ITEM 1. BUSINESS
General
The Federal Home Loan Bank of Boston is a federally chartered corporation organized by the U.S. Congress (Congress) in 1932 and is a government-sponsored enterprise (GSE). Unless otherwise indicated or unless the context requires otherwise, all references in this discussion to “the Bank,” "we," "us," "our," or similar references mean the Federal Home Loan Bank of Boston. Our primary regulator is the Federal Housing Finance Agency (the FHFA).
We are privately capitalized, and our mission is to provide highly reliable wholesale funding and liquidity to our members. We develop and deliver competitively priced financial products, services, and expertise that support housing finance, community development, and economic growth, including programs targeted to lower-income households. We principally serve the residential-mortgage and community-development lending activities of our members and certain nonmember institutions (referred to as housing associates) located in our district. Our district is comprised of Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, and Vermont. There are 12 district Federal Home Loan Banks (the FHLBanks or the FHLBank System) located across the United States (the U.S.), each supporting the lending activities of its members within their districts. Each FHLBank is a separate entity with its own board of directors, management, and employees.
We are exempt from ordinary federal, state, and local taxation except for local real-estate tax. In lieu of taxes, we set aside funds at a 10 percent rate on our income for our Affordable Housing Program (AHP). In addition, we paid a 20 percent assessment for the Resolution Funding Corporation (REFCorp) until the obligation was fully satisfied during the second quarter of 2011. For further information on these assessments, see - Assessments.
We are managed with the primary objectives of enhancing the value of our membership and fulfilling our public purpose. In pursuit of our primary objectives, we have four long-term strategic priorities, which are to:
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position the Bank to compete effectively in the wholesale funding market and meet members' need for funding housing, community development and economic growth;
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continue to build retained earnings while containing risk so that we can provide a stable return on members’ stock investment and repurchase excess stock over time;
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advocate stakeholder interests in policy matters, and effectively respond to pending GSE reform and other legislative and regulatory initiatives; and
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continue to evolve as a strong and agile organization that responds quickly and effectively to emerging risks and opportunities while upholding our commitment to efficient and effective operation.
We combine private capital and public sponsorship in a way that is intended to enable our members and housing associates to assure the flow of credit and other services for housing and community development. We serve the public through our members and housing associates by providing these institutions with a readily available, low-cost source of funds, called advances, as well as other products and services that are intended to support the availability of residential-mortgage and community-investment credit. In addition, we provide liquidity by investing in mortgage loans through a mortgage loan investment program. Under this program, we offer participating financial institutions the opportunity to originate mortgage loans for sale to us. Our primary source of income is derived from the interest spread between interest-earning assets and interest-bearing liabilities. We are generally able to borrow funds at favorable rates due to our GSE status.
Our members and housing associates are comprised of institutions located throughout our district. Institutions eligible for membership include thrift institutions (savings banks, savings and loan associations, and cooperative banks), commercial banks, credit unions, qualified community development financial institutions (CDFIs), and insurance companies that are active in housing finance. We are also authorized to lend to housing associates such as state housing-finance agencies located in New England. Members are required to purchase and hold our capital stock as a condition of membership and for advances and certain other activities transacted with us. The par value of our capital stock is $100 per share and is not publicly traded on any stock exchange. The U.S. government does not guarantee either the member's investment in or any dividend on our stock. We are capitalized by the capital stock purchased by our members and by retained earnings. Members may receive dividends, which are determined by our board of directors, and may request redemption of their capital stock at par value subject to certain conditions, as discussed further in Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Capital.
Federal Housing Finance Agency
The FHFA, an independent agency in the executive branch of the U.S. government, supervises and regulates the FHLBanks. The FHFA replaced the Federal Housing Finance Board (the Finance Board) as the FHLBanks' regulator upon the enactment of the Housing and Economic Recovery Act of 2008, as amended (HERA). All regulations, orders, and decisions of the Finance Board remain in effect until modified or superseded.
The FHFA is financed through assessments on the entities it regulates, which include the FHLBanks, as discussed under Item 8 - Financial Statements and Supplementary Data - Notes to the Financial Statements - Note 1 - Summary of Significant Accounting Policies - FHFA Expenses. HERA prohibits assessments on the FHLBanks in excess of the costs and expenses related to the FHLBanks.
The FHFA has broad supervisory authority over the FHLBanks, including, but not limited to, the power to suspend or remove any entity-affiliated party (including any director, officer, or employee) of an FHLBank who violates certain laws or commits certain other acts; to issue and serve a notice of charges upon an FHLBank or any entity-affiliated party; to obtain a cease and desist order, or a temporary cease and desist order; to stop or prevent any unsafe or unsound practice or violation of law, order, rule, regulation, or condition imposed in writing; to issue civil money penalties against an FHLBank or an entity-affiliated party; to require an FHLBank to maintain capital levels in excess of usual regulatory requirements; to require an FHLBank to take certain actions, or refrain from certain actions, under the prompt corrective action provisions that authorize or require the FHFA to take certain supervisory actions, including the appointment of a conservator or receiver for an FHLBank under certain conditions; and to require any one or more of the FHLBanks to repay the primary obligations of another FHLBank on outstanding consolidated obligations (COs).
The FHFA conducts an annual on-site examination and other periodic reviews of our operations to assess our safety and soundness as well as our compliance with statutory and regulatory requirements. In addition, we are required to submit information on our financial condition and results of operations each month to the FHFA. We are generally prohibited by FHFA regulations from disclosing the results of those examinations and reviews. However, we do consider the information we gather from these processes in setting our business objectives and conducting our operations. Information from those examinations and reviews could become publicly available either through the FHFA or through the FHFA's Office of Inspector General, which can sometimes occur via their reports to Congress.
The Office of Finance
The Federal Home Loan Banks' Office of Finance (the Office of Finance) was established by the Federal Home Loan Bank Board, predecessor of the Finance Board, to facilitate the issuing and servicing of debt in the form of COs of the FHLBanks. COs are issued on a joint and several basis. The FHLBanks, through the Office of Finance as their agent, are the issuers of COs for which they are jointly and severally liable. The Office of Finance also provides the FHLBanks with credit and market data and maintains the FHLBanks' joint relationships with credit-rating agencies. The FHLBanks are charged for the costs of operating the Office of Finance, as discussed in Item 8 - Financial Statements and Supplementary Data - Notes to the Financial Statements - Note 1 - Summary of Significant Accounting Policies - Office of Finance Expenses. The Office of Finance is governed by a board of directors that is constituted of the FHLBank presidents and five independent directors.
Available Information
Our web site (www.fhlbboston.com) provides a link to the section of the Electronic Data Gathering and Reporting (EDGAR) web site, as maintained by the Securities and Exchange Commission (the SEC), containing all reports electronically filed, or furnished, including our annual report on Form 10-K, our quarterly reports on Form 10-Q, and reports on Form 8-K as well as any amendments to such reports. These reports are made available free of charge on our web site as soon as reasonably practicable after electronically filing or being furnished to the SEC. These reports may also be read and copied at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. Further information about the operation of the Public Reference Room may be obtained by calling 1-800-SEC-0330. In addition, the SEC maintains a web site that contains reports and other information regarding our electronic filings (located at http://www.sec.gov). The Bank's and the SEC's web site addresses have been included as inactive textual references only. Information on those web sites is not part of this report.
Employees
As of February 28, 2014, we had 198 full-time employees and one part-time employee.
Membership
The following table summarizes our membership, by type of institution, as of December 31, 2013, 2012, and 2011.
The financial services industry continues to undergo a period of rapid change based on economic, regulatory, political, and other factors that had their inception with the financial crisis in 2008. Given these factors, we believe it is reasonably possible that one or more of our more significant members, either by outstanding advances or by capital stock investment, could be acquired by or merge with an institution that is not a member. The loss of significant members could lower overall demand for our products and services and, thereby, adversely impact our performance. See Item 1A
ITEM 1A. RISK FACTORS
The following discussion summarizes some of the most important risks that we face. This discussion is not exhaustive, and there may be other risks that we face, which are not described below. The risks described below, if realized, may result in us being prohibited from paying dividends, and/or repurchasing and redeeming our capital stock and could adversely impact our business operations, financial condition, and future results of operations.
CREDIT RISKS
We are subject to credit-risk exposures related to the loans that back our investments. Increased delinquency rates and credit losses beyond those currently expected could adversely impact the yield on or value of those investments.
We invested in private-label MBS until the third quarter of 2007. These investments are backed by prime, subprime, and/or Alt-A hybrid and pay-option adjustable-rate mortgage loans. Although we only invested in senior tranches with the highest long-term debt rating when purchasing private-label MBS, many of these securities have sustained and will sustain credit losses under current modeling assumptions, and have been downgraded by various NRSROs. See Part II - Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition - Investments for a description of our portfolio of investments in these securities.
As described under Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates, other-than-temporary-impairment assessment is a subjective and complex determination by management.
We employ relatively stressful assumptions for other-than-temporary-impairment assessments of private-label MBS. These assumptions resulted in projected future credit losses, thereby causing other-than-temporary impairment losses from certain of these securities. We incurred credit losses of $2.6 million for private-label MBS that we determined were other-than-temporarily impaired for the year ended December 31, 2013. If macroeconomic trends or collateral credit performance within our private-label MBS portfolio deteriorate further than currently anticipated, or if foreclosures or similar activity are delayed or impeded, we may use even more stressful assumptions, including, but not limited to, lower house prices, higher loan-default rates, and higher loan-loss severities in future other-than-temporary impairment assessments.
We have also invested in securities issued by HFAs with an amortized cost of $183.6 million as of December 31, 2013. These securities' cash flows are based on the performance of the underlying loans, although some of these securities carry additional credit enhancements such as bond insurance. Although our policies require that State or local housing-finance agency obligations (HFA securities) must carry a credit rating of double-A (or equivalent) or higher as of the date of purchase, some have since been downgraded and, where applicable, some of the related bond insurers have been downgraded. Further, the fair values of some of our HFA securities have also fallen but the decline in market value is attributable to changes in interest rates and credit spreads and to general illiquidity of these investments, and not to a deterioration in the fundamental credit quality of these obligations. Gross unrealized losses on these securities totaled $19.6 million at December 31, 2013. Although we have determined that none of these securities is other-than-temporarily impaired at December 31, 2013, should the underlying loans underperform our projections, we could realize credit losses from these securities.
Declines in U.S. home prices or in activity in the U.S. housing market or rising delinquency or default rates on mortgage loans could result in credit losses and adversely impact our business operations and/or financial condition.
A deterioration of the U.S. housing market and national decline in home prices could adversely impact the financial condition of a number of our borrowers, particularly those whose businesses are concentrated in the mortgage industry. One or more of our borrowers may default on their obligations to us for a number of reasons, such as changes in financial condition, a reduction in liquidity, operational failures, or insolvency. In addition, the value of residential mortgage loans pledged to us as collateral may further decrease. If a borrower defaults, and we are unable to obtain additional collateral to make up for the reduced value of such residential mortgage loan collateral, we could incur losses. A default by a borrower lacking sufficient collateral to cover its obligations to us could result in significant financial losses, which would adversely impact our results of operations and financial condition. Our top five advances borrowing members by par value of outstanding advances are set forth in Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition- Advances in the table captioned “Top Five Advance-Borrowing Institutions.”
Also, a deterioration of the U.S. housing market and national decline in home prices could result in further increases in delinquency rates and loss severities on the mortgage loans underlying our investments in MBS, the risks of which are discussed under - We are subject to credit-risk exposures related to the mortgage loans that back our investments. Increased delinquency rates and credit losses beyond those currently expected could adversely impact the yield on or value of those investments.
Further, as discussed in Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition - Critical Accounting Estimates, our methodology for determining our allowance for loan losses is determined based on our investments in MPF loans and considers factors relevant to those investments. Important factors in determining this allowance are the delinquency rates and trends in the delinquency rates on our investments in conventional mortgage loans. If delinquency or default rates rise for these investments or other factors in determining the allowance worsen, we may determine to increase our allowance for loan losses, which would adversely impact our results of operations and financial condition.
We have geographic concentrations that could adversely impact our business operations and/or financial condition.
We, by nature of our charter and our business operations, are exposed to credit risk resultant from limited geographic diversity. Our advances business is generally limited to operations within our district. While we employ conservative credit rating and collateral practices to limit exposure, a decline in our district's economic conditions could create a credit exposure to our members' advances obligations in excess of collateral held.
We have concentrations of mortgage loans in some geographic areas based on our investments in MPF loans and private-label MBS and on our receipt of collateral pledged for advances. See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition - Mortgage Loans for additional information on these concentrations. To the extent that any of these geographic areas experience significant declines in the local housing markets, declining economic conditions, or a natural disaster, we could experience increased losses on our investments in the MPF loans or the related MBS or be exposed to a greater risk that the pledged collateral securing related advances would be inadequate in the event of default on such an advance.
Counterparty credit risk could adversely impact us.
We assume counterparty credit risk through our money-market and derivatives transactions. Our counterparties include major domestic and international financial institutions. The insolvency or other inability of a significant counterparty to perform its obligations under such transactions or other agreements could have an adverse impact on our financial condition and results of operations.
Investments in mortgage loans via out-of-district MPF participating financial institutions could expose us to unexpected credit risks.
We have entered into a participation facility with the FHLBank of Chicago pursuant to which we may purchase up to $1.5 billion of 100 percent participation interests in MPF loans purchased by the FHLBank of Chicago from its members. Investments in out-of-district MPF loans pursuant to this facility or otherwise, including through other participation facilities that we may enter into for the purchase of participation interests in MPF loans, could expose us to credit and servicing risks attendant with participating financial institutions with whom we do not engage in the course of our normal member lending operations. For additional information on this participation facility, see Item 1 - Business - Business Lines - Mortgage Loan Finance - MPF Loan Participations.
BUSINESS AND REPUTATION RISKS
Sustained low advances balances and/or limited opportunities for loan purchases at our offered pricing could adversely impact results of operations.
Our primary business is providing liquidity to our members by making advances to, and purchasing mortgage loans from, our members. We compete with other sources of liquidity, including deposits, investment banks, commercial banks, and, in certain circumstances, other FHLBanks. Many of our competitors are not subject to the same body of regulation applicable to us. This is one factor among several that may enable our competitors to offer wholesale funding on terms that we are not able to offer and that members deem more desirable than the terms we offer on our advances.
The availability to our members of different products from alternative funding sources, with terms more attractive than the terms of products we offer, may significantly decrease the demand for our advances and/or loan purchases. Further, any changes we make in the pricing of our advances in an effort to compete effectively with these competitive funding sources could decrease the profitability of advances, which could reduce earnings. More generally, a decrease in the demand for advances and/or loan purchases, or a decrease in the profitability of advances and/or mortgage loan investments, could adversely impact our financial condition and results of operations.
For example, as discussed under Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Executive Summary - Advances Balances, the outstanding par value of advances declined to $19.4 billion at March 31, 2013 and subsequently recovered to $27.2 billion at December 31, 2013, from $55.8 billion at December 31, 2008. Advances at December 31, 2008 were at a historical high due to the extraordinary financial circumstances arising in connection with the liquidity crisis at that time. During 2013 and continuing into 2014, our members continued to experience high levels of deposits, which we believe was the principal factor in the continuing muted demand for advances, although we did experience some growth in advances from 2012 levels. We cannot predict whether this trend will continue and note that our members continue to experience high levels of deposits. Deposits serve as liquidity alternatives to advances. The overall decline in our advances balances since 2008 has negatively impacted and is likely to continue to negatively impact future earnings.
The loss of significant members could result in lower demand for our products and services.
At December 31, 2013, our five largest stock-holding members held 47.4 percent of our stock and our largest stock-holding member had affiliates with memberships in other FHLBanks, allowing their affiliates the flexibility of borrowing from other FHLBanks. The loss of significant members or a significant reduction in the level of business they conduct with us is likely to lower overall demand for our products and services in the future and adversely impact our performance.
Also, consolidations within the financial services industry could reduce the number of current and potential members in our district. Industry consolidation could also cause us to lose members whose business and stock investments are so substantial that their loss could threaten our viability. In turn, we might be forced to consider strategic alternatives, which could include a merger with another FHLBank district.
For example, Bank of America Rhode Island, N.A. (BANA RI) merged into its parent Bank of America, N.A. (BANA) in April 2013. BANA is ineligible for Bank membership, so the merger resulted in the capital stock of our then largest member by capital stock being reclassified to mandatorily redeemable capital stock, a reduction of $857.8 million or 24.5 percent, of our total Class B capital stock outstanding at the time. For a discussion of our expectations of the impact of the loss of this member upon completion of the merger, see Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition - Advances.
A decrease in demand for our products and services due to the loss of significant members could adversely impact our results of operations and financial condition, the impact of which could be greater during periods when we are experiencing losses or reduced net income.
We are subject to a complex body of laws and regulations, which could change in a manner detrimental to our business operations and/or financial condition.
The FHLBanks are GSEs, organized under the authority of the FHLBank Act, and as such, are governed by federal laws and regulations promulgated, adopted, and applied by the FHFA, an independent agency in the executive branch of the federal government that regulates the FHLBanks. Congress may amend the FHLBank Act or other statutes in ways that significantly affect (1) the rights and obligations of the FHLBanks and (2) the manner in which the FHLBanks carry out their mission and
business operations. New or modified legislation enacted by Congress or regulations adopted by the FHFA or other financial services regulators could adversely impact our ability to conduct business or the cost of doing business.
For example, the Dodd-Frank Act and regulations issued and to be issued under it have impacted and are likely to continue to impact our business operations, funding costs, rights, obligations, and/or the environment in which we carry out our mission. The Dodd-Frank Act, among other things, regulates the over-the-counter derivatives market, mandates central clearing of certain derivatives, and establishes new requirements for MBS, including a risk-retention requirement. Regulations implementing these and other parts of the Dodd-Frank Act are impacting most financial institutions, including us. Moreover, certain regulations affecting our members could impact the extent to which they can engage in business with the Bank. For additional discussion of the Dodd-Frank Act and certain other recent and potential legislative and regulatory developments that could impact us, see Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Legislative and Regulatory Developments.
Moreover, Congress, the Obama administration, and various federal agencies have advanced plans to reform the federal support of U.S. housing finance, specifically targeting Fannie Mae and Freddie Mac. These plans are likely to directly and indirectly impact other GSEs that support the U.S. housing market, including the FHLBanks. Any such reforms that are implemented could adversely impact the profitability of the FHLBanks or limit future growth opportunities. For additional information, see Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Legislative and Regulatory Developments - Other Significant Developments - Housing Finance and Housing GSE Reform.
Additionally, legal and regulatory developments not directly applicable to us may nonetheless have an important impact on us. For example, the Consumer Financial Protection Bureau (the CFPB) has issued a final rule on qualified mortgage loans that is likely to impact the mix of mortgages originated by many of our members, as discussed under Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Legislative and Regulatory Developments - Other Significant Developments - CFPB Final Rule on Qualified Mortgages. Many of our members pledge mortgage loans to us as collateral for advances, so we expect to receive a mix of qualified mortgage loans and non-qualified mortgage loans, including seasoned loans (originated prior to January 10, 2014, and grandfathered under CFPB rule), pledged as collateral. The value and marketability of mortgage loans that are non-qualified mortgage loans and seasoned loans, including those pledged as collateral to secure advances, may be adversely impacted. Furthermore, we note that this rule adds to the litany of cumulative regulatory impacts enacted in the last few years, which could dampen the volume of mortgage loan originations. This, in turn, could reduce demand for our advances.
We cannot predict what additional regulations will be issued or what additional legislation will be enacted, and we cannot predict the effect of any such additional regulations or legislation on our business operations and/or financial condition. We also note that in 2013 the FHFA communicated its interest in maintaining the FHLBanks' focus on mission-related activities, as discussed under Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operation - Financial Condition - Investments. Additional changes in regulatory or statutory requirements could result in, for example, an increase in the FHLBanks' cost of funding, a change in permissible business activities, limitations on advances made to our members, or a decrease in the size, scope, or nature of the FHLBanks' lending, investment, or mortgage-financing activities, all and any of which could adversely impact our financial condition and results of operations.
The board of directors' dividend practices could decrease demand for our products that require capital stock purchases and/or result in withdrawals from membership.
The board of directors has discretion over the declaration of any dividends, subject to applicable law and our capital plan. Historically, the board has varied dividend declarations based on our financial condition, outlook and economic environment. For example, from November 2008 until February 22, 2011, the board did not declare any dividends based on our focus on accumulating retained earnings toward our retained earnings target at the time. However, as our financial condition and outlook improved, the board recommenced declaring dividends on February 22, 2011, and dividends have been declared each quarter since that time. Moreover, our level of retained earnings currently exceeds our minimum retained earnings target, which was set at $700 million as of October 25, 2013. Nonetheless, if our financial performance or condition were to deteriorate significantly in the future, our board of directors could determine to reduce or eliminate dividends.
Should the board of directors determine to suspend or lower dividend declarations, we could experience decreased member demand for our products requiring capital stock purchases and/or withdrawals from membership that could adversely impact our business operations and financial condition.
Our limited excess stock repurchases from members could decrease demand for advance products and increase membership withdrawals.
We are required to satisfy our minimum regulatory capital requirements at all times. If we were to fail to maintain an adequate level of total capital to comply with minimum regulatory capital requirements, we would be precluded from repurchasing excess stock or from redeeming capital stock until we restored compliance, which could cause members to withdraw from membership.
Since December 8, 2008, we have generally maintained a moratorium on excess stock repurchases. On each of March 11, 2013 and March 9, 2012, we completed a partial repurchase of excess stock and expect to complete an additional partial repurchase of excess stock on May 1, 2014. We otherwise continue a moratorium on the repurchase of excess stock, other than in limited, former member-related instances of insolvency. The limited excess stock repurchases could be an incentive for members to withdraw from membership or limit certain of their business with us to avoid associated stock purchase requirements and a disincentive to prospective members from becoming members, either of which could adversely impact our business operations and financial condition.
An NRSRO's downgrade of the U.S. federal government's credit ratings could adversely impact our funding costs and/or access to the capital markets, require us to deliver collateral to certain derivatives counterparties, and/or adversely impact demand for certain of our products.
Certain of the NRSROs have indicated that the credit ratings of the FHLBanks are constrained by the credit ratings of the U.S. federal government. Accordingly, a downgrade of the U.S. federal government's credit rating by such an NRSRO is likely to be followed by a similar downgrade of the FHLBanks. Further downgrades of the U.S. federal government (and, in turn, the FHLBanks) are possible, and any resulting downgrades to our credit ratings could adversely impact our funding costs and/or market access. Additionally, further downgrades could trigger obligations to deliver collateral (in some cases, in addition to amounts already delivered, depending on the downgrade) to certain derivatives counterparties to which we are a net obligor, as discussed under Item 8 - Financial Statements and Supplementary Data - Notes to the Financial Statements - Note 11 - Derivatives and Hedging Activities and Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition - Derivative Instruments - Derivative Instruments Credit Risk. Further, member and housing associate demand for certain of our products, such as letters of credit and standby bond purchase agreements, is influenced by our credit ratings and downgrade of our credit ratings could weaken or eliminate demand for such products. To the extent that we cannot access funding when needed on acceptable terms to effectively manage our cost of funds or demand for our products falls, our financial condition and results of operations could be adversely impacted.
Negative information about us, the FHLBanks or housing GSEs, in general, could adversely impact our cost and availability of financing, or could limit membership growth.
Negative information impacting us or any other FHLBank, such as material losses or increased risk of losses, could also adversely impact our cost of funds. More broadly, negative information about housing GSEs, in general, could adversely impact us. One possible source of negative information that could impact us either directly or indirectly could be from reports to Congress from the FHFA or its Office of Inspector General. Further, in 2014, an FHFA rule will require us to perform stress tests under various scenarios and make the results of a severely adverse economic conditions test publicly available. The results of the stress test, or the public’s reaction to the results, could adversely impact the Bank. For additional information on the test, see Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Legislative and Regulatory Developments - Significant FHFA Developments - Final Rule on Stress-Testing.
The housing GSEs Fannie Mae, Freddie Mac, and the FHLBanks issue highly rated agency debt to fund their operations. From time to time negative announcements by any of the housing GSEs concerning accounting problems, risk-management issues, and regulatory enforcement actions have created pressure on debt pricing for all GSEs, as investors have perceived such instruments as bearing increased risk.
Any such negative information or other factors could result in the FHLBanks having to pay a higher rate of interest on COs to make them attractive to investors. If we maintain our existing pricing on our advances products and other services notwithstanding increases in CO interest rates the spreads we earn would fall and our results of operations would be adversely impacted. If, in response to this decrease in spreads, we change the pricing of our advances, the advances may be less attractive to members, and the amount of new advances and our outstanding advance balances may decrease. In either case, the increased cost of issuing COs could adversely impact our financial condition and results of operations. Moreover, such negative information could deter prospective members from becoming members which could adversely impact our financial condition and results of operations.
We could fail to meet our minimum regulatory capital requirements and/or maintain a capital classification of "adequately capitalized," which could result in prohibitions on dividends, excess stock repurchases, capital stock redemptions, and additional regulatory prohibitions.
We are required to satisfy certain minimum regulatory capital requirements, including risk-based capital requirements and certain regulatory capital and leverage ratios, which are described in Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Capital, and are subject to the FHFA's regulation on FHLBank capital classification and critical capital levels (the Capital Rule). Any failure to satisfy these requirements will result in our becoming subject to certain capital restoration requirements and being prohibited from paying dividends and redeeming or repurchasing capital stock without the prior approval of the FHFA.
The Capital Rule, among other things, establishes criteria for four capital classifications and corrective action requirements for FHLBanks that are classified in any classification other than adequately capitalized. An adequately capitalized FHLBank is one that has sufficient permanent and total capital to satisfy its risk-based and minimum capital requirements. We satisfied these requirements at December 31, 2013. However, pursuant to the Capital Rule, the FHFA has discretion to reclassify an FHLBank and modify or add to corrective action requirements for a particular capital classification. If we become classified into a capital classification other than adequately capitalized, we would be subject to the corrective action requirements for that capital classification in addition to being subject to prohibitions on declaring dividends and redeeming or repurchasing capital stock.
We could be subject to enforcement action by the FHFA that could result in prohibitions on dividends, excess stock repurchases, and capital stock redemptions and/or adversely impact our results of operations.
The FHFA is the FHLBank System's safety and soundness regulator and has broad powers to cause us to take or refrain from taking certain actions including, but not limited to, paying dividends, repurchasing excess stock, redeeming capital stock, increasing or decreasing our total assets, and curtailing our investing activities.
Our efforts to maintain adequate capital levels could impede our ability to generate asset growth including, but not limited to, meeting member advance requests.
We are mandated to maintain minimum regulatory capital thresholds including, but not limited to, a minimum regulatory capital ratio of 4.0 percent, which is a percentage equal to permanent capital divided by total assets. Moreover, we have a policy that requires us to maintain a minimum regulatory capital amount equal to 4.0 percent of total assets plus our minimum retained earnings target. As a condition for borrowing advances from us, members are required to invest in capital stock, permitting members to leverage their stock investment to borrow at multiples of that stock investment. In certain scenarios, members seeking to leverage their excess stock availability may be unable to borrow at the fullest capacity if overall asset growth causes our total regulatory capital ratio to fall below 4.0 percent, even after discretionary assets, including, but not limited to, short-term investments, are disposed.
We could become liable for all or a portion of the COs of the FHLBanks, which could adversely impact our financial condition and results of operations.
Each of the FHLBanks relies upon the issuance of COs as a primary source of funds. COs are the joint and several obligations of all of the FHLBanks, backed only by the financial resources of the FHLBanks. Accordingly, we are jointly and severally liable with the other FHLBanks for the COs issued by the FHLBanks through the Office of Finance, regardless of whether we receive all or any portion of the proceeds from any particular issuance of COs. The FHFA, at its discretion, may require any FHLBank to make principal or interest payments due on any COs, whether or not the primary obligor FHLBank has defaulted on the payment of that obligation (although this has never happened). Accordingly, we could incur significant liability beyond our primary obligation under COs due to the failure of other FHLBanks to meet their obligations, which could adversely impact our financial condition and results of operations.
Additionally, due to our relationship with other FHLBanks, we could be impacted by events other than the default on a CO. Events that impact other FHLBanks such as member failures, capital deficiencies, and other-than-temporary impairment charges may cause the FHFA, at its discretion, to require an FHLBank to either provide capital to or purchase assets from another FHLBank. Our financial condition and results of operations could be adversely impacted if we were required to either provide capital or purchase assets.
Loan-modification programs could adversely impact the value of our investments in MBS and mortgage loans.
Federal and state government authorities, as well as private entities, such as financial institutions and the servicers of residential mortgage loans, have proposed, commenced, or promoted implementation of programs intended to provide homeowners with assistance in avoiding residential mortgage loan foreclosures. Loan-modification programs, as well as future legislative, regulatory or other actions, including, for example, amendments to the bankruptcy laws or the use of eminent domain, in each case resulting in the modification of outstanding mortgage loans via the reduction of interest rates or principal balances of modified mortgage loans, could adversely impact the value of and the returns from our investments in MBS and mortgage loans. For additional information on developments such as these that could impact us, see Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Legislative and Regulatory Developments - Other Significant Developments - Home Affordable Refinance Program, Other Foreclosure Prevention Efforts, and Related Legislation.
Compliance with regulatory contingency liquidity requirements could adversely impact our results of operations.
We are required to maintain sufficient liquidity through short-term investments in an amount at least equal to our cash outflows under two different scenarios, as discussed in Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources. The requirement is designed to enhance our protection against temporary disruptions in access to the capital markets resulting from a rise in capital markets volatility. To satisfy this additional requirement, we maintain balances in shorter-term investments, which could earn lower interest rates than alternate investment options and could, in turn, adversely impact net interest income. In certain circumstances, we may need to fund overnight or shorter-term advances with short-term discount notes that have maturities beyond the maturities of the related advances, thus increasing our short-term advance pricing or reducing net income through lower net interest spread. To the extent these increased prices make our advances less competitive, advance levels and, therefore, our net interest income could be adversely impacted.
MARKET AND LIQUIDITY RISKS
Prolonged, low interest rates could continue to adversely impact our financial condition and results of operations.
Like many financial institutions, we realize a significant portion of our income from the spread between interest earned on our outstanding loans and investments and interest paid on our borrowings and other liabilities, as measured by our net interest spread. However, as discussed under Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Executive Summary - Low Interest-Rate Environment, the Federal Reserve has taken and is expected to continue several measures intended to maintain low short-term and longer-term interest rates. These measures as well as other systemic events could continue to result in a prolonged low interest-rate environment. A continued, prolonged low interest-rate environment could continue to adversely impact us in various ways, including through lower market yields on investments and faster prepayments on our investments with associated reinvestment risk. Our investment income and, in turn, our financial condition and results of operations, could be adversely impacted to the extent that the foregoing, or similar, risks are realized.
Changes in interest rates could adversely impact our financial condition and results of operations.
Although we use various methods and procedures to monitor and manage exposures due to changes in interest rates, we could experience instances when either our interest-bearing liabilities will be more sensitive to changes in interest rates than our interest-earning assets, or vice versa. These impacts could be exacerbated by prepayment and extension risk, which is the risk that mortgage-related assets will be refinanced and prepaid in low interest-rate environments, thus requiring us to reinvest the proceeds at lower, and possibly negative, spreads, or will remain outstanding at below-market yields when interest rates increase. Moreover, accelerated prepayments in a low interest-rate environment could result in elevated levels of premium expense recognition due to the fact that the majority of our mortgage assets were purchased at premium prices. In any case, changes in interest rates could adversely impact our financial condition and results of operations.
Any inability of the Bank to access the capital markets could adversely impact our business operations, financial condition, and results of operations.
Our primary source of funds is the sale of COs in the capital markets. Our ability to obtain funds through the sale of COs depends in part on prevailing conditions in the capital markets at that time, which are beyond our control. Accordingly, we cannot make any assurance that we will be able to obtain funding on terms acceptable to us, if at all. If we cannot access funding when needed, our ability to support and continue our operations would be adversely impacted, which would thereby adversely impact our financial condition and results of operations.
OPERATIONAL RISKS
The inability to retain key personnel could adversely impact our operations.
We rely on key personnel for many of our functions and have a relatively small workforce, given the size and complexity of our business. Our ability to retain such personnel is important to our ability to conduct our operations and measure and maintain risk and financial controls. Our ability to retain key personnel could be challenged as the U.S. employment market improves.
We rely heavily upon information systems and other technology and any disruption or failure of such information systems or other technology could adversely impact our reputation, financial condition, and results of operations.
We rely heavily on our information systems and other technology to conduct and manage our business, and so failures or interruptions of these information systems or other technology could have a material adverse impact on our financial condition and results of operations as discussed under Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Operational Risk. Additionally, most of our information systems have been co-located with a third-party service provider on which we are reliant to provide a secure location and a stable operating environment for these systems. Any failure to provide such stability or security by the third-party service provider could result in failures or interruptions in our ability to conduct business. Further, our AHP and MPF investment activities rely on the secure processing, storage, and transmission of a large volume of private borrower information, such as names, residential addresses, social security numbers, credit rating data, and other consumer financial information. This information could be exposed in several ways, including through unauthorized access to our computer systems, computer viruses that attack our computer systems, software or networks, accidental delivery of information to an unauthorized party, and loss of encrypted media containing this information. Any of these events could result in financial losses, legal and regulatory sanctions, and reputational damage.
We rely on third parties for certain important services and could be adversely impacted by disruptions in those services.
We rely on third parties to provide certain important services. For example, in participating in the MPF program, we rely on the FHLBank of Chicago in its capacity as the MPF Provider. Our investments in mortgage loans through the MPF program account for 7.5 percent of our total assets as of December 31, 2013, and 21.9 percent of interest income for the year ended December 31, 2013. If the FHLBank of Chicago changes, or ceases to operate the MPF program or experiences a failure or interruption in its information systems and other technology in its operation of the MPF program, our mortgage-investment business could be adversely impacted, and we could experience a related decrease in net interest margin, financial condition, and profitability. In the same way, we could be adversely impacted if any of the FHLBank of Chicago's third-party vendors engaged in the operation of the MPF program were to experience operational or technological difficulties.
As another example, we rely on the Office of Finance for, among other things, the placement of COs, which are our primary source of funds. A disruption in this service would disrupt our access to these funds, as also discussed under - Market and Liquidity Risks - Any inability of the Bank to access the capital markets could adversely impact our business operations, financial condition, and results of operations.
We rely on models for many of our business operations and changes in the assumptions used could have a significant effect on our financial position, results of operations, and assessments of risk exposure.
For example, we use models to assist in our determination of the fair values of financial instruments. The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market parameters. For financial instruments that are actively traded and have quoted market prices or parameters readily available, there is little to no subjectivity in determining fair value. If market quotes are not available, fair values are based on discounted cash flows using market estimates of interest rates and volatility or on dealer prices or prices of similar instruments. Pricing models and their underlying changes in assumptions are based on our best estimates for discount rates, prepayments, market volatility, and other factors. These assumptions could have a significant effect on the reported fair values of assets and liabilities, including derivatives, the related income and expense, and the expected future behavior of assets and liabilities. While the models we use to value instruments and measure risk exposures are subject to periodic validation by our staff and by independent parties, rapid changes in market conditions in the interim could impact our financial position. The use of different models and assumptions, as well as changes in market conditions, could significantly impact our financial condition and results of operations.
We rely upon derivative instruments to reduce our interest-rate risk; however, we could be unable to enter into effective derivative instruments on acceptable terms.
We use over-the-counter derivative instruments that are entered into with swap dealers to reduce our interest-rate risk. If, due to an absence of creditworthy swap dealers or guarantors, we are unable to manage our hedging positions properly, or we are unable to enter into hedging instruments upon acceptable terms, we could be unable to effectively manage our interest-rate and other risks without altering our business strategies, which could adversely impact our financial condition and results of operations.
One factor that could impact our ability to manage our hedging positions properly or enter into hedging instruments upon acceptable terms is the Dodd-Frank Act, which requires the issuance of various regulations impacting derivatives that have, among other things, required us to clear some of our derivatives through derivatives clearing organizations that are registered with the CFTC. Such a mandate is intended to reduce counterparty credit risk among derivative market participants by requiring such entities to directly face derivatives clearing organizations, rather than swap dealers, on swap contracts subject to the clearing mandate. However, such cleared derivatives are intermediated by futures commission merchants (a clearing member) responsible for making and receiving payments to and from swap market participants on behalf of the derivatives clearing organization. Accordingly, operational failures or the insolvency of one or more clearing members or derivatives clearing organizations could result in losses to us. Further, we might need, either as an economic or regulatory matter, to structure our derivatives such that they are clearable through a derivatives clearing organization. However, as so structured, such derivatives could then be less effective hedges.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
We occupy approximately 54,000 rentable square feet in the Prudential Tower, 800 Boylston Street, Boston, Massachusetts 02199 that serves as our headquarters. We also maintain 9,969 square feet of leased property for an off-site back-up facility in Westborough, Massachusetts.
We believe our properties are adequate to meet our requirements for the foreseeable future.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Private-label MBS Complaint
On April 20, 2011, we filed a complaint (the original complaint) in the Superior Court Department of the Commonwealth of Massachusetts in Suffolk County, against various securities dealers, underwriters, control persons, issuers/depositors, and credit rating agencies based on our investments in certain private-label MBS issued by 115 securitization trusts for which we originally paid approximately $5.8 billion. Since the original complaint was filed, the defendants filed certain notices of removal to remove the case to the United States District Court for the District of Massachusetts. On March 9, 2012, our motion to remand the matter to state court was denied.
On June 29, 2012, we filed an amended complaint (the amended complaint) in the United States District Court for the District of Massachusetts against various securities dealers, underwriters, control persons, issuers/depositors, and credit rating agencies based on our investments in certain private-label MBS issued by 111 securitization trusts for which we originally paid approximately $5.7 billion. The amended complaint asserts, as the original complaint had asserted, claims based on untrue or misleading statements in the sale of securities, signing or circulating securities documents that contained material misrepresentations and omissions, negligent misrepresentation, unfair or deceptive trade practices, fraud by the rating agencies, and controlling person liability. We are seeking various forms of relief including rescission, recovery of damages, recovery of purchase consideration plus interest (less income received to date), and recovery of reasonable attorneys' fees and costs of suit.
