, in connection with the origination of a Bank-funded mortgage.
Affordable Housing Program (AHP): Bank program that provides primarily direct grants and/or subsidized loans to assist members in meeting communities’ affordable housing needs. Each FHLBank sets aside approximately 10 percent of its net income to fund the program with a minimum $100 million annual contribution by all twelve FHLBanks.
ALCO: Asset/Liability Management Committee of the Bank.
AMA: Acquired member assets.
APBO: Accumulated Post-retirement Benefit Obligation.
Adjustable-rate mortgage: Mortgage that features predetermined adjustments of the loan interest rate at regular intervals based on an established index.
Banking On Business (BOB): Bank program that assists eligible small businesses with start-up and expansion. A small business is defined as any firm, proprietorship, partnership or corporation that has less than 50 employees and the lesser of $10 million in annual receipts or the annual receipts limits set by the Small Business Administration’s (SBA) size standards by North American Industry Classification (NAIC).
Capital plan: New capital structure for FHLBanks, required by the GLB Act, that produces a more permanent source of capital and facilitates compliance with new risk-based capital requirements.
Capital stock: The five-year redeemable stock issued by the Bank pursuant to its capital plan.
Community financial institution (CFI): Bank member that has deposits insured under the FDIC and average total assets for 2008 of less than $1 billion over the past three years and is exempt from the requirement of having at least 10 percent of total assets in residential mortgage loans.
Community investment cash advance: General framework under which the FHLBanks may offer an array of specific standards for projects, targeted beneficiaries and targeted income levels that the Finance Agency has determined support community lending.
Community Lending Program (CLP): Bank program that funds community and development projects through an $825 million noncompetitive revolving loan pool. When loans are repaid, the money is available to be lent to other projects.
Collateralized mortgage obligation: Type of bond that divides cash flows from a pool of mortgages into multiple classes with different maturities or risk profiles.
Constant Maturity Treasury (CMT): Refers to the par yield that would be paid by a U.S. Treasury bill, note or bond that matures in exactly one, two, three, five, seven, ten, 20 or 30 years.
Consolidated Obligation (CO): Bonds and discount notes that are the joint and several liability of all twelve FHLBanks and are issued and serviced through the OF. These instruments are the primary source of funds for the FHLBanks.
Committee on Uniform Securities Identification Procedures (CUSIP): CUSIP-based identifiers provide a unique name for a wide range of global financial instruments including equity and debt issues, derivatives and syndicated loans. The CUSIP consists of a combination of nine characters, both letters and numbers, which identify a company or issuer and the type of security.
Collateral: Property subject to a security interest that secures the discharge of an obligation (e.g., mortgage or debt obligation); a security interest that an FHLBank is required by statute to obtain and thereafter maintain beginning at the time of origination or renewal of a loan.
Conventional loan/mortgage: Mortgage that is neither insured nor guaranteed by the FHA, VA or any other agency of the Federal government.
Convexity: A measure of the change in price sensitivity or duration of an asset or liability for specified changes in interest rates. While all fixed income instruments have some degree of convexity, mortgage assets and callable liabilities have notable convexity characteristics because of the option components within those instruments.
Cost of funds: Estimated cost of issuing FHLBank System consolidated obligations and discount notes.
Credit enhancement fee: Fee payable monthly by an MPF Bank to a PFI in consideration of the PFI’s obligation to fund the realized loss for a Master Commitment; based on fee rate applicable to such Master Commitment and subject to terms of the Master Commitment and applicable MPF mortgage product, which may include performance and risk participation features.
Demand Deposit Account (DDA): The account each member maintains with the Bank. All incoming and outgoing wires, loan credits and debits, as well as any principal and interest payments from securities and loans are posted into the DDA.
Delivery commitment: Mandatory commitment of the parties, evidenced by a written, machine- or electronically generated transmission issued by an MPF Bank to a PFI accepting the PFI’s oral mortgage loan delivery commitment offer.
Duration: A common measure of the price sensitivity of an asset or liability to specified changes in interest rates.
EITF: Emerging Issues Task Force.
Exempt securities: Bank securities under Section 3(a)(2) of the Securities Exchange Act of 1933.
Fannie Mae, Federal National Mortgage Association (FNMA): GSE established in 1938 to expand the flow of mortgage money by creating a secondary market.