On September 30, 2013, the court issued orders granting and denying motions to dismiss filed by the defendants. More specifically, the court:
•
upheld claims based on negligent misrepresentation and unfair or deceptive trade practices against non-rating agency defendants;
•
upheld claims based on fraud but dismissed claims based on negligent misrepresentation and unfair or deceptive trade practices against rating agency defendants;
•
upheld claims based on the Massachusetts Uniform Securities Act against underwriter and corporate seller defendants, but dismissed such claims against issuer/depositor defendants and control person defendants (with respect to claims that were premised solely on control of an issuer/depositor); and
•
dismissed the claims against DB Structured Products, Inc. that were solely premised on a claim of its successor liability.
On January 28, 2014, each of Moody’s Investors Service, Inc. and Moody’s Corporation (together, Moody’s) and McGraw Hill Financial, Inc. and Standard & Poor’s Financial Services LLC (together, S&P) filed renewed motions for reconsideration of their previously denied motions to dismiss the claims against these defendants based on lack of jurisdiction or, alternatively, for leave to make an immediate appeal. We simultaneously filed a separate motion to sever and transfer the claims against Moody’s and S&P to the U.S. District Court for the Southern District of New York. These motions are pending.
On February 7, 2014, we filed a motion for approval of statistical sampling methodology to facilitate the analysis of each private-label MBS in litigation. This motion is pending.
The current list of defendants in these actions includes the following and/or their affiliates and subsidiaries and/or defendants under their control or controlled by affiliates or subsidiaries thereof: Barclays Capital Inc.; The Bear Stearns Companies LLC; Capital One Financial Corporation; Citigroup, Inc.; Credit Suisse (USA), Inc.; DB Structured Products, Inc.; DB U.S. Financial Market Holding Corporation; EMC Mortgage Corporation; Impac Mortgage Holdings, Inc.; JPMorgan Chase & Co.; Moody's; Morgan Stanley; Nomura Holding America, Inc.; RBS Holdings USA Inc.; S&P, UBS Americas Inc.; and WaMu Capital, Corp.
RBS Citizens N.A., which is affiliated with RBS Holdings USA Inc., but is not a defendant in the complaint, is a member of the Bank and held approximately 12.3 percent of our capital stock (including mandatorily redeemable capital stock) as of December 31, 2013.
Class Action Complaint
On January 13, 2014, we filed a class action complaint (the class action complaint) in the Superior Court Department of the Commonwealth of Massachusetts in Suffolk County, against EMC Mortgage Corporation and Bear, Stearns & Co., now known as J.P. Morgan Securities, LLC, based on our investment in certain private-label MBS trusts. The class action complaint asserts claims of conversion, unjust enrichment, and violation of Massachusetts statutory law based on the withholding of value that rightfully belonged to the private-label MBS trusts. We are seeking various forms of relief including restitution, recovery of damages, and reasonable attorneys' fees and costs of suit.
Other Legal Proceedings
From time to time, we are subject to various pending legal proceedings arising in the normal course of business. After consultation with legal counsel, we do not anticipate that the ultimate liability, if any, arising out of these matters will have a material adverse effect on our financial condition or results of operations.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The par value of our capital stock is $100 per share. Our stock is not publicly traded and can be purchased only by our members at par. As of February 28, 2014, 444 members and six nonmembers held a total of 35.2 million shares of our Class B stock. Our capital plan provides us with the authority to issue Class A capital stock, $100 par value per share (Class A stock). However, we have not issued and do not intend to issue Class A stock at this time.
Dividends are solely within the discretion of our board of directors. The board of directors declared dividends during 2013, 2012, and 2011 as set forth in the below table. Dividend rates are quoted in the form of an interest rate, which is then applied to each stockholder's average capital-stock-balance outstanding during the quarter to determine the dollar amount of the dividend that each stockholder will receive. The dividend rate was based upon a spread to average short-term interest rates experienced during the quarter.
_________________________
(1)
Average capital stock amounts do not include average balances of mandatorily redeemable stock.
(2)
The dividend amounts do not include the interest expense on mandatorily redeemable stock.
On February 20, 2014, our board of directors declared a cash dividend that was equivalent to an annual yield of 1.49 percent, the approximate daily average three-month LIBOR for the fourth quarter of 2013 plus 125 basis points. The dividend amount, based on average daily balances of Class B shares outstanding for the fourth quarter of 2013 totaled $12.9 million and was paid on March 4, 2014. In declaring the dividend, the board stated that it anticipates that it will declare cash dividends through 2014 generally consistent with this dividend, although a quarterly loss or a significant adverse event or trend would cause a dividend to be suspended.
Dividends are declared and paid in accordance with a schedule adopted by the board of directors that enables our board of directors to declare each quarterly dividend after net income is known, rather than basing the dividend on estimated net income. For example, in 2013, quarterly dividends were declared in February, April, July, and October based on the immediately preceding quarter's net income and were paid on the second business day of the month that followed the month of declaration. We expect to continue this approach through 2014.
Dividends may be paid only from current net earnings or previously retained earnings. In accordance with the FHLBank Act and FHFA regulations, we may not declare a dividend if we are not in compliance with our minimum capital requirements or if we would fall below our minimum capital requirements or would not be adequately capitalized as a result of a dividend except, in this latter case, with the Director of the FHFA's permission. Further, we may not pay dividends to our members if the principal and interest due on any CO issued through the Office of Finance on which we are the primary obligor has not been paid in full, or under certain circumstances, if we become a noncomplying FHLBank as that term is defined in FHFA regulations as a result of any inability to either comply with regulatory liquidity requirements or satisfy our current obligations.
Our retained earnings policy provides that when our minimum retained earnings target exceeds the level of our retained earnings, the quarterly dividend payout cannot exceed 40 percent of our earnings for the quarter. Our minimum retained earnings target was $700.0 million as of December 31, 2013 compared with $788.8 million in retained earnings at December 31, 2013.
We may not pay dividends in the form of capital stock or issue new excess stock to members if our excess stock exceeds 1.0 percent of our total assets or if the issuance of excess stock would cause our excess stock to exceed 1.0 percent of our total assets. At December 31, 2013, we had excess stock outstanding totaling $1.7 billion or 3.8 percent of our total assets.
Should we determine to issue Class A stock, dividends declared on Class A Stock may differ from dividends declared on Class B stock but may not exceed dividends declared on Class B Stock.
We have adopted a minimum capital level in excess of regulatory requirements to provide further protection for our capital base. This adopted minimum capital level provides that we will maintain a minimum capital level equal to 4.0 percent of total assets plus our minimum retained earnings target, an amount equal to $2.5 billion at December 31, 2013. Our permanent capital level was $4.3 billion at December 31, 2013, so we were in excess of this requirement by $1.8 billion on that date. If necessary to satisfy this adopted minimum capital level, however, we will take steps to control asset growth and/or maintain capital levels, the latter of which may limit future dividends.
Our capital plan and the Joint Capital Agreement require us to allocate 20 percent of our net income to a separate restricted retained earnings account. The Joint Capital Agreement requires each FHLBank to make such contributions until the total amount in the restricted retained earnings account is at least equal to 1.0 percent of the daily average carrying value of that FHLBank's outstanding total COs (excluding fair-value adjustments) for the calendar quarter. Amounts in the restricted retained earnings account cannot be used to pay dividends. This requirement lowers the amount of dividends we can declare until the amount required to be maintained in the restricted account is satisfied. As of December 31, 2013, $106.8 million of our retained earnings are amounts in the restricted retained earnings account compared with our total contribution requirement of $352.1 million at that date. For additional information on the Joint Capital Agreement, see Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Internal Capital Practices and Policies - Restricted Retained Earnings and the Joint Capital Agreement.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data for each of the five years ended December 31, 2013, 2012, 2011, 2010, and 2009, have been derived from our audited financial statements. Financial information is included elsewhere in this report in regard to our financial condition as of December 31, 2013 and 2012, and our results of operations for the years ended December 31, 2013, 2012, and 2011. This selected financial data should be read in conjunction with the financial statements and the related notes appearing in this report.
_______________________
(1)
Investments include available-for-sale securities, held-to-maturity securities, trading securities, interest-bearing deposits, securities purchased under agreements to resell and federal funds sold.
(2)
The allowance for credit losses amounted to $2.2 million, $4.4 million, $7.8 million, $8.7 million, and $2.1 million for the years ended December 31, 2013, 2012, 2011, 2010, and 2009, respectively.
(3)
Capital stock is putable at the option of a member, subject to applicable restrictions.
(4)
The FHLBanks satisfied their obligation to REFCorp in the second quarter of 2011, as discussed under Item 1 - Business - Assessments - REFCorp Assessment.
(5)
The dividend payout ratio for 2010 and 2009 is not meaningful.
(6)
Weighted-average dividend rate is the dividend amount declared divided by the average daily balance of capital stock eligible for dividends.
(7)
Return on average equity is net income divided by the total of the average daily balance of outstanding Class B capital stock, accumulated other comprehensive loss and total retained earnings (accumulated deficit).
(8)
Net interest margin is net interest income before provision for credit losses as a percentage of average earning assets.
(9)
Total regulatory capital ratio is capital stock (including mandatorily redeemable capital stock) plus total retained earnings as a percentage of total assets. See Item 8 - Financial Statements and Supplementary Data - Notes to the Financial Statements - Note 16 - Capital.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
This report includes statements describing anticipated developments, projections, estimates, or future predictions of ours that are “forward-looking statements.” These statements may use forward-looking terminology such as, but not limited to, “anticipates,” “believes,” “expects,” “plans,” “intends,” “may,” “could,” “estimates,” “assumes,” “should,” “will,” “likely,” or their negatives or other variations on these terms. We caution that, by their nature, forward-looking statements are subject to a number of risks or uncertainties, including the risk factors set forth in Item 1A - Risk Factors and the risks set forth below. Accordingly, we caution that actual results could differ materially from those expressed or implied in these forward-looking statements or could impact the extent to which a particular objective, projection, estimate, or prediction is realized. As a result, you are cautioned not to place undue reliance on such statements. We do not undertake to update any forward-looking statement herein or that may be made from time to time on our behalf.
Forward-looking statements in this report may include, among others, our expectations for:
•
income, retained earnings, and dividend payouts;
•
repurchases of excess stock;
•
credit losses on advances and investments in mortgage loans and ABS, particularly private-label MBS;
•
balance-sheet changes and components thereof, such as changes in advances balances and the size of our portfolio of investments in mortgage loans;
•
our minimum retained earnings target; and
•
the interest-rate environment in which we do business.
Actual results may differ from forward-looking statements for many reasons, including, but not limited to:
•
changes in interest rates, the rate of inflation (or deflation), housing prices, employment rates, and the general economy, including changes resulting from changes in U.S. fiscal policy or ratings of the U.S. federal government;
•
changes in demand for our advances and other products resulting from changes in members' deposit flows and credit demands or otherwise;
•
the willingness of our members to do business with us despite continuing limited repurchases of excess stock and modest dividend payments;
•
changes in the financial health of our members;
•
insolvencies of our members;
•
changes in borrower defaults on mortgage loans;
•
deterioration in the credit performance of our private-label MBS portfolio beyond forecasted assumptions concerning loan default rates, loss severities, and prepayment speeds resulting in the realization of additional other-than-temporary impairment charges;
•
changes in the credit performance of our investments in mortgage loans and changes in loss severities from those investments;
•
changes in advance prepayments as a result of changes in interest rates or other factors;
•
the volatility of market prices, rates, and indices that could affect the value of collateral we hold as security for obligations of our members and counterparties;
•
issues and events across the FHLBank System and in the political arena that may lead to legislative, regulatory, judicial, or other developments impacting the marketability of COs, our financial obligations with respect to COs, our ability to access
the capital markets, our members, the manner in which we operate, or the organization and structure of the FHLBank System;
•
competitive forces including, without limitation, other sources of funding available to our members, other entities borrowing funds in the capital markets, and our ability to attract and retain skilled employees;
•
the pace of technological change and our ability to develop and support technology and information systems sufficient to manage the risks of our business effectively;
•
the loss of members due to, among other ways, member withdrawals, mergers and acquisitions;
•
changes in investor demand for COs;
•
changes in the terms of interest-rate-exchange-agreements and similar agreements we enter into in support of our business operations;
•
the timing and volume of market activity;
•
the volatility of reported results due to changes in the fair value of certain assets and liabilities, including, but not limited to, private-label MBS;
•
our ability to introduce new (or adequately adapt current) products and services and successfully manage the risks associated with our products and services, including new types of collateral used to secure advances;
•
the availability of derivatives of the types and in the quantities needed for risk-management purposes from acceptable counterparties;
•
losses arising from litigation filed against us or one or more of the other FHLBanks;
•
gains resulting from legal claims we have;
•
losses arising from our joint and several liability on COs;
•
significant business disruptions resulting from natural or other disasters, acts of war, or terrorism; and
•
new accounting standards, including the development of supporting systems.
These risk factors are not exhaustive. We operate in a changing economic and regulatory environment, and new risk factors will emerge from time to time. We cannot predict such new risk factors nor can we assess the impact, if any, of such new risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those implied by any forward-looking statements.
EXECUTIVE SUMMARY
Our net income was $212.3 million for the year ended December 31, 2013, compared with net income of $207.1 million for the same period in 2012. The increase was driven in part by a $65.6 million increase in other income, the majority of which was due to an increase of $51.0 million from litigation settlements related to certain investments in private-label mortgage-backed securities, offset by a $36.6 million decrease in net prepayment fees from investments and advances. Importantly, our retained earnings balance is now in excess of our minimum retained earnings target. We consider this to be a significant milestone, reflecting a concerted effort to build retained earnings that began over five years ago. While we continue to face certain challenges, in light of this milestone, the board has now commenced and may determine to continue to declare larger dividends and/or direct us to complete larger and/or more frequent repurchases of excess stock than it has in the past five years, subject to applicable restrictions.
We note that:
•
retained earnings increased from $587.6 million at December 31, 2012, to $788.8 million at December 31, 2013;
•
accumulated other comprehensive loss related to the noncredit portion of other-than-temporary impairment losses on held-to-maturity securities improved from an accumulated other comprehensive loss of $385.2 million at December 31, 2012, to an accumulated other comprehensive loss of $324.9 million at December 31, 2013;
•
we continue to be in compliance with all regulatory capital requirements as of December 31, 2013;
•
on February 20, 2014, our board of directors declared a cash dividend that was equivalent to an annual yield of 1.49 percent; and
•
the board of directors approved the repurchase of $500.0 million of excess capital stock to be completed on May 1, 2014, and has announced that it may approve a second partial repurchase of excess stock later in 2014, although a quarterly loss or a significant adverse event or trend could cause such an additional repurchase to be suspended.
The principal challenges we face are the continuing, prolonged low interest-rate environment, muted demand for advances and potential losses on our investments in private-label MBS. We continue to believe that these factors are likely to negatively impact future earnings, absent unpredictable events such as prepayment fee income and litigation settlements.
•
Interest-Rate Environment. Since 2008, the Federal Reserve has targeted and maintained a historically low interest-rate environment, initially for short-term financial instruments and later for long-term financial instruments with the implementation of quantitative easing programs. We expect the Federal Reserve to continue to try to keep short-term interest rates low in the near term but are less certain about the outlook for longer term interest rates for the reasons discussed under - Economic Conditions.
A prolonged low interest-rate environment continues to adversely impact us in various ways such as members significantly increasing their reliance on short-term advances that typically have lower market yields than longer-term advances; lower market yields on investments (as we continue to experience), including money-market investments in which our capital is deployed; and potentially faster prepayments on our mortgage-related assets, with resultant reinvestment risk. For additional information, see - Economic Conditions - Interest-Rate Environment.
•
Advances Balances. The outstanding par balance of advances increased from $20.3 billion at December 31, 2012, to $27.2 billion at December 31, 2013. Advance growth was particularly significant during the quarter ended December 31, 2013, as advances increased $5.0 billion, or 22.0 percent, from September 30, 2013. While many members increased advances borrowing during this period, this increase was concentrated primarily in short-term advances. We cannot predict whether this trend will continue and note that our members continue to experience high levels of deposits. Deposits serve as liquidity alternatives to advances. The overall decline in our advances balances since 2008 has negatively impacted and is likely to continue to negatively impact future earnings, particularly given the persistent low interest-rate environment discussed above.
The trend in advances balances is illustrated by the following graph:
•
Investments in Private-Label MBS. The amortized cost of our total investments in private-label MBS and ABS backed by home-equity loans has declined to $1.5 billion at December 31, 2013, compared with $6.4 billion at September 30, 2007, and other-than-temporary impairment credit losses recognized in recent periods have dropped significantly from those of
earlier periods; however, additional modest losses from this portfolio are likely and, if economic conditions unexpectedly worsen, larger losses are possible. We have determined that 16 of our private-label MBS, representing an aggregated par value of $135.7 million, incurred additional other-than-temporary impairment credit losses of $2.6 million during the year ended December 31, 2013. We continue to update our modeling assumptions to reflect current developments impacting the loan performance of the mortgage loans that back our investments in private-label MBS, particularly Alt-A mortgage loans originated from 2005 to 2007 that comprise a significant portion of the loans backing these securities. Generally, performance trends on this collateral have continued to improve during the year ended December 31, 2013, as economic conditions have improved nationally, leading to higher house prices, lower default and loss rates, accordingly, and higher market prices for securities tied to this type of collateral since December 31, 2012. However, not all areas of the country have participated equally in the housing recovery, with some areas still influenced by such factors as continuing elevated unemployment rates, high levels of foreclosures and troubled real estate loans, and limited refinancing opportunities for many borrowers, especially those whose houses are worth less than the balance of their mortgages. Moreover, financially distressed properties have generally lagged general house price recovery rates, and may not reflect the degree of recovery in house price values reported in their surrounding areas.
We also update our modeling assumptions based on noneconomic factors that impact or could impact the performance of these investments, including certain federal programs (and proposed programs) intended to assist and/or protect borrowers, and related developments that could result in further losses. We continue to monitor these and related developments, including litigation involving private-label MBS, which could result in loss severities beyond current expectations due to disruptions of cash flows from impacted securities and further declines in real estate prices.
For the year ended December 31, 2013, we recognized $19.7 million in interest income resulting from the increased accretable yields of certain private-label MBS for which we had previously recognized credit losses. For a discussion of this accounting treatment, see Item 8 - Financial Statements and Supplementary Data - Note 1 - Notes to the Financial Statements - Summary of Significant Accounting Policies - Investment Securities - Other-than-Temporary Impairment - Interest Income Recognition.
Other significant trends and developments include the following:
•
Legislative and Regulatory Developments. We continue to operate in an uncertain legislative and regulatory environment undergoing profound change principally stemming from the Dodd-Frank Act. Additionally, the FHFA expressed an interest in 2013 in maintaining the FHLBanks' focus on core mission-related activities, such as making advances and acquiring member assets, as we do through the MPF program. However, it is unclear whether the FHFA will remain focused on this interest, particularly given the appointment of the Honorable Melvin L. Watt as Director of the FHFA on January 6, 2014. Nonetheless, the FHFA could require the FHLBanks to satisfy certain core-mission asset ratios. If such requirements were instituted, we may have to divest nonmission-related assets or reduce nonmission-related activities, which could adversely impact our desired level of investments and, in turn, our results of operations. Finally, the U.S. federal government continues to consider reforms for housing finance and housing GSEs, which are ultimately likely to impact us. For additional information, see - Legislative and Regulatory Developments.
•
Net Interest Margin. Despite the historically low interest-rate environment, we continue to achieve a favorable, but declining, net interest margin. Net interest margin is expressed as the percentage of net interest income to average earning assets. Net interest margin for the year ended December 31, 2013, was 0.65 percent, a three basis point decrease from net interest margin for the year ended December 31, 2012. Prepayment-fee income was an important contributor to net interest margin for the year ended December 31, 2012, and to a lesser extent the year ended December 31, 2013, as demonstrated by the tables captioned “Net Interest Spread and Margin without Prepayment-Fee Income” under - Results of Operations. These prepayment fees represent a substantial contribution to our net income that should not be counted on to recur every year. The favorable net interest margin was also impacted by an increase in yields on certain previously other-than-temporarily impaired private-label MBS for which a significant improvement in cash flows has been projected, and lower than expected prepayment activity on fixed-rate mortgage-related assets, the funding of which we have been able to refinance at lower rates. Demand for COs remained strong and funding costs have remained low throughout 2013, a trend we expect to continue.
Notwithstanding favorable net interest margin and favorable net interest spread for the year, we expect these measurements to decline based on the sustained low interest-rate environment noted above combined with increasingly limited opportunities to redeem and refinance our debt, coupled with the continued amortization of our seasoned investments in mortgage loans (including fixed-rate agency MBS).
ECONOMIC CONDITIONS
Economic Environment
Generally, 2013 saw improvements in the labor market, housing market, and stock market, which have provided more capacity to drive consumption. Fiscal policy remained a restraining factor to economic growth, although the extent of restraint is diminishing. These factors signal continued, albeit moderate improvement in economic conditions in 2014 and beyond. The strength of economic growth could affect our members’ lending and investment environment and in turn members’ demand for advances and opportunities for us to invest in mortgage loans.
The United States and New England added jobs at a modest pace during 2013, but the New England region has consistently trailed the pace of the nation. Between December 2012 and December 2013, employment grew by 1.7 percent nationally and 1.2 percent in the region. This pattern of stronger national year-over-year employment growth has persisted since March 2011. Consequently, by December 2013, both the United States and New England are 0.9 percent below their respective prerecession employment levels, despite the fact that New England had a less pronounced employment decline in the economic recession and a faster initial recovery in 2010. The national unemployment rate continued to decline during 2013, reaching 6.7 percent in December 2013. New England’s unemployment rate trended down at a slower pace during the period, reaching 6.8 percent in December 2013, 0.1 percent higher than the national level of the same period.
2013 marked a year of strong housing market recovery both nationwide and in New England, boosting construction activities and providing tailwinds for the economy. Regionally, the FHFA House Price Index grew by 1.5 percent between the fourth quarters of 2012 and 2013, the first positive annual change since the fourth quarter of 2006, though this was below the 4.8 percent growth rate nationwide over the same period. The housing market is expected to continue to be a positive factor to the national and regional economy in 2014 and beyond, but the pace of home price appreciation is expected to slow down primarily due to the impact of anticipated increases in mortgage rates. Despite the housing market's recovery, mortgage refinancing activity, the principal impetus for mortgage loan applications, declined in 2013 and is expected to continue to decline in 2014 as mortgage rates are expected to rebound from historically low levels.
Interest-Rate Environment
Since 2010 and continuing into 2014, we generally have been operating in a historically low interest-rate environment, which has adversely impacted our results of operations.
Since the summer months of 2013, we witnessed a significant increase in long-term interest rates that we believe was attributable to an increase in market perceptions that the Federal Reserve could begin to shift away from supporting a low interest-rate environment initially by ending or curtailing its quantitative easing program. We note that on March 19, 2014, the Federal Reserve issued a press release providing that a highly accommodative stance of monetary policy remains appropriate and that when it decides to take a less accommodative stance, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.
The interest-rate environment adversely impacts our results of operations in two ways. First, short-term interest rates continue to hover close to record low levels, compressing the yields and margins that we can earn on our liquidity investments and short-term advances because our funding costs essentially have a floor of zero percent. Second, the increase in long-term interest rates has slowed our investments in mortgage loans due to lower investment opportunities as mortgage loan originations have fallen, driven by a decline in refinancing activity as long-term interest rates have increased.
The following chart illustrates the interest-rate environment.
The federal funds target rate has remained constant at 0.25 percent during the time periods displayed in the chart above.
RESULTS OF OPERATIONS
Comparison of the year ended December 31, 2013, versus the year ended December 31, 2012
For the years ended December 31, 2013 and 2012, we recognized net income of $212.3 million and $207.1 million, respectively. This $5.2 million increase was primarily driven by an increase in litigation settlements of $51.0 million, an $18.3 million decrease in loss on early extinguishment of debt, an increase of $14.9 million in net gains on derivatives and hedging activities, and a $4.6 million decrease in credit losses on other-than-temporary impairment of investment securities. Offsetting these increases to net income was a decrease in net interest income of $56.6 million of which $36.6 million relates to net prepayment fees that declined from $66.3 million in 2012 to $29.7 million in 2013 and a $20.3 million increase in the net unrealized losses on trading securities.
Net Interest Income
Net interest income for the year ended December 31, 2013, decreased $56.6 million from $312.4 million in 2012 to $255.9 million in 2013. This decrease was primarily attributable to a $36.6 million decrease in prepayment fee income and a decline in average earning assets, which decreased from $46.2 billion for the year ended December 31, 2012, to $39.3 billion for the year ended December 31, 2013. This decline in average earning assets was driven by a $4.8 billion drop in average investments balances and a decrease of $2.2 billion in average advances balances. Partially offsetting these declines in net interest income was $19.7 million of increased accretable yields of certain private-label MBS for which we had previously recognized other-than-temporary impairment credit losses, an increase of $10.4 million from $9.3 million recorded in 2012.
Net interest margin for the year ended December 31, 2013, in comparison with the same period in 2012, decreased to 65 basis points from 68 basis points, and net interest spread decreased to 56 basis points from 58 basis points for the same period in 2012. Net interest spread is the difference between the yields on interest-earning assets and interest-bearing liabilities. Contributing to the decrease in net interest spread was the change in average yield on interest-earning assets, which decreased by nine basis points to 1.49 percent, while the average cost of interest-bearing liabilities decreased by seven basis points to 0.93 percent. The decline in the average yield on interest-earning assets in 2013 is primarily attributable to the decreases in prepayment fee income partially offset by the accretion of discount from previously impaired investment securities discussed above.
The following table presents major categories of average balances, related interest income/expense, and average yields for interest-earning assets and interest-bearing liabilities. Our primary source of earnings is net interest income, which is the interest earned on advances, mortgage loans, and investments less interest paid on COs, deposits, and other sources of funds.
_________________________
(1)
The average balances of held-to-maturity securities and available-for-sale securities are reflected at amortized cost; therefore the resulting yields do not give effect to changes in fair value or the noncredit component of a previously recognized other-than-temporary impairment reflected in accumulated other comprehensive loss.
Rate and Volume Analysis
Changes in both average balances (volume) and interest rates influence changes in net interest income and net interest margin. The following table summarizes changes in interest income and interest expense for the years ended December 31, 2013 and 2012. Changes in interest income and interest expense that are not identifiable as either volume-related or rate-related, but are equally attributable to both volume and rate changes, have been allocated to the volume and rate categories based upon the proportion of the absolute value of the volume and rate changes.
Average Balance of Advances Outstanding
The average balance of total advances decreased $2.2 billion, or 9.4 percent, for the year ended December 31, 2013, compared with the same period in 2012. Although the average balances fell, we experienced a rise in advances balances during the year concentrated in short-term advances, as discussed under - Executive Summary - Advances Balances. We cannot predict whether this trend will continue. The following table summarizes average balances of advances outstanding during the years ended December 31, 2013, 2012 and 2011 by product type.
Putable advances that are classified as fixed-rate advances in the table above are typically hedged with interest-rate-exchange agreements in which a short-term rate is received, typically three-month LIBOR. In addition, approximately 20.4 percent of average long-term fixed-rate advances were similarly hedged with interest-rate swaps. Therefore, a significant portion of our advances, including overnight advances, short-term fixed-rate advances, fixed-rate putable advances, certain fixed-rate bullet advances, and variable-rate advances, either earn a short-term interest rate or are swapped to a short-term index, resulting in yields that closely follow short-term market interest-rate trends. The average balance of all such advances totaled $12.2 billion for the year ended December 31, 2013, representing 56.7 percent of the total average balance of advances outstanding during the year ended December 31, 2013. The average balance of all such advances totaled $14.5 billion for the year ended December 31, 2012, representing 60.6 percent of the total average balance of advances outstanding during the year ended December 31, 2012.
For the years ended December 31, 2013 and 2012, net prepayment fees on advances were $23.5 million and $65.8 million, respectively. For the years ended December 31, 2013 and 2012, prepayment fees on investments were $6.2 million and $535,000, respectively. Prepayment-fee income is unpredictable and inconsistent from period to period, occurring only when advances and investments are prepaid prior to the scheduled maturity or repricing dates, and generally when prevailing reinvestment yields are lower than those of the prepaid advances.
Because prepayment-fee income recognized during these periods does not necessarily represent a trend that will continue in future periods, and due to the fact that prepayment-fee income represents a one-time fee that is generally recognized in the period in which the corresponding advance or investment security is prepaid, we believe it is important to review the results of net interest spread and net interest margin excluding the impact of prepayment-fee income. These results are presented in the following table.
Average Balance of Investments
Average short-term money-market investments, consisting of interest-bearing deposits, securities purchased under agreements to resell, and federal funds sold, decreased $2.5 billion, or 35.4 percent, for the year ended December 31, 2013, compared with the same period in 2012. The yield earned on short-term money market investments is highly correlated to short-term market interest rates. These investments are used for liquidity management and to manage our leverage ratio in response to fluctuations in other asset balances. For the year ended December 31, 2013, average balances of securities purchased under agreements to resell decreased $2.7 billion and average balances of federal funds sold increased $211.4 million in comparison to the year ended December 31, 2012.
Average investment-securities balances decreased $2.3 billion, or 19.2 percent for the year ended December 31, 2013, compared with the same period in 2012, which occurred in the following investment categories:
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$1.1 billion decline in MBS;
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$835.0 million decline in agency and supranational institutions' debentures; and
•
$379.1 million decline in FDIC-guaranteed corporate bonds.
The average aggregate balance of our investments in mortgage loans for the year ended December 31, 2013, was $154.6 million higher than the average aggregate balance of these investments for the year ended December 31, 2012, representing an increase of 4.7 percent.
Average Balance of COs
Average CO balances decreased $6.6 billion, or 16.2 percent, for the year ended December 31, 2013, compared with the same period in 2012, resulting from our reduced funding needs principally due to the decline in our average investments and advances balances. This overall decline consisted of a decrease of $3.5 billion in CO discount notes and a decrease of $3.1 billion in CO bonds.
The average balance of term CO discount notes decreased $3.4 billion and overnight CO discount notes decreased $62.0 million for the year ended December 31, 2013, in comparison with the same period in 2012. The average balance of CO discount notes represented approximately 26.6 percent of total average COs during the year ended December 31, 2013, as compared with 30.8 percent of total average COs during the year ended December 31, 2012. The average balance of CO bonds represented 73.4 percent and 69.2 percent of total average COs outstanding during the years ended December 31, 2013 and 2012, respectively.
Impact of Derivatives and Hedging Activities
Net interest income includes interest accrued on interest-rate-exchange agreements that are associated with advances, investments, deposits, and debt instruments that qualify for hedge accounting. We generally use derivative instruments that qualify for hedge accounting as interest rate risk-management tools. These derivatives serve to stabilize net interest income and
net interest margin when interest rates fluctuate. Accordingly, the impact of derivatives on net interest income and net interest margin should be viewed in the overall context of our risk-management strategy. The following tables show the net effect of derivatives and hedging activities on net interest income, net gains (losses) on derivatives and hedging activities, and net unrealized gains (losses) on trading securities for the years ended December 31, 2013, 2012, and 2011 (dollars in thousands).
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(1)
Represents the amortization/accretion of hedging fair-value adjustments for closed hedge positions.
(2)
Represents interest income/expense on derivatives included in net interest income.
_____________________
(1)
Represents the amortization/accretion of hedging fair-value adjustments for closed hedge positions.
(2)
Represents interest income/expense on derivatives included in net interest income.
_____________________
(1)
Represents the amortization/accretion of hedging fair-value adjustments for closed hedge positions.
(2)
Represents interest income/expense on derivatives included in net interest income.
Net interest margin for the years ended December 31, 2013 and 2012, was 0.65 percent and 0.68 percent, respectively. If derivative instruments had not been used as hedges to mitigate the impact of interest-rate fluctuations, net interest margin would have been 0.96 percent and 0.99 percent, respectively.
Interest paid and received on interest-rate-exchange agreements that are economic hedges, is classified as net losses on derivatives and hedging activities in other income. As shown under - Other Income (Loss) and Operating Expenses below, interest accruals on derivatives classified as economic hedges totaled a net expense of $3.8 million and $7.5 million, respectively for the years ended December 31, 2013 and 2012.
For more information about our use of derivatives to manage interest-rate risk, see Item 7A
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Sources and Types of Market and Interest-Rate Risk
Market risk is the risk to earnings or shareholder value due to adverse movements in interest rates, market prices, or interest-rate spreads. Market risk arises in the normal course of business from our investment in mortgage assets, where risk cannot be eliminated; from the fact that assets and liabilities are priced in different markets; and from tactical decisions to, from time to time, assume some risk to generate income.
Our balance sheet is comprised of different portfolios that require different types of market- and interest-rate-risk management strategies. The majority of our balance sheet is comprised of assets that can be funded individually or collectively without imposing significant residual interest-rate risk on ourselves.
However, those assets and liabilities with embedded options, particularly our mortgage-related assets, including the portfolio of whole loans acquired through the MPF program, our portfolio of MBS and ABS, and our portfolio of bonds issued by HFAs, represent more complex cash-flow structures and contain more risk of prepayment and/or call options. Because many of these assets are backed by residential mortgages that allow the borrower to prepay and refinance at any time without incurring a penalty, the behavior of these portfolios is asymmetric based on the movement of interest rates. If rates fall, borrowers have an incentive to refinance mortgages without penalty, which could leave us with lower-yielding replacement assets against existing debt assigned to the portfolio. If rates rise, borrowers will tend to hold existing loans longer than they otherwise would, imposing on us the risk of having to refinance maturing debt assigned to these portfolios at a higher rate, thereby narrowing the interest-rate spread generated by the assets.
Further, unequal moves in the various different yield curves associated with our assets and liabilities create risks that changes in individual portfolio or instrument valuations, or changes in projected income, will not be equally offset by changes in valuations or projected income associated with individual portfolios or instruments on the opposite side of the balance sheet, even if the financial terms of the opposing financial portfolios or instruments are closely matched.
These risks cannot always be profitably managed with a strategy in which each asset is offset by a liability with a substantially identical cash-flow structure. Therefore, we generally view each portfolio as a whole and allocate funding and hedging to these
portfolios based on an evaluation of the collective market and interest-rate risks posed by these portfolios. We measure the estimated impact to fair value of these portfolios as well as the potential for income to decline due to movements in interest rates, and make adjustments to the funding and hedge instruments assigned as necessary to keep the portfolios within established risk limits.
We also incur interest-rate risk in the investment of our noninterest-bearing member stock capital and retained earnings in interest-earning assets. Traditionally we have sought to invest our capital in liquid short-term money market assets to maintain liquidity and to provide our members with a money market-based return on capital. While this capital investment strategy is comparatively risk-neutral in terms of our market risk, it exposes our interest income to the level and volatility of rates in the markets. As the Federal Reserve has sought to stimulate the U.S. economy during the prolonged economic recession through a low-rate accommodative policy, our net interest income realized on our member stock capital investment has been lower than could have been realized on alternative longer-term investments.
Types of Market and Interest-Rate Risk
Interest-rate and market risk can be divided into several categories, including repricing risk, yield-curve risk, basis risk, and options risk. Repricing risk refers to differences in the average sensitivities of asset and liability yields attributable to differences in the average timing of maturities and/or coupon resets between assets and liabilities. Differences in the timing of repricing of assets and liabilities can cause spreads between assets and liabilities to either increase or decline.
Yield-curve risk reflects the sensitivity of net income to changes in the shape or slope of the yield curve that could impact the performance of assets and liabilities differently, even though average sensitivities are the same.
When assets and liabilities are affected by yield changes in different markets, basis risk can result. For example, if we invest in LIBOR-based floating-rate assets and fund those assets with short-term discount notes, potential compression in the spread between LIBOR and discount-note rates could adversely impact our net income.
We also face options risk, particularly in our portfolio of advances, mortgage loans, MBS, and HFA securities. When a borrower prepays an advance, we could suffer lower future income if the principal portion of the prepaid advance is reinvested in lower-yielding assets that continue to be funded by higher-cost debt. For this reason, we are required by regulation to assess a prepayment fee that makes us financially indifferent to the prepayment, or in the case of callable advances, to charge an interest rate that is reflective of the value of the member's option to prepay the advance without a fee. However, in the mortgage loan, MBS, and HFA-bond portfolios, borrowers or issuers often have the right to repay their obligations prior to maturity without penalty, potentially requiring us to reinvest the returned principal at lower yields. If interest rates decline, borrowers may be able to refinance existing mortgage loans at lower interest rates, resulting in the prepayment of these existing mortgages and forcing us to reinvest the proceeds in lower-yielding assets. If interest rates rise, borrowers may avoid refinancing mortgage loans for periods longer than the average term of liabilities funding the mortgage loans, causing us to have to refinance the assets at higher cost. This right of redemption is effectively a call option that we have written to the obligor. Another less prominent form of options risk includes coupon-cap risk, which may be embedded into certain floating-rate MBS and limit the amount by which asset coupons may increase.
Strategies to Manage Market and Interest-Rate Risk
General
We use various strategies and techniques to manage our market and interest-rate risk. Principal among our tools for interest-rate-risk management is the issuance of debt that can be used to match interest-rate-risk exposures of our assets. For example, we can issue a CO with a maturity of 30 years to fund an investment with a 30 year maturity. The debt may be noncallable until maturity or callable on and/or after a certain date.
COs may be issued to fund specific assets or to manage the overall exposure of a portfolio or the balance sheet. At December 31, 2013, fixed-rate noncallable debt, not hedged by interest-rate swaps, amounted to $13.4 billion, compared with $13.5 billion at December 31, 2012, and fixed-rate callable debt not hedged by interest-rate swaps amounted to $1.2 billion and $858.0 million at December 31, 2013, and December 31, 2012, respectively.
To achieve certain risk-management objectives, we also use interest-rate derivatives that alter the effective maturities, repricing frequencies, or option-related characteristics of financial instruments. These may include swaps, swaptions, caps, collars, and floors; futures and forward contracts; and exchange-traded options. For example, as an alternative to issuing a fixed-rate bond
to fund a fixed-rate advance, we might enter into an interest-rate swap that receives a floating-rate coupon and pays a fixed-rate coupon, thereby effectively converting the fixed-rate advance to a floating-rate advance.
Because the interest-rate swaps and hedged assets and liabilities trade in different markets, they are subject to basis risk that is reflected in our VaR calculations and fair-value disclosures, but that is not reflected in hedge ineffectiveness, because these interest-rate swaps are designed to only hedge changes in fair values of the hedged items that are attributable to changes in the benchmark LIBOR interest rate.
Advances
In addition to the general strategies described above, one tool that we use to reduce the interest-rate risk associated with advances are contractual provisions for advances with original fixed maturities of greater than six months that require borrowers to pay us prepayment fees, which make us financially indifferent if the borrower prepays such advances prior to maturity. These provisions protect against a loss of income under certain interest-rate environments.
Prepayment-fee income can be used to offset the cost of purchasing and retiring high-cost debt to maintain our asset-liability sensitivity profile. In cases where derivatives are used to hedge prepaid advances, prepayment-fee income can be used to offset the cost of terminating the associated hedge.
Investments
We hold certain long-term bonds issued by U.S. federal agencies, U.S. federal government corporations and instrumentalities, and supranational institutions as available-for-sale. To hedge the market and interest-rate risk associated with these assets, we may enter into interest-rate swaps with matching terms to those of the bonds to create synthetic floating-rate assets. At December 31, 2013, and December 31, 2012, this portfolio of hedged investments had an amortized cost of $828.6 million and $1.1 billion, respectively.
We also manage the market and interest-rate risk in our MBS portfolio. For MBS classified as held-to-maturity, we use debt that matches the characteristics of the portfolio assets. For example, for floating-rate ABS, we use debt that reprices on a short-term basis, such as CO discount notes or CO bonds that are swapped to a LIBOR-based floating-rate. For commercial MBS that are nonprepayable or prepayable for a fee for an initial period, we may use fixed-rate debt.
We also use interest-rate swaps to manage the fair-value sensitivity of the portion of our MBS portfolio that is classified as trading securities. These interest-rate-exchange agreements provide an economic offset to the duration and convexity risks arising from these assets.
Mortgage Loans
We manage the interest-rate and prepayment risk associated with mortgage loans through a combination of debt issuance and derivatives. We issue both callable and noncallable debt to achieve cash-flow patterns and liability durations similar to those expected on the mortgage loans.
We mitigate our exposure to changes in interest rates by funding a portion of our mortgage portfolio with callable debt. When interest rates change, our option to redeem this debt offsets a large portion of the fair-value change driven by the mortgage-prepayment option. These bonds are effective in managing prepayment risk by allowing us to respond in kind to prepayment activity. Conversely, if interest rates increase, we may allow the debt to remain outstanding until maturity. We use various cash instruments including shorter-term debt, callable, and noncallable long-term debt to reprice debt when mortgages prepay faster or slower than expected. Our debt-repricing capacity depends on market demand for callable and noncallable debt, which fluctuates from time to time. Additionally, because the mortgage-prepayment option is not fully hedged by callable debt, the combined market value of our mortgage assets and debt will be affected by changes in interest rates.
Swapped Consolidated Obligation Debt
We may also issue bonds together with interest-rate swaps that receive a coupon that offsets the bond coupon and that offsets any optionality embedded in the bond, thereby effectively creating a floating-rate liability. We may employ this strategy to secure long-term debt that meets funding needs versus relying on short-term CO discount notes. Total CO bond debt used in conjunction with interest-rate-exchange agreements was $7.0 billion, or 30.2 percent of our total outstanding CO bonds at December 31, 2013, compared with $8.9 billion, or 34.4 percent of total outstanding CO bonds, at December 31, 2012.
Measurement of Market and Interest-Rate Risk
We measure our exposure to market and interest-rate risk using several techniques applied to the balance sheet and to certain portfolios within the balance sheet. Principal among these measurements as applied to the balance sheet is the potential future change in market value of equity (MVE) and interest income due to potential changes in interest rates, interest-rate volatility, spreads, and market prices. We also measure VaR, duration of equity, and the other metrics discussed below.
We use certain quantitative systems to evaluate our risk position. These systems are capable of employing various interest-rate term-structure models and valuation techniques to determine the values and sensitivities of complex or option-embedded instruments such as mortgage loans; MBS; callable bonds and swaps; and adjustable-rate instruments with embedded caps and floors, among others. These models require the following:
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specification of the contractual and behavioral features of each instrument;
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determination and specification of appropriate market data, such as yield curves and implied volatilities;
•
utilization of appropriate term-structure and prepayment models to reasonably describe the potential evolution of interest rates over time and the expected behavior of financial instruments in response;
•
for option-free instruments, the expected cash flows are specified in accordance with the term structure of interest rates and discounted using spot rates derived from the same term structure; and
•
for option-embedded instruments, the models use standardized option pricing methodology to determine the likelihood of embedded options being exercised or not.
We use various measures of market and interest-rate risk, as set forth below in this section. Some measures have associated, prescriptive corrective actions under our policies, as described below, but others do not.
Market Value of Equity Estimation and Market Risk Limit. MVE is the net economic value of total assets and liabilities, including any off-balance-sheet items. In contrast to the GAAP-based shareholder's equity account, MVE represents the shareholder's equity account in present-value terms. Specifically, MVE equals the difference between the theoretical market value of our assets and the theoretical market value of our liabilities.
Market Value of Equity/Book Value of Equity Ratio. MVE, and in particular, the ratio of MVE to the book value of equity (BVE), is a theoretical measure of the current value of shareholder investment based on market rates, spreads, prices, and volatility at the reporting date. However, we caution that care must be taken to properly interpret the results of the MVE analysis as the theoretical basis for these valuations may not be fully representative of future realized prices. Further, valuations are based on market curves and prices respective of individual assets, liabilities, and derivatives, and therefore are not representative of future net income to be earned by us through the spread between asset market curves and the market curves for funding costs. MVE should not be considered indicative of our market value as a going concern because it does not consider future new business activities, risk-management strategies or the net profitability of assets after funding costs are subtracted.
For purposes of measuring this ratio, the BVE is equal to our permanent capital, which consists of the par value of capital stock including mandatorily redeemable capital stock, plus retained earnings. BVE excludes accumulated other comprehensive loss. At December 31, 2013, our MVE was $4.2 billion and our BVE was $4.3 billion. At December 31, 2012, our MVE was $3.9 billion and our BVE was $4.3 billion. Our ratio of MVE to BVE was 97.5 percent at December 31, 2013, compared with 92.7 percent at December 31, 2012.
Market Value of Equity/Par Stock Ratio. We also measure the ratio of our MVE to the par value of our Class B Stock, which we refer to as our MVE to par stock ratio. We have established an MVE to par stock floor of 100 percent, reflecting our intent to preserve the value of our members' capital investment. As of December 31, 2013, that ratio was 119.4 percent.
The following chart displays our MVE to BVE and MVE to par stock ratios over the preceding quarters, based on the factors described above.
Value at Risk. VaR measures the change in our MVE to a 99th percent confidence interval, based on a set of stress scenarios (VaR stress scenarios) using historical interest-rate and volatility movements that have been observed over six-month intervals starting at the most recent month-end and going back monthly to 1992.
The table below presents the historical simulation VaR estimate as of December 31, 2013, and December 31, 2012, which represents the estimates of potential reduction to our MVE from potential future changes in interest rates and other market factors. Estimated potential market value loss exposures are expressed as a percentage of the current MVE and are based on historical behavior of interest rates and other market factors over a 120-business-day time horizon.
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(1)
VaR exposures at December 31, 2012, were determined based on VaR stress scenarios going back monthly to 1978, consistent with FHFA regulations. Beginning with the calculation of VaR at June 30, 2013, to be consistent with FHFA guidance, we have excluded VaR stress scenarios prior to 1992 because market-risk stress conditions are effectively captured in those scenarios beginning in 1992 and therefore properly present our current VaR exposure.
(2)
Loss exposure is expressed as a percentage of base MVE.
The following table outlines our VaR exposure to the 99th percentile, consistent with FHFA regulations, over 2013 and 2012.
As measured by VaR at a 99th percent confidence interval, our potential losses to MVE due to changes in interest rates and other market factors increased to $136.9 million as of December 31, 2013, from $80.0 million as of December 31, 2012. The increase in VaR since December 31, 2012, resulted from higher rates and higher levels of long term advances with longer maturities.
Our risk-management policy requires that VaR not exceed $275.0 million. Should the limit be exceeded, the policy requires management to notify the board of directors' Risk Committee of such breach. We complied with our VaR limit at all times during the year ended December 31, 2013.
Duration of Equity. Another measure of risk that we use is duration of equity. Duration of equity measures the percentage change to shareholder value due to movements in interest rates. A positive duration of equity generally indicates an appreciation in shareholder value in times of falling rates and a depreciation in shareholder value for increasing rate environments. We have established a limit of +/- 4.0 years for duration of equity based on a balanced consideration of market-value sensitivity and net interest-income sensitivity. Our policies require us to notify our board of directors' Risk Committee of such breach. We did not breach this limit in 2013.
As of December 31, 2013, our duration of equity was +0.9 years, compared with +0.3 years at December 31, 2012.
Certain Market and Interest-Rate Risk Metrics under Potential Interest-Rate Scenarios
We also monitor the sensitivities of MVE and the duration of equity to potential interest-rate scenarios. The following table presents certain market and interest-rate risk metrics under different interest-rate scenarios (dollars in thousands).
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(1)
Given the current environment of low interest rates, downward rate shocks are floored as they approach zero, and therefore may not be fully representative of the indicated rate shock.
(2)
The income simulation metric for December 31, 2013 is based on projections of adjusted net income over a range of potential interest-rate scenarios over the following 12-month horizon divided by regulatory capital. Regulatory capital is capital stock (including mandatorily redeemable capital stock) plus total retained earnings, and projections of adjusted net income exclude interest expense on mandatorily redeemable capital stock.
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(1)
Given the current environment of low interest rates, downward rate shocks are floored as they approach zero, and therefore may not be fully representative of the indicated rate shock.
(2)
The income simulation results for December 31, 2012 have been revised to conform to the current period methodology, which is based on projections of adjusted net income over a range of potential interest-rate scenarios over the following 12-month horizon divided by regulatory capital. Regulatory capital is capital stock (including mandatorily redeemable capital stock) plus total retained earnings, and projections of adjusted net income exclude interest expense on mandatorily redeemable capital stock.
Convexity Management Action Trigger and Limit. We measure the convexity of our MVE and have established a management action trigger at a decline of 10 percent and a limit at a decline of 15 percent in an up or down 200 basis point parallel rate shock scenario. Our policies require management to notify the board of director’s risk committee if the limit is breached and to take steps to reduce the risk exposure. As per the percent change in MVE lines in the above tables, we satisfied the limit at each of December 31, 2013 and December 31, 2012.
MPF Portfolio Management Action Trigger of 25 Percent of Our VaR Limit. We have established a management action trigger for VaR exposure from our investments in mortgage loans through the MPF program such that the VaR from these investments shall not exceed 25 percent of our overall VaR limit. While we seek to limit interest-rate risk through matching asset maturity and optionality with its corresponding funding, mortgage loans cannot be perfectly match funded due to factors including, but not limited to, borrower prepayment behavior and basis risk between the swap and our funding curves. This management action trigger was $68.8 million at December 31, 2013, based on our overall VaR limit of $275.0 million. Our actual MPF portfolio VaR exposure at December 31, 2013, was $87.0 million, compared with $27.0 million as of December 31, 2012.
We exceeded the MPF Portfolio VaR management action trigger at December 31, 2013. The breach is largely the result of the combined impact of the higher interest-rate environment that occurred during the second quarter of 2013 and of the stress impact of certain modeled scenarios where mortgages underperform our CO curve. As a result of the breach, management reviewed the risk exposure in the MPF portfolio and the risk exposure of the entire balance sheet as required by the trigger. Although we found the MPF risk exposure to correlate with the risk exposure of the entire balance sheet, because the risk of the overall balance sheet as measured by VaR remains well below both its management action trigger and limit, no reduction to the MPF risk profile was required. Should the MPF VaR management action trigger continue to be breached, and should our VaR increase closer to its trigger and limit, management expects to reduce our risk exposure by making changes to the balance sheet including adding long-term debt or pay-fixed swaps.
Duration Gap. We measure the duration gap of our assets and liabilities, including all related hedging transactions. Duration gap is the difference between the estimated durations (percentage change in market value for a 100 basis point shift in interest rates) of assets and liabilities (including the effect of related hedges) and reflects the extent to which estimated sensitivities to market changes, including, but not limited to, maturity and repricing cash flows for assets and liabilities are matched. Higher numbers, whether positive or negative, indicate greater sensitivity in the MVE in response to changing interest rates. A positive duration gap means that our total assets have an aggregate duration, or sensitivity to interest-rate changes greater than our liabilities, and a negative duration gap means that our total assets have an aggregate duration shorter than our liabilities. Our duration gap was +1.0 months at December 31, 2013, compared with +0.4 months at December 31, 2012.
Income Simulation and Repricing Gaps. To provide an additional perspective on market and interest-rate risks, we have an income-simulation model that projects net interest income over a range of potential interest-rate scenarios, including parallel
interest-rate shocks, nonparallel interest-rate shocks, and nonlinear changes to our funding curve and LIBOR. We measure simulated 12-month net income and return on regulatory capital under these scenarios; the simulations are solely based on simulated movements in the swap and the CO curve and do not reflect potential impacts of credit events, including, but not limited to, future other-than-temporary impairment charges. Management has put in place escalation-action triggers whereby senior management is explicitly informed of instances where our projected return on regulatory capital would fall below three-month LIBOR over the following 12-month horizon in any of the assumed interest-rate scenarios. The results of this analysis for December 31, 2013, showed that in the worst-case scenario, our return on equity falls to 173 basis points above the average yield on three-month LIBOR under a yield curve scenario wherein interest rates instantaneously rise by 300 basis points in a parallel fashion across all yield curves.
The income simulation metric for December 31, 2013 is based on projections of adjusted net income over a range of potential interest-rate scenarios over the following 12-month horizon divided by regulatory capital. Regulatory capital is capital stock (including mandatorily redeemable capital stock) plus total retained earnings, and projections of adjusted net income exclude interest expense on mandatorily redeemable capital stock. The results for December 31, 2012, have been revised to conform to the current period methodology.
Economic Capital Ratio Limit. We have established a limit of 4.0 percent for the ratio of the MVE to the market value of assets, referred to as the economic capital ratio. FHFA regulations require us to maintain a regulatory capital ratio of book value of regulatory capital to book value of total assets of no less than 4.0 percent, as discussed in Item 8
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial Statements
Index to financial statements and supplementary data:
Management's Report on Internal Control over Financial Reporting
The management of the Federal Home Loan Bank of Boston is responsible for establishing and maintaining adequate internal control over financial reporting.
Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
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. Management assessed the effectiveness of internal control over financial reporting as of December 31, 2013, based on the framework established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on that assessment, management concluded that, as of December 31, 2013, internal control over financial reporting is effective based on the criteria established in Internal Control - Integrated Framework (1992).
Additionally, our internal control over financial reporting as of December 31, 2013, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of the Federal Home Loan Bank of Boston:
In our opinion, the accompanying statements of condition and the related statements of operations, comprehensive income, capital, and cash flows, present fairly, in all material respects, the financial position of the Federal Home Loan Bank of Boston (the Bank) at December 31, 2013, and 2012, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Bank maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Bank's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements and on the Bank's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included 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. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
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.
Boston, Massachusetts
March 24, 2014
_______________________________________
(a) Fair values of held-to-maturity securities were $4,499,441 and $5,699,230 at December 31, 2013 and 2012, respectively.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
FEDERAL HOME LOAN BANK OF BOSTON
NOTES TO FINANCIAL STATEMENTS
Background Information
We are a federally chartered corporation and one of 12 district Federal Home Loan Banks (the FHLBanks or the FHLBank System). The FHLBanks are government-sponsored enterprises (GSEs) that serve the public by enhancing the availability of credit for residential mortgages and targeted community development. Each FHLBank operates in a specifically defined geographic territory, or district. We provide a readily available, competitively priced source of funds to our members and certain nonmember institutions (referred to as housing associates) located within the six New England states, which are Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, and Vermont. Certain regulated financial institutions, including community development financial institutions (CDFIs) and insurance companies with their principal places of business in New England and engaged in residential housing finance, may apply for membership. State and local housing authorities (housing associates) that meet certain statutory criteria may also borrow from us. While eligible to borrow, housing associates are not our members and, therefore, are not allowed to hold capital stock. As a cooperative, current and former members own all of our outstanding capital stock and may receive dividends on their investment. We do not have any wholly or partially owned subsidiaries, and we do not have an equity position in any partnerships, corporations, or off-balance-sheet special-purpose entities.
All members must purchase our stock as a condition of membership, as well as a condition of engaging in certain business activities with us. Capital stock of former members will remain outstanding as long as business activities with those former members exist. See Note 16 - Capital, for a complete description of the capital-stock-purchase requirements. We consider related parties to be those members with 10 percent or more of the voting interests of our capital stock outstanding. See Note 21 - Transactions with Shareholders for additional information.
The FHFA, our primary regulator, was established and became the independent federal regulator of the FHLBanks, Federal Home Loan Mortgage Corporation (Freddie Mac), and Federal National Mortgage Association (Fannie Mae), effective July 30, 2008, with the passage of the Housing and Economic Recovery Act of 2008, as amended (HERA). Pursuant to HERA, all existing regulations, orders, determinations, and resolutions of the FHLBank's former regulator, the Federal Housing Finance Board (the Finance Board), remain in effect until modified, terminated, set aside, or superseded by the FHFA Director, any court of competent jurisdiction, or operation of law. In accordance with HERA, the Finance Board was abolished one year after the date of enactment of HERA.
A purpose of the FHFA is to ensure that the FHLBanks operate in a safe and sound manner, including maintenance of adequate capital and internal controls. In addition, the FHFA is responsible for ensuring that 1) the operations and activities of each FHLBank foster liquid, efficient, competitive, and resilient national housing finance markets, 2) each FHLBank complies with the title and the rules, regulations, guidelines, and orders issued under HERA and the authorizing statutes, 3) each FHLBank carries out its statutory mission only through activities that are authorized under and consistent with HERA and the authorizing statutes, and 4) the activities of each FHLBank and the manner in which such FHLBank is operated is consistent with the public interest. Each FHLBank operates as a separate entity with its own management, employees, and board of directors.
The Office of Finance is the FHLBanks' fiscal agent and is a joint office of the FHLBanks established to facilitate the issuance and servicing of the FHLBanks' COs and to prepare the combined quarterly and annual financial reports of the 12 FHLBanks. As provided by the Federal Home Loan Bank Act of 1932, as amended (the FHLBank Act), and applicable regulations, COs are backed only by the financial resources of all 12 FHLBanks and are our primary source of funds. Deposits, other borrowings, and the issuance of capital stock, which is principally held by our current and former members, provide other funds. We primarily use these funds to provide loans, called advances, and other products and also to fund investments, which are principally used for liquidity and leverage management. We also use these funds to invest in mortgage loans. In addition, we offer correspondent services, such as wire-transfer, investment-securities-safekeeping, and settlement services.
Note 1 - Summary of Significant Accounting Policies
Use of Estimates
These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The preparation of financial statements in accordance with GAAP requires management to make subjective assumptions and estimates that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of income and expenses. The most significant of these estimates include but are
not limited to, fair-value estimates, other-than-temporary impairment analysis, the allowance for loan losses, and deferred premium/discounts associated with prepayable assets. Actual results could differ from these estimates.
Fair Value
The fair-value amounts, recorded on the statement of condition and in the note disclosures for the periods presented, have been determined by us using available market and other pertinent information, and reflect our best judgment of appropriate valuation methods. Although we use our best judgment in estimating the fair value of these financial instruments, there are inherent limitations in any valuation technique. Therefore, these fair values may not be indicative of the amounts that would have been realized in market transactions at the reporting dates. See Note 19 - Fair Values for more information.
Financial Instruments Meeting Netting Requirements
We present certain financial instruments on a net basis when they have a legal right of offset and all other requirements for netting are met (collectively referred to as the netting requirements). For these financial instruments, we have elected to offset our asset and liability positions, as well as cash collateral received or pledged, when we have met the netting requirements.
The net exposure for these financial instruments can change on a daily basis; therefore, there may be a delay between the
time this exposure change is identified and additional collateral is requested, and the time when this collateral is received or
pledged. Likewise, there may be a delay for excess collateral to be returned. For derivative instruments that meet the
requirements for netting, any excess cash collateral received or pledged is recognized as a derivative liability or derivative
asset. See Note 11 - Derivatives and Hedging Activities for additional information regarding these agreements.
Based on the fair value of the related collateral held, the securities purchased under agreements to resell were fully collateralized for the periods presented. At December 31, 2013, we had $3.8 billion in securities purchased under agreements to resell. There were no offsetting amounts related to these securities at December 31, 2013.
Interest-Bearing Deposits, Securities Purchased Under Agreements to Resell, and Federal Funds Sold
These investments provide short-term liquidity and are carried at cost. Federal funds sold consist of short-term, unsecured loans made to investment-grade counterparties. Securities purchased under agreements to resell are treated as short-term collateralized loans which are classified as assets in the statement of condition. These securities purchased under agreements to resell are held in safekeeping in our name by third-party custodians, which we have approved. If the fair value of the underlying securities decreases below the fair value required as collateral, the counterparty has the option to provide additional securities in safekeeping in our name in an amount equal to the decrease or remit cash in such amount. If the counterparty defaults on this obligation, we will decrease the dollar value of the resale agreement accordingly. We have not sold or repledged the collateral received on securities purchased under agreements to resell. Securities purchased under agreements to resell averaged $2.8 billion during 2013 and $5.5 billion during 2012, and the maximum amount outstanding at any month-end during 2013 and 2012 was $3.8 billion and $7.5 billion, respectively.
Investment Securities
We classify investments as trading, available-for-sale, or held-to-maturity at the date of acquisition. Purchases and sales of securities are recorded on a trade date basis.
Trading. Securities classified as trading are held for liquidity purposes and carried at fair value. We record changes in the fair value of these investments through other income as net unrealized (losses) gains on trading securities. FHFA regulation and our risk-management policy prohibit trading in or the speculative use of these instruments and limit the credit risks we have from these instruments.
Available-for-sale. We classify certain investments that are not classified as held-to-maturity or trading as available-for-sale and carry them at fair value. Changes in fair value of available-for-sale securities not being hedged by derivatives, or in an economic hedging relationship, are recorded in accumulated other comprehensive loss as net unrealized (losses) gains on available-for-sale securities. For available-for-sale securities that have been hedged under fair-value hedge designations, we record the portion of the change in fair value related to the risk being hedged in other income as net gains (losses) on derivatives and hedging activities together with the related change in the fair value of the derivative. The remainder of the change in the fair value of the investment is recorded in accumulated other comprehensive loss as net unrealized (losses) gains on available-for-sale securities.
Held-to-Maturity. We carry at amortized cost certain investments for which we have both the ability and intent to hold to maturity, adjusted for periodic principal repayments, amortization of premiums, and accretion of discounts using the level-yield method, previous other-than-temporary impairment, and accretion of the noncredit portion of other-than-temporary impairment recognized in accumulated other comprehensive loss.
Changes in circumstances may cause us to change our intent to hold certain securities to maturity without calling into question our 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 us that could not have been reasonably anticipated may cause us to sell or transfer a held-to-maturity security without necessarily calling into question our intent to hold other debt securities to maturity. In addition, sale of a debt security that meets either of the following two conditions would not be considered inconsistent with the original classification of that security:
•
the sale occurs near enough 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
•
the sale of a security occurs after we have 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.
Premiums and Discounts. We amortize premiums and accrete discounts on mortgage-backed securities (MBS) using the level-yield method over the estimated lives of the securities. This method requires a retrospective adjustment of the effective yield each time we change the estimated life, based on actual prepayments received and changes in expected prepayments, as if the new estimate had been known since the original acquisition date of the securities. We estimate prepayment speeds on each individual security using the most recent three months of historical constant prepayment rates, as available, or may subscribe to third-party data services that provide estimates of cash flows, from which we determine expected asset lives. We amortize premiums and accrete discounts on other investments using the level-yield method to the contractual maturity of the securities.
Gains and Losses on Sales. We compute gains and losses on sales of investment securities using the specific identification method and include these gains and losses in other income (loss).
Securities issued by GSEs and U.S. government-owned corporations are not guaranteed by the U.S. government.
Investment Securities - Other-than-Temporary Impairment
We evaluate our individual available-for-sale and held-to-maturity securities in an unrealized loss position for other-than-temporary impairment each quarter. An investment is considered impaired when its fair value is less than its amortized cost. We consider other-than-temporary impairment to have occurred if we:
•
have an intent to sell the investment;
•
believe it is more likely than not that we will be required to sell the investment before the recovery of its amortized cost based on available evidence; or
•
do not expect to recover the entire amortized cost of the debt security.
Recognition of Other-than-Temporary Impairment. If either of the first two conditions above is met, we recognize an other-than-temporary impairment charge in earnings equal to the entire difference between the security's amortized cost and its fair value as of the statement of condition date.
For securities in an unrealized loss position that meet neither of the first two conditions and for each of our private-label MBS, we perform an analysis to determine if we will recover the entire amortized cost of each of these securities. The present value of the cash flows expected to be collected is compared with the amortized cost of the debt security to determine whether a credit loss exists. If the present value of the cash flows expected to be collected is less than the amortized cost of the debt security, the security is deemed to be other-than-temporarily impaired and the carrying value of the debt security is adjusted to its fair value. However, rather than recognizing the entire difference between the amortized cost and fair value in earnings, only the amount of the impairment representing the credit loss (that is, the credit component) is recognized in earnings, while the amount related to all other factors (that is, the noncredit component) is recognized in accumulated other comprehensive loss, which is a component of equity. For a security that is determined to be other-than-temporarily impaired, in the event that the
present value of the cash flows expected to be collected is less than the fair value of the security, the credit loss on the security is limited to the amount of that security's unrealized losses.
The total other-than-temporary impairment is presented in the statement of operations with an offset for the amount of the noncredit portion of other-than-temporary impairment that is recognized in accumulated other comprehensive loss. The remaining amount in the statement of operations represents the credit loss for the period.
Accounting for Other-than-Temporary Impairment Recognized in Accumulated Other Comprehensive Loss. For subsequent accounting of other-than-temporarily impaired securities, we record an additional other-than-temporary impairment if the present value of cash flows expected to be collected is less than the amortized cost of the security. The total amount of this additional other-than-temporary impairment (both credit and non-credit, if any) is determined as the difference between the security's amortized cost less the amount of other-than-temporary impairment recognized in accumulated other comprehensive loss prior to the determination of this additional other-than-temporary impairment and its fair value. Any additional credit loss is limited to that security's unrealized losses, or the difference between the security's amortized cost and its fair value as of the statement of condition date. This additional credit loss, up to the amount in accumulated other comprehensive loss related to the security, is reclassified out of accumulated other comprehensive loss and recognized in earnings. Any credit loss in excess of the related accumulated other comprehensive loss is recognized in earnings.
Interest Income Recognition. Upon subsequent evaluation of a debt security when there is no additional other-than-temporary impairment, we adjust the accretable yield on a prospective basis if there is a significant increase in the security's expected cash flows. This adjusted yield is used to calculate the amount to be recognized into income over the remaining life of the security so as to match the amount and timing of future cash flows expected to be collected. Subsequent changes in estimated cash flows that are deemed significant will change the accretable yield on a prospective basis. For debt securities classified as held-to-maturity, the other-than-temporary impairment recognized in accumulated other comprehensive loss is accreted to the carrying value of each security on a prospective basis, based on the amount and timing of future estimated cash flows (with no effect on earnings unless the security is subsequently sold or there are additional decreases in cash flows expected to be collected). The estimated cash flows and accretable yield are re-evaluated each quarter.
Advances
We report advances at amortized cost. Advances carried at amortized cost are reported net of premiums/discounts and any hedging adjustments, as discussed in Note 8 - Advances. We generally record our advances at par. However, we may record premiums or discounts on advances in the following cases:
•
Advances may be acquired from another FHLBank when one of our members acquires a member of another FHLBank. In these cases, we may purchase the advances from the other FHLBank at a price that results in a fair market yield for the acquired advance.
•
In the event that a hedge of an advance is discontinued, the cumulative hedging adjustment is recorded as a premium or discount and amortized over the remaining life of the advance.
•
When the prepayment of an advance is followed by disbursement of a new advance and the transactions effectively represent a modification of the previous advance the prepayment fee received is deferred, recorded as a discount to the modified advance, and accreted over the life of the new advance.
•
When an advance is modified under our advance restructuring program and our analysis of the restructuring concludes that the transaction is an extinguishment of the prior loan rather than a modification, the deferred prepayment fee is recognized into income immediately, recorded as premium on the new advance, and amortized over the life of the new advance.
•
When we make an AHP advance, the present value of the variation in the cash flow caused by the difference in the interest rate between the AHP advance rate and our related cost of funds for comparable maturity funding is charged against the AHP liability and recorded as a discount on the AHP advance.
We amortize the premiums and accrete the discounts on advances to interest income using the level-yield method. We record interest on advances to interest income as earned.
Prepayment Fees. We charge borrowers a prepayment fee when they prepay certain advances before the original maturity. We record prepayment fees net of hedging fair-value adjustments included in the carrying value of the advance as prepayment fees on advances, net in the interest income section of the statement of operations.
Advance Modifications. In cases in which we fund a new advance concurrently with or within a short period of time of the prepayment of an existing advance by the same member, we evaluate whether the new advance meets the accounting criteria to
qualify as a modification of the existing advance or whether it constitutes a new advance. We compare the present value of cash flows on the new advance with the present value of cash flows remaining on the existing advance. If there is at least a 10 percent difference in the present value of cash flows or if we conclude the difference between the advances is more than minor based on a qualitative assessment of the modifications made to the advance's original contractual terms, the advance is accounted for as a new advance. In all other instances, the new advance is accounted for as a modification.
If a new advance qualifies as a modification of the existing advance, the net prepayment fee on the prepaid advance is deferred, recorded in the basis of the modified advance, and amortized to interest income over the life of the modified advance using the level-yield method. This amortization is recorded in advance interest income. If the modified advance is hedged, changes in fair value are recorded after the amortization of the basis adjustment. This amortization results in offsetting amounts being recorded in net interest income and net gains (losses) on derivatives and hedging activities in other income.
For prepaid advances that were hedged and met the hedge-accounting requirements, we terminate the hedging relationship upon prepayment and record the prepayment fee net of the hedging fair-value adjustment in the basis of the advance as prepayment fees on advances, net in interest income. If we fund a new advance to a member concurrent with or within a short period of time after the prepayment of a previous advance to that member, we evaluate whether the new advance qualifies as a modification of the original hedged advance. If the new advance qualifies as a modification of the original hedged advance, the hedging fair-value adjustment and the prepayment fee are included in the carrying amount of the modified advance and are amortized in interest income over the life of the modified advance using the level-yield method. If the modified advance is also hedged and the hedge meets the hedging criteria, the modified advance is marked to fair value after the modification, and subsequent fair-value changes are recorded in other income as net gains (losses) on derivatives and hedging activities.
If a new advance does not qualify as a modification of an existing advance, prepayment of the existing advance is treated as an advance termination and any prepayment fee, net of hedging adjustments, is recorded to prepayment fees on advances, net in the interest income section of the statement of operations.
Commitment Fees
We record commitment fees for standby letters of credit to members as deferred fee income when received, and amortize these fees on a straight-line basis to service-fees income in other income over the term of the standby letter of credit. We believe the likelihood of standby letters of credit being drawn upon is remote based upon past experience.
Mortgage Loans Held for Portfolio
We participate in the Mortgage Partnership Finance® (MPF®) program through which we invest in conventional, residential, fixed-rate mortgage loans (conventional mortgage loans) and government-insured or -guaranteed residential fixed-rate mortgage loans (government mortgage loans) that are purchased from participating financial institutions (see Note 9 - Mortgage Loans Held for Portfolio). We classify our investments in mortgage loans for which we have the intent and ability to hold for the foreseeable future or until maturity or payoff as held for portfolio. As of December 31, 2013, all our investments in mortgage loans are held for portfolio. Accordingly, these investments are reported at their principal amount outstanding net of unamortized premiums, discounts, unrealized gains and losses from investments initially classified as mortgage loan commitments and the allowance for credit losses on mortgage loans.
Premiums and Discounts. We compute the amortization of mortgage-loan-origination fees (premiums and discounts) as interest income using the level-yield method over the contractual term to maturity of each individual loan, which results in income recognition in a manner that is effectively proportionate to the actual repayment behavior of the underlying assets and reflects the contractual terms of the assets without regard to changes in estimated prepayments based on assumptions about future borrower behavior.
Credit-Enhancement Fees. FHFA regulations require that our investments in mortgage loans held in our portfolio be credit enhanced so that our risk of loss is limited to the losses of an investor in at least an investment-grade category, such as triple-B. For conventional mortgage loans, participating financial institutions retain a portion of the credit risk on the loans in which we invest by providing credit-enhancement protection either through a direct liability to pay credit losses up to a specified amount or through a contractual obligation to provide supplemental mortgage insurance. Participating financial institutions are paid a credit-enhancement fee for assuming credit risk and in some instances all or a portion of the credit-enhancement fee may be performance-based. Credit-enhancement fees are paid monthly and are determined based on the remaining unpaid principal balance of the pertinent MPF loans. The required credit-enhancement amount varies depending on the MPF product. Credit-enhancement fees are recorded as an offset to mortgage-loan-interest income. To the extent that losses in the current month
exceed performance-based credit-enhancement fees accrued, the remaining losses may be recovered from future performance-based credit-enhancement fees payable to the participating financial institution.
Other Fees. We record other nonorigination fees in connection with our MPF program activities, such as delivery-commitment-extension fees, pair-off fees, price-adjustment fees, and counterparty fees in connection with the MPF Xtra product in other income. Delivery-commitment-extension fees are charged when a participating financial institution requests to extend the period of the delivery commitment beyond the original stated expiration. Pair-off fees represent a make-whole provision; they are received when the amount funded under a delivery commitment is less than a certain threshold (under-delivery) of the delivery-commitment amount. Price-adjustment fees are received when the amount funded is greater than a certain threshold (over-delivery) of the delivery-commitment amount. To the extent that pair-off fees relate to under-deliveries of loans, they are recorded in service fee income. Fees related to over-deliveries represent purchase-price adjustments to the related loans acquired and are recorded as part of the carrying value of the loan. The FHLBank of Chicago pays us a counterparty fee for the costs and expenses of marketing activities for loans originated for sale via the MPF Xtra product.
We offer the MPF Xtra product, which provides our participating financial institutions with the ability to sell certain fixed-rate loans to Fannie Mae, as a third-party investor. Loans sold under MPF Xtra are first sold to the FHLBank of Chicago (the MPF Provider), which concurrently sells them to Fannie Mae. The MPF Provider is the master servicer for such loans. Such loans are not held on our balance sheet and the related credit and market risks are transferred to Fannie Mae. Unlike other MPF products, participating financial institutions under the MPF Xtra product do not provide any credit-enhancement amount and do not receive credit-enhancement fees because the credit risk of such loans is transferred to Fannie Mae. Through a purchase price adjustment, the MPF Provider receives a transaction fee for its master servicing, and custodial and administrative activities for such loans from the participating financial institutions, and the MPF Provider pays us a counterparty fee for the costs and expenses of marketing activities for these loans. We indemnify the MPF Provider for certain retained risks, including the risk of the MPF Provider's required repurchase of loans in the event of fraudulent or inaccurate representations and warranties from the participating financial institution regarding the sold loans. We may, in turn, seek reimbursement from the related participating financial institution in any such circumstance, however, the value of such a reimbursement right may be limited in the event of the related participating financial institution's insolvency.
Mortgage-Loan Participations. We have purchased participations in MPF loans from the FHLBank of Chicago under a participation facility pursuant to which we may purchase up to $1.5 billion of 100 percent participation interests in MPF loans purchased by the FHLBank of Chicago. We generally consider our investments in participation interests to be the equivalent of purchasing mortgage loans directly because the participation facility permits us to maintain certain controls over the quality of the underlying mortgage loans while obtaining the economic benefits of such investments. Accordingly, references to our investments in mortgage loans throughout this report include the participation interests purchased under this participation facility. As of December 31, 2013, we had $477.5 million in 100 percent participation interests outstanding that had been purchased under this facility.
We have also sold full and partial participation interests in MPF loans to the FHLBank of Chicago, although our last such sale was in 2006. For these loans, we share with the FHLBank of Chicago the pro rata purchase amounts for each respective loan acquired from the participating financial institution; the relevant pro rata share of principal and interest payments; and the pro rata responsibility for credit-enhancement fees and credit losses. Each of us may hedge our respective share of the delivery commitments.
Allowance for Credit Losses
An allowance for credit losses is a valuation allowance separately established for each identified portfolio segment, if necessary, to provide for probable losses inherent in our portfolio as of the statement of condition date. To the extent necessary, an allowance for credit losses for off-balance-sheet credit exposure is recorded as a liability.
Portfolio Segments. A portfolio segment is defined as the level at which an entity develops and documents a systematic methodology for determining its allowance for credit losses. We have established an allowance methodology for each of our portfolio segments. See Note 10 - Allowance for Credit Losses for additional information.