Financial Accounting Standards Board (FASB): Board created in 1973 responsible for establishing and interpreting generally accepted accounting principles and improving standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors and users of financial information.
Federal Deposit Insurance Corporation (FDIC): Federal agency established in 1933 that guarantees (with limits) funds on deposit in member banks and performs other functions such as making loans to or buying assets from member banks to facilitate mergers or prevent failures.
Federal Home Loan Bank Act (the Act): Enacted by Congress in 1932 creating the FHLBank Board, whose role was to supervise a series of discount banks across the country. The intent was to increase the supply of money available to local institutions that made home loans and to serve them as a reserve credit resource. The FHLBank Board became the Federal Housing Finance Board in 1989, which was replaced by The Federal Housing Finance Agency in 2008.
Federal Home Loan Bank’s Office of Finance (OF): FHLBank System’s centralized debt issuance facility that also prepares combined financial statements, selects/evaluates underwriters, develops/maintains the infrastructure needed to meet FHLBank System goals, and administers REFCORP and FICO funding programs.
Federal Housing Finance Agency (Finance Agency): Independent regulatory agency (established on enactment of the Housing Act) of the executive branch ensuring the FHLBanks, Federal National Mortgage Association and Federal Home Loan Mortgage corporation operate in a safe and sound manner, carry out their statutory missions and remain adequately capitalized and able to raise funds in the capital markets.
Federal Housing Administration (FHA): Government agency established in 1934 and insures lenders against loss on residential mortgages.
Financing Corporation (FICO): Mixed-ownership, government corporation in charge of servicing debt on bonds that were issued as a result of the savings and loan “bailout”. Mixed-ownership corporations are those with capital stock owned by both the United States and borrowers or other private holders.
First Front Door (FFD): Bank program developed to provide grant assistance to cover the down payment and closing costs to first-time homebuyers at or below 80 percent area median income.
First Loss Account (FLA): Notational account established by an MPF Bank for each Master Commitment based on and in the amount required under the applicable MPF mortgage product description and Master Commitment.
Freddie Mac, Federal Home Loan Mortgage Corporation (FHLMC): GSE chartered by Congress in 1970 to keep money flowing to mortgage lenders in support of homeownership and rental housing.
Generally Accepted Accounting Principles (GAAP): Accounting term that encompasses the conventions, rules, and procedures necessary to define accepted accounting practice at a particular time. GAAP includes not only broad guidelines of general application, but also detailed practices and procedures. Those conventions, rules, and procedures provide a standard by which to measure financial presentations.
Ginnie Mae, Government National Mortgage Association (GNMA): GSE established by Congress in 1968 that guarantees securities backed by a pool of mortgages.
Gramm-Leach-Bliley Act (GLB Act): Enacted in 1999 that set forth the following:
•
Banks with less than $500 million in assets may use long-term loans for loans to small businesses, small farms and small agri-businesses.
•
A new, permanent capital structure for FHLBanks is established. Two classes of stock are authorized, redeemable on six months’ and five years’ notice. FHLBanks must meet a 5 percent leverage minimum tied to total capital and a risk-based requirement tied to permanent capital.
•
Equalizes the stock purchase requirement for banks and thrifts.
•
Voluntary membership for federal savings associations took effect six months after enactment.
•
Annual $300 million funding formula for REFCORP obligations of FHLBanks is changed to 20 percent of annual net earnings.
•
Governance of the FHLBanks is decentralized from the Finance Board (the regulator at that time) to the individual FHLBanks. Changes include the election of a chairperson and vice chairperson of each FHLBank by its directors rather than the Finance Board and a statutory limit on FHLBank directors’ compensation.
Government-sponsored enterprise (GSE): A private organization with a government charter whose function is to provide liquidity for the residential loan market or another identified government purpose.
HUD: Housing and Urban Development.
Index amortizing swap: Typically a fixed to float rate interest rate swap whereby the notional principal amortizes in response to changes in the referenced index.
Internal Credit Rating (ICR): A scoring system used by the Bank to measure the financial condition of a member or housing associate and is based on quantitative and qualitative factors.
Joint and several liability: Obligation for which multiple parties are each individually and all collectively liable for payment.