Nonaccrual Loans. We place conventional mortgage loans on nonaccrual status when the collection of the contractual principal or interest is 90 days or more past due. When a conventional mortgage loan is placed on nonaccrual status, accrued but uncollected interest is reversed against interest income in the current period. We generally record cash payments received on nonaccrual loans first as interest income and then as a reduction of principal as specified in the contractual agreement, unless we consider the collection of the remaining principal amount due to be doubtful. If we consider the collection of the remaining principal amount to be doubtful, cash payments received are applied first solely to principal until the remaining principal
amount due is expected to be collected and then as a recovery of any charge-off, if applicable, followed by recording interest income. A loan on nonaccrual status may be restored to accrual status when the collection of the contractual principal and interest is less than 90 days past due. We do not place government mortgage loans on nonaccrual status when the collection of the contractual principal or interest is 90 days or more past due because of the U.S. government guarantee of the loan and the contractual obligations of each related servicer, as more fully discussed in Note 10 - Allowance for Credit Losses.
Impairment Methodology. A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement.
Loans that are on nonaccrual status and that are considered collateral-dependent are measured for impairment based on the fair value of the underlying property less estimated selling costs. Loans are considered collateral-dependent if repayment is expected to be provided solely by the sale of the underlying property, that is, there is no other available and reliable source of repayment. Collateral-dependent loans are impaired if the fair value of the underlying collateral less estimated selling costs is insufficient to recover the unpaid principal balance on the loan. Interest income on impaired loans is recognized in the same manner as nonaccrual loans as discussed above.
Charge-Off Policy. We evaluate whether to record a charge-off on a conventional mortgage loan upon the occurrence of a confirming event. Confirming events include, but are not limited to, the occurrence of foreclosure or notification of a claim against any of the credit enhancements. A charge-off is recorded if we determine that the recorded investment in the loan is not likely to be recovered.
Troubled Debt Restructurings
We consider a troubled debt restructuring of a financing receivable to have occurred when we grant a concession to a borrower that we would not otherwise consider for economic or legal reasons related to the borrower's financial difficulties. We place conventional mortgage loans that are deemed to be troubled debt restructurings as a result of our modification program on nonaccrual when payments are 60 days or more past due.
We also consider troubled debt restructurings to have occurred when a borrower has filed for bankruptcy under Chapter 7 of the U.S. Bankruptcy Code (Chapter 7 bankruptcy) pursuant to which the bankruptcy court has discharged the borrower's obligation to us and the borrower has not reaffirmed the debt. However, we do not consider a trouble debt restructuring of a financing receivable to have occurred when we expect to collect the recorded investment in full.
REO
REO includes assets that have been received in satisfaction of debt or as a result of actual foreclosures. REO is recorded as other assets in the statement of condition and is carried at the lower of cost or fair value less estimated selling costs. Fair value is derived from third-party valuations of the property. If the fair value of the REO less estimated selling costs is less than the recorded investment in the MPF loan at the date of transfer, we recognize a charge-off to the allowance for credit losses. Subsequent realized gains and realized or unrealized losses are included in other income (loss) in the statement of operations.
Derivatives
All derivatives are recognized on the statement of condition at fair value and are reported as either derivative assets or derivative liabilities, net of cash collateral, including initial and variation margin, and accrued interest received from or pledged to clearing members and/or counterparties. We offset fair-value amounts recognized for derivatives and fair-value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) arising from derivatives recognized at fair value executed with the same clearing member and/or counterparty when the netting requirements have been met. If these netted amounts are positive, they are classified as an asset and, if negative, they are classified as a liability. Derivative assets and derivative liabilities reported on the statement of condition also include net accrued interest. Cash flows associated with derivatives are reflected as cash flows from operating activities in the statement of cash flows unless the derivative meets the criteria to be a financing derivative.
Each derivative is designated as one of the following:
•
a qualifying hedge of the change in fair value of a recognized asset or liability or an unrecognized firm commitment (a fair value hedge);
•
a qualifying 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); or
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a nonqualifying hedge of an asset or liability (an economic hedge) for asset-liability-management purposes.
Accounting for Fair-Value or Cash-Flow Hedges. If hedging relationships meet certain criteria, including, but not limited to, formal documentation of the hedging relationship and an expectation to be highly effective, they qualify for fair-value or cash-flow hedge accounting and the offsetting changes in fair value of the hedged items are recorded either in earnings in the case of fair-value hedges or accumulated other comprehensive loss in the case of cash-flow hedges. Our approaches to hedge accounting are:
•
long-haul hedge accounting, which generally requires us to formally assess (both at the hedge's inception and at least quarterly) 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 or forecasted transactions and whether those derivatives may be expected to remain effective in future periods; and
•
short-cut hedge accounting, which can be used for transactions for which the assumption can be made that the change in fair value of a hedged item, due to changes in the benchmark rate, exactly offsets the change in fair value of the related derivative. Under the short-cut method, the entire change in fair value of the interest-rate swap is considered to be effective at achieving offsetting changes in fair values or cash flows of the hedged asset or liability.
Derivatives that are used in fair-value hedges are typically executed at the same time as the hedged items, and we designate the hedged item in a qualifying hedge relationship as of the trade date. In many hedging relationships that use the short-cut method, we may designate the hedging relationship upon our commitment to disburse an advance or trade a CO that settles within the shortest period of time possible for the type of instrument based on market-settlement conventions. In such circumstances, although the advance or CO will not be recognized in the financial statements until settlement date, the hedge meets the criteria for applying the short-cut method, provided all other short-cut criteria are also met. We then record the changes in fair value of the derivative and the hedged item beginning on the trade date.
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 gains (losses) 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 accumulated other comprehensive loss, a component of capital, until earnings are affected by the variability of the cash flows of the hedged transaction.
For both fair-value and cash-flow hedges, any hedge ineffectiveness (which represents the amount by which the changes in the fair value of the derivative differ 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 gains (losses) on derivatives and hedging activities.
Accounting for Economic Hedges. An economic hedge is defined as a derivative hedging specific or nonspecific assets, liabilities, or firm commitments that does not qualify or was not designated for fair-value or cash-flow hedge accounting, but is an acceptable hedging strategy under our risk-management policy. These economic hedging strategies also comply with FHFA regulatory requirements prohibiting speculative derivative transactions. An economic hedge by definition introduces the potential for earnings variability caused by the changes in fair value of the derivatives that are recorded in income but not offset by corresponding changes in the fair value of the economically hedged assets, liabilities, or firm commitments. As a result, we recognize only the net interest and the change in fair value of these derivatives in other income (loss) as net gains (losses) on derivatives and hedging activities with no offsetting fair-value adjustments for the economically hedged assets, liabilities, or firm commitments.
Accrued Interest Receivable and Payable. The differential between accrual of interest receivable and payable on derivatives designated as a fair-value hedge or as a cash-flow hedge is recognized through adjustments to the interest income or interest expense of the designated hedged investment securities, advances, COs, deposits, or other financial instruments. The differential between accrual of interest receivable and payable on economic hedges is recognized in other income (loss), along with changes in fair value of these derivatives, as net gains (losses) on derivatives and hedging activities.
Discontinuance of Hedge Accounting. We may discontinue hedge accounting prospectively when:
•
we determine 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);
•
the derivative and/or the hedged item expires or is sold, terminated, or exercised;
•
it is no longer probable that the forecasted transaction will occur in the originally expected period;
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a hedged firm commitment no longer meets the definition of a firm commitment; or
•
we determine that designating the derivative as a hedging instrument is no longer appropriate.
When hedge accounting is discontinued because we determine that the derivative no longer qualifies as an effective fair-value hedge of an existing hedged item, we either terminate the derivative or continue to carry the derivative on the statement of condition at its fair value and cease to adjust the hedged asset or liability for changes in fair value, and begin to amortize the cumulative basis adjustment on the hedged item into earnings over the remaining life of the hedged item using the level-yield method.
When hedge accounting is discontinued because we determine that the derivative no longer qualifies as an effective cash-flow hedge of an existing hedged item, we continue to carry the derivative on the statement of condition at its fair value and amortize the cumulative other comprehensive loss adjustment to earnings when earnings are affected by the existing hedged item.
If it is no longer probable that a forecasted transaction will occur by the end of the originally expected period or within two months thereafter, we immediately recognize the gain or loss that was in accumulated other comprehensive loss in earnings. In rare cases, we may discontinue cash-flow hedge accounting, but the existence of extenuating circumstances related to the nature of the forecasted transaction and that are outside of our control or influence may make it probable that the forecasted transaction will occur in the future, on a date that is beyond the additional two-month period of time. In such cases, the gain or loss on the derivative remains in accumulated other comprehensive loss and is recognized in earnings when the forecasted transaction occurs.
When hedge accounting is discontinued because the hedged item no longer meets the definition of a firm commitment, we continue 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.
Embedded Derivatives. We may issue debt, make advances, or purchase financial instruments in which a derivative is embedded. Upon execution of these transactions, we assess whether the economic characteristics of the embedded derivative are clearly and closely related to the economic characteristics of the remaining component of the advance, debt, deposit, or other financial instrument (the host contract) and whether a separate, nonembedded instrument with the same terms as the embedded instrument would meet the definition of a derivative. When we determine 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. 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 earnings (for example, an investment security classified as trading, as well as hybrid financial instruments) or if we 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. At December 31, 2013 and 2012, we had certain advances with embedded features that met the requirement to be separated from the host contract and designate the embedded features as a stand-alone derivative. The value of the embedded derivatives is included in total advances on the statement of condition. See Note 8 - Advances for the fair value of the embedded derivatives.
Premises, Software, and Equipment
We record premises, software, and equipment at cost less accumulated depreciation and amortization and compute depreciation on a straight-line basis over estimated useful lives ranging from three to 10 years. We amortize leasehold improvements on a straight-line basis over the shorter of the estimated useful life of the improvement or the remaining term of the lease. We capitalize improvements and major renewals but expense ordinary maintenance and repairs when incurred. We include gains and losses on disposal of premises, software, and equipment in other income (loss) on the statement of operations. The cost of purchased software and certain costs incurred in developing computer software for internal use are capitalized and amortized over future periods. At December 31, 2013, and 2012, we had $1.6 million and $1.5 million, respectively, in unamortized computer software costs.
Accumulated Depreciation and Amortization. Our accumulated depreciation and amortization related to premises, software, and equipment was $13.0 million and $11.2 million at December 31, 2013, and 2012, respectively.
Depreciation and Amortization Expense. Depreciation and amortization expense for premises, software, and equipment was $1.9 million, $1.9 million, and $2.0 million for the years ended December 31, 2013, 2012, and 2011, respectively. These amounts include $714,000, $827,000, and $863,000 of amortization of computer software costs for the years ended December 31, 2013, 2012, and 2011, respectively.
Disposal of Premises, Software, and Equipment. There were no realized gains or losses on disposal of premises, software, and equipment in 2013. For the years ended December 31, 2012 and 2011, we had a net realized gain of $4,000 and a net realized loss of $134,000, respectively, on disposal of premises, software, and equipment.
COs
We record COs at amortized cost.
Discounts and Premiums. We accrete discounts and amortize premiums on COs to interest expense using the level-yield method over the contractual term to maturity of the CO.
Concessions on COs. We pay concessions to dealers in connection with the issuance of certain COs. The Office of Finance prorates the amounts paid to dealers based upon the percentage of debt issued that we assumed. We defer and amortize these dealer concessions using the level-yield method over the contractual term to maturity of the COs. Unamortized concessions are included in other assets on the statement of condition and the amortization of those concessions is included in CO interest expense on the statement of operations.
Mandatorily Redeemable Capital Stock
We reclassify stock subject to redemption from equity to a liability after a member exercises a written redemption request, gives notice of intent to withdraw from membership, or attains nonmember status by merger or acquisition, charter termination, or other involuntary termination from membership, since the shares meet the definition of a mandatorily redeemable financial instrument upon such instances. Member shares meeting this definition are reclassified to a liability at fair value. Dividends declared on member shares classified as a liability are accrued at the expected dividend rate and reflected as interest expense on the statement of operations. The repayment of these mandatorily redeemable financial instruments is reflected as cash outflows in the financing activities section of the statement of cash flows once settled.
We do not take into consideration our members' right to cancel a redemption request in determining when shares of capital stock should be classified as a liability because such cancellation would be subject to a cancellation fee equal to two percent of the par amount of the shares of Class B stock that is the subject of the redemption notice. If a member cancels its written notice of redemption or notice of withdrawal, we will reclassify mandatorily redeemable capital stock from a liability to equity. After the reclassification, dividends on the capital stock will no longer be classified as interest expense.
Restricted Retained Earnings
In 2011, the 12 FHLBanks entered into a joint capital enhancement agreement, as amended (the Joint Capital Agreement). Since the third quarter of 2011, the Joint Capital Agreement has required each FHLBank to contribute 20 percent of its quarterly net income to a separate restricted retained earnings account at that FHLBank until that account balance equals at least one percent of that FHLBank's average balance of outstanding COs for the previous quarter. Restricted retained earnings are not available to pay dividends, and we present them separate from other retained earnings on the statement of condition.
FHFA Expenses
We fund a portion of the costs of operating the FHFA. The portion of the FHFA's expenses and working capital fund paid by the FHLBanks 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. We must pay an amount equal to one-half of our annual assessment twice each year.
Office of Finance Expenses
Each FHLBank's proportionate share of Office of Finance operating and capital expenditures has been calculated using a formula based upon the following components: (1) two-thirds based upon each FHLBank's share of total COs outstanding and (2) one-third based upon an equal pro-rata allocation.
Assessments
Affordable Housing Program. The FHLBank Act requires us to establish and fund an AHP based on positive annual net earnings, providing grants to members to assist in the purchase, construction, or rehabilitation of housing for very low- to moderate-income households. We charge the required funding for the AHP to earnings and establish a liability, except when annual net earnings are zero or negative, in which case there is no requirement to fund an AHP. We also issue AHP advances at interest rates below the customary interest rate for nonsubsidized advances. A discount on the AHP advance and charge against the AHP liability is recorded for the present value of the variation in the cash flow caused by the difference in the interest rate between the AHP advance rate and our related cost of funds for comparable maturity funding. The discount on AHP advances is accreted to interest income on advances using the level-yield method over the life of the advance. See Note 14 - Affordable Housing Program for additional information.
REFCorp. Although we are exempt from ordinary federal, state, and local taxation except for local real-estate tax, we were required to make payments to REFCorp through the second quarter of 2011, after which our obligation was satisfied. These payments represented a portion of the interest on bonds that were issued by REFCorp. REFCorp is a government corporation established by Congress in 1989 that provided funding for the resolution and disposition of insolvent savings institutions. Officers, employees, and agents of the Office of Finance are authorized to act for and on behalf of REFCorp to carry out the functions of REFCorp. See Note 15 - Resolution Funding Corporation for additional information.
Cash Flows
In the statement of cash flows, we consider noninterest bearing cash and due from banks as cash and cash equivalents. Federal funds sold and interest-bearing deposits 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.
Related-Party Activities
We defined related parties as members with 10 percent or more of the voting interests of our capital stock outstanding. See Note 21 - Transactions with Shareholders for additional information.
Segment Reporting
We report on an enterprise-wide basis. The enterprise-wide method of evaluating our financial information reflects the manner in which the chief operating decision-maker manages the business.
Reclassification
Certain amounts in the 2012 and 2011 financial statements have been reclassified to conform to the financial statement presentation for the year ended December 31, 2013.
Subsequent Events
Subsequent events have been evaluated through the date of filing this financial report with the Securities and Exchange Commission. See Note 23 - Subsequent Events for more information.
"Mortgage Partnership Finance," and "MPF," are registered trademarks of the FHLBank of Chicago.
Note 2 - Recently Issued and Adopted Accounting Guidance
Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. On January 17, 2014, the Financial Accounting Standards Board (FASB) issued guidance clarifying when consumer mortgage loans collateralized by real estate should be reclassified to REO. Specifically, such collateralized mortgage loans should be reclassified to REO when either the creditor obtains legal title to the residential real estate property upon completion of a foreclosure, or the borrower conveys all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. This guidance is effective for interim and annual periods beginning on or after December 15, 2014, and may be adopted under either the modified retrospective transition method or the prospective transition method. We are currently assessing the impact the amended guidance will have on our financial condition, results of operations, and cash flows.
Inclusion of the Overnight Index Swap Rate as a Benchmark Interest Rate for Hedge Accounting Purposes. On July 17, 2013, the FASB amended existing guidance to include the Fed Funds Effective Swap Rate (also referred to as Overnight Index Swap Rate (OIS)) as a U.S. benchmark interest rate for hedge accounting purposes. Including OIS as an acceptable U.S. benchmark interest rate, in addition to United States Treasuries and London Interbank Offered Rates (LIBOR), provides a more comprehensive spectrum of interest-rate resets to utilize as the designated benchmark interest-rate risk component under the hedge accounting guidance. The amendments also remove the restriction on using different benchmark interest rates for similar hedges. The amendments apply to all entities that elect to apply hedge accounting of the benchmark interest rate, and were effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. The adoption of this guidance did not affect our financial condition, results of operations, or cash flows.
Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date. On February 28, 2013, the FASB issued guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date. This guidance requires an entity to measure these obligations as the sum of (1) the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and (2) any additional amount the reporting entity expects to pay on behalf of its co-obligors. In addition, this guidance requires an entity to disclose the nature and amount of the obligation as well as other information about those obligations. This guidance is effective for interim and annual periods beginning on or after December 15, 2013, and should be applied retrospectively to obligations with joint and several liability existing at the beginning of an entity's fiscal year of adoption.
Upon adoption of this guidance on January 1, 2014, we continued to recognize the COs for which we are the direct obligor as a liability, and did not recognize any amount for COs for which other FHLBanks are direct obligors. Adoption of this guidance did not have an impact on our financial condition, results of operations or cash flows. See Note 20 - Commitments and Contingencies for additional information regarding the FHLBanks' joint and several liability.
Disclosures about Offsetting Assets and Liabilities. On December 16, 2011, the FASB and the International Accounting Standards Board (the IASB) issued common disclosure requirements intended to help investors and other financial statement users better assess the effect or potential effect of offsetting arrangements on an entity's financial position, whether an entity's financial statements are prepared on the basis of GAAP or International Financial Reporting Standards (IFRS). This guidance was amended on January 31, 2013, to clarify that its scope includes only certain financial instruments that are either offset on the balance sheet or are subject to an enforceable master netting arrangement or similar agreement. We are required to disclose both gross and net information about derivative, repurchase, and security lending instruments that meet these criteria. This guidance, as amended, became effective for us for interim and annual periods beginning on January 1, 2013, and was applied retrospectively for all comparative periods presented. The adoption of this guidance has resulted in additional financial statement disclosures but did not affect our financial condition, results of operations, or cash flows. We do not have repurchase agreements and reverse repurchase agreements or securities borrowing and securities lending transactions that are subject to offset in our statement of condition. As a result, we are only providing the required disclosures related to derivative instruments. See Note 11 - Derivatives and Hedging Activities for disclosures related to this guidance.
Presentation of Comprehensive Income. On February 5, 2013, the FASB issued guidance to improve the transparency of reporting reclassifications out of accumulated other comprehensive loss. This guidance does not change the current requirements for reporting net income or comprehensive income in financial statements. Rather, it requires an entity to present, either on the face of the financial statement where net income is presented or in the footnotes, significant amounts reclassified out of accumulated other comprehensive loss. These amounts are presented based on the respective lines of net income only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under GAAP to be reclassified in their entirety to net income, we are required to cross-reference to other required disclosures that provide additional detail about these other amounts. This guidance became effective
for interim and annual periods beginning after December 15, 2012, and has been applied prospectively. The adoption of this guidance resulted in additional financial statement disclosures but did not affect our financial condition, results of operations, or cash flows. See Note 17 - Accumulated Other Comprehensive Loss for disclosures related to this guidance.
Regulatory Guidance
Framework for Adversely Classifying Loans, Other REO, and Other Assets and Listing Assets for Special Mention. On April 9, 2012, the FHFA issued Advisory Bulletin 2012-02, Framework for Adversely Classifying Loans, Other REO, and Other Assets and Listing Assets for Special Mention (AB 2012-02). AB 2012-02 establishes a standard and uniform methodology for adversely classifying loans, other REO, and certain other assets (excluding investment securities), and prescribes the timing of asset charge-offs based on these classifications. The guidance is generally consistent with the Uniform Retail Credit Classification and Account Management Policy issued by the federal banking regulators in June 2000. The adverse classification requirements were implemented as of January 1, 2014, and the charge-off requirements will be implemented no later than January 1, 2015. Adopting the provisions of AB 2012-02 is not expected to have a material impact on our results of operations or financial condition.
Note 3 - Cash and Due from Banks
Compensating Balances. We maintain collected cash balances with various commercial banks in return for certain services. The related agreements contain no legal restrictions on the withdrawal of funds. The average collected cash balances were $189.4 million and $198.9 million for the years ended December 31, 2013 and 2012, respectively.
Note 4 - Trading Securities
Major Security Types. Our trading securities as of December 31, 2013 and 2012, were (dollars in thousands):
Net unrealized (losses) gains on trading securities were as follows:
We do not participate in speculative trading practices and typically hold these investments over a longer time horizon.
Note 5 - Available-for-Sale Securities
Major Security Types. Our available-for-sale securities as of December 31, 2013, were (dollars in thousands):
_______________________
(1)
Amortized cost of available-for-sale securities includes adjustments made to the cost basis of an investment for accretion, amortization, collection of cash, and fair-value hedge accounting adjustments.
Our available-for-sale securities as of December 31, 2012, were (dollars in thousands):
_______________________
(1)
Amortized cost of available-for-sale securities includes adjustments made to the cost basis of an investment for accretion, amortization, collection of cash, and fair-value hedge accounting adjustments.
The following table summarizes our available-for-sale securities with unrealized losses as of December 31, 2013, which are aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands):
The following table summarizes our available-for-sale securities with unrealized losses as of December 31, 2012, which are aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands):
Redemption Terms. The amortized cost and fair value of our available-for-sale securities by contractual maturity at December 31, 2013 and 2012, were (dollars in thousands):
_______________________
(1)
MBS are not presented by contractual maturity because their expected maturities will likely differ from contractual maturities because borrowers of the underlying loans may have the right to call or prepay obligations with or without call or prepayment fees.
Interest-Rate-Payment Terms. The following table details additional interest-rate-payment terms for our available-for-sale securities (dollars in thousands):
Sale of Available-for-Sale Securities. The following table shows the proceeds from sale and gross gains and losses realized on the sale of our available-for-sale securities (dollars in thousands):
Note 6 - Held-to-Maturity Securities
Major Security Types. Our held-to-maturity securities as of December 31, 2013, were (dollars in thousands):
Our held-to-maturity securities as of December 31, 2012, were (dollars in thousands):
The following table summarizes our held-to-maturity securities with unrealized losses as of December 31, 2013, which are aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands).
The following table summarizes our held-to-maturity securities with unrealized losses as of December 31, 2012, which are aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands).
Redemption Terms. The amortized cost and fair value of our held-to-maturity securities by contractual maturity at December 31, 2013 and 2012, are shown below (dollars in thousands). Expected maturities of some securities and MBS may differ from contractual maturities because borrowers of the underlying loans may have the right to call or prepay their obligations with or without call or prepayment fees.
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(1)
Carrying value of held-to-maturity securities represents the sum of amortized cost and the amount of noncredit-related other-than-temporary impairment recognized in accumulated other comprehensive loss.
(2)
MBS are not presented by contractual maturity because their expected maturities will likely differ from contractual maturities because borrowers of the underlying loans may have the right to call or prepay their obligations with or without call or prepayment fees.
Interest-Rate-Payment Terms. The following table details additional interest-rate-payment terms for investment securities classified as held-to-maturity (dollars in thousands):
Sale of Held-to-Maturity Securities.
There were no sales of held-to-maturity securities during the years ended December 31, 2013 and 2012.
During the year ended December 31, 2011, we realized a gain of $8.5 million on the sale of held-to-maturity securities issued by GSEs that had a carrying value of $366.7 million. These securities were sold back to the securities dealer because the securities delivered did not conform to the terms of the purchase agreement. The sale is an isolated and unusual event that could not have been reasonably anticipated. Therefore, the sale does not impact our ability and intent to hold the remaining investments classified as held-to-maturity through their stated maturity dates.
Note 7 - Other-Than-Temporary Impairment
We evaluate our individual available-for-sale and held-to-maturity securities for other-than-temporary impairment each quarter. As part of our evaluation of securities for other-than-temporary impairment, we consider whether we intend to sell each security for which fair value is less than amortized cost or whether it is more likely than not that we will be required to sell the security before the anticipated recovery of the remaining amortized cost. If either of these conditions is met, we recognize an other-than-temporary impairment charge in earnings equal to the entire difference between the security's amortized cost basis and its fair value at the statement of condition date. For securities in an unrealized loss position that meet neither of these conditions (excluding agency MBS) and for all residential private-label MBS, we perform a cash-flow analysis to determine whether the entire amortized cost basis of these impaired securities, including all previously other-than-temporarily impaired securities, will be recovered. If we do not expect to recover the entire amount, the unrealized loss position is considered to be other-than-temporarily impaired. We evaluate the security's other-than-temporary impairment to determine the amount of credit loss to be recognized in earnings, which is limited to the amount of that security's unrealized loss.
In performing a detailed cash-flow analysis, we identify the best estimate of the cash flows expected to be collected. If this estimate results in a present value of expected cash flows (discounted at the security's effective yield) that is less than the amortized cost basis of a security (that is, a credit loss exists), other-than-temporary impairment is considered to have occurred. For determining the present value of variable-rate and hybrid private-label residential MBS, we use the effective interest rate derived from a variable-rate index, such as one-month LIBOR, plus the contractual spread, plus or minus a fixed-spread adjustment when there is an existing discount or premium on the security. Because the implied forward yield curve of a selected variable-rate index changes over time, the effective interest rates derived from that index will also change over time and would therefore impact the present value of the subject security.
Available-for-Sale Securities
As a result of our evaluations, we determined that none of our available-for-sale securities were other-than-temporarily impaired at December 31, 2013. At December 31, 2013, we held certain available-for-sale securities in an unrealized loss position. These unrealized losses reflect the impact of normal yield and spread fluctuations attendant with security markets. These unrealized losses are considered temporary as we expect to recover the entire amortized cost basis on these available-for-sale securities in an unrealized loss position and neither intend to sell these securities nor is it more likely than not that we will be required to sell these securities before the anticipated recovery of each security's remaining amortized cost basis. Additionally, there have been no shortfalls of principal or interest on any available-for-sale security. Regarding securities that were in an unrealized loss position as of December 31, 2013:
•
Debentures issued by a supranational institution that were in an unrealized loss position as of December 31, 2013, are expected to return contractual principal and interest, based on our review and analysis of independent third-party credit reports on the supranational institution, and such supranational institution is rated triple-A (or equivalent) by each of the nationally recognized statistical rating organizations (NRSROs).
•
Debentures issued by U.S. government-owned corporations are not obligations of the U.S. government and not guaranteed by the U.S. government. However, these securities are rated at the same level as the U.S. government by the NRSROs. These ratings reflect the U.S. government's implicit support of the government-owned corporation as well as the entity's underlying business and financial risk.
•
We have concluded that the probability of default on debt issued by Fannie Mae and Freddie Mac is remote given their status as GSEs and their support from the U.S. government.
•
Our U.S. government-guaranteed securities are MBS issued by the Government National Mortgage Association (Ginnie Mae). We determined that the strength of Ginnie Mae's guarantees as a direct obligation from the U.S. government is sufficient to protect us from losses based on current expectations.
•
Agency MBS. For MBS issued by Fannie Mae and Freddie Mac, which we sometimes refer to as agency MBS in this report, we determined that the strength of the issuers' guarantees through direct obligation or support from the U.S. government is sufficient to protect us from losses based on current expectations.
Held-to-Maturity Securities
HFA Securities. We have reviewed our investments in HFA securities and have determined that unrealized losses reflect the impact of normal market yield and spread fluctuations and illiquidity in the credit markets. We have determined that all unrealized losses are temporary given the creditworthiness of the issuers and the underlying collateral, including an assessment of past payment history (no shortfalls of principal or interest), property vacancy rates, debt service ratios, over-collateralization and other credit enhancement, and third-party bond insurance as applicable. As of December 31, 2013, none of our held-to-maturity investments in HFA securities were rated below investment grade by an NRSRO. Because the decline in market value is attributable to changes in interest rates and credit spreads and to illiquidity in the credit markets and not to a significant deterioration in the fundamental credit quality of these obligations, and because we do not intend to sell the investments nor is it more likely than not that we will be required to sell the investments before recovery of the amortized cost basis, we do not consider these investments to be other-than-temporarily impaired at December 31, 2013.
Agency MBS. For agency MBS, we determined that the strength of the issuers' guarantees through direct obligation or support from the U.S. government is sufficient to protect us from losses based on current expectations. Additionally, there have been no shortfalls of principal or interest on any such security. As a result, we have determined that, as of December 31, 2013, all of the gross unrealized losses on such MBS are temporary. We do not believe that the declines in market value of these securities are attributable to credit quality, and because we do not intend to sell the investments, nor is it more likely than not that we will be required to sell the investments before recovery of the amortized cost basis, we do not consider any of these investments to be other-than-temporarily impaired at December 31, 2013.
Private-Label Residential MBS and ABS Backed by Home Equity Loans. To ensure consistency in determination of the other-than-temporary impairment for private-label residential MBS and certain home equity loan investments (including home equity ABS) among all FHLBanks, the FHLBanks use an FHLBank System governance committee (the OTTI Governance Committee) and a formal process to ensure consistency in key other-than-temporary impairment modeling assumptions used for purposes of their cash-flow analyses for the majority of these securities. We use the FHLBanks' uniform framework and approved assumptions for purposes of our other-than-temporary impairment cash-flow analyses of our private-label residential MBS and certain home equity loan investments. For certain private-label residential MBS and home equity loan investments where underlying collateral data is not available, we have used alternative procedures to assess these securities for other-than-temporary impairment. We are responsible for making our own determination of impairment and the reasonableness of assumptions, inputs, and methodologies used and for performing the required present value calculations using appropriate historical cost bases and yields.
Our evaluation includes estimating the projected cash flows that we are likely to collect based on an assessment of available information, including the structure of the applicable security and certain assumptions to determine whether we will recover the entire amortized cost basis of the security, such as:
•
the remaining payment terms for the security;
•
prepayment speeds;
•
default rates;
•
loss severity on the collateral supporting each security based on underlying loan-level borrower and loan characteristics;
•
expected housing price changes; and
•
interest-rate assumptions.
In accordance with related guidance from the FHFA, we have contracted with the FHLBanks of San Francisco and Chicago to perform the cash-flow analysis underlying our other-than-temporary impairment decisions in certain instances. In the event that neither the FHLBank of San Francisco or the FHLBank of Chicago has the ability to model a particular MBS that we own, we project the expected cash flows for that security based on our expectations as to how the underlying collateral and impact on deal structure resultant from collateral cash flows are forecasted to occur over time. These assumptions are based on factors including, but not limited to loan-level data for each security and modeling variable expectations for securities similar in nature modeled by either the FHLBank of San Francisco or the FHLBank of Chicago. We form our expectations for those securities by reviewing, when available, loan-level data for each such security, and, when such loan-level data is not available for a security, by reviewing loan-level data for similar loan pools as a proxy for such data. Specifically, we have contracted with the
FHLBank of San Francisco to perform cash-flow analyses for our residential private-label MBS other than subprime private-label MBS, and with the FHLBank of Chicago to perform cash-flow analyses for our subprime private-label MBS.
To assess whether the entire amortized cost basis of private-label residential MBS will be recovered, cash-flow analyses for each of our private-label residential MBS were performed. These analyses use two third-party models.
The first third-party model considers borrower characteristics and the particular attributes of the loans underlying our securities, in conjunction with assumptions about current home prices and future changes in home prices and interest rates, producing monthly projections of prepayments, defaults, and loss severities. A significant input to the first model is the forecast of future housing-price changes, based on an assessment of individual housing markets for the relevant states and core-based statistical areas (CBSA), as defined by the United States Office of Management and Budget. The OTTI Governance Committee developed a short-term housing price forecast using whole percentages, with projected changes ranging from a decrease of 5.0 percent to an increase of 7.0 percent over the 12- month period beginning January 1, 2014. For the vast majority of markets, the short-term forecast has changes from a decrease of 1.0 percent to an increase of 5.0 percent. Thereafter home prices were projected to recover using one of five different recovery paths. Under those recovery paths, home prices were projected to increase as follows:
The month-by-month projections of future loan performance are derived from the first model to determine projected prepayments, defaults, and loss severities. These projections are then input into a second model that calculates the projected loan-level cash flows and then allocates those cash flows and losses among the various classes in the securitization structure in accordance with the cash-flow and loss-allocation rules prescribed by the securitization structure. In a securitization in which the credit enhancement for the senior securities is derived from the presence of subordinate securities, losses are generally allocated first to the subordinate securities until their principal balance is reduced to zero. The projected cash flows are based on a number of assumptions and expectations and the results of these models can vary significantly with changes in assumptions and expectations. The scenario of cash flows determined based on the model approach described above reflects a best estimate scenario and includes a base case current-to-trough housing price forecast and a base case housing price recovery path described in the prior paragraph.
For those securities for which an other-than-temporary impairment was determined to have occurred during the year ended December 31, 2013, the following table presents a summary of the average projected values over the remaining lives of the securities for the significant inputs used to measure the amount of the credit loss recognized in earnings, as well as related current credit enhancement. Credit enhancement is defined as the percentage of subordinated tranches, over-collateralization, and other credit enhancement, if any, in a security structure that will generally absorb losses before we will experience a credit loss on the security. The calculated averages represent the dollar-weighted averages of all the private-label residential MBS and home equity loan investments in each category shown (dollars in thousands).
_______________________
(1)
Securities are classified in the table above based upon the current performance characteristics of the underlying loan pool and therefore the manner in which the loan pool backing the security has been modeled (as prime, Alt-A, or subprime), rather than their classification of the security at the time of issuance.
The following table sets forth our securities for which other-than-temporary impairment credit losses were recognized during the life of the security through December 31, 2013 (dollars in thousands). Securities are classified in the table below based on their classifications at the time of issuance. We note that we have instituted litigation in relation to certain of the private-label MBS in which we invested. Our complaint asserts, among others, claims for untrue or misleading statements in the sale of securities. It is possible that classifications of private-label MBS as provided herein when based on classification at the time of issuance (as per the following tables in this Note 7, for example) as disclosed by those securities' issuance documents, as well as other statements about the securities, are inaccurate.
The following table presents a roll-forward of the amounts related to credit losses recognized in earnings. The roll-forward is the amount of credit losses on investment securities on which we recognized a portion of other-than-temporary impairment charges into accumulated other comprehensive loss (dollars in thousands).
_______________________
(1)
For the years ended December 31, 2013, 2012, and 2011, additional credit losses for which an other-than-temporary impairment charge was previously recognized relate to securities that were also previously impaired prior to January 1, 2013, 2012, and 2011.
(2)
Represents reductions related to securities having reached final maturity during the period and, therefore, are no longer held by us at the end of the period.
(3)
Prior to 2013, we included a reduction for realized credit losses (that is, an actual principal or interest cash payment shortfall has occurred) that occurred during the period on securities that remained in the portfolio as of the end of each period. Beginning with the period ending December 31, 2013, those amounts have been reinstated, as appropriate, in the beginning and ending balances reflected above and will be removed from the roll-forward when the applicable securities reach their final maturity, or are sold, and are no longer held in portfolio. Realized credit losses totaled $34.1 million, $45.6 million, and $52.6 million for the years ended December 31, 2013, 2012, and 2011, respectively.
Note 8 - Advances
General Terms. We offer a wide range of fixed- and variable-rate advance products with different maturities, interest rates, payment characteristics, and optionality. Advances have maturities ranging from one day to 30 years or even longer with the approval of our credit committee. At December 31, 2013, and 2012, we had advances outstanding with interest rates ranging from (0.22) percent to 8.37 percent and (0.15) percent to 8.37 percent, respectively, as summarized below (dollars in thousands). Advances with negative interest rates contain embedded interest-rate features that have met the requirements to be separated from the host contract and are recorded as stand-alone derivatives, and which we economically hedge with derivatives containing offsetting interest-rate features.
_________________________
(1)
At December 31, 2013 and 2012, we had certain advances with embedded features that met the requirements to be separated from the host contract and designate the embedded features as a stand-alone derivative.
We offer putable advances that provide us with the right to put the fixed-rate advance to the borrower (and thereby extinguish the advance) on predetermined exercise dates (put dates), and offer, subject to certain conditions, replacement funding at then-current advances rates. Generally, we would exercise the put options when interest rates increase. At December 31, 2013, and 2012, we had putable advances outstanding totaling $2.6 billion and $3.3 billion, respectively.
The following table sets forth our advances outstanding by the year of contractual maturity or next put date for putable advances (dollars in thousands):
We also offer callable advances that provide borrowers with the right to call, on predetermined option exercise dates, the advance prior to maturity without incurring prepayment or termination fees (callable advances). In exchange for receiving the right to call the advance on a predetermined call schedule, the borrower pays a higher fixed rate for the advance relative to an equivalent maturity, noncallable, fixed-rate advance. If the call option is exercised, replacement funding may be available. Other advances may only be prepaid by paying a fee (a prepayment fee) that makes us financially indifferent to the prepayment of the advance. At December 31, 2013, and 2012, we had callable advances outstanding totaling $30.5 million and $32.5 million, respectively.
Interest-Rate-Payment Terms. The following table details interest-rate-payment types for our outstanding advances (dollars in thousands):
Credit-Risk Exposure and Security Terms. Our potential credit risk from advances is principally concentrated in commercial banks, insurance companies, savings institutions, and credit unions. At December 31, 2013 and 2012, we had $7.8 billion and $1.8 billion, respectively, of advances issued to members with at least $1.0 billion of advances outstanding. These advances were made to three borrowers at December 31, 2013, and one borrower at December 31, 2012, representing 28.6 percent and 9.0 percent, respectively, of total par value of outstanding advances. For information related to our credit risk on advances and allowance for credit losses, see Note 10 - Allowance for Credit Losses.
Prepayment Fees. We record prepayment fees received from borrowers on prepaid advances net of any associated basis adjustments related to hedging activities on those advances and net of deferred prepayment fees on advance prepayments considered to be loan modifications. Additionally, for certain advances products, the prepayment-fee provisions of the advance agreement could result in either a payment from the borrower or to the borrower when such an advance is prepaid, based upon market conditions at the time of prepayment (referred to as a symmetrical prepayment fee). Advances with a symmetrical prepayment fee provision are hedged with derivatives containing offsetting terms, so that we are financially indifferent to the borrower's decision to prepay such advances. The net amount of prepayment fees is reflected as interest income in the statement of operations.
We also offer an advance restructuring program under which the prepayment fee on prepaid advances may be satisfied by the borrower's agreement to pay an interest rate on a new advance sufficient to amortize the prepayment fee by the maturity date of the new advance, rather than paying the fee in immediately available funds to us. If we conclude an advance restructuring is an extinguishment of the prior loan rather than a modification, the deferred prepayment fee is recognized into income immediately.
For the years ended December 31, 2013, 2012, and 2011, net advance prepayment fees recognized in income are reflected in the following table (dollars in thousands):
Note 9 - Mortgage Loans Held for Portfolio
We invest in mortgage loans through the MPF program. These investments are either guaranteed or insured by federal agencies, as is the case with government mortgage loans, or are credit-enhanced by the related participating financial institution, as is the case with conventional mortgage loans. All such investments are held for portfolio. The mortgage loans are typically originated and credit-enhanced by the related participating financial institution. The majority of these loans are serviced by the originating institution or an affiliate thereof. However, a portion of these loans are sold servicing-released by the participating financial institution and serviced by a third-party servicer.
The following table presents certain characteristics of the mortgage loans in which we have invested (dollars in thousands):
The following table details the par value of mortgage loans held for portfolio (dollars in thousands):
See Note 10 - Allowance for Credit Losses for information related to our credit risk from our investments in mortgage loans and allowance for credit losses based on these investments.
Note 10 - Allowance for Credit Losses
An allowance for credit losses is a valuation allowance separately established for each identified portfolio segment, if necessary, to provide for probable losses inherent in our portfolio as of the statement of condition date. To the extent necessary, an allowance for credit losses for off-balance-sheet credit exposure is recorded as a liability.
Portfolio Segments. We have established an allowance methodology for each of our portfolio segments. A portfolio segment is defined as the level at which an entity develops and documents a systematic method for determining its allowance for credit losses. We have developed and documented a systematic methodology for determining an allowance for credit losses for our:
•
credit products, such as our advances and letters of credit;
•
investments in government mortgage loans held for portfolio;
•
investments in conventional mortgage loans held for portfolio;
•
investments via term securities purchased under agreements to resell; and
•
investments via term federal funds sold.
Classes of Financing Receivables. Classes of financing receivables generally are a disaggregation of a portfolio segment to the extent that is needed to understand the exposure to credit risk arising from these financing receivables. We determined that no further disaggregation of portfolio segments identified above is needed as we assessed and measured the credit risk arising from these financing receivables at the portfolio segment level.
Secured Member Credit Products
We manage our credit exposure to secured member credit products through an integrated approach that generally includes establishing a credit limit for each borrower, includes an ongoing review of each borrower's financial condition, and is coupled with collateral and lending policies that are intended to limit risk of loss while balancing borrowers' needs for a reliable source of funding. In addition, we lend to eligible borrowers in accordance with the FHLBank Act, FHFA regulations, and other applicable laws. The FHLBank Act requires us to obtain sufficient collateral to secure our credit products. The estimated value of the collateral pledged to secure each borrower's credit products is calculated by applying collateral discounts, or haircuts, to the market value or unpaid principal balance of the collateral, as applicable. We accept certain investment securities, residential mortgage loans, deposits, and other assets as collateral. We require all borrowers that pledge securities collateral to place physical possession of such securities collateral with our safekeeping agent, the borrower's approved designated agent, or the borrower's securities corporation, subject to a control agreement giving us appropriate control over such collateral. In addition, community financial institutions are eligible to use expanded statutory collateral provisions for small-business and agriculture loans. Members also pledge their Bank capital stock as collateral. Collateral arrangements may vary depending upon borrower credit quality, financial condition, performance, borrowing capacity, and overall credit exposure to the borrower. We can call for additional or substitute collateral to further safeguard our security interest. We believe our policies appropriately manage our credit risks arising from our credit products.
Depending on the financial condition of the borrower, we may allow the borrower to retain possession of loan collateral pledged to us while agreeing to hold such collateral for our benefit or require the borrower to specifically assign or place physical possession of such loan collateral with us or a third-party custodian that we approve.
We are provided an additional safeguard for our security interests by Section 10(e) of the FHLBank Act, which generally affords any security interest granted by a borrower to the Bank priority over the claims and rights of any other party. The exceptions to this prioritization are limited to 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 higher priority perfected security interests. However, the priority granted to our security interests under Section 10(e) of the FHLBank Act may not apply when lending to insurance company members. This is due to the anti-preemption provision contained in the McCarran-Ferguson Act, which provides that federal law does not preempt state insurance law unless the federal law expressly regulates the business of insurance. Thus, if
state law conflicts with Section 10(e) of the FHLBank Act, the protection afforded by this provision may not be available to us. However, we perfect our security interests in the collateral pledged by our members, including insurance company members, by filing UCC-1 financing statements, taking possession or control of such collateral, or taking other appropriate steps.
Using a risk-based approach and taking into consideration each borrower's financial strength, we consider the types and level of collateral to be the primary indicator of credit quality on our credit products. At December 31, 2013 and 2012, we had rights to collateral, on a borrower-by-borrower basis, with an estimated value in excess of our outstanding extensions of credit.
We continue to evaluate and make changes to our collateral guidelines based on market conditions. At December 31, 2013 and 2012, none of our secured member credit products outstanding were past due, on nonaccrual status, or considered impaired. In addition, there were no troubled debt restructurings related to credit products during the years ended December 31, 2013 and 2012.
Based upon the collateral held as security, our credit extension and collateral policies, management's credit analysis, and the repayment history on secured member credit products, we have not recorded any allowance for credit losses on our secured member credit products at December 31, 2013, and 2012. At December 31, 2013 and 2012, no liability to reflect an allowance for credit losses for off-balance-sheet credit exposures was recorded. See Note 20 - Commitments and Contingencies for additional information on our off-balance-sheet credit exposure.
Government Mortgage Loans Held for Portfolio
We invest in government mortgage loans secured by one- to four-family residential properties. Government mortgage loans are mortgage loans insured or guaranteed by the Federal Housing Administration, the U.S. Department of Veterans Affairs, the Rural Housing Service of the U.S. Department of Agriculture, or by the U.S. Department of Housing and Urban Development.
The servicer provides and maintains insurance or a guarantee from the applicable government agency. The servicer is responsible for compliance with all government agency requirements and for obtaining the benefit of the applicable insurance or guaranty with respect to defaulted government-guaranteed mortgage loans. Any losses incurred on these loans that are not recovered from the insurer or guarantor are absorbed by the related servicer. Therefore, we only have credit risk for these loans if the servicer fails to pay for losses not covered by insurance or guarantees. Based on our assessment of our servicers for our government loans, there is no allowance for credit losses for the government mortgage loan portfolio as of December 31, 2013 and 2012. In addition, these mortgage loans are not placed on nonaccrual status due to the government guarantee or insurance on these loans and the contractual obligation of the loan servicers to repurchase their related loans when certain criteria are met.
Conventional Mortgage Loans Held for Portfolio
We use a model to determine our allowance for credit losses based on our investments in conventional mortgage loans. We periodically adjust the key inputs to this model in an effort intended to properly align our loss projections with the market conditions that are relevant to these loans. The key inputs to our method include past and current performance of these loans (including portfolio-delinquency and default-migration statistics), overall loan-portfolio-performance characteristics (including loss-mitigation features, especially credit enhancements, as discussed below under - Credit Enhancements), and estimated loss-severity estimates (i.e. rates of expected cash shortfalls) for these loans. We update key inputs at least once per quarter. We use a third-party loan-loss projection model to determine our loss-severity estimates for our master commitments. The inputs to this model include loan-related characteristics (such as property types and locations), industry data (such as foreclosure timelines and associated costs), and current and projected housing prices. Additionally, we review our method's default migration factor on a quarterly basis to determine if the portfolio has exhibited any change in loans migrating from current to delinquent or from delinquent to default and make adjustments as appropriate.
Individually Evaluated Mortgage Loans. Certain conventional mortgage loans, primarily impaired mortgage loans that are
considered collateral dependent, may be specifically identified for purposes of calculating the allowance for credit losses. A
mortgage loan is considered collateral dependent if repayment is only expected to be provided by the sale of the underlying
property, that is, if it is considered likely that the borrower will default and there is no credit enhancement from a
participating financial institution to offset losses under the master commitment. The estimated credit losses on impaired
collateral-dependent loans may be separately determined because sufficient information exists to make a reasonable estimate
of the inherent loss for such loans on an individual loan basis. We apply an appropriate loss severity rate, which is used to estimate the fair value of our collateral. The resulting incurred loss is equal to the difference between the carrying value
of the loan and the estimated fair value of the collateral less estimated selling costs.
Collectively Evaluated Mortgage Loans. We evaluate the credit risk of our investments in conventional mortgage loans for impairment on a collective basis that considers loan-pool-specific attribute data at the master commitment pool level, applies estimated loss severities, and incorporates available credit enhancements to establish our best estimate of probable incurred losses at the reporting date. We do not consider credit enhancement cash flows that are projected and assessed as not probable of receipt in reducing estimated losses. Migration analysis is a methodology for estimating the rate of default experienced on pools of similar loans based on our historical experience. We apply migration analysis to conventional loans that are currently not past due, loans that are 30 to 59 days past due, 60 to 89 days past due, and 90 or more days past due. We then estimate the dollar amount of loans in these categories that we believe are likely to migrate to a realized loss position and apply a loss severity factor to estimate losses that would be incurred at the statement of condition date. Additionally, for our investments in loans modified under our temporary loan modification plan, on the effective date of a loan modification we measure the present value of expected future cash flows discounted at the loan's effective interest rate and reduce the carrying value of the loan accordingly. See - Troubled Debt Restructurings below for information on our temporary loan modification program and loans that have been discharged pursuant to Chapter 7 bankruptcy.
Estimating a Margin of Imprecision. We also assess a factor for the margin of imprecision to the estimation of credit losses for the homogeneous population. The margin of imprecision is a factor in the allowance for credit losses that recognizes the imprecise nature of the measurement process and is included as part of the mortgage loan allowance for credit loss. This amount represents a subjective management judgment based on facts and circumstances that exist as of the reporting date that is unallocated to any specific measurable economic or credit event and is intended to cover other inherent losses that may not be captured in our methodology. The actual loss that may occur on homogeneous populations of mortgage loans may differ from the estimated loss.
Credit Quality Indicators. Key credit quality indicators for mortgage loans include the migration of past due loans, nonaccrual loans, loans in process of foreclosure, and impaired loans. The tables below set forth certain key credit quality indicators for our investments in mortgage loans at December 31, 2013 and 2012 (dollars in thousands):
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(1)
Includes loans where the decision of foreclosure or similar alternative such as pursuit of deed-in-lieu of foreclosure has been reported.
(2)
Loans that are 90 days or more past due or in the process of foreclosure expressed as a percentage of the recorded investment in the total loan portfolio class.
(3)
Includes conventional mortgage loans with contractual principal or interest payments 90 days or more past due and not accruing interest as well as loans modified within the previous six months under our temporary loan modification plan.
_______________________
(1)
Includes loans where the decision of foreclosure or similar alternative such as pursuit of deed-in-lieu of foreclosure has been reported.
(2)
Loans that are 90 days or more past due or in the process of foreclosure expressed as a percentage of the recorded investment in the total loan portfolio class.
(3)
Includes conventional mortgage loans with contractual principal or interest payments 90 days or more past due and not accruing interest as well as loans modified within the previous six months under our temporary loan modification plan.
Individually Evaluated Impaired Loans. The following tables present the recorded investment, par value and any related allowance for impaired loans individually assessed for impairment at December 31, 2013 and 2012, and the average recorded investment and interest income recognized on these loans during the years ended December 31, 2013 and 2012 (dollars in thousands).
Credit Enhancements. Our allowance for credit losses factors in the credit enhancements associated with conventional mortgage loans under the MPF program. These credit enhancements apply after the homeowner's equity is exhausted and can include primary and/or supplemental mortgage insurance or other kinds of credit enhancement. The credit enhancement amounts estimated to protect us against credit losses are determined through the use of a model. Any incurred losses that would be recovered from the credit enhancements are not reserved as part of our allowance for loan losses. In such cases, a receivable is generally established to reflect the expected recovery from credit-enhancement arrangements.
Conventional mortgage loans are required to be credit enhanced so that the risk of loss is limited to the losses equivalent to an investor in a double-A rated MBS at the time of purchase. We share the risk of credit losses on our investments in mortgage loans with the related participating financial institution by structuring potential losses on these investments into layers with respect to each master commitment. We analyze the risk characteristics of our mortgage loans using a third-party model to determine the credit enhancement amount at the time of purchase. This credit-enhancement amount is broken into a first-loss account and a credit-enhancement obligation of each participating financial institution, which is calculated based on the risk analysis to equal the difference between the amounts needed for the master commitment to have a rating equivalent to a double-A rated MBS and our initial first-loss account exposure.
The first-loss account represents the first layer or portion of credit losses that we absorb with respect to our investments in mortgage loans after considering the borrower's equity and primary mortgage insurance. The participating financial institution is required to cover the next layer of losses up to an agreed-upon credit-enhancement obligation amount, which may consist of a direct liability of the participating financial institution to pay credit losses up to a specified amount, a contractual obligation of a participating financial institution to provide supplemental mortgage insurance, or a combination of both. We absorb any remaining unallocated losses.
The aggregate amount of the first-loss account is documented and tracked but is neither recorded nor reported as an allowance for loan losses in our financial statements. As credit and special hazard losses are realized that are not covered by the liquidation value of the real property or primary mortgage insurance, they are first charged to us, with a corresponding reduction of the first-loss account for that master commitment up to the amount in the first-loss account at that time. Over time, the first-loss account may cover the expected credit losses on a master commitment, although losses that are greater than expected or that occur early in the life of a master commitment could exceed the amount in the first-loss account. In that case, the excess losses would be charged to the participating financial institution's credit-enhancement amount, then to us after the participating financial institution's credit-enhancement amount has been exhausted.
For loans in which we buy or sell participations from or to other FHLBanks that participate in the MPF program (MPF Banks), the amount of the first-loss account remaining to absorb losses for loans that we own is partly dependent on the percentage of our participation in such loans. Assuming losses occur on a proportional basis between loans that we own and loans owned by other MPF Banks, at December 31, 2013 and 2012, the amount of first-loss account remaining for losses allocatable to us was $17.0 million and $16.7 million, respectively.
Participating financial institutions are paid a credit-enhancement fee for assuming credit risk and in some instances all or a portion of the credit-enhancement fee may be performance-based. For certain MPF products, our losses incurred under the first-loss account can be mitigated by withholding future performance-based credit-enhancement fees that would otherwise be payable to the participating financial institutions. We record credit-enhancement fees paid to participating financial institutions as a reduction to mortgage-loan-interest income. We incurred credit-enhancement fees of $3.0 million, $3.2 million, and $3.1 million during the years ended December 31, 2013, 2012, and 2011, respectively.
Withheld performance-based credit-enhancement fees can mitigate losses from our investments in mortgage loans and therefore we consider our expectations for each master commitment for such withheld fees in determining the allowance for loan losses. More specifically, we determine the amount of credit-enhancement fees available to mitigate losses as follows: accrued credit-enhancement fees to be paid to participating financial institutions; plus projected credit-enhancement fees to be paid to the participating financial institutions using the weighted average life of the loans within each relevant master commitment (the CE Fees Estimation Factor); minus any losses incurred or expected to be incurred. Previously, for the year ended December 31, 2012, and the quarter ended March 31, 2013, we had determined the CE Fees Estimation Factor using the projected credit-enhancement fees to be paid to the participating financial institutions over the next 12 months. We believe that our current approach is an improvement from our prior estimation method. Available credit-enhancement fees cannot be shared between master commitments and, as a result, some master commitments may have sufficient credit-enhancement fees to recover all losses while other master commitments may not.
The following table demonstrates the impact on our estimate of the allowance for credit losses resulting from the loss-mitigating features of conventional mortgage loans (dollars in thousands).
Roll-Forward of Allowance for Credit Losses on Mortgage Loans. The following table presents a roll-forward of the allowance for credit losses on conventional mortgage loans for the years ended December 31, 2013, 2012, and 2011, as well as the recorded investment in mortgage loans by impairment methodology at December 31, 2013, 2012, and 2011 (dollars in thousands). The recorded investment in a loan is the par amount of the loan, adjusted for accrued interest, unamortized premiums or discounts, deferred derivative gains and losses, and direct write-downs. The recorded investment is net of any valuation allowance.
_________________________
(1)
These amounts exclude government mortgage loans because we make no allowance for credit losses based on our investments in government mortgage loans, as discussed above under - Government Mortgage Loans Held for Portfolio.
Troubled Debt Restructurings. We consider a troubled debt restructuring of a financing receivable to have occurred when we grant a concession to a borrower that we would not otherwise consider for economic or legal reasons related to the borrower's financial difficulties. We have granted a concession when we do not expect to collect all amounts due to us under the original contract as a result of the restructuring.
We also consider troubled debt restructurings to have occurred when a borrower has filed for bankruptcy under Chapter 7 of the U.S. Bankruptcy Code (Chapter 7 bankruptcy) pursuant to which the bankruptcy court has discharged the borrower's obligation to us and the borrower has not reaffirmed the debt, except in cases where certain supplemental mortgage insurance policies are held or where all contractual amounts due are still expected to be collected as a result of certain credit enhancements or government guarantees.
Our program for mortgage loan troubled debt restructurings primarily involves modifying the borrower's monthly payment for a period of up to 36 months to achieve a housing expense ratio of no more than 31 percent of their qualifying monthly income. The principal amortization schedule for the outstanding principal balance is first recalculated to reflect a new principal and interest payment for a term not to exceed 40 years. This would result in a balloon payment at the original maturity date of the loan as the maturity date and number of remaining monthly payments are not adjusted. If the 31 percent housing expense ratio is not achieved through reamortization, the interest rate is reduced for the temporary modification period of up to 36 months in 0.125 percent increments below the original note rate, to a floor rate of 3.00 percent, resulting in reduced principal and interest payments, until the desired 31 percent housing expense ratio is met.
A mortgage loan considered to be a troubled debt restructuring is individually evaluated for impairment when determining its related allowance for credit losses. Credit loss is measured by factoring the loss severity rate incurred as of the reporting date as well as the economic loss attributable to delaying the original contractual principal and interest due dates, if applicable. During the year ended December 31, 2013, we had five troubled debt restructurings. The recorded investment in the troubled debt
restructurings post-modification was $1.0 million as of the modification date. During the year ended December 31, 2012, we had 13 troubled debt restructurings. The recorded investment in these troubled debt restructurings post-modification was $2.6 million as of the modification date. During the year ended December 31, 2011, we had one troubled debt restructuring. The recorded investment in the troubled debt restructuring post-modification was $196,000 as of the modification date.
As of December 31, 2013, we had mortgage loans with a recorded investment of $3.3 million that we considered troubled debt restructurings of which $2.6 million were performing and $706,000 were nonperforming. As of December 31, 2012, we had mortgage loans with a recorded investment of $2.8 million that we considered troubled debt restructurings, of which $1.9 million were performing and $912,000 were nonperforming.
As of December 31, 2013 and 2012, we had troubled debt restructurings with a recorded investment of $86,000 and $88,000, respectively, that resulted from borrowers that filed for Chapter 7 bankruptcy in which the bankruptcy court discharged the borrowers' obligations to us and the borrowers did not reaffirm the debt. We did not record an additional impairment charge or increase our allowance for credit losses since there is sufficient credit-enhancement remaining for the master commitment associated with these loans.
During the years ended December 31, 2013, 2012, and 2011, certain of our investments in conventional mortgage loans modified as troubled debt restructurings within the previous 12 months experienced a payment default. We consider a loan modified as a troubled debt restructuring to be in default if its contractual principal or interest is 60 days or more past due. During the years ended December 31, 2013 and 2012, the recorded investment in troubled debt restructurings that subsequently defaulted was $120,000 and $442,000, respectively. During the year ended December 31, 2011, no troubled debt restructurings had defaulted.
REO. At December 31, 2013 and 2012, we had $5.3 million and $8.7 million, respectively, in assets classified as REO. During the years ended December 31, 2013, 2012, and 2011, we sold REO assets with a recorded carrying value of $12.1 million, $10.2 million, and $9.6 million respectively. Upon the sale of these properties, and inclusive of any proceeds received from primary mortgage-insurance coverage, we recognized net losses totaling $3.0 million and net gains totaling $409,000 and $517,000 during the years ended December 31, 2013, 2012, and 2011, respectively. Gains and losses on the sale of REO assets are recorded in other income.
Federal Funds Sold and Securities Purchased Under Agreements to Resell.
These investments are all short-term (less than three months). We invest in federal funds sold with investment-grade counterparties, and we only evaluate these investments for purposes of an allowance for credit losses if the investment is not paid when due. All investments in federal funds sold as of December 31, 2013 and 2012, were repaid according to their contractual terms.
Securities purchased under agreements to resell are considered collateralized financing arrangements and effectively represent short-term loans to investment-grade counterparties. The terms of these loans are structured such that if the market value of the underlying securities decreases below the market value required as collateral, the counterparty must provide additional securities as collateral in an amount equal to the decrease or remit cash in such amount. If we determine that an agreement to resell is impaired, the difference between the fair value of the collateral and the amortized cost of the agreement is charged to earnings. Based upon the collateral held as security, we determined that no allowance for credit losses was needed for the securities purchased under agreements to resell at December 31, 2013 and 2012.
Note 11 - Derivatives and Hedging Activities
Nature of Business Activity
We are exposed to interest-rate risk primarily from the effects of interest-rate changes on interest-earning assets and funding sources that finance these assets. The goal of our interest-rate risk-management strategy is to manage interest-rate risk within appropriate limits. As part of our effort to mitigate the risk of loss, we have established policies and procedures, which include guidelines on the amount of exposure to interest-rate changes we will accept. In addition, we monitor the risk to our interest income, net interest margin, and average maturity of interest-earning assets and funding sources.
Consistent with FHFA regulations, we enter into derivatives to manage the interest-rate-risk exposures inherent in otherwise unhedged assets and liabilities and achieve our risk-management objectives. FHFA regulations and our risk-management policy prohibit trading in or the speculative use of these derivative instruments and limit credit risk arising from these instruments.
The use of derivatives is an integral part of our financial management strategy. We may enter into derivatives that do not necessarily qualify for hedge accounting.
The most common ways in which we use derivatives are to:
•
change the repricing frequency of assets and liabilities from fixed to floating or floating to fixed, considering interest-rate-risk-management and funding needs;
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hedge the cash flows of assets and liabilities that have embedded options, considering interest-rate-risk-management and funding needs; and
•
hedge the mark-to-market sensitivity of existing assets or liabilities or of anticipated transactions.
Application of Derivatives
We may use derivatives to adjust the effective maturity, repricing frequency, or option characteristics of our financial instruments, including our advances products, investments, and COs to achieve risk-management objectives. We use derivatives as:
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a fair-value or cash-flow hedge of a financial instrument or a forecasted transaction; and
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an economic hedge in general asset-liability management where derivatives serve a documented risk-mitigation purpose but do not qualify for hedge accounting. These hedges are primarily used to manage mismatches between the coupon features of our assets and liabilities. For example, we use derivatives in our overall interest-rate-risk management to adjust the interest-rate sensitivity of COs to approximate more closely the interest-rate sensitivity of assets (both advances and investments), and/or to adjust the interest-rate sensitivity of advances, investments, or mortgage loans to approximate more closely the interest-rate sensitivity of liabilities.
We use derivatives as a method to achieve our financial and risk-management objectives. We reevaluate our hedging strategies from time to time and may change the hedging techniques we use or may adopt new strategies.
We transact most of our derivatives with large banks and major broker-dealers. Some of these banks and broker-dealers or their affiliates buy, sell, and distribute COs. Derivative transactions may be either over-the-counter with a counterparty (bilateral derivatives) or cleared through a futures commission merchant (clearing member) with a derivatives clearing organization (DCO) as the counterparty (cleared derivatives).
Once a derivative transaction has been accepted for clearing by a DCO, the derivative transaction is novated and the executing counterparty is replaced with the DCO. The DCO notifies the clearing member of the required initial and variation margin and the clearing agent notifies us of the required initial and variation margin. See - Managing Credit Risk on Derivatives for a more detailed discussion of cleared derivatives. We are not a derivatives dealer and do not trade derivatives for short-term profit.
Types of Derivatives
We may use the following derivatives to reduce funding costs and/or to manage our interest-rate risks.
•
Interest-Rate Swaps. An interest-rate swap is an agreement between two entities to exchange cash flows in the future. The agreement sets the dates on which the cash flows will be paid and the manner in which the cash flows will be calculated. One of the simplest forms of an interest-rate swap involves the promise by one party to pay cash flows equivalent to the interest on a notional amount at a predetermined fixed rate for a given period of time. In return for this promise, this party receives cash flows equivalent to the interest on the same notional amount at a variable-rate index for the same period of time. The variable-rate index we utilize in most of our derivative transactions is LIBOR.
•
Optional Termination Interest-Rate Swaps. An optional termination interest-rate swap is an interest-rate swap in which one counterparty has the right, but not the obligation, to terminate the interest-rate swap prior to its stated maturity date. We use optional termination interest-rate swaps to hedge callable CO bonds and putable advances. In each case, we own an option to terminate the hedged item, that is redeem a callable bond or demand repayment of a putable advance on specified dates, and the counterparty to the optional termination interest-rate swap owns the option to terminate the interest-rate swap on those same dates.
•
Forward-Start Interest-Rate Swaps. A forward-start interest-rate swap is an interest rate swap (as described above) with a deferred effective date. We designate forward-start interest-rate swaps as cash-flow hedges of expected debt issuances.
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Swaptions. A swaption is an option on an interest-rate swap that gives the buyer the right to enter into a specified interest-rate swap at a certain time in the future. When used as a hedge, a swaption can protect us if we are planning to lend or borrow funds in the future against future interest rate changes. We may purchase both payer swaptions and receiver swaptions. A payer swaption is the option to make fixed-interest payments at a later date and a receiver swaption is the option to receive fixed-interest payments at a later date.
•
Interest-Rate Cap and Floor Agreements. In an interest-rate cap agreement, a cash flow is generated if the price or rate of an underlying variable rises above a certain threshold or cap price. In an interest-rate floor agreement, a cash flow is generated if the price or rate of an underlying variable falls below a certain threshold or floor price. These agreements are intended to serve as protection against the interest rate on a variable-rate asset or liability falling below or rising above a certain level.
•
Options. An option is an agreement between two entities that conveys the right, but not the obligation, to engage in a future transaction on an underlying security or other financial asset at an agreed-upon price during a certain period of time or on a specific date.
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Futures/Forwards Contracts. We may use futures and forward contracts to hedge interest-rate risk. For example, certain mortgage purchase commitments that we enter into are considered derivatives. We may hedge these commitments by selling MBS to-be-announced (TBA) for forward settlement. A TBA represents a forward contract for the sale of MBS at a future agreed-upon date for an established price.
Types of Assets and Liabilities Hedged
We formally document at inception all relationships between derivatives designated as hedging instruments and hedged items, as well as our risk-management objectives and strategies for undertaking various hedge transactions and our method of assessing hedge effectiveness. This process includes linking all derivatives that are designated as fair-value or cash-flow hedges to specific assets or liabilities on the statement of condition; firm commitments; or forecasted transactions. We also formally assess (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. We typically use regression analyses or other statistical or scenario-based analyses to assess the effectiveness of our hedges. We apply hedge accounting to hedges that we deem highly effective and that otherwise meet the hedge-accounting requirements. When we determine that a derivative has not been or is not expected to be effective as a hedge, we discontinue hedge accounting prospectively, as discussed below.
Investments. We primarily invest in U.S. agency obligations, MBS, ABS, and the taxable portion of HFA securities, 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. FHFA guidance and our policies limit this source of interest-rate risk by restricting the types of mortgage investments we may own to those with limited average life changes under certain interest-rate-shock scenarios and establishing limitations on duration of equity and changes to market value of equity. We may manage our prepayment and duration risk by funding investment securities with COs that have call features or by hedging the prepayment risk with caps or floors, optional termination interest rate swaps, or swaptions.
For long-term investment securities that are classified as held-to-maturity, we manage our interest-rate-risk exposure by issuing funding instruments with offsetting market-risk characteristics. For example, we typically fund floating-rate MBS whose coupons reset monthly with short-term discount notes or with CO bonds with fixed rates that have been converted to a floating rate with an interest-rate swap, while we might use long-term CO bonds to fund fixed-rate commercial MBS.
For available-for-sale securities to which we have designated a qualifying fair-value hedge relationship has been designated, we record the portion of the change in fair value related to the risk being hedged in other income as net gains (losses) on derivatives and hedging activities together with the related change in fair value of the derivative, and the remainder of the change in fair value is recorded in other comprehensive loss as net unrealized loss on available-for-sale securities.
We may also manage the risk arising from changing market prices or cash flows of investment securities classified as trading by entering into economic hedges that offset the changes in fair value or cash flows of the securities. These economic hedges are not specifically designated as hedges of individual assets, but rather are collectively managed to provide an offset to the changes in the fair values of the assets. The market-value changes of trading securities are included in net unrealized (losses)gains on trading securities in the statement of operations, while the changes in fair value of the associated derivatives are included in other income as net gains (losses) on derivatives and hedging activities.
Advances. We offer an array of advance structures intended to meet our members' funding needs. These advances may have maturities up to 30 years with variable or fixed rates and may include early termination features or options. The repricing
characteristics and optionality embedded in certain advances may create interest-rate risk. We may use interest-rate swaps to adjust the repricing and/or options characteristics of advances to more closely match the characteristics of our funding liabilities. Typically, we hedge fixed-rate advances with interest-rate swaps where we pay a fixed-rate coupon and receive a variable-rate coupon, effectively converting the advance to a floating-rate advance. This type of hedge is treated as a fair-value hedge. Additionally, certain floating-rate advances that contain either an interest-rate cap or floor, or both a cap and a floor, may be hedged with a derivative containing an offsetting cap and/or floor, where the hedge relationship is treated as a fair-value hedge.
With each issue of a putable advance, we effectively purchase from the related borrower an embedded put option that enables us to terminate a fixed-rate advance on predetermined put dates, and offer, subject to certain conditions, replacement funding at then-current advances rates. We may hedge a putable advance by entering into a derivative that is cancelable by the derivative counterparty, where we pay a fixed-rate coupon and receive a variable-rate coupon. This type of hedge is treated as a fair-value hedge. The swap counterparty would normally exercise its option to cancel the derivative at par on any defined exercise date if interest rates had risen, and at that time, we could, at our option, require immediate repayment of the advance.
Additionally, the borrower's ability to prepay an advance can create interest-rate risk. When a borrower prepays an advance, we could suffer lower future income if the principal portion of the prepaid advance were invested in lower-yielding assets that continue to be funded by higher-cost debt. To protect against this risk, we generally charge a prepayment fee that makes us financially indifferent to a borrower's decision to prepay an advance. If the advance is hedged with a derivative instrument, the prepayment fee will generally offset the cost of terminating the designated hedge. When we offer advances (other than short-term advances) that a borrower may prepay without a prepayment fee, we usually finance such advances with callable debt or otherwise hedge this option.
Mortgage Loans. We invest in mortgage loans through the MPF program as discussed in Note 9 - Mortgage Loans Held for Portfolio. The prepayment options embedded in mortgage loans can result in extensions or contractions in the expected lives of these investments, depending on changes in estimated prepayment behavior. We address a portion of the interest-rate risk inherent in mortgage loans by duration-matching mortgage loans with funding liabilities. As interest rates change, the portfolio is rebalanced to maintain the targeted duration level. We may also manage against prepayment, or convexity risk by funding some mortgage loans with COs that have early redemption features. Net income could be reduced if we reinvest the proceeds from prepaid mortgage loans in lower-yielding assets and if our higher funding costs are not reduced concomitantly.
Swaptions may also be used to hedge the prepayment risk from our investments in mortgage loans. We may also purchase interest-rate caps and floors, optional termination interest rate swaps, call options, and put options to minimize the prepayment risk embedded in our investments in 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. Changes in fair value of these economic hedges are recognized in current period earnings and presented on the statement of operations as net gains (losses) on derivatives and hedging activities.
COs. We may enter into derivatives to hedge (or partially hedge, depending on the risk-strategy) the interest-rate risk associated with our specific debt issuances, including using derivatives to change the effective interest-rate sensitivity of debt to better match the characteristics of funded assets. We endeavor to manage the risk arising from changing market prices and volatility of a CO by matching the cash inflow on the derivative with the cash outflow on the CO.
As an example of such a hedging strategy, when fixed-rate COs are issued, we simultaneously enter into a matching derivative in which the counterparty pays us fixed-interest cash flows designed to mirror in timing and amount the interest cash outflows we pay on the CO. At the same time, we may pay a variable cash flow that closely matches the interest payments we receive on short-term or variable-rate assets. In some cases, the hedged CO may have a nonstatic coupon that is subject to fair-value risk and that is matched by the receivable coupon on the hedging interest-rate swap. These transactions are treated as fair-value hedges.
In a typical cash-flow or economic hedge of anticipated CO issuance, we may enter into interest-rate swaps for the anticipated issuance of fixed-rate CO bonds to lock in a spread between an earning asset and the cost of funding. The interest-rate swap is terminated upon issuance of the fixed-rate CO bond. Changes in fair value of the hedging derivative, to the extent that the hedge is effective, will be recorded in accumulated other comprehensive loss and reclassified into earnings in the period or periods during which the cash flows of the fixed-rate CO bond affects earnings (beginning upon issuance and continuing over the life of the CO bond).
Firm Commitments. Mortgage-purchase commitments are considered derivatives. We may hedge these commitments by selling MBS TBA or other derivatives for forward settlement. These hedges do not qualify for hedge accounting treatment. The
mortgage purchase commitment and the TBA used in the economic hedging strategy are recorded on the statement of condition 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. The basis adjustments on the resulting performing loans are then amortized into net interest income over the life of the loans.
We may also hedge a firm commitment for a forward-starting advance through the use of an interest-rate swap. In this case, the swap functions as the hedging instrument for both the firm commitment and the subsequent advance. The fair-value change associated with the firm commitment is recorded as a basis adjustment of the advance at the time the commitment is terminated and the advance is issued. The basis adjustment is then amortized into interest income over the life of the advance.
Financial Statement Impact and Additional Financial Information. The notional amount of derivatives is a factor in determining periodic interest payments or cash flows received and paid. However, the notional amount of derivatives reflects our involvement in the various classes of financial instruments and represents neither the actual amounts exchanged nor our overall exposure to credit and market risk; the overall risk is much smaller. The risks of derivatives can be measured meaningfully on a portfolio basis that takes into account the counterparties, the types of derivatives, the items being hedged, and any offsets between the derivatives and the items being hedged.
The following table presents the fair value of derivative instruments, including the effect of netting adjustments and cash collateral as of December 31, 2013 (dollars in thousands):
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(1)
Mortgage-delivery commitments are classified as derivatives with changes in fair value recorded in other income.
(2)
Amounts represent the effect of master-netting agreements intended to allow us to settle positive and negative positions with the same counterparty.
The following table presents the fair value of derivative instruments as of December 31, 2012 (dollars in thousands):
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(1)
Mortgage-delivery commitments are classified as derivatives with changes in fair value recorded in other income.
(2)
Amounts represent the effect of master-netting agreements intended to allow us to settle positive and negative positions with the same counterparty.
Net gains (losses) on derivatives and hedging activities recorded in Other Income (Loss) for the years ended December 31, 2013, 2012, and 2011 were as follows (dollars in thousands).
The following tables present, by type of hedged item, the gains (losses) on derivatives and the related hedged items in fair-value hedge relationships and the impact of those derivatives on our net interest income for the years ended December 31, 2013, 2012, and 2011 (dollars in thousands):
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(1)
The net interest on derivatives in fair-value hedge relationships is presented in the statement of operations as interest income or interest expense of the respective hedged item.
The gain or loss recognized in other comprehensive income for forward-start interest-rate swaps associated with CO bond hedged items in cash-flow hedging relationships was a gain of $13.4 million and a loss of $32.7 million for the years ended December 31, 2013 and 2012, respectively.
For the years ended December 31, 2013 and 2012, there were no reclassifications from accumulated other comprehensive loss into earnings as a result of the discontinuance of cash-flow hedges because the original forecasted transactions were not expected to occur by the end of the originally specified time period or within a two-month period thereafter. As of December 31, 2013, the maximum length of time over which we are hedging our exposure to the variability in future cash flows for forecasted transactions is seven years.
As of December 31, 2013, the amount of deferred net losses on derivative instruments accumulated in other comprehensive loss, related to cash flow hedges expected to be reclassified to earnings during the next 12 months is $7.7 million.
Managing Credit Risk on Derivatives. We are subject to credit risk on our hedging activities due to the risk of nonperformance by nonmember counterparties (including DCOs and their clearing members acting as agent to the DCOs as well as bilateral counterparties) to the derivative agreements. We manage credit risk through credit analysis, collateral requirements and adherence to the requirements set forth in our policies, U.S. Commodity Futures Trading Commission (the CFTC) regulations,
and FHFA regulations. All counterparties must execute master-netting agreements prior to entering into any non-cleared derivative (bilateral derivative) with us.
Our master-netting agreements for bilateral derivatives contain bilateral-collateral exchange agreements that require that credit exposure beyond a defined threshold amount be secured by readily marketable, U.S. Treasury or GSE securities, or cash. The level of these collateral threshold amounts varies according to the counterparty's Standard & Poor's Ratings Services (S&P) or Moody's Investors Service Inc. and Moody’s Corporation (together, Moody's) long-term credit ratings. Credit exposures are then measured daily and adjustments to collateral positions are made in accordance with the terms of the master-netting agreements. These master-netting agreements also contain bilateral ratings-tied termination events permitting us to terminate all outstanding agreements with a counterparty in the event of a specified rating downgrade by Moody's or S&P. Based on credit analyses and collateral requirements, we do not anticipate any credit losses on our derivative agreements.