London Interbank Offered Rate (LIBOR): Offer rate that a Euromarket bank demands to place a deposit at (or equivalently, make a loan to) another Euromarket bank in London. LIBOR is frequently used as the reference rate for the floating-rate coupon in interest rate swaps and option contracts such as caps and floors.
Loan level credit enhancement: Portion of the credit enhancement pertaining to the risks of an individual mortgage loan.
Master Commitment: A document executed by a PFI and an MPF Bank, which provides the terms under which the PFI will deliver mortgage loans to the MPF Bank.
Master Servicer: Financial institution that the MPF Provider has engaged to perform various master servicing duties on its behalf in connection with the MPF Program.
Maximum Borrowing Capacity (MBC): Total possible borrowing limit for an individual member. This is determined based on the type and amount of collateral each member has available to pledge as security for Bank loans to members. It is computed using specific asset balances (market and/or book values) from qualifying collateral categories, which are discounted by applicable collateral weighting percentages. The MBC is equal to the aggregate collateral value net of any pledged assets.
Mortgage-Backed securities (MBS): Investment instrument backed by mortgage loans as security.
Mortgage Partnership Finance (MPF) Program: FHLBank of Chicago program offered by select FHLBanks to their members to provide an alternative for funding mortgages through the creation of a secondary market.
Office of Federal Housing Enterprise Oversight (OFHEO): Government agency established in 1992 and responsible for ensuring the financial safety and soundness of Fannie Mae and Freddie Mac.
ORERC: Other real estate-related collateral.
Pair-off fee: A fee assessed against a PFI when the aggregate principal balance of mortgages funded or purchased under a delivery commitment falls above or below the tolerance specified.
Permanent capital: Retained earnings and capital stock.
Participating Financial Institution (PFI): Bank member participating in the MPF Program, which is legally bound to originate, sell and/or service mortgages in accordance with the PFI Agreement, which it signs with the MPF Bank of which it is a member.
Real Estate Mortgage Investment Conduit (REMIC): Multi-class bond backed by a pool of mortgage securities or mortgage loans.
Real Estate Owned (REO): Mortgaged property acquired by a servicer on behalf of the mortgagee, through foreclosure or deed in lieu of foreclosure.
Resolution Funding Corporation (REFCORP): Mixed-ownership, government corporation created by Congress in 1989 to issue “bailout” bonds and raise industry funds to finance activities of the Resolution Trust Corporation, and merge or close insolvent institutions inherited from the disbanded Federal Savings and Loan Insurance Corporation. Mixed-ownership corporations are those with capital stock owned by both the United States and borrowers or other private holders.
RHS: Rural Housing Service
RPAF: Registered Public Accounting Firm.
SERP: Supplemental Executive Retirement Plan.
Servicer: Institution approved to service mortgages funded or purchased by an MPF Bank. The term servicer refers to the institution acting in the capacity of a servicer of mortgages for an MPF Bank under a PFI Agreement.
SFAS: Statement of Financial Accounting Standard.
Standby letter of credit: Document issued by the FHLBanks on behalf of a member as a guarantee against which funds can be drawn, that is used to facilitate various types of business transactions the member may have with third parties. Standby is defined as the Bank standing by to make good on the obligation made by the member to the beneficiary.
Supplemental Mortgage Insurance (SMI) policy: Any and all supplemental or pool mortgage guarantee insurance policies applicable to mortgages delivered under the Master Commitment.
Underlying: A specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates or other variable. An underlying may be the price or rate of an asset or liability, but is not the asset or liability itself.
Veterans Affairs, Department of (VA): Federal agency with oversight for programs created for veterans of the U.S. armed forces. Mortgage loans granted by a lending institution to qualified veterans or to their surviving spouses may be guaranteed by the VA.
Weighted average coupon (WAC): Weighted average of the interest rates of loans within a pool or portfolio.
Weighted average life (WAL): The average amount of time that will elapse from the date of a security’s issuance until each dollar of principal is repaid. The WAL of mortgage loans or mortgage-backed securities is only an assumption. The average amount of time that each dollar of principal is actually outstanding is influenced by, among other factors, the rate at which principal, both scheduled and unscheduled, is paid on the mortgage loans.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this amended report to be signed on its behalf by the undersigned, thereunto duly authorized.
Federal Home Loan Bank of Pittsburgh
(Registrant)
Date: March 27, 2009
By:
/s/John R. Price
John R. Price
President and Chief Executive Officer