We execute bilateral derivatives with nonmember counterparties with long-term ratings of single-A (or equivalent) or better by the major NRSROs at the time of the transaction, although risk-reducing trades (trades that reduce our net credit exposure or exposure sensitivity to the counterparty) are permitted for counterparties whose ratings have fallen below these ratings. Some of these counterparties or their affiliates buy, sell, and distribute COs. See Note 13 - Consolidated Obligations for additional information.
For cleared derivatives, the DCO is our counterparty. We post initial margin and exchange variation margin through a clearing member who acts as our agent to the DCO and who guarantees our performance to the DCO, subject to the terms of relevant agreements. These arrangements expose us to institutional credit risk in the event that one of our agents (clearing members) or one of the DCOs fails to meet its obligations. The use of cleared derivatives is intended to mitigate credit risk exposure because the DCO, which is fully secured at all times through margin maintained with its clearing members, is substituted for the credit risk exposure of individual counterparties in bilateral derivatives and collateral is posted at least once daily for changes in the value of cleared derivatives through a clearing member.
We have analyzed the rights, rules, and regulations governing our cleared derivatives and determined that those rights, rules and regulations should result in a net claim through each of our clearing members with the related DCO upon an event of default including a bankruptcy, insolvency or similar proceeding involving the DCO or one of our clearing members, or both. For this purpose, net claim generally means a single net amount reflecting the aggregation of all amounts indirectly owed by us to the relevant DCO and indirectly payable to us from the relevant DCO. Based on this analysis, we are presenting a net derivative receivable or payable for all of our transactions through a particular clearing member with a particular DCO.
Certain of our bilateral derivatives master-netting agreements contain provisions that require us to post additional collateral with our bilateral derivatives counterparties if our credit ratings are lowered. Under the terms that govern such agreements, if our credit rating is lowered by Moody's or S&P to a certain level, we are required to deliver additional collateral on bilateral derivative instruments in a net liability position. In the event of a split between such credit ratings, the lower rating governs. The aggregate fair value of all bilateral derivative instruments with these provisions that were in a net-liability position (before cash collateral and related accrued interest) at December 31, 2013, was $608.1 million for which we had delivered collateral with a post-haircut value of $474.1 million in accordance with the terms of the master-netting agreements. The following table sets forth the post-haircut value of incremental collateral that certain bilateral derivatives counterparties could have required us to deliver based on incremental credit rating downgrades at December 31, 2013 (dollars in thousands).
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(1)
Ratings are expressed in this table according to S&P's conventions but include the equivalent of such rating by Moody's. If there is a split rating, the lower rating is used.
(2)
Additional collateral of $17.4 million could be called by counterparties as of December 31, 2013, at our current credit rating of AA+ (based on the lower of our credit ratings from S&P and Moody's) and is not included in the table.
For cleared derivatives, the DCO determines initial margin requirements and generally credit ratings are not factored into the initial margin. However, clearing members may require additional initial margin to be posted based on credit considerations, including but not limited to credit rating downgrades. We were not required to post additional initial margin with our clearing agent at December 31, 2013.
Offsetting of Certain Derivative Assets and Derivative Liabilities. We present derivative instruments, related cash collateral, including initial and variation margin, received or pledged and associated accrued interest, on a net basis by clearing member and/or by counterparty when it has met the netting requirements.
The following presents separately the fair value of derivative instruments meeting or not meeting netting requirements, with and without the legal right of offset, including the related collateral received from or pledged to counterparties, based on the terms of our master netting arrangements or similar agreements as of December 31, 2013 and 2012 (dollars in thousands).
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(1)
Consists of mortgage delivery commitments.
(2)
Includes noncash collateral at fair value. Any overcollateralization with a counterparty is not included in the determination of the net amount. At December 31, 2013 and 2012, we had additional net credit exposure of $7.1 million and $18.0 million, respectively, due to instances where our collateral pledged to a counterparty exceeded our net derivative liability position.
Note 12 - Deposits
We offer demand and overnight deposits for members and qualifying nonmembers. In addition, we offer short-term interest-bearing deposit programs to members. Members that service mortgage loans may deposit funds collected in connection with mortgage loans pending disbursement of such funds to the owners of the mortgage loans. We classify these items as "other" in the following table.
Deposits classified as demand, overnight, and other pay interest based on a daily interest rate. Term deposits pay interest based on a fixed rate determined at the issuance of the deposit. Deposits at December 31, 2013 and 2012, include hedging adjustments of $1.1 million and $2.7 million, respectively. The average interest rates paid on average deposits during 2013 and 2012 was 0.003 percent and 0.008 percent, respectively.
The following table details interest-bearing and noninterest-bearing deposits (dollars in thousands):
The aggregate amount of time deposits with a denomination of $100,000 or more was $20.0 million as of December 31, 2013 and 2012.
Note 13 - Consolidated Obligations
COs consist of CO bonds and CO discount notes. CO bonds are issued primarily to raise intermediate- and long-term funds and are not subject to any statutory or regulatory limits on maturity. CO discount notes are issued to raise short-term funds and have original maturities of up to one year. These notes sell at less than their face amount and are redeemed at par value when they mature.
Although we are primarily liable for our portion of COs (that is, those issued from which we received issuance proceeds), we are also jointly and severally liable with the other FHLBanks for the payment of principal and interest on all COs. The FHFA, at its discretion, may require any FHLBank to make principal or interest payments due on any CO whether or not the CO represents a primary liability of such FHLBank. Although an FHLBank has never paid the principal or interest payments due on a CO on behalf of another FHLBank, if that event should occur, FHFA regulations provide that the paying FHLBank is entitled to reimbursement from the noncomplying FHLBank for any payments made on its behalf and other associated costs, including interest to be determined by the FHFA. If, however, the FHFA determines that the noncomplying FHLBank is unable to satisfy its repayment obligations, the FHFA may allocate the outstanding liabilities of the noncomplying FHLBank among the remaining FHLBanks on a pro rata basis in proportion to each FHLBank's participation in all COs outstanding. The FHFA reserves the right to allocate the outstanding liabilities for the COs among the FHLBanks in any other manner it may determine to ensure that the FHLBanks operate in a safe and sound manner. See Note 20 - Commitments and Contingencies for additional information regarding the FHLBanks' joint and several liability.
The par values of the 12 FHLBanks' outstanding COs, including COs held by other FHLBanks, were approximately $766.8 billion and $687.9 billion at December 31, 2013 and 2012, respectively. Regulations require each FHLBank to maintain unpledged qualifying assets equal to outstanding COs for which it is primarily liable. Such qualifying assets include cash; secured advances; assets with an assessment or rating at least equivalent to the current assessment or rating of the COs; obligations of or fully guaranteed by the U.S.; obligations, participations, or other instruments of or issued by Fannie Mae or the Government National Mortgage Association; mortgages, obligations, or other securities which are or ever have been sold by Freddie Mac under the FHLBank Act; and such securities as fiduciary and trust funds may invest in under the laws of the state in which the FHLBank is located. Any assets subject to a lien or pledge for the benefit of holders of any issues of COs are treated as if they were free from lien or pledge for purposes of compliance with these regulations.
COs - Bonds. The following table sets forth the outstanding CO bonds for which we were primarily liable at December 31, 2013 and 2012, by year of contractual maturity (dollars in thousands):
_______________________
(1)
The CO bonds' weighted-average rate excludes concession fees.
COs outstanding were issued with either fixed-rate coupon-payment terms or variable-rate coupon-payment terms that may use a variety of indices for interest-rate resets, including the federal funds effective rate, LIBOR, and others. To meet the expected specific needs of certain investors in COs, both fixed-rate CO bonds and variable-rate CO bonds may contain features, which may result in complex coupon-payment terms and call options. When these COs are issued, we may enter into derivatives containing features that offset the terms and embedded options, if any, of the CO bonds.
Our CO bonds outstanding at December 31, 2013 and 2012, included (dollars in thousands):
The following is a summary of the CO bonds for which we are primarily liable at December 31, 2013 and 2012, by year of contractual maturity or next call date for callable CO bonds (dollars in thousands):
CO bonds, beyond having fixed-rate or variable-rate interest-rate payment terms, may also have the following interest-rate payment terms:
Step-Up bonds pay interest at increasing fixed rates for specified intervals over the life of the CO bond and can be called at our option on the step-up dates.
The following table sets forth the CO bonds for which we were primarily liable by interest-rate-payment type at December 31, 2013 and 2012 (dollars in thousands):
COs - Discount Notes. Outstanding CO discount notes for which we were primarily liable, all of which are due within one year, were as follows (dollars in thousands):
_______________________
(1)
The CO discount notes' weighted-average rate represents a yield to maturity excluding concession fees.
Concessions on COs. Unamortized concessions on COs were $5.6 million and $5.9 million at December 31, 2013 and 2012, respectively, and are included in other assets on the statement of condition. The amortization of these concessions is included in CO interest expense and totaled $2.9 million, $4.0 million, and $7.0 million in 2013, 2012, and 2011, respectively.
Note 14 - Affordable Housing Program
The FHLBank Act requires each FHLBank to establish and maintain an AHP to provide subsidies in the form of direct grants and below-market interest-rate advances (AHP advances). These funds are intended 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 10 percent of net income before interest expense associated with mandatorily redeemable capital stock and the assessment for AHP, but after any assessment for REFCorp. We accrue this expense monthly based on our net earnings, and the accruals are accumulated into our AHP payable account. We reduce our AHP payable account as we disburse the funds either in the form of direct grants to member institutions or as a discount on below-market-rate AHP advances. Calculation of the REFCorp assessment is discussed in Note 15 - Resolution Funding Corporation.
On August 5, 2011, the FHFA certified that the FHLBanks had fully satisfied their REFCorp obligation with their payment made on July 15, 2011, which was accrued as applicable in each FHLBank's June 30, 2011, financial statements. The FHLBanks are parties to a Joint Capital Agreement which requires each FHLBank to allocate 20 percent of its net income to a separate restricted retained earnings account, which obligation commenced with the third quarter of 2011. Because the REFCorp assessment reduced the amount of net earnings used to calculate the AHP assessment, it had the effect of reducing the total amount of funds allocated to the AHP. The amounts allocated to the new restricted retained earnings account, however, are not treated as an assessment and do not reduce our net income. As a result, our AHP contributions as a percentage of pre-assessment earnings have increased because the REFCorp obligation has been fully satisfied.
If we experience a net loss during a quarter, but still have net earnings for the year, our obligation to the AHP would be calculated based on our net earnings for that calendar year. In annual periods where our net earnings are zero or less, our AHP assessment is zero since our required annual contribution is limited to our annual net earnings. If the result of the aggregate 10 percent calculation described above was less than $100 million for all 12 FHLBanks, then each FHLBank would be required to contribute such prorated sums as may be required to assure that the aggregate contributions of the FHLBanks equals $100 million. The proration would be made on the basis of the income of the FHLBanks for the year, except that the required annual AHP contribution for an FHLBank cannot exceed its net earnings for the year pursuant to an FHFA regulation. Each FHLBank's required annual AHP contribution is limited to its annual net earnings. Our AHP expense for 2013, 2012, and 2011 was $24.2 million, $23.1 million, and $17.8 million, respectively.
There was no shortfall, as described above, in any of 2013, 2012, or 2011. If an FHLBank is experiencing financial instability and finds that its required AHP contributions are contributing to the financial instability, the FHLBank may apply to the FHFA for a temporary suspension of its contributions. We did not make such an application in any of 2013, 2012, or 2011.
We charge the amount set aside for the AHP to income and recognize it as a liability. We then reduce the AHP liability as the funds are disbursed. We had outstanding principal in AHP advances of $99.9 million at both December 31, 2013 and 2012, respectively.
The following table presents a roll-forward of the AHP liability for the years ended December 31, 2013 and 2012 (dollars in thousands):
Note 15 - Resolution Funding Corporation
On August 5, 2011, the FHFA certified that the FHLBanks had fully satisfied their REFCorp obligation with their payments made on July 15, 2011. Prior to the satisfaction of the FHLBanks' REFCorp obligation, each FHLBank was required to pay to REFCorp 20 percent of net income calculated in accordance with GAAP after the assessment for the AHP, but before the assessment for the REFCorp until the total amount of payments actually made was equivalent to a $300 million annual annuity whose final maturity date was April 15, 2030. The FHFA shortened or lengthened the period during which the FHLBanks made payments to REFCorp based on actual payments made relative to the referenced annuity. The FHFA, in consultation with the U.S. Secretary of the Treasury, selected the appropriate discounting factors used in calculating the annuity. Calculation of the AHP assessment is discussed in Note 14 - Affordable Housing Program.
Following the satisfaction of their REFCorp obligation, the FHLBanks entered into the Joint Capital Agreement which requires each FHLBank to allocate 20 percent of its net income to a separate restricted retained earnings account until the required contribution is satisfied, beginning in the third quarter of 2011. See Note 16 - Capital for further discussion.
Note 16 - Capital
We are subject to capital requirements under our capital plan, the FHLBank Act, and FHFA regulations:
1.
Risk-based capital. We are required to maintain at all times permanent capital, defined as Class B stock, including Class B stock classified as mandatorily redeemable capital stock, and retained earnings, in an amount at least equal to the sum of our credit-risk capital requirement, market-risk capital requirement, and operations-risk capital requirement, calculated in accordance with FHFA rules and regulations, referred to herein as the risk-based capital requirement. Only permanent capital satisfies the risk-based capital requirement.
2.
Total regulatory capital. We are required to maintain at all times a total capital-to-assets ratio of at least four percent. Total regulatory capital is the sum of permanent capital, the amount paid-in for Class A stock, the amount of any general loss allowance if consistent with GAAP and not established for specific assets, and other amounts from sources determined by the FHFA as available to absorb losses. We have never issued Class A stock.
3.
Leverage capital. We are required to maintain at all times a leverage capital-to-assets ratio of at least five percent. A leverage capital-to-assets ratio is defined as permanent capital weighted 1.5 times divided by total assets.
The FHFA may require us to maintain a greater amount of permanent capital than is required as defined by the risk-based capital requirements.
The following tables demonstrate our compliance with our regulatory capital requirements at December 31, 2013 and 2012 (dollars in thousands):
We are a cooperative whose members and former members own all of our capital stock. Shares of capital stock cannot be purchased or sold except between us and our members at $100 per share par value. We have only issued Class B stock and each member is required to purchase Class B stock equal to the sum of 0.35 percent of certain member assets eligible to secure advances under the FHLBank Act, 3.00 percent for overnight advances, 4.00 percent for advances with an original maturity greater than overnight and up to three months, and 4.50 percent for all other advances and other specified assets related to activity between us and the member.
The Gramm-Leach-Bliley Act of 1999, as amended, made FHLBank membership voluntary for all members. Members may redeem Class B stock after no sooner than five years' notice provided in accordance with our capital plan (the redemption-notice period). The effective date of termination of membership for any member that voluntarily withdraws from membership is the end of the redemption-notice period, at which time any stock that is held as a condition of membership shall be divested, subject to any other applicable restrictions at that time. At that time, any stock held pursuant to activity-based stock investment requirements shall remain outstanding until such requirements are eliminated by disposition of the related business activity. Any member that withdraws from membership may not be readmitted to membership in any FHLBank until five years from the divestiture date for all capital stock that is held as a condition of membership. This restriction does not apply if the member is transferring its membership from one FHLBank to another on an uninterrupted basis.
The redemption-notice period can also be triggered by the involuntary termination of membership of a member by our board of directors or by the FHFA, the merger or acquisition of a member into a nonmember institution, or the relocation of a member to a principal location outside our district. At the end of the redemption-notice period, if the former member's activity-based stock investment requirement is greater than zero, we may require the associated remaining obligations to us to be satisfied in full prior to allowing the member to redeem the remaining shares.
Because our Class B stock is subject to redemption in certain instances, we can experience a reduction in our capital, particularly due to membership terminations due to merger and acquisition activity. However, there are several mitigants to this risk, including, but not limited to, the following:
•
the activity-based portion of the stock-investment requirement allows us to retain stock beyond the redemption-notice period if the associated member-related activity is still outstanding, until the obligations are paid in full;
•
the redemption notice period allows for a significant period in which we can restructure our balance sheet to accommodate a reduction in capital;
•
our board of directors may modify the membership stock-investment requirement or the activity-based stock-investment requirement, or both, to address expected shortfalls in capitalization due to membership termination; and
•
our board of directors or the FHFA may suspend redemptions in the event that such redemptions would cause us not to meet our minimum regulatory capital requirements.
Our board of directors may declare and pay dividends in either cash or capital stock, subject to limitations in applicable law and our capital plan.
Restricted Retained Earnings. Pursuant to the Joint Capital Agreement, and our capital plan, we, together with the other FHLBanks, are required to contribute 20 percent of our quarterly net income to a restricted retained earnings account until the balance of that account equals at least one percent of the FHLBank's average balance of outstanding COs (excluding fair-value adjustments) for the calendar quarter. At December 31, 2013, our total contribution requirement totaled $352.1 million. As of December 31, 2013 and 2012, restricted retained earnings totaled $106.8 million and $64.4 million, respectively. These restricted retained earnings are not available to pay dividends.
Mandatorily Redeemable Capital Stock. We will reclassify capital stock subject to redemption from equity to liability once a member exercises a written notice of redemption, gives notice of intent to withdraw from membership, or attains nonmember status by merger or acquisition, charter termination, or involuntary termination from membership. 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. If a member cancels its written notice of redemption or notice of withdrawal, we will reclassify mandatorily redeemable capital stock from a liability to equity. After the reclassification, dividends on the capital stock would no longer be classified as interest expense.
At December 31, 2013 and 2012, we had $977.3 million and $215.9 million, respectively, in capital stock subject to mandatory redemption. Redemption of capital stock is subject to the redemption-notice period and our satisfaction of applicable minimum capital requirements. For the years ended December 31, 2013, 2012, and 2011, dividends on mandatorily redeemable capital stock of $5.8 million, $1.0 million, and $721,000, respectively, were recorded as interest expense.
The following table is a roll-forward of our capital stock that is subject to mandatory redemption during the years ended December 31, 2013, 2012, and 2011 (dollars in thousands).
The number of stockholders holding mandatorily redeemable capital stock was six at each of December 31, 2013, 2012, and 2011, respectively.
Consistent with our capital plan, we are not required to redeem membership stock until the expiration of the redemption notice period. Furthermore, we are not required to redeem activity-based stock until the later of the expiration redemption-notice period or the activity to which the capital stock relates no longer remains outstanding. If activity-based stock becomes excess stock as a result of an activity-based asset no longer outstanding, we may repurchase such shares, in our sole discretion, subject to the statutory and regulatory restrictions on excess capital-stock redemption discussed below. The year of redemption in the following table represents the end of the redemption-notice period. However, as discussed above, if activity to which the capital stock relates remains outstanding beyond the redemption-notice period, the activity-based stock associated with this activity will remain outstanding until the activity no longer remains outstanding. The following table sets forth the amount of mandatorily redeemable capital stock by year of expiry of redemption period at December 31, 2013 and 2012 (dollars in thousands).
_______________________
(1)
Amount represents mandatorily redeemable capital stock that has reached the end of the five-year redemption period but the member-related activity remains outstanding. Accordingly, these shares of stock will not be redeemed until the activity is no longer outstanding.
A member may cancel or revoke its written notice of redemption or its notice of withdrawal from membership prior to the end of the redemption-notice period. Our capital plan provides that we will charge the member a cancellation fee in the amount of 2.0 percent of the par amount of the shares of Class B stock that is the subject of the redemption notice. We will assess a redemption-cancellation fee unless the board of directors decides that it has a bona fide business purpose for waiving the imposition of the fee, and such a waiver is consistent with the FHLBank Act.
Excess Capital Stock. Our capital plan provides us with the discretion to repurchase capital stock from a member at par value if that stock is not required by the member to meet its total stock investment requirement (excess capital stock) subject to all applicable limitations. In conducting any repurchases, we repurchase any shares that are the subject of an outstanding redemption notice from the member from whom we are repurchasing prior to repurchasing any other shares that are in excess of the member's total stock-investment requirement. We may also allow the member to sell the excess capital stock at par value to another one of our members.
Since December 8, 2008, we have maintained a moratorium on all excess capital stock repurchases to help preserve our capital in the light of the challenges that arose at that time, which were principally due to our investments in private-label MBS. At December 31, 2013 and 2012, members and nonmembers with capital stock outstanding held excess capital stock totaling $1.7 billion and $2.1 billion, respectively, representing approximately 48.8 percent and 58.1 percent respectively of total capital stock outstanding. FHFA rules limit our ability to create member excess capital stock under certain circumstances. We may not pay dividends in the form of capital stock or issue new excess capital stock to members if our excess capital stock exceeds one percent of our total assets or if the issuance of excess capital stock would cause our excess capital stock to exceed one percent of our total assets. At December 31, 2013, we had excess capital stock outstanding totaling 3.8 percent of our total assets. For the year ended December 31, 2013, we complied with the FHFA's excess capital stock rule.
On March 9, 2012, we completed a partial repurchase of excess capital stock in the amount of $250.0 million. Of this amount, $12.6 million was repurchased from mandatorily redeemable capital stock. This was our first such repurchase since the moratorium was established in December 2008, and was the only such repurchase that we made in 2012.
On March 11, 2013, we completed another partial repurchase of excess capital stock in the amount of $300.0 million. Of this amount, $25.0 million was repurchased from mandatorily redeemable capital stock. This was the only repurchase that we made in 2013.
Capital Classification Determination. We are subject to the FHFA's regulation on FHLBank capital classification and critical capital levels (the Capital Rule). The Capital Rule, among other things, defines criteria for four capital classifications and corrective action requirements for FHLBanks that are classified in any classification other than adequately capitalized. An adequately capitalized FHLBank is one that has sufficient permanent and total capital to satisfy its risk-based and minimum capital requirements. We satisfied these requirements at December 31, 2013. However, pursuant to the Capital Rule, the FHFA has discretion to reclassify an FHLBank and modify or add to corrective action requirements for a particular capital classification. If we become classified into a capital classification other than adequately capitalized, we will be subject to the corrective action requirements for that capital classification in addition to being subject to prohibitions on declaring dividends and redeeming or repurchasing capital stock. By letter dated March 20, 2014, the Director of the FHFA notified us that, based on December 31, 2013 financial information, we met the definition of adequately capitalized under the Capital Rule.
Note 17 - Accumulated Other Comprehensive Loss
The following table presents a summary of changes in accumulated other comprehensive loss for the years ended December 31, 2013, 2012, and 2011 (dollars in thousands):
_______________________
(1)
Recorded in net amount of impairment losses reclassified (from) to accumulated other comprehensive loss in the statement of operations.
(2)
Recorded in net gains on derivatives and hedging activities in the statement of operations.
(3)
Recorded in other operating expenses in the statement of operations.
Note 18 - Employee Retirement Plans
Qualified Defined Benefit Multiemployer Plan. We participate in the Pentegra Defined Benefit Plan for Financial Institutions (the Pentegra Defined Benefit Plan), a funded, tax-qualified, noncontributory defined-benefit pension plan. The Pentegra Defined Benefit Plan is treated as a multiemployer plan for accounting purposes, but operates as a multiple-employer plan under the Employee Retirement Income Security Act of 1974, as amended (ERISA), and the Internal Revenue Code. Accordingly, certain multiemployer plan disclosures, including the certified zone status, are not applicable to the Pentegra Defined Benefit Plan. Under the Pentegra Defined Benefit Plan, contributions made by a 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. Also, in the event a participating employer is unable to meet its contribution requirements, the required contributions for the other participating employers could increase proportionately. The plan covers substantially all of our officers and employees. We were not required nor did we pay a funding improvement surcharge to the plan for the years ended December 31, 2013, 2012, and 2011.
The Pentegra Defined Benefit Plan operates on a fiscal year from July 1 through June 30. The Pentegra Defined Benefit Plan files one Form 5500 on behalf of all employers who participate in the plan. The Employer Identification Number is 13-5645888 and the three-digit plan number is 333. We do not have any collective bargaining agreements in place.
The Pentegra Defined Benefit Plan's annual valuation process includes calculating the plan's funded status and separately calculating the funded status of each participating employer. The funded status is defined as the market value of assets divided by the funding target (100 percent of the present value of all benefit liabilities accrued at that date). As permitted by ERISA, the Pentegra Defined Benefit Plan accepts contributions for the prior plan year up to eight and a half months after the asset valuation date. Accordingly, the market value of assets at the valuation date (July 1) will increase by any subsequent contributions designated for the immediately preceding plan year ended June 30.
The most recent Form 5500 available for the Pentegra Defined Benefit Plan is for the plan year ended June 30, 2012. For the Pentegra Defined Benefit Plan plan years ended June 30, 2012 and 2011, our contributions did not represent more than five percent of the total contributions to the Pentegra Defined Benefit Plan.
The following table sets forth our net pension costs and funded status under the Pentegra Defined Benefit Plan (dollars in thousands):
______________________
(1)
The significant increase in the funded status from July 1, 2011, of both the Pentegra Defined Benefit Plan as a whole and our own funded status, is primarily due to a provision contained in the Moving Ahead for Progress in the 21st Century Act (MAP-21), which was signed into law by President Obama on July 6, 2012, and which changed the calculation of the discount rate used in measuring the pension plan liability. MAP-21 allows plan sponsors to measure the pension plan
liability using a 25-year average of interest rates plus or minus a corridor. Prior to MAP-21, the discount rate used in measuring the pension plan liability was based on the 24-month average of interest rates. Over time, the pension funding stabilization effect of MAP-21 will decline because the 24-month smoothed segment rates and 25-year corridors are likely to converge.
(2)
The funded status as of July 1, 2013, is preliminary and may increase because the plan's participants were permitted to make contributions for the plan year ended June 30, 2013, through March 15, 2014. Contributions made on or before March 15, 2014, and designated for the plan year ended June 30, 2013, will be included in the final valuation as of July 1, 2013. The final funded status as of July 1, 2013, will not be available until the Form 5500 for the plan year July 1, 2013, through June 30, 2014 is filed. This Form 5500 is due to be filed no later than April 2015.
(3)
The funded status as of July 1, 2012, is preliminary and may increase because the plan's participants were permitted to make contributions for the plan year ended June 30, 2012, through March 15, 2013. Contributions made on or before March 15, 2013, and designated for the plan year ended June 30, 2012, will be included in the final valuation as of July 1, 2012. The final funded status as of July 1, 2012, will not be available until the Form 5500 for the plan year July 1, 2012, through June 30, 2013 is filed. This Form 5500 is due to be filed no later than April 2014.
Qualified Defined Contribution Plan. We also participate in the Pentegra Defined Contribution Plan for Financial
Institutions, a tax-qualified defined contribution plan. The plan covers substantially all of our officers and employees. We contribute a percentage of the participants' compensation by making a matching contribution equal to a percentage of voluntary employee contributions, subject to certain limitations. Our matching contributions are charged to compensation and benefits expense.
Nonqualified Defined Contribution Plan. We also maintain the Thrift Benefit Equalization Plan, a nonqualified, unfunded deferred compensation plan covering certain of our senior officers and directors. The plan's liability consists of the accumulated compensation deferrals and the accumulated earnings on these deferrals. Our obligation from this plan was $5.1 million and $3.6 million at December 31, 2013 and 2012, respectively. We maintain a rabbi trust intended to satisfy future benefit obligations.
The following table sets forth expenses relating to our defined contribution plans (dollars in thousands):
Nonqualified Supplemental Defined Benefit Retirement Plan. We also maintain a nonqualified, single-employer unfunded defined-benefit plan covering certain senior officers, for which our obligation is detailed below. We maintain a rabbi trust intended to meet future benefit obligations.
Postretirement Benefits. We sponsor a fully insured postretirement benefit program that includes life insurance benefits for eligible retirees. We provide life insurance to all employees who retire on or after age 55 after completing six years of service. No contributions are required from the retirees. There are no funded plan assets that have been designated to provide postretirement benefits.
In connection with the nonqualified supplemental defined benefit retirement plan and postretirement benefits, we recorded the following amounts as of December 31, 2013 and 2012 (dollars in thousands):
______________________
(1)
This represents projected benefit obligation for the nonqualified supplemental defined benefit retirement plan and accumulated postretirement benefit obligation for postretirement benefits.
Amounts recognized in other liabilities on the statement of condition for our nonqualified supplemental defined benefit retirement plan and postretirement benefits at December 31, 2013 and 2012, were $9.7 million and $8.7 million, respectively.
Amounts recognized in accumulated other comprehensive loss for our nonqualified supplemental defined benefit retirement plan and postretirement benefits as of December 31, 2013 and 2012, were (dollars in thousands):
The accumulated benefit obligation for the nonqualified supplemental defined benefit retirement plan was $5.9 million and $5.3 million at December 31, 2013 and 2012, respectively.
The following table presents the components of net periodic benefit cost and other amounts recognized in accumulated other comprehensive loss for our nonqualified supplemental defined benefit retirement plan and postretirement benefits for the years ended December 31, 2013, 2012, and 2011 (dollars in thousands):
The estimated net actuarial loss that will be amortized from accumulated other comprehensive loss into net periodic benefit cost during 2014 is $449,000 for our nonqualified supplemental defined benefit retirement plan and $1,000 for our postretirement benefits.
Key assumptions used for the actuarial calculations to determine benefit obligations and net periodic benefit cost for our nonqualified supplemental defined benefit retirement plan and postretirement benefits at December 31, 2013 and 2012, were:
The discount rate for the nonqualified supplemental defined benefit retirement plan as of December 31, 2013, 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 Citigroup Pension Discount Curve as of December 31, 2013, and solving for the single discount rate that produces the same present value.
Our nonqualified supplemental defined benefit retirement plan and postretirement benefits are not funded; therefore, no contributions will be made in 2014 other than the payment of benefits.
Estimated future benefit payments for our nonqualified supplemental defined benefit retirement plan and postretirement benefits, reflecting expected future services, for the years ending December 31 are (dollars in thousands):
Note 19 - Fair Values
The carrying values, fair values, and fair-value hierarchy of our financial instruments at December 31, 2013 and 2012, were as follows (dollars in thousands). These fair values do not represent an estimate of our overall market value as a going concern, which would take into account, among other things, our future business opportunities and the net profitability of our assets and liabilities.
_______________________
(1)
Carried at fair value on a recurring basis.
(2)
Private-label residential MBS and HFA securities are categorized as Level 3. Private-label residential MBS that have incurred other-than-temporary impairment losses are measured at fair value on a nonrecurring basis. See the recurring and nonrecurring tables below for more details.
_______________________
(1)
Carried at fair value on a recurring basis.
(2)
Private-label residential MBS and HFA securities are categorized as Level 3. Private-label residential MBS that have incurred other-than-temporary impairment losses are measured at fair value on a nonrecurring basis. See the recurring and nonrecurring tables below for more details.
Fair-Value Methodologies and Techniques.
We have determined the fair-value amounts above using available market and other pertinent information and our best judgment of appropriate valuation methods. Although we use our best judgment in estimating the fair value of these financial instruments, there are inherent limitations in any estimation technique or valuation methodology. For example, because an active secondary market does not exist for a portion of our 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 fair values are not necessarily indicative of the amounts that would be realized in current market transactions, although they do reflect our judgment of how a market participant would estimate the fair values.
Fair-Value Hierarchy. Fair value is the price in an orderly transaction between market participants to sell an asset or transfer a liability in the principal (or advantageous) market for the asset or liability at the measurement date (an exit price).
U.S. GAAP establishes a fair-value hierarchy and requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The inputs are evaluated and an overall level for the fair-value measurement is determined. This overall level is an indication of market observability of the fair-value measurement for the asset or liability.
The fair-value hierarchy prioritizes the inputs used to measure fair value into three broad levels:
Level 1
Quoted prices (unadjusted) for identical assets or liabilities in an active market that the reporting entity can access on the measurement date.
Level 2
Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. If the asset or liability has a specified or contractual term, a Level 2 input must be observable for substantially the full term of the asset or liability. Level 2 inputs include the following: (1) quoted prices for similar assets or liabilities in active markets; (2) quoted prices for identical or similar assets or liabilities in markets that are not active; (3) inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates and yield curves that are observable at commonly quoted intervals, volatilities, and prepayment speeds); and (4) inputs that are derived principally from or corroborated by observable market data (e.g., implied spreads).
Level 3
Unobservable inputs for the asset or liability.
We review the fair-value hierarchy classifications on a quarterly basis. Changes in the observability of the valuation inputs may result in a reclassification of certain assets or liabilities. These reclassifications are reported as transfers in/out as of the beginning of the quarter in which the changes occur. There were no such transfers during the years ended December 31, 2013 and 2012.
Summary of Valuation Methodologies and Primary Inputs
Cash and Due from Banks. The fair value approximates the recorded carrying value.
Interest-Bearing Deposits. The fair value approximates the recorded carrying value.
Securities Purchased under Agreements to Resell. The fair value is determined by calculating the present value of expected future cash flows. The discount rates used in these calculations are the rates for securities with similar terms.
Federal Funds Sold. The 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 federal funds with similar terms.
Investment Securities. We determine the fair values of our investment securities, other than HFA floating-rate securities, based on prices obtained for each of these securities that we request from four designated third-party pricing vendors. The fair value of each such security is the average of such vendor prices that are within a cluster pricing tolerance range. A cluster is defined as a group of available vendor prices for a given security that is within a defined price tolerance range of the median vendor price depending on the security type. An outlier is any vendor price that is outside of the defined cluster and is evaluated for reasonableness. The use of the average of available vendor prices within a cluster and the evaluation of reasonableness of outlier prices does not discard available information. In addition, the fair values produced by this method are reviewed for reasonableness.
We request prices on each of our securities subject to this fair-value method from four third-party vendors, when available. These pricing vendors use methods that generally employ, but are not limited to, benchmark yields, recent trades, dealer estimates, valuation models, benchmarking of like securities, sector groupings, and/or matrix pricing. We establish a median price for each security using a formula that is based on the number of prices received:
•
if four prices are received, the average of the two middle prices is used;
•
if three prices are received, the middle price is used;
•
if two prices are received, the average of the two prices is used; and
•
if one price is received, it is used subject to validation of outliers as described below.
Vendor prices that are outside of a defined cluster are identified as outliers and are subject to additional review including, but not limited to, comparison to prices provided by an additional third-party valuation vendor, prices for similar securities, and/or nonbinding dealer estimates, or the use of internal model prices, which we believe reflect the facts and circumstances that a market participant would consider. We also perform this analysis in those limited instances where no third-party vendor price or only one third-party vendor price is available to determine fair value. If the analysis indicates that an outlier (or outliers) is (are) not representative of fair value and that the average of the vendor prices within the tolerance threshold of the median price is the best estimate, then we use the average of the vendor prices within the tolerance threshold of the median price as the final price. If, on the other hand, we determine that an outlier (or some other price identified in the analysis) is a better estimate of fair value, then the outlier (or the other price as appropriate) is used as the final price. In all cases, the final price is used to determine the fair value of the security.
As of December 31, 2013, four vendor prices were received for 93.8 percent of our investment securities and the final prices for substantially all of those securities were computed by averaging the four prices. The relative proximity of the prices received supports our conclusion that the final computed prices are reasonable estimates of fair value. Based on the current low level of market activity for private-label residential MBS, the nonrecurring fair-value measurements for such securities as of December 31, 2013 and 2012, fell within Level 3 of the fair-value hierarchy. Our fixed-rate HFA securities also fall within Level 3 of the fair-value hierarchy due to the current lack of market activities for these bonds.
As an additional step, we reviewed the final fair-value estimates of our private-label MBS holdings as of December 31, 2013, for reasonableness using an implied yield test. We calculated an implied yield for each of our private-label MBS using the estimated fair value derived from the process described above and the security's projected cash flows from our other-than-temporary impairment process. This yield was compared to the implied yield for comparable securities according to price information from dealers and other third-party sources. Significant variances or inconsistencies were evaluated in conjunction with all of the other available pricing information to determine whether an adjustment to the fair-value estimate was appropriate.
Investment Securities - HFA Floating Rate Securities. The 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 securities with similar terms. Our floating rate HFA securities also fall within Level 3 of the fair-value hierarchy due to the current lack of market activity for these bonds.
Advances. We determine the fair value of advances by calculating the present value of expected future cash flows from the advances and excluding the amount of accrued interest receivable. The discount rates used in these calculations are the current replacement rates for advances with similar terms. We calculate our replacement advance rates at a spread to our cost of funds. Our cost of funds approximates the CO curve. See - COs within this note for a discussion of the CO curve. We use market-based expectations of future interest-rate volatility implied from current market prices for similar options to estimate the fair values of advances with optionality. In accordance with the FHFA's advances regulations, advances with a maturity or repricing period greater than six months require a prepayment fee sufficient to make us financially indifferent to the borrower's decision to prepay the advances. Therefore, we do not assume prepayment risk when we determine the fair value of advances. Additionally, we do not account for credit risk in determining the fair value of our advances due to the strong credit protections that mitigate the credit risk associated with advances. Collateral requirements for advances provide surety for the repayment such that the probability of credit losses on advances is very low. We have the ability to establish a blanket lien on all financial assets of most members, and in the case of federally insured depository institutions, our lien has a statutory priority over all other creditors with respect to collateral that has not been perfected by other parties. All of these factors serve to mitigate credit risk on advances.
Mortgage Loans. The fair values for mortgage loans are determined based on quoted market prices of similar mortgage loans adjusted for credit and liquidity risk.
REO. Fair value is derived from third-party valuations of the property, which fall within Level 3 of the fair-value hierarchy.
Accrued Interest Receivable and Payable. The fair value approximates the recorded carrying value.
Derivative Assets/Liabilities - Interest-Rate-Exchange Agreements. We base the fair values of interest-rate-exchange agreements on available market prices of derivatives having similar terms, including accrued interest receivable and payable. The fair-value methodology uses standard valuation techniques for derivatives such as discounted cash-flow analysis and comparisons with similar instruments.
The fair values of all interest-rate-exchange agreements are netted by clearing member and/or by counterparty, including cash collateral received from or delivered to the counterparty. If these netted amounts are positive, they are classified as an asset, and if negative, they are classified as a liability. We generally use a midmarket pricing convention based on the bid-ask spread as a practical expedient for fair-value measurements. Because these estimates are made at a specific point in time, they are susceptible to material near-term changes. We have evaluated the potential for the fair value of the instruments to be affected by counterparty risk and our own credit risk and have determined that no adjustments were significant to the overall fair-value measurements.
The discounted cash-flow model uses market-observable inputs (inputs that are actively quoted and can be validated to external sources), including the following:
•
Discount rate assumption. At December 31, 2013 and 2012, we used either the overnight-index swap (OIS) curve or the LIBOR swap curve depending on the terms of the ISDA agreement we have with each derivative counterparty.
•
Forward interest rate assumption. LIBOR swap curve.
•
Volatility assumption. Market-based expectations of future interest rate volatility implied from current market prices for similar options.
Derivative Assets/Liabilities - Commitments to Invest in Mortgage Loans. Commitments to invest in mortgage loans are recorded as derivatives in the statement of condition. The fair values of such commitments are based on the end-of-day delivery commitment prices provided by the FHLBank of Chicago and a spread, derived from MBS TBA delivery commitment prices with adjustment for the contractual features of the MPF program, such as servicing and credit-enhancement features.
Deposits. We determine the fair values of term deposits by calculating the present value of expected future cash flows from the deposits and reducing this amount by any accrued interest payable. The discount rates used in these calculations are the costs of currently issued deposits with similar terms.
COs. We estimate fair values based on the cost of issuing comparable term debt, excluding non-interest selling costs. Fair values of COs without embedded options are determined based on internal valuation models that use market-based yield curve inputs obtained from the Office of Finance. Fair values of COs with embedded options are determined by internal valuation models with market-based inputs obtained from the Office of Finance and derivative dealers.
The inputs used to determine the fair values of COs are as follows:
•
CO Curve. The Office of Finance constructs an internal yield curve, referred to as the CO curve, using the U.S. Treasury curve as a base yield curve that is then adjusted by adding indicative spreads obtained from market observable sources. These market indications are generally derived from pricing indications from dealers, historical pricing relationships, recent GSE debt trades, and secondary market activity.
•
Volatility Assumption. To estimate the fair values of COs with optionality, we use market-based expectations of future interest-rate volatility implied from current market prices for similar options.
Mandatorily Redeemable Capital Stock. The fair value of capital stock subject to mandatory redemption is generally equal to its par as indicated by contemporaneous member purchases and sales at par value. Fair value also includes an estimated dividend earned at the time of reclassification from equity to liabilities, until that amount is paid, and any subsequently declared dividend. Capital stock can only be acquired by our members at par value and redeemed at par value. Our capital stock is not traded and no market mechanism exists for the exchange of capital stock outside of our cooperative structure.
Commitments. The fair value of our standby bond-purchase agreements is based on the present value of the estimated fees we receive for providing these agreements discounted at yields comparable to those of the related bonds, taking into account the remaining terms of such agreements. For fixed-rate advance commitments, fair value also considers the difference between current levels of interest rates and the committed rates.
Subjectivity of Estimates. Estimates of the fair value of financial assets and liabilities using the methodologies described above 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, possible distributions of future interest rates used to value options, and the selection of discount rates that appropriately reflect market and credit risks. The use of different assumptions could 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.
Fair Value Measured on a Recurring Basis.
The following tables present our assets and liabilities that are measured at fair value on the statement of condition, which are recorded on a recurring basis at December 31, 2013 and 2012, by fair-value hierarchy level (dollars in thousands):
_______________________
(1)
These amounts represent the application of the netting requirements which allow us to settle positive and negative positions and also cash collateral and related accrued interest held or placed with the same clearing member and/or counterparty.
_______________________
(1)
These amounts represent the application of the netting requirements which allow us to settle positive and negative positions and also cash collateral and related accrued interest held or placed with the same clearing member and/or counterparty. We did not hold cash collateral, including accrued interest, associated with derivatives subject to master netting agreements as of December 31, 2012.
Fair Value on a Nonrecurring Basis
We measure certain held-to-maturity investment securities and REO at fair value on a nonrecurring basis, that is, they are not measured at fair value on an ongoing basis but are subject to fair-value adjustments only in certain circumstances (for example, upon recognizing an other-than-temporary impairment on a held-to-maturity security).
The following tables present financial assets by level within the fair-value hierarchy which are recorded at fair value on a nonrecurring basis at December 31, 2013 and 2012 (dollars in thousands).
Note 20 - Commitments and Contingencies
Joint and Several Liability. COs are backed by the financial resources of the FHLBanks. The FHFA has authority to require any FHLBank to repay all or a portion of the principal and interest on COs for which another FHLBank is the primary obligor. No FHLBank has ever been asked or required to repay the principal or interest on any CO on behalf of another FHLBank. We evaluate the financial condition of the other FHLBanks primarily based on known regulatory actions, publicly available financial information, and individual long-term credit-rating action as of each period-end presented. Based on this evaluation, as of December 31, 2013, and through the filing of this report, we do not believe that it is reasonably likely that we will be required to repay the principal or interest on any CO on behalf of another FHLBank.
We have considered applicable FASB guidance and determined it is not necessary to recognize a liability for the fair value of our joint and several liability for all of the COs. The joint and several obligation is mandated by FHFA regulations and is not the result of an arms-length transaction among the FHLBanks. The FHLBanks have no control over the amount of the guaranty or the determination of how each FHLBank would perform under the joint and several obligation. Because the FHLBanks are subject to the authority of the FHFA as it relates to decisions involving the allocation of the joint and several liability for the FHLBanks' COs, the FHLBanks' joint and several obligation is excluded from the initial recognition and measurement provisions. Accordingly, we have not recognized a liability for our joint and several obligation related to other FHLBanks' COs at December 31, 2013 and 2012. The par amounts of other FHLBanks' outstanding COs for which we are jointly and severally liable totaled $727.5 billion and $653.5 billion at December 31, 2013 and 2012, respectively. See Note 13 - Consolidated Obligations for additional information.
Off-Balance-Sheet Commitments
The following table sets forth our off-balance-sheet commitments as of December 31, 2013 and 2012 (dollars in thousands):
__________________________
(1)
The amount of standby letters of credit outstanding excludes commitments to issue standby letters of credit that expire within one year totaling $15.7 million as of December 31, 2013. Also excluded are commitments to issue standby letters of credit that expire within one year totaling $12.6 million at December 31, 2012.
(2)
Commitments for unused line-of-credit advances are generally for periods of up to 12 months. Since many of these commitments are not expected to be drawn upon, the total commitment amount does not necessarily indicate future liquidity requirements.
(3)
We had no unsettled CO bonds that were hedged with associated interest-rate swaps at December 31, 2013. We had $100.0 million in unsettled CO bonds that were hedged with associated interest-rate swaps at December 31, 2012.
Standby Letters of Credit. Standby letters of credit are executed with members or housing associates for a fee. A standby letter of credit is a financing arrangement between us and a member or housing associate pursuant to which we agree to fund the associated member's or housing associate's obligation to a third-party beneficiary should that member or housing associate fail to fund such obligation. If we are required to make payment for a beneficiary's draw, the payment amount is converted into a collateralized advance to the member or housing associate. The original terms of these standby letters of credit range from final expiries in 15 days to 20 years. Our unearned fees for the value of the guarantees related to standby letters of credit are recorded in other liabilities and totaled $562,000 and $523,000 at December 31, 2013 and 2012, respectively.
We monitor the creditworthiness of our members and housing associates that have standby letter of credit agreements outstanding based on our evaluations of the financial condition of the member or housing associate. We review available financial data, which can include regulatory call reports filed by depository institution members, regulatory financial statements filed with the appropriate state insurance department by insurance company members, audited financial statements of housing associates, SEC filings, and rating-agency reports to ensure that potentially troubled members are identified as soon as possible. In addition, we have access to most members' regulatory examination reports. We analyze this information on a regular basis.
Standby letters of credit are fully collateralized at the time of issuance. Based on our credit analyses and collateral requirements, we have not deemed it necessary to record any additional liability on these commitments.
Standby Bond-Purchase Agreements. We enter into standby bond-purchase agreements with state housing authorities from time to time whereby we, for a fee, agreed to purchase and hold the housing authority’s bonds until the designated remarketing agent can find an investor or the housing authority repurchases the bonds according to a schedule established by the standby bond-purchase agreement. Each standby bond-purchase agreement specifies the terms that would require us to purchase the bonds. The last standby bond-purchase commitment we had entered into expired in April 2013. At December 31, 2012, we had standby bond-purchase agreements with one state housing authority. During the years ended December 31, 2013 and 2012, we were not required to purchase any bonds under these agreements.
Commitments to Invest in Mortgage Loans. Commitments to invest in mortgage loans are generally for periods not to exceed 45 business days. Such commitments are recorded as derivatives at their fair values on the statement of condition.
Pledged Collateral. We have pledged securities, as collateral, related to derivatives. See Note 11 - Derivatives and Hedging Activities for additional information about our pledged collateral and other credit-risk-related contingent features.
Lease Commitments. We charged to operating expense net rental costs of approximately $2.7 million, $2.6 million, and $3.4 million for the years ended December 31, 2013, 2012, and 2011, respectively. Future minimum rentals at December 31, 2013, were as follows (dollars in thousands):
Lease agreements for our premises generally provide for increases in the basic rentals resulting from increases in property taxes and maintenance expenses. We do not expect any such increases to have a material effect on us.
Legal Proceedings. We are subject to various legal proceedings arising in the normal course of business from time to time. Management does not anticipate that the ultimate liability, if any, arising out of these matters will have a material effect on our financial condition, results of operations, or cash flows.
Other commitments and contingencies are discussed in Note 8 - Advances, Note 11 - Derivatives and Hedging Activities, Note 13 - Consolidated Obligations, Note 14 - Affordable Housing Program, Note 15 - Resolution Funding Corporation, Note 16 - Capital, and Note 18 - Employee Retirement Plans.
Note 21 - Transactions with Shareholders
We are a cooperative whose members own our capital stock and may receive dividends on their investment in our capital stock. In addition, certain former members and nonmembers that still have outstanding transactions with us are also required to maintain their investment in our capital stock until the transactions mature or are paid off. All advances are issued to members or housing associates, and mortgage loans held for portfolio are generally acquired from members. We also maintain demand-deposit accounts for members and housing associates primarily to facilitate settlement activities that are directly related to advances, mortgage-loan purchases, and other transactions between us and the member or housing associate. In instances where the member has an officer who serves as 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 transactions with all other members.
Beginning in the second quarter of 2013, we defined related parties as members with 10 percent or more of the voting interests of our capital stock outstanding. In prior reports, we defined related parties as members whose capital stock holdings are in excess of 10 percent of total capital stock outstanding. The voting interest method of defining our related parties reflects a more narrow approach and is in agreement with accounting guidance. Shareholder concentrations, defined as members whose capital stock holdings are in excess of 10 percent of total capital stock outstanding, are disclosed in the shareholder concentration section below.
Related Parties. Under the FHLBank Act and FHFA regulations, each member directorship is designated to one of the six states in our district. Each member eligible to vote is entitled to cast by ballot one vote for each share of stock that it was required to hold as of the record date, which is December 31, of the year prior to each election, subject to the limitation that no member may cast more votes than the average number of shares of our stock that are required to be held by all members located in such member's state. Eligible members are permitted to vote all their eligible shares for one candidate for each open member directorship in the state in which the member is located and for each open independent directorship. A nonmember stockholder is not entitled to cast votes for the election of directors unless it was a member as of the record date. At December 31, 2013 and 2012, no shareholder owned more than 10 percent of the total voting interests due to statutory limits on members' voting rights, therefore, we did not have any related parties.
Shareholder Concentrations. We consider shareholder concentrations as members or nonmembers whose capital stock holdings (including mandatorily redeemable capital stock) are in excess of 10 percent of total capital stock outstanding. The following tables present transactions with shareholders whose holdings of capital stock exceed 10 percent or more of total capital stock outstanding at December 31, 2013 and 2012 (dollars in thousands):
__________________________
(1)
Capital stock outstanding at December 31, 2012, included $1.9 million held by CW Reinsurance Company, a subsidiary of Bank of America Corporation (BANA). Bank of America Rhode Island, N.A. (BANA RI) merged into BANA, its parent, during the quarter ended June 30, 2013. BANA is ineligible for Bank membership.
We held sufficient collateral to support the advances to the above institutions such that we do not expect to incur any credit losses on these advances.
We recognized interest income on outstanding advances from the above shareholders during the years ended December 31, 2013, 2012, and 2011 as follows (dollars in thousands):
__________________________
(1)
Includes interest income from advances outstanding to BANA RI through the date of its merger with BANA in April 2013.
During 2013, we received prepayment fees of $903,000 from Bank of America, N.A. and the corresponding principal amount prepaid to us was $4.2 million. During 2012, we did not receive any prepayment fees from Bank of America Rhode Island, N.A. During 2011, we received prepayment fees of $292,000 from Bank of America Rhode Island, N.A. and the corresponding principal amount prepaid to us was $500.0 million.
We did not receive any prepayment fees from RBS Citizens, N.A. during 2013 and 2011. During 2012, we received prepayment fees of $29,000 from RBS Citizens, N.A. The corresponding principal amount prepaid to us during 2012 was $135,000.
Transactions with Directors' Institutions. We provide, in the ordinary course of business, products and services to members whose officers or directors serve on our board of directors. In accordance with FHFA regulations, transactions with directors' institutions are conducted on the same terms as those with any other member.
The following table presents the outstanding balances of capital stock, advances, and accrued interest receivable with members whose officers or directors serve on our board of directors, and those balances as a percentage of our total balance as reported on our statement of condition (dollars in thousands):
Note 22 - Transactions with Other FHLBanks
We may occasionally enter into transactions with other FHLBanks. These transactions are summarized below.
Overnight Funds. We may borrow or lend unsecured overnight funds from or to other FHLBanks. All such transactions are at current market rates. Interest income and interest expense related to these transactions with other FHLBanks are included within other interest income and interest expense from other borrowings in the statement of operations.
MPF Mortgage Loans. We pay a transaction-services fee to the FHLBank of Chicago for our participation in the MPF program. This fee is assessed monthly, and is based upon the amount of mortgage loans which we invested in after January 1, 2004, and which remain outstanding on our statement of condition. For the years ended December 31, 2013, 2012 and 2011, we recorded $1.5 million, $1.3 million, and $1.1 million, respectively in MPF transaction-services fee expense to the FHLBank of Chicago which has been recorded in the statement of operations as other expense.
COs. From time to time, one FHLBank may transfer to another FHLBank the COs for which the transferring FHLBank was originally the primary obligor but upon transfer the assuming FHLBank becomes the primary obligor. During the years ended December 31, 2013 and 2012, we assumed debt obligations with a par amount of $70.0 million and $380.0 million, respectively, and a fair value of approximately $80.1 million and $427.9 million, respectively, on the day they were assumed, which had been the obligations of another FHLBank. During the year ended December 31, 2011, there were no transfers of COs between us and other FHLBanks.
Note 23 - Subsequent Events
On February 20, 2014, the board of directors declared a cash dividend at an annualized rate of 1.49 percent based on capital stock balances outstanding during the fourth quarter of 2013. The dividend, including dividends on mandatorily redeemable capital stock, amounted to $12.9 million and was paid on March 4, 2014.
Supplementary Financial Data
Supplementary financial data for the years ended December 31, 2013 and 2012, are included in the following tables. The following unaudited results of operations include, in the opinion of management, all adjustments necessary for a fair statement of the results of operations for each quarterly period presented below.
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
Our senior management is responsible for establishing and maintaining a system of disclosure controls and procedures designed to ensure that information required to be disclosed by us in the reports filed or submitted under the Securities
Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of controls and procedures.
We have evaluated the effectiveness of the design and operation of our disclosure controls and procedures, with the participation of the president and chief executive officer and chief financial officer, as of the end of the period covered by this report. Based on that evaluation, our president and chief executive officer and chief financial officer have concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of the end of the fiscal quarter covered by this report.
Management's Report on Internal Control over Financial Reporting
Management's report on internal control over financial reporting as of December 31, 2013 is included in Item 8 - Financial Statements and Supplementary Data - Financial Statements - Management's Report on Internal Control over Financial Reporting.
The Bank's independent registered public accounting firm, PricewaterhouseCoopers LLP, has also issued a report regarding the effectiveness of the Bank's internal control over financial reporting as of December 31, 2013, which is included in Item 8 - Financial Statements and Supplementary Data - Financial Statements - Report of Independent Registered Public Accounting Firm.
Changes in Internal Control over Financial Reporting
During the quarter ended December 31, 2013, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. OTHER INFORMATION
None
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Our board of directors is constituted of a combination of industry directors nominated and elected by our members on a state-by-state basis (member directors) and independent directors nominated by our board and elected by a plurality of all our members (independent directors). Our board of directors is currently constituted of eight member directors and six independent directors. One independent directorship is currently vacant. Two of the independent directors are designated as public interest directors.
An FHFA regulation (the Election Regulation) regarding FHLBank board of director elections and director eligibility gives the Director of the FHFA the annual responsibility to determine the size of each FHLBank's board of directors. Further, for each FHLBank, the Election Regulation requires the Director of the FHFA to allocate:
•
the directorships between member directorships and independent directorships, subject to the requirement that a majority, but no more than 60 percent, of the directorships be member directorships; and
•
the member directorships among the states in each FHLBank's district based on the number of shares of FHLBank stock required to be held by members in each state, subject to any state statutory minimum. For us, the only state statutory minimum is for Massachusetts, which is three member directorships.
If, during a director's term of office, the Director of the FHFA eliminates the directorship to which he or she has been elected or, for member directorships, redesignates such directorship to another state, the director's term will end as of December 31 of the year in which the Director of the FHFA takes such action.
Based on the requirements of the Election Regulation, the Acting Director of the FHFA allocated our member directorships among the six New England states that comprise our district for each of 2013 and 2014 as follows:
The elections for the member directorships for 2014 were completed in the fourth quarter of 2013 and involved elections for two Massachusetts and one Connecticut member directorships and one independent directorship. See - 2013 Director Elections below for additional information.
Director Requirements
Board of director elections are conducted in accordance with the FHLBank Act, HERA, regulations issued under each of the foregoing, including the Election Regulation, and our governance documents. In accordance with such statutes and regulations:
•
each director is required to be a U.S. citizen;
•
no director may be a member of our management;
•
each director is elected for a four-year term (unless the Director of the FHFA designates a shorter term for staggering purposes); and
•
no director can be elected to more than three consecutive full terms.
Additional requirements are applicable to member directors, independent directors, and nominees for each as set forth in the following two sections. Apart from such additional requirements, however, FHLBanks are not permitted to establish additional eligibility criteria for directorships.
The Election Regulation provides for members to elect directors by ballot, rather than by voting at a meeting. As a result, we do not solicit proxies, and members are not permitted to solicit or use proxies to cast their votes in the election. A member may not split its votes among multiple nominees for a single directorship. There are no family relationships between any current director (or any of the nominees from the most recent election), any executive officer, and any proposed executive officer. No director or executive officer has an involvement in any legal proceeding required to be disclosed pursuant to Item 401(f) of Regulation S-K.
Member Director and Member Director Nominee Requirements and Nominations
Candidates for member directorships in a particular state are nominated by members in that state. Each member that is required to hold stock as of the record date, which is December 31 of the year prior to each election (the record date), may nominate and vote for representatives from members in its respective state for open member directorships. FHLBank boards of directors are not permitted to nominate or elect member directors, although they may elect a director to fill a vacant directorship. Further, the Election Regulation provides that no director, officer, employee, attorney, or agent, other than in a personal capacity, may support the nomination or election of a particular individual for a member directorship. In addition to the requirements applicable to all directors, each member director and each nominee for member directorships must be an officer or director of a member that is in compliance with the minimum capital requirements established by its regulator.
Because of the foregoing requirements for member director nominations and elections, we do not know what factors our members considered in nominating candidates for member directorships or in voting to elect our member directors. However, when our board of directors has a vacancy, FHFA regulations require the remaining directors to elect a director to fill the vacancy and, in those instances, we can know what was considered in electing such directors, although none of our member directors hold their current directorships due to a vacancy.
Independent Director and Independent Director Nominee Requirements and Nominations
Candidates for independent directorships are nominated by our board of directors. In addition to the requirements applicable to all directors, each independent director is required to be a bona fide resident of our district, and no independent director may serve as an officer, employee, or director of any of our members or other recipient of advances from us and may not be an officer of any FHLBank. At least two of the independent directors must be public interest directors. Public interest directors, as defined by FHFA regulations, are independent directors who have at least four years of experience representing consumer or community interests in banking services, credit needs, housing, or consumer financial protection. Pursuant to FHFA regulations, each independent director must either satisfy the requirements to be a public interest director or have knowledge or experience in one or more of the following areas: auditing and accounting, derivatives, financial management, organizational management, project development, risk-management practices, and the law.
Our members are permitted to (and we ask them to) identify candidates to be considered for inclusion on the nominee slate for independent directorship, but to be considered for nomination, an individual must submit an application to us. We are required to submit information about nominees for independent directorships to the FHFA for review prior to announcing such nominations. In addition, our board of directors is required by FHFA regulations to consult with our Advisory Council in establishing the independent director nominee slate. For information on the Advisory Council, see Item 1 - Business - Business Lines - Targeted Housing and Community Investment Programs. Before nominating any individual for an independent directorship, other than for a public interest directorship, our board of directors must determine that the nominee's knowledge or experience is commensurate with that needed to oversee a financial institution with a size and complexity that is comparable to ours. Our board of directors has made these determinations for each nominee for independent directorships. The Election Regulation permits our directors, officers, attorneys, employees, agents, and Advisory Council to support the candidacy of the board of director nominees for independent directorships.
In determining whom to nominate for independent directorships, the board of directors selected:
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Andrew J. Calamare in 2012 to serve as an independent director, based on his significant experience in business, organizational management, legal, bank regulatory and insurance company matters, as well as experience and involvement in multiple boards of directors that represent consumer or community interests;
•
Joan Carty in 2010 to serve as a public interest director, based on her experience serving as president and chief executive officer of Housing Development Fund, a Stamford, Connecticut-based CDFI that finances multifamily housing, lends directly to low and moderate-income households for first-time purchases, and provides homeownership counseling, homebuyer education, and foreclosure-intervention counseling;
•
Patrick E. Clancy in 2010 to serve as a public interest director, based on his experience serving as president and chief executive officer of The Community Builders, a Boston, Massachusetts-based nonprofit corporation that has developed over 25,000 affordable housing units over the past 40 years;
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Cornelius K. Hurley in 2013 to serve as an independent director, based on his legal and banking experience, having served as general counsel of a large regional bank, and as director of the Center for Finance, Law and Policy at Boston University School of Law, in Boston, Massachusetts;
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Jay F. Malcynsky in 2012 to serve as an independent director, based on his significant experience in law, government-relations and political consulting as well as his involvement in multiple boards of directors of charitable organizations; and
•
Emil J. Ragones in 2011 to serve as an independent director, based on his experience as a former partner at Ernst & Young specializing in information technology audit and controls and related experience in implementing business strategies for financial systems, incorporating or improving information technology and financial controls, addressing regulatory examination findings surrounding information technology and financial controls, and reviewing governance matters applicable to information technology.
Further, all of the independent directors have been independent directors of the Bank prior to their most recent nominations, and our board of directors considered their experience gained from serving on and contributions to our board in selecting them for their most recent nominations.
Additional information on the backgrounds of our directors, including these independent directors, is available under - Information Regarding Current Directors.
One independent directorship is currently vacant due to a resignation that was effective as of December 31, 2013. The board is currently assessing the skills of the current directors and the board’s needs, and expects to fill the vacancy with a candidate whose skills and experience enhance the board’s effectiveness'.
2013 Director Elections
For the election of both member and independent directors, each member eligible to vote is entitled to cast by ballot one vote for each share of stock that it was required to hold as of the record date, subject to the limitation that no member may cast more votes than the average number of shares of our stock that are required to be held by all members located in such member's state. Eligible members are permitted to vote all their eligible shares for one candidate for each open member directorship in the state in which the member is located and for each open independent directorship. For independent directors, unless the board of directors nominates more persons than there are independent directorships to be filled in an election, the candidates must receive at least 20 percent of the number of votes eligible to be cast in the election to be elected. If no nominee receives at least 20 percent of the eligible votes, the Election Regulation requires us to identify additional nominees and conduct additional elections until the directorship is filled.
The nominations were sent by email but nominating certificates were returned by mail. Ballots were distributed and returned by mail. As contemplated by the Election Regulation, no in-person meeting of the members was held in connection with the election. Information about the results of the election was reported on a current report on Form 8-K filed with the SEC on October 25, 2013, as supplemented by Form 8-K/A filed with the SEC on December 20, 2013 and on January 27, 2014.
Information Regarding Current Directors
The term for each director position is four years unless a shorter term is assigned to a director position by the FHFA to implement staggering of the expiration dates of the terms. None of our directors serve as an executive officer of the Bank.
Member Directors
The member directors currently serving on the board of directors provided the information set forth below regarding their principal occupation, business experience, and other matters.
Donna L. Boulanger, age 60, has served as president, chief executive officer and trustee of North Brookfield Savings Bank, located in North Brookfield, Massachusetts, since February 2008. Ms. Boulanger also currently serves on the First District
Community Depository Institutions Advisory Council of the Federal Reserve Bank of Boston, and on the boards of directors of the Massachusetts Bankers Association and the Depositors Insurance Fund, which is also a Bank member. Ms. Boulanger began serving as a director of the Bank on January 1, 2014, and her current term will conclude on December 31, 2017.
Steven A. Closson (vice chair), age 64, serves as a director of Androscoggin Savings Bank, located in Lewiston, Maine. Mr. Closson joined Androscoggin Savings Bank as a senior vice president and treasurer in 1987 and was promoted to president and chief executive officer and elected to Androscoggin Savings Bank's board of directors in 1991. He retired from that position on December 31, 2011. Mr. Closson has served as a director of the Bank since January 1, 2004, and his current term will conclude on December 31, 2015.
Peter F. Crosby, age 63, serves as president, chief executive officer, and trustee of Passumpsic Savings Bank and president, chief executive officer, and director of Passumpsic Bancorp. Mr. Crosby has served as president and chief executive officer of each of Passumpsic Savings Bank and Passumpsic Bancorp, each located in St. Johnsbury, Vermont, since 1999. Mr. Crosby has also served as trustee of Passumpsic Savings Bank and director of Passumpsic Bancorp since 2003. Mr. Crosby began serving at those institutions in 1973. Mr. Crosby also serves as a director of Blue Cross/Blue Shield of Vermont, Inc. and is chair of its Audit Committee. Mr. Crosby has served as a director of the Bank since January 1, 2005, and his current term will conclude on December 31, 2014.
Stephen G. Crowe, age 63, serves as a director of MountainOne Bank and a trustee of MountainOne Financial, its holding company. From 2002 to 2012, Mr. Crowe served as president and chief executive officer of MountainOne Bank. Mr. Crowe served as president and chief executive officer of each of Hoosac Bank from 1994 to 2009 and Williamstown Savings Bank from 2002 to 2009 (merged into Hoosac Bank in June 2012). Mr. Crowe is also a director of The Savings Bank Life Insurance Company of Massachusetts, which is also a Bank member. Mr. Crowe also served as a treasurer of the American Bankers Association in 2011 and 2012, and presently serves on the board of trustees for the Massachusetts College of Liberal Arts. Mr. Crowe's service as a director of the Bank began on January 1, 2012 and his current term will conclude on December 31, 2015.
Martin J. Geitz, age 57, has served as president and chief executive officer of The Simsbury Bank & Trust Company, located in Simsbury, Connecticut, since October 2004 and its holding company, SBT Bancorp, Inc., since its formation in 2005. Mr. Geitz is also a member of the board of directors of The Simsbury Bank & Trust Company and SBT Bancorp, Inc. Mr. Geitz currently serves as the president of the Connecticut Community Bankers Association. Mr. Geitz began serving as a director of the Bank on January 1, 2014, and his current term will conclude on December 31, 2017.
John W. McGeorge, age 69, has served as chief executive officer and chairman of the board of Needham Bank, of Needham, Massachusetts since April 2006. He also served as president of Needham Bank from April 2006 through April 2012. Mr. McGeorge began serving as a director of the Bank on January 1, 2014, and his current term will conclude on December 31, 2017.
John F. Treanor, age 66, has served as a director of The Washington Trust Company, located in Westerly, Rhode Island, since 2001. Mr. Treanor also served as president and chief operating officer at The Washington Trust Company for 10 years prior to his retirement in October 2009. Prior positions included executive vice president, chief financial officer, and chief operating officer of Springfield Institution for Savings in Springfield, Massachusetts (1994 to 1999); executive vice president, treasurer, and chief financial officer of Sterling Bancshares Corporation in Waltham, Massachusetts (1991 to 1994); and various senior management positions at Shawmut National Corporation in Boston, Massachusetts and Hartford, Connecticut (1969-1991). Mr. Treanor also serves on the board of directors of The Beacon Mutual Insurance Company. Mr. Treanor has served as a director of the Bank since January 1, 2011, and his current term will conclude on December 31, 2016.
Kenneth A. Wilman Jr., age 52, has served as president and chief executive officer and a director of Profile Bank, FSB, located in Rochester, New Hampshire since October 2002. Prior to his current position, Mr. Wilman served as vice president of lending from August 1992 until September 2002. Prior to that, he was employed at the Office of Thrift Supervision as a Federal Bank Examiner from 1990 until 1992. Mr. Wilman has served as a director of the Bank since January 1, 2011, and his current term will conclude on December 31, 2014.
Independent Directors
The independent directors currently serving on the board provided the following information about their principal occupation, business experience, and other matters.
Andrew J. Calamare (chair), age 58, has served as executive vice president of The Co-operative Central Bank, located in Boston, Massachusetts, since January 2011. Prior to his current position, Mr. Calamare served as president and chief executive officer of the Life Insurance Association of Massachusetts since 2000. Prior to that position, Mr. Calamare served as of counsel with the law firm Quinn and Morris, as special counsel to the Rhode Island General Assembly, and as Commissioner of Banks for the Commonwealth of Massachusetts. Mr. Calamare has served as a director of the Bank since March 30, 2007, and his current term will conclude on December 31, 2016.
Joan Carty, age 62, has served as president and chief executive officer of Housing Development Fund in Stamford, Connecticut, since 1994. She has also served as executive director of Bridgeport Neighborhood Fund, of Bridgeport, Connecticut; Neighborhood Preservation Program, of Stamford, Connecticut; and Neighborhood Housing Services, of Brooklyn, New York. Ms. Carty has served as a director of the Bank since January 1, 2008, and her current term will conclude on December 31, 2014.
Patrick E. Clancy, age 67, served from 1977 through 2011 as president and chief executive officer of The Community Builders, a Boston-based nonprofit corporation that has developed or redeveloped approximately 25,000 units of affordable and mixed-income housing. He continues to engage in the field as an independent consultant and developer. Mr. Clancy has served as director of the Bank since March 30, 2007, and his current term will conclude on December 31, 2014.
Cornelius K. Hurley, age 68, has served as director of the Boston University Center for Finance, Law & Policy, the successor to the Morin Center for Banking and Financial Law at Boston University School of Law, since 2005. Prof. Hurley also serves as a director of Computershare Trust Company, N.A., located in Canton, Massachusetts, a wholly owned subsidiary of Computershare, Ltd. Prior to serving as director of the Center for Finance, Law & Policy, Prof. Hurley served as managing director of The Secura Group from 1990 to 1997, and as general counsel and director of human resources of Shawmut National Corporation and its predecessor companies from 1981 to 1990. He also previously served as assistant general counsel to the Board of Governors of the Federal Reserve System. Prof. Hurley was previously appointed as a director of the Bank on March 30, 2007, for a term that expired on December 31, 2008. Prof. Hurley was reappointed as a director of the Bank on April 16, 2009, to fill an open vacancy on the board, which ended on December 31, 2013. His current term will conclude on December 31, 2017.
Jay F. Malcynsky, age 60, has served as president and managing partner of Gaffney, Bennett and Associates, Inc., a Connecticut-based corporation specializing in government relations and political consulting since 1984. Mr. Malcynsky is also a practicing lawyer in Connecticut and Washington, D.C., specializing in administrative law and regulatory compliance. Mr. Malcynsky previously served as a director of the Bank from 2002 to 2004. Mr. Malcynsky was reappointed as a director on March 30, 2007, and his current term will conclude on December 31, 2016.
Emil J. Ragones, age 67, has served since 2008 as executive in residence at Accounting Management Solutions, Inc., a company located in Boston, Massachusetts, providing accounting and financial management services. Prior to his current position, Mr. Ragones served as partner at Ernst & Young for 39 years, including 24 years of service as an audit partner. In addition to performing financial statement audits, Mr. Ragones specialized in providing information technology auditing, as well as advisory and consulting services to clients in a variety of industries, including to financial services clients. Prior to his retirement from Ernst & Young in 2007, Mr. Ragones spent seven years in the firm's national professional practice. Mr. Ragones has served as a director of the Bank since September 24, 2010, and his current term will conclude on December 31, 2015.
Audit Committee Financial Expert
Our board of directors has a standing Audit Committee that satisfies the "Audit Committee" definition under Section 3(a)(58)(A) of the Securities Exchange Act of 1934. Our board of directors' Audit Committee Charter is available in full on our website at the following location: http://www.fhlbboston.com/downloads/aboutus/Audit_Committee_Charter.pdf.
The members of the Audit Committee are Directors Ragones (chair), Crowe (vice chair), Malcynsky, McGeorge, Treanor, and Calamare (ex officio). The board has determined that Director Crowe is the "audit committee financial expert" within the meaning of the SEC rules. Mr. Crowe is not an auditor or accountant for us, does not perform fieldwork, and is not a Bank employee. In accordance with the SEC's safe harbor relating to Audit Committee financial experts, a person designated or identified as an Audit Committee financial expert will not be deemed an "expert" for purposes of federal securities laws. In addition, such a designation or identification does not impose on any such person any duties, obligations, or liabilities that are greater than those imposed on such persons as a member of the Audit Committee and board of directors in the absence of such designation or identification and does not affect the duties, obligations, or liabilities of any other member of the Audit
Committee or board of directors. See Item 13 - Certain Relationships and Related Transactions, and Director Independence for additional information regarding Mr. Crowe’s independence.
Report of the Audit Committee
The Audit Committee assists the board in fulfilling its oversight responsibilities for (1) the integrity of our financial reporting, (2) the establishment of an adequate administrative, operating, and internal accounting control system, (3) our compliance with legal and regulatory requirements, (4) the independent registered public accounting firm's independence, qualifications, and performance, (5) the independence and performance of our internal audit function, and (6) our compliance with internal policies and procedures. The Audit Committee has adopted, and annually reviews, a charter outlining the practices it follows.
Management is responsible for the Bank's internal controls and the financial reporting process. PricewaterhouseCoopers LLP (PwC), our independent registered public accounting firm, is responsible for performing an independent audit of the financial statements and of the effectiveness of internal control over financial reporting in accordance with auditing standards promulgated by the Public Company Accounting Oversight Board (PCAOB). Our internal auditors are responsible for preparing an annual audit plan and conducting internal audits under the direction of the Director of Internal Audit, who is accountable to the Audit Committee. The Audit Committee acts in an oversight role with the responsibility to monitor and oversee these processes.
The Audit Committee has reviewed and discussed the audited financial statements with management, including a discussion of the quality, not just the acceptability, of the accounting principles used, the reasonableness of significant accounting judgments and estimates, and the clarity of disclosures in the financial statements. In addressing the quality of management's accounting judgments, members of the Audit Committee asked for representations and reviewed certifications prepared by the chief executive officer and chief financial officer that the audited financial statements present, in all material respects, the financial condition and results of operations, and have expressed to both management and PwC their general preference for conservative policies when a range of accounting options is available. In meeting with PwC, the Audit Committee asked them to address and discuss their responses to several questions that the Audit Committee believes are particularly relevant to its oversight. These questions include:
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Are there significant judgments or estimates made by management in preparing the financial statements that would have been made differently had PwC themselves prepared and been responsible for the financial statements?
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Based on PwC's experience, and their knowledge of the Bank, do the financial statements present fairly, with clarity and completeness, the Bank's financial position and performance for the reporting period in accordance with GAAP and SEC disclosure requirements?
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Based on PwC's experience, and their knowledge of the Bank, has the Bank implemented internal controls and internal audit procedures that are appropriate for the Bank?
The Audit Committee believes that by focusing its discussions with PwC, it promotes a meaningful discussion that provides a basis for its oversight judgments.
The Audit Committee has discussed with PwC the matters required to be discussed by PCAOB Auditing Standard No. 16, Communications with Audit Committees, PwC has provided to the Audit Committee the written disclosures and the letter required by PCAOB Rule 3526, Communication with Audit Committees Concerning Independence, and the Audit Committee has discussed with PwC their independence.
In reliance on these reviews and discussions, and the report of the independent registered public accounting firm, the Audit Committee has recommended to the board of directors, and the board of directors has approved, that the audited financial statements be included in the Bank's annual report on Form 10-K for the year ended December 31, 2013, for filing with the SEC.
Executive Officers
The following table sets forth the names, titles, and ages of our executive officers:
_________________________
(1)
Each of the executive officers listed serves on our Management Committee, with the exception of Mr. Donahue.
Edward A. Hjerpe III has served as president and chief executive officer since July 2009. Mr. Hjerpe came to us from Strata Bank and Service Bancorp, Inc., where he was interim chief executive officer from September 2008 until joining us. Mr. Hjerpe was a financial, strategy, and management consultant from August 2007 to September 2008, and both president and chief operating officer of the New England Region of Webster Bank and senior vice president of Webster Financial Corporation from May 2004 to June 2007. Prior to those roles, Mr. Hjerpe served as executive vice president, chief operating officer, and chief financial officer at FIRSTFED AMERICA BANCORP, Inc. from July 1997 to May 2004. Mr. Hjerpe also worked with us from 1988 to 1997, first as vice president and director of financial analysis and economic research, and ultimately as executive vice president and chief financial officer. Mr. Hjerpe has been involved in numerous community, civic, industry, and nonprofit organizations over the course of his career. He currently serves as a member of the board of directors of the Office of Finance and was the 2013 chair of the FHLBank Presidents Conference. He also serves as the chair of the board of Dental Services of Massachusetts, is a current member and past chair of the board of trustees of St. Anselm College in Manchester, New Hampshire, and is a current member of the board of directors of the Pentegra Defined Benefit Plan for financial institutions. Mr. Hjerpe earned a B.A. in business and economics from St. Anselm College, and an M.A. and Ph.D. in economics from the University of Notre Dame.
M. Susan Elliott has served as executive vice president and chief business officer since October 2009. Prior to assuming that position, Ms. Elliott had served as executive vice president of member services since January 1994. She previously served as senior vice president and director of marketing from August 1992 to January 1994. Ms. Elliott joined us in 1981. Ms. Elliott holds a B.S. from the University of New Hampshire and an M.B.A. from Babson College.
Frank Nitkiewicz has served as executive vice president and chief financial officer since January 2006. Prior to assuming that position, Mr. Nitkiewicz had served as senior vice president, chief financial officer, and treasurer from August 1999 until December 31, 2005, and senior vice president and treasurer from October 1997 to August 1999. Mr. Nitkiewicz joined us in 1991. He holds a B.S. and a B.A. from the University of Maryland and an M.B.A. from the Kellogg Graduate School of Management at Northwestern University.
Timothy J. Barrett has served as senior vice president and treasurer since November 2010. Prior to employment with us, Mr. Barrett served as assistant treasurer at FMR LLC, the parent company of Fidelity Investments from September 2008 to October 2010; served as treasurer and chief investment officer at Fidelity Personal Bank & Trust from August 2007 to September 2008; served as managing director, global treasury at Investors Bank & Trust from September 2004 to July 2007; served in various senior roles in treasury at FleetBoston Financial (including merged entities) from 1985 to 2004; and served as an investment manager for Citibank, NA from 1981 to 1985. Mr. Barrett received his B.A. from St. Anselm College and his M.B.A. from Rensselaer Polytechnic Institute.
George H. Collins has served as senior vice president and chief risk officer since November 2006. Prior to assuming that position, Mr. Collins had served as first vice president, director of market risk management from 2005 to 2006. Mr. Collins joined us in July 2000 as vice president and assistant treasurer. He holds a B.S. in applied mathematics and economics from the State University of New York at Stony Brook.
Brian G. Donahue was promoted from first vice president to senior vice president in 2013 and has served as controller and chief accounting officer since February 2010. Prior to assuming that position, Mr. Donahue had served as first vice president and controller since 2007, vice president and controller from 2004 to 2007, as assistant vice president and assistant controller from 2001 to 2004, and in progressively responsible positions from 1992 to 1999, when he served as assistant controller. Mr. Donahue worked for two years as assistant vice president and division controller for State Street Bank and Trust Company,
from 1999 to 2001. Prior to joining us in 1992, Mr. Donahue was an associate with Price Waterhouse. Mr. Donahue earned his B.B.A. from James Madison University and his M.B.A. from Boston University, and is a certified public accountant.
Barry F. Gale has served as senior vice president and executive director of human resources since April 2013. Prior to employment with us, Mr. Gale served as senior director of human resources at Thomson Reuters where he spent 18 years in progressively senior roles. Prior to that position, Mr. Gale served in human resources roles at each of Citizens Financial Group and The Colonial Group. Mr. Gale holds a B.S. in business management from The University of Massachusetts, Boston.
Carol Hempfling Pratt has served as senior vice president and general counsel since June 2010. Prior to employment with us, Ms. Pratt had spent her entire legal career specializing in corporate and banking law at the Boston law firm of Foley Hoag LLP, where she began as an associate in 1984 and was promoted to partner in 1992. Ms. Pratt holds a B.A. from Northwestern University and a J.D. from Northwestern University School of Law.
Code of Ethics and Business Conduct
We have adopted a Code of Ethics and Business Conduct that sets forth the guiding principles and rules of behavior by which we operate and conduct our daily business with our customers, vendors, shareholders, and with our employees. The Code of Ethics and Business Conduct applies to all directors and employees, including the chief executive officer, chief financial officer, and chief accounting officer, and all other professionals serving in a finance, accounting, treasury, or investor-relations role. The purpose of the Code of Ethics and Business Conduct is to avoid conflicts of interest and to promote honest and ethical conduct and compliance with the law, particularly as related to the maintenance of our financial books and records and the preparation of our financial statements. The Code of Ethics and Business Conduct can be found on our website (http://www.fhlbboston.com/downloads/aboutus/code_of_ethics.pdf). All future amendments to, or waivers from, the Code of Ethics and Business Conduct will be posted on our website. The information contained within or connected to our website is not incorporated by reference into this annual report on Form 10-K and should not be considered part of this or any report filed with the SEC.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Compensation Discussion and Analysis
Executive Summary
We attract, reward, and retain senior managers, including our president, chief financial officer, and other most highly compensated executive officers (the named executive officers) by offering a total rewards package that includes base salary as a core component, cash incentive opportunities, qualified and nonqualified retirement plans, and certain perquisites.
For the year ended December 31, 2013, the named executive officers were:
Edward A. Hjerpe III
President and Chief Executive Officer;
Frank Nitkiewicz
Executive Vice President and Chief Financial Officer;
M. Susan Elliott
Executive Vice President and Chief Business Officer;
George H. Collins
Senior Vice President and Chief Risk Officer;
Carol Hempfling Pratt
Senior Vice President and General Counsel; and
Timothy J. Barrett
Senior Vice President and Treasurer.
Compensation program objectives are set forth in our Total Rewards Philosophy, which was used in determining the total rewards packages for the named executive officers for 2013. Total rewards packages, including base salary, cash incentive opportunities, and retirement plans, were set based on each named executive officer's performance, tenure, experience, and complexity of position and to be competitive in the labor market for senior managers in which we compete. Overall, the named executive officers were awarded moderate increases in base salary effective January 1, 2014. Additionally, we adopted an executive incentive plan (an EIP) in 2013 (the 2013 EIP). The 2013 EIP was designed with incentive payout opportunities that were lower than the competitive market, but higher than the 2012 EIP incentive opportunities, based on our then-current and improving financial condition. Cash incentives awarded under EIPs in 2013 were determined based on the criteria set forth in the 2013 EIP and the 2011 EIP.
Compensation Committee
Pursuant to a charter approved by the board of directors, the Human Resources and Compensation Committee (the Compensation Committee) assists the board of directors in developing and maintaining personnel and compensation policies that support our business objectives. The Compensation Committee develops and recommends the compensation philosophy for the board of directors' review and approval. The Compensation Committee reviews and recommends to the board of directors, for its approval, human resources policies and plans applicable to the compensation philosophy, such as compensation, benefits, and incentive plans in which the named executive officers may participate.
The members of the Compensation Committee are:
Stephen G. Crowe, Chair;
Jay F. Malcynsky, Vice Chair;
Joan Carty;
Steven A. Closson;
John W. McGeorge; and
Andrew J. Calamare (ex officio).
Compensation Committee Interlocks and Insider Participation
No member of the Compensation Committee has at any time been an officer or employee with us. None of our executive officers has served or is serving on our board of directors or the compensation committee of any entity whose executive officers served on the Compensation Committee or our board of directors.
Compensation Committee Report
The Compensation Committee has reviewed and discussed with management the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K. Based on our review and discussion, we recommended to the board of directors that the Compensation Discussion and Analysis be included in the annual report on the Form 10-K for the fiscal year ending December 31, 2013.
Shareholder Advisory Vote on Executive Compensation
We are governed and directors are elected as described under Item 10 - Directors, Executive Officers and Corporate Governance. As such, we do not engage in a proxy process and have not otherwise engaged in any activity that would require a consent solicitation of our members. Accordingly, there is no shareholder advisory vote on executive compensation in determining our compensation policies and decisions.
Objectives of our Compensation Program and What it is Designed to Reward
We are committed to providing a compensation package that enables us to attract, reward, motivate, and retain highly skilled executive officers, including the named executive officers, who make significant contributions to the success of our business.
In 2006, with the approval of the Compensation Committee and board of directors, we retained McLagan Partners (McLagan), a compensation consulting firm specializing in the financial services industry, to assist with a comprehensive total rewards study. A major outcome of the study was the adoption of a "Total Rewards Philosophy," the principles of which have been the basis for determining total compensation for the named executive officers since that time. The Total Rewards Philosophy was updated in 2009 to ensure its consistency with an FHFA advisory bulletin on executive compensation principles. FHLBank executive compensation is subject to FHFA review, as described under - FHFA Oversight of Executive Compensation.
The Total Rewards Philosophy defines compensation goals, competitive market and peer groups, components and comparability of the total rewards package, performance evaluation and compensation, and responsibility for administration and oversight of compensation and benefits programs. The Compensation Committee and board of directors are responsible for periodically reviewing the Total Rewards Philosophy to ensure consistency with our overall business objectives, the competitive market, and our financial condition.
The Total Rewards Philosophy provides for a total compensation and benefits package for employees, including the named executive officers, that:
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Is tailored to our unique cooperative structure and the FHLBank System.
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Is reasonable, comparable, and competitive in the marketplace in which we compete and therefore enables us to attract, retain, motivate, and reward talent.
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Is consistent with sound risk management practices and is tied to the short-term and long-term financial performance and our condition. This includes designing incentive programs so that staff engaged in risk-management and compliance functions are rewarded in a manner independent of the financial performance of the business areas they monitor.
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Directly links individual total rewards opportunities to our mission and annual and long-term business and financial strategies and to a combination of Bankwide, business unit/team, and individual performance metrics linked to the objectives of the employee's principal functions.
•
Delivers an optimal mix of compensation and benefits to maximize the total value derived and perceived by different employee groups while maximizing our cost-effectiveness.
Risk and Bank Compensation Practices and Policies
One objective of our Total Rewards Philosophy is the alignment of compensation practices and policies with sound risk- management practices. In support of this objective, our chief risk officer reviews the design of our compensation plans and policies, including the 2013 EIP, to ensure these plans do not promote or reward imprudent risk taking. Additionally, the 2013 EIP includes long-term incentive opportunities based on the level of retained earnings and targeted regulatory results at December 31, 2015 with associated deferred payouts of 50 percent of the 2013 EIP's awards, which are intended to align management's interests with the long-term financial performance and condition of the Bank.
Further, as described under - Executive Incentive Plan - Additional Conditions on Long-Term Awards, the long-term incentive opportunities are subject to reduction or elimination in certain cases including in the case of certain material revisions to our financial results or to data used to determine the 2013 short-term awards, which are intended to further reduce the risk of imprudent risk taking.
Further, our chief risk officer and our head of human resources jointly engage in periodic reviews of our compensation practices and policies in an effort to ensure that such practices or policies do not result in risks that are reasonably likely to have a material adverse effect. They report on the results of these reviews to the Compensation Committee at least annually. In developing that report, compensation policies and practices are reviewed first on a stand-alone basis, then in combination with enterprise-wide risk-management controls that constrain risk taking, and finally in conjunction with procedural risk controls at the business department level that are intended to further mitigate risk-taking activities. In January 2014, the Compensation Committee concluded that none of the compensation policies or plans in effect are reasonably likely to have a material adverse effect on the Bank based on the report and related discussions.
Compensation plans and policies for staff engaged in risk-management and compliance functions are intended to reward participants in a manner independent of the financial performance of the business areas they monitor. For example, as discussed under - Executive Incentive Plan - Incentive Goals, Mr. Collins' goals, as chief risk officer, differ somewhat and have different weightings under the 2013 EIP than the other named executive officers. These differences are intended to align his incentives with appropriately managing our risk profile. Likewise, all participants in the 2013 EIP working in ERM have somewhat different goals and weightings than their peers in other departments.
In addition to our internal processes, the FHFA has oversight authority over our executive compensation. In the exercise of this authority, the FHFA has issued certain compensation principles, one of which is that executive compensation should be consistent with sound risk management and preservation of the par value of FHLBank stock. Also, the FHFA reviews all executive compensation, including the 2013 EIP, relative to these principles and such other factors as the FHFA determines to be appropriate, prior to their effectiveness. For additional information on this oversight, see - FHFA Oversight of Executive Compensation.
Overview of the Labor Market for Senior Managers
The labor market in which we compete for senior managers, including the named executive officers, is broader in scope than only the FHLBank System or other GSEs, such as Fannie Mae and Freddie Mac. In fact, we must compete directly with financial institutions in the private sector to attract and retain the most qualified and highly sought-after staff. The local financial services labor market is dominated by traditionally high-paying asset-management firms that may be labor market competitors even though they are not business competitors. As a result, we may, at times, have to expand recruiting efforts to a regional or national basis to recruit named executive officers and other senior executives with the specialized skills needed to manage the complex risks of a wholesale lending and mortgage loan investment operation. For these reasons, we must be
positioned to offer a competitive compensation package to attract and retain talented managers. When setting compensation levels, we also consider the high cost of living in the Boston area.
The Total Rewards Philosophy defines two primary competitive peer groups for the named executive officers: the other FHLBanks and commercial/regional banks. Both peer groups are considered in setting the total rewards package. However, no specific target among the peer groups is selected for named executive officer compensation. Rather, the data is used as a general matter to ensure the total rewards packages remain competitive as determined by the Compensation Committee relative to those peer groups.
The first primary peer group consists of the other FHLBanks that serve as the primary peer group for determining the proportionate mix of pay and benefits. While all of the FHLBanks share the same mission, they may differ in their relative mix of products and services and location among urban and smaller-city locations, both of which impact labor-market competition and compensation by individual FHLBank. However, due to the FHLBank System's unique cooperative structure, all FHLBanks generally must rely on a similarly structured total rewards package for the named executive officers, including base salary, cash incentives, and benefits, since none can offer equity-based compensation opportunities such as those offered at their non-FHLBank competitors. In 2013, we participated in, and used the results of, the annual FHLBank System survey of key positions to determine whether the total rewards packages for the named executive officers, as well as the proportionate mix of pay and benefits, are competitive with the median for each matched position as discussed below in more detail.
The second primary peer group, commercial/regional banks, serves as a relevant comparator group for competitive positioning of the total rewards package for those positions requiring financial services experience, including the named executive officers. The commercial/regional bank peer group focuses on large and mid-sized commercial/regional banks and financial services firms but excludes large global investment banks. Both the Bank and commercial banks engage in wholesale lending and share similarities in several functional areas, particularly middle-office and support areas, but with a marked difference between the two in capital-market activities and market risk. The commercial bank peer group consists mostly of banks with multiple product lines/offerings and significant assets. The most significant difference between us and the commercial/regional bank peer group is that we are focused on wholesale banking activities while the peer group generally engages in both wholesale and retail activities. The market analysis focuses on the wholesale activities and excludes retail-focused positions.
We worked with McLagan to match several of the positions held by the named executive officers to comparable positions in the commercial/regional banks peer group of McLagan's proprietary 2013 FHLB Custom Survey and its 2013 Finance and Business Services Survey. Named executive officer positions were matched to those survey positions that represented realistic job opportunities based on scope, similarity of positions, experience, complexity, and responsibilities. Realistic job opportunities included positions for which the named executive officers would be qualified at the external firms as well as positions at the firm that we would consider when recruiting for experienced executives. This approach generally resulted in comparing the named executive officers to divisional rather than overall heads of businesses and functions.
The following is a list of survey participants that were included by McLagan in the commercial/regional banks peer group in the 2013 FHLB Custom Survey or the 2013 Finance and Business Services Survey. Not all participants reported positions that matched the data set for the named executive officers.
ABN AMRO Securities (USA) LLC
Ernst & Young
PricewaterhouseCoopers
Advent Software
Fannie Mae
Prudential Financial
Ally Financial Inc.
Fidelity Investments
Rabobank Nederland
American Express
Fifth Third Bank
Raymond, James & Associates
Banco Bilbao Vizcaya Argentaria
First Merit Bank
RBS/Citizens Bank
Bank Hapoalim
First Niagara
Regions Financial Corporation
Bank of America
Freddie Mac
Robert W. Baird & Co. Inc.
Bank of the West
FTI Consulting
Royal Bank of Canada
Bank of Tokyo - Mitsubishi UFJ
GE Capital
Sallie Mae
BBVA Compass
HSBC
Santander (includes legacy Sovereign)
BMO Financial Group
Huntington Bancshares, Inc.
Societe Generale
BNP Paribas
ICAP
Standard Chartered Bank
BOK Financial Corporation
ING
State Street Bank & Trust Company
BP Oil International Ltd.
Jefferies
SunTrust Banks
Branch Banking & Trust Co.
JP Morgan
SVB Financial Group
Brown Brothers Harriman & Co.
KBC Bank
Synovus
Capital One
KeyCorp
TD Securities
Charles Schwab & Co., Inc
Lloyds Banking Group
The Bank Of New York Mellon
CIBC World Markets
M&T Bank Corporation
The Bank of Nova Scotia
Citigroup
Macquarie Bank
The CIT Group
Comerica
Mitsubishi UFJ Trust & Banking Corporation (USA)
The Northern Trust Corporation
Commerzbank
Mizuho Corporate Bank, Ltd.
The Vanguard Group, Inc.
Credit Industriel et Commercial
Natixis
TIAA-CREF
Credit Agricole CIB
Newedge
UniCredit
Cushman & Wakefield, Inc.
Nomura Securities
Union Bank, N.A.
Depository Trust & Clearing Corporation
Nord/LB
Webster Bank
Dexia
Piper Jaffray
Wells Fargo Bank
DZ Bank
PNC Bank
Zions Bancorporation
East West Bancorp
Popular Community Bank
Data from international banks only contained results from their U.S. operations.
Elements of our Compensation Plan and Why Each Element is Selected
We compensate the named executive officers principally based on their performance, tenure, experience, and complexity of position through a package that consists of a mix of base salary, cash-incentive opportunities, qualified and nonqualified retirement plans, and various other health and welfare benefits, that is, total rewards. From time to time, we will also award special cash bonuses outside of an EIP to compensate a named executive officer based on unusual or exemplary circumstances. Each compensation element is discussed in greater detail below. Due to our cooperative structure, we cannot offer equity-based compensation programs, so we have historically used higher base salaries, cash-incentive opportunities, and strong retirement benefits to keep our compensation packages competitive relative to the market and to replace some of the value of compensation that competitors might offer through equity-based compensation programs. The named executive officers may also be provided with certain additional perquisites. Although we do not engage in benchmarking, the Total Rewards Philosophy provides that our total rewards package, including that for named executive officers, should be competitive with the median total rewards package for matched positions in the two primary peer groups, as discussed under - Overview of the Labor Market for Senior Managers above. Historically, the Compensation Committee has set total rewards packages for each of the named executive officers so that their total rewards package of base salary, cash incentives, and retirement plans would be competitive with the median total rewards packages at the commercial/regional bank peer group, including base salary and short- and long-term incentives, and so that their total cash compensation, that is, base salary plus cash incentives, would be competitive with the median total cash compensation of the named executive officer's peers at other FHLBanks, particularly the FHLBanks of Atlanta, Chicago, Dallas, New York, and San Francisco, since these FHLBanks are also located in larger urban areas and are more representative of the Boston labor market than FHLBanks located in smaller cities. The Compensation
Committee has also considered median total cash compensation at the other FHLBanks as the comparator since it includes base salaries and cash incentives, but does not consider the value of retirement plans since they are generally of similar value across the FHLBank System. The Compensation Committee has been informed by the same data in setting current total rewards packages, however, the Compensation Committee has also considered our financial condition in setting total rewards packages, as it has each year since 2009, for each of the named executive officers at levels lower than the Total Rewards Philosophy may have otherwise indicated.
How we Determine the Amount for Each Element of our Compensation Plan
The board of directors sets annual goals and objectives for the chief executive officer. In 2013, these goals and objectives were developed to align with our strategic business plan. At the end of the year, the chief executive officer provides the Compensation Committee with a self-assessment of his corporate and individual achievements. Based on the Compensation Committee's evaluation of his performance and review of competitive market data for the defined peer groups, the Compensation Committee determines and recommends an appropriate total compensation and benefits package to the board of directors for approval. In the case of other named executive officers, the chief executive officer reviews individual performance and submits market data and recommendations to the Compensation Committee regarding appropriate compensation. The Compensation Committee reviews these recommendations and submits its recommendations to the full board of directors. The board of directors reviews the recommendations and approves the compensation it considers appropriate giving consideration to the labor market for senior managers and the Total Rewards Philosophy.
The Compensation Committee does not set specific, predetermined targets for the allocation of total rewards between base salary, cash incentives, and benefits, including retirement and other health and welfare plans and perquisites. Rather, the Compensation Committee considers the value and mix of the total rewards package offered to each named executive officer compared with the total rewards package for positions of comparable scope, responsibility, and complexity of position at the two defined peer groups, the incumbent's performance, experience and tenure, and internal equity.
Base Salary
Base salary is the core component of the total rewards packages for the named executive officers. Base salary adjustments for all named executive officers are considered at least annually as part of the year-end annual performance review process and more often if considered necessary by the Compensation Committee during the year, such as in recognition of a promotion or to ensure internal equity.
After review and nonobjection by the FHFA, the board of directors awarded the named executive officers an increase in base salary on January 23, 2014, with retroactive application to January 1, 2014. In determining the amount of the increases, the Compensation Committee considered market data from the annual FHLBank System survey of key positions, and the McLagan 2013 FHLB Custom Survey, and McLagan's 2013 Finance and Business Survey discussed under - Overview of the Labor Market for Senior Managers above. Additionally, the Compensation Committee considered the recommendations of Mr. Hjerpe for the other named executive officers based on individual performance, tenure, experience, and complexity of the named executive officer's position and internal equity. Mr. Hjerpe recommended, and the board of directors awarded at the recommendation of the Compensation Committee, merit increases in base salary for each of the named executive officers. The percentage increases in base salary were generally consistent with merit and adjustment increases granted to staff.
The following table sets forth the base salary increases which took effect on January 1, 2014:
Executive Incentive Plan
General Overview of EIPs
EIPs are cash incentive plans which are reviewed by the Compensation Committee and may be adopted by the board of directors on an annual basis. EIPs are not necessarily adopted every year. For example, no EIP was adopted in 2009 based on our annual net loss in 2008 and expectations of additional losses in 2009. Generally, EIPs are used to promote achievement of strategic objectives by aligning cash incentive opportunities for corporate officers, including the named executive officers, with our short- and long-term financial performance and strategic direction. These incentive opportunities are also designed to facilitate retention and commitment of key officers. EIPs have included specific goals, including profitability, business growth, regulatory examination results and remediation, and operational goals for each of the corporate officers, including the named executive officers.
The Compensation Committee reviews each EIP's plan design, eligible participants, goals, goal weighting, achievement levels, and payout opportunities. The Compensation Committee administers the EIP and has full power and binding authority to construe, interpret, and administer and adjust the EIP during or at the end of the plan year for extraordinary circumstances. Extraordinary circumstances may include changes in, among other things, business strategy, impact of severe economic fluctuations, or regulatory changes. The Committee shall not make adjustments for extraordinary circumstances that include changes to goals, weights, or levels of achievement without resubmission to the FHFA.
Purpose of the 2013 EIP
The 2013 EIP is intended to reward and retain corporate officers during a period of continued improving financial strength. At the time the 2013 EIP was adopted, we had resumed dividend payments to members, and had completed a partial repurchase of excess stock but otherwise continued our moratorium on the repurchase of excess capital stock. Incentive opportunities for 2013 EIP participants reflect the then-current and improving financial situation, but remain lower than the competitive market, with the intent that future EIP incentive opportunities will increase to market competitive levels as our financial performance improves.
2013 EIP Plan Design
The design of the 2013 EIP was guided by principles intended to:
•
recognize that our current overall focus is earnings generation and balance-sheet strength that supports achievement of the minimum retained earnings target, continued payment of dividends, continued repurchase of excess capital stock and funding of the AHP;
•
reinforce and reward our commitment to conservative, prudent, sound risk-management practices and preservation of the par value of capital stock;
•
reflect a reasonable assessment of our financial situation and prospects while rewarding achievement of our financial plan and strategic objectives;
•
tie a significant percentage of incentive awards to our long-term financial condition and performance; and
•
recognize the importance of individual performance through metrics linked to our strategic goals and/or objectives of the participant's principal functions and independent of the areas the participant monitors.
Incentive Goals
The 2013 EIP's short-term financial and nonfinancial goals were derived from, or are consistent with, our strategic business plan and objectives and were generally weighted based on desired business outcomes. Where possible, the goal achievement levels have generally been set so that the target (that is, middle achievement level) is consistent with projections in our strategic business plan. For certain nonfinancial EIP goals for which there is no direct reference in the strategic business plan, the goals and goal achievement levels are established consistent with our strategic objectives and the impact of achievement of the objectives. To mitigate unnecessary or excessive risk-taking, the 2013 EIP contains measures for overall performance that are achieved through Bankwide collaboration of activity but cannot be individually attained or altered by participants in the 2013 EIP. Additionally, the 2013 EIP includes long-term incentive opportunities based on the level of retained earnings and targeted regulatory results at December 31, 2015, which are intended to align management's interests with our long-term financial performance and condition. Further, Mr. Collins' goals, as chief risk officer, differ somewhat and have different weightings than the other named executive officers, which are intended to align his incentives with appropriately managing our risk profile and are intended to be independent of the financial performance of the individual business areas that ERM monitors. Further, as described in greater detail under - Determination of Awards under the 2013 EIP, the Compensation Committee and the board of directors maintained authority over all awards under the 2013 EIP.
Short-Term Incentive Goals and Actual Achievement
The 2013 EIP includes the following short-term incentive goals for the named executive officers, except for Mr. Collins:
•
Adjusted increase in retained earnings over December 31, 2012, balance (the retained earnings goal): This goal is measured by the increase in the adjusted retained earnings balance at December 31, 2013, over the retained earnings balance at December 31, 2012. Adjusted increase in retained earnings is a measure of retained earnings that excludes the impact of prepayment fee income, debt retirement expense, and private-label MBS litigation settlement income. The difference between GAAP retained earnings and this measure of retained earnings is that GAAP retained earnings does not provide for the exclusions described in the immediately prior sentence.
•
New business and mission goal (the new business goal): This goal is measured by the total amount of advances with terms of one year or greater (and not prepayable without fee) we disbursed during 2013, including restructured advances that result in extension of the advance in maturity of one year or longer, but excluding AHP-related disbursements (qualifying advances).
•
Pre-assessment, pre-other-than-temporary impairment core net income (the net income goal): Pre-assessment, pre-other-than-temporary impairment core net income (as such term is defined in the 2013 EIP) is a measure of net income that excludes the impact of AHP expenses, gains (losses) on debt retirement, net prepayment fees, net unrealized gains (or losses) attributable to hedges, other-than-temporary impairment credit losses on private-label MBS and private-label MBS litigation settlement income. The difference between GAAP net income and this measure of net income is that GAAP net income does not provide for the exclusions described in the immediately prior sentence. Achievement of this goal was subject to compliance with our VaR and duration of equity limits for at least 10 of the 12 months of the year. We complied with these limits for 12 months. These limits are described under Item 7A - Quantitative and Qualitative Disclosures about Market Risk - Measurement of Market and Interest-Rate Risk.
•
Bankwide operational initiatives goal (the operational goal): This goal is measured based on our performance relative to targeted improvements for our derivatives operations (the derivatives component), MPF operations (the MPF component), and contracts management (the contracts component).
•
Individual, Bankwide or department-specific initiatives goal (the individual goal): Unlike the other short-term goals, this goal is measured according to each individual EIP participant's successful contributions toward the achievement of Bankwide strategic goals or completion of department-specific initiatives. Individual goals for all plan participants are
established at the beginning of the plan year but can be modified throughout the year on a case-by-case basis with the written approval of the chief executive officer, except for the named executive officers. Revisions to individual goals for the named executive officers must be recommended by the chief executive officer and approved by the Compensation Committee. Each EIP participant, including the named executive officers, establishes an individual goal comprised of two to four initiatives that are evaluated by that participant's manager, except in the case of Mr. Hjerpe who, in his role as president and chief executive officer, establishes his goal and initiatives in concert with the Compensation Committee. Achievement of Mr. Hjerpe's individual goal is evaluated by the Compensation Committee at the end of the year and the Compensation Committee, in turn, makes a recommendation to the board of directors. Initiatives within each participant's individual goal may be weighted equally or may have different weights based on the criticality of the initiative and the participant's ability to influence the outcome.
Mr. Collins' short-term incentive goals, as chief risk officer, differ somewhat and have different weightings from the other named executive officers. These differences are intended to align his incentives with appropriately managing our risk profile and are intended to be independent of the financial performance of the individual business areas that ERM monitors. Under the 2013 EIP, Mr. Collins' short-term incentive goals include the retained earnings, operational, and individual goals but exclude the new business and net income goals. Mr. Collins' short-term goals also include:
•
Bankwide ERM initiatives (the ERM goals): These goals are described and measured as set forth in Table 11.2. Mr. Collins' achievement of these goals was evaluated by Mr. Hjerpe in his capacity as Mr. Collins' manager.
•
Remediation of 2012 Report of Examination Findings (the remediation goal): This goal is measured by the clearance rate of 2012 FHFA examination findings that identified our weaknesses, excluding a finding on our asset classification report.
The following Table 11.1 sets forth the named executive officers' short-term goals and the related weight for all goals and the levels of achievement, and the actual achievement for each of those goals, other than the operational, ERM and individual goals which are set forth in Tables 11.2, 11.3 and 11.4, respectively, for the year ended December 31, 2013.
___________________________
(1)
The actual achievement has been adjusted to net out the impacts of prepayment fee income, private-label MBS litigation settlement income, and debt retirement expense, such that these “one-time” income/expense events are recognized over the original term to maturity of the affected asset or liability.
(2)
These performance levels were adjusted from the amounts originally established in the 2013 EIP. The 2013 EIP provides that the originally established performance levels were to be adjusted up or down by $400,000 for every basis point by which the average daily federal funds rate deviated from the 0.20 percent assumed in our strategic business plan. In 2013, the average daily federal funds rate deviation was (9.2) basis points, resulting in a $3.7 million reduction for each of the performance levels.
The following table 11.2 sets forth the operational goal's components and the actual achievement for the year ended December 31, 2013.
The following table 11.3 sets forth the ERM Goals and the actual achievement for the year ended December 31, 2013.
The following Table 11.4 sets forth the named executive officers' individual, Bankwide or department specific goals, levels of achievement, and actual results. Each component of each named executive officer’s individual, Bankwide or department specific goals was weighted equally.
___________________________
(1)
This ratio is discussed under Item 7A - Quantitative and Qualitative Disclosures about Market Risk - Measurement of Market and Interest-Rate Risk - Market Value of Equity Estimation and Market Risk Limit.
Long-Term Incentive Goals
In addition, the 2013 EIP includes two long-term incentive goals, the first of which is based on our actual retained earnings at December 31, 2015. This goal is weighted at 67 percent of the total long-term opportunity. The following table sets forth such goal.
The second long-term incentive goal will be measured by the achievement of certain targeted regulatory goals by December 31, 2015. There are no achievement categories for this goal; either it is satisfied or not. This goal is weighted at 33 percent of the total long-term opportunity.
Incentive Opportunities under the 2013 EIP
Incentive opportunities under the 2013 EIP are based on each named executive officer's base salary at December 31, 2013 (referred to as 2013 incentive salaries). The following is each named executive officer's 2013 incentive salary:
The following Table 11.5 sets forth the combined short and long-term incentive opportunities under the 2013 EIP, in each case expressed as percentages of the named executive officers' 2013 incentive salaries:
At the conclusion of 2013, individual awards were calculated based on actual goal achievement as of December 31, 2013. Participants were eligible to receive 50 percent of such award in a cash payment in March 2014, following approval of the board of directors. Table 11.6 below sets forth the incentive opportunities for the short-term incentive opportunity that were payable in March 2014, in each case expressed as percentages of the named executive officers' 2013 incentive salaries:
The remaining 50 percent of the combined award, calculated at the end of 2013, then becomes the target long-term incentive opportunity, with threshold and excess incentive opportunities tied to threshold and excess levels of achievement of the long-term goal, as set forth in Table 11.7 below.
Table 11.7
Long-Term Incentive Opportunity
Threshold
Target
Excess
All Named Executive Officers
50% of the remaining 50% of the combined short- and long-term incentive opportunity
the remaining 50% of the combined short- and long-term incentive opportunity
150% of the remaining 50% of the combined short- and long-term incentive opportunity
Determination of Awards under the 2013 EIP
Awards for the short-term goals, other than the operational, ERM, and individual goals under the 2013 EIP, were based on actual goal achievement determined objectively at the conclusion of the year. Results for each goal were measured and the award for each goal was then calculated independently based on the following formula:
If the result for the goal were less than the threshold level of achievement (Table 11.1), then the award for that goal would have been zero. However, all goals in the 2013 EIP were achieved above threshold. For goals achieved above the excess level of achievement (Table 11.1), there were no incremental payouts for achievements above excess per plan design. The remaining annual goals were achieved at a level between the threshold and excess levels of achievement. In administering the EIP, as with prior EIPs, the Compensation Committee determined that participants would receive an interpolated award for having exceeded threshold. In such instance, the award for each goal would be calculated according to the following formula:
Our staff calculated the named executive officers' awards under the 2013 EIP's short-term goals, in accordance with actual year-end results and the foregoing formulas. Mr. Hjerpe reviewed the results of the operational goal and each other named executive officer's level of achievement under that named executive officer's individual goal, and for Mr. Collins, the operational and ERM goals, and made award recommendations to the Compensation Committee for the Compensation Committee's consideration. In making those recommendations, Mr. Hjerpe validated the individual performance for those goals from a range of threshold to excess, with such range calculated based on the goal weight and incentive opportunity. The Compensation Committee discussed and adopted those recommendations. The Compensation Committee determined Mr. Hjerpe's incentive award for his individual goal following the Compensation Committee's review of the level of achievement for this goal as
provided by Mr. Hjerpe and the Compensation Committee's assessment of Mr. Hjerpe's achievement of this goal. The Compensation Committee and board of directors determined that Mr. Hjerpe achieved all of his three individual goal initiatives at excess, as set forth in Table 11.4.
Based on those calculations and determinations, the combined incentive awards were calculated, by goal, as follows:
The named executive officers were eligible to receive 50 percent of the combined award illustrated above in a cash payment in March 2014, following approval of the board of directors. The below table's column “short-term award” sets forth the short-term incentive award paid to the named executive officers in March 2014 and the remaining 50 percent which then becomes the target level of achievement for the long-term incentive opportunity.
In addition to the foregoing awards, Mr. Hjerpe recommended, and the Compensation Committee and the board of directors determined to award Ms. Pratt an additional $100,000 payment under the 2013 EIP as an adjustment to her short-term award in recognition of her efforts in overseeing our pending litigation arising out of our investments in certain private label mortgage-backed securities. This payment is represented in the Summary Compensation Table.
Final awards under the 2013 EIP's long-term incentive opportunities cannot be determined until after December 31, 2015, since they are based on retained earnings and targeted regulatory results as of that date. Based on the Bank's and individual levels of achievement as of December 31, 2013, the named executive officers are eligible for long-term incentive opportunities, payable in March 2016, as follows:
Additional Conditions on Long-Term Awards
Long-term awards are subject to the following additional conditions.
•
Participants must be employed by us on the payment date in March 2016 to receive the long-term award, although participants that terminate employment by reason of death or disability or who are eligible to retire prior to that date may receive a pro-rata payment of the award in certain instances, as detailed in the 2013 EIP.
•
At the discretion of the board of directors, the calculated long-term award may be reduced or eliminated (but not to a number that is less than zero) for some or all participants, as applicable, if, during calendar years 2014 and/or 2015, any of the following occur such that if it had occurred prior to the year-end 2013 calculations, it would have negatively impacted the goal results and reduced the associated payout calculation:
◦
operational errors or omissions result in material revisions to our 2013 financial results, information submitted to the FHFA, or data used to determine the combined award at year-end 2013;
◦
significant information to the SEC, Office of Finance, and/or FHFA is submitted materially beyond any deadline or applicable grace period, other than late submissions that are caused by acts of God or other events beyond the reasonable control of the participants; or
◦
we fail to make sufficient progress, as determined by the FHFA, in the timely remediation of examination and other supervisory findings relevant to the goal results or payout calculation.
•
The actual payment of the long-term award is subject to the final approval of the board of directors and review and non-objection by the FHFA (to the extent required by the FHFA).
Retirement and Deferred Compensation Plans
We offer participation in qualified and nonqualified retirement plans to the named executive officers as key elements of our total rewards package. The benefits received under these plans are intended to enhance the competitiveness of our total compensation and benefits relative to the market by complementing the named executive officers' base salary and cash incentive opportunities. We maintain four retirement plans in which the named executive officers participate, including:
•
Pentegra Defined Benefit Plan for Financial Institutions (the Pentegra Defined Benefit Plan), a funded, tax-qualified, noncontributory plan that provides retirement benefits for all eligible employees;
•
Pension Benefit Equalization Plan (the Pension BEP), a nonqualified, unfunded defined benefit plan covering certain senior officers, as defined in the plan, which includes the named executive officers;
•
Pentegra Defined Contribution Plan for Financial Institutions (the Pentegra Defined Contribution Plan), a 401(k) thrift plan, under which we match employee contributions for all eligible employees; and
•
Thrift Benefit Equalization Plan (the Thrift BEP), a nonqualified, unfunded defined contribution plan with a deferred compensation feature, which is available to the named executive officers, other senior officers, and directors.
The Compensation Committee believes that the Thrift BEP, together with the Pension BEP, provide retirement benefits that are necessary for our total rewards package to remain competitive, particularly compared with labor market competitors who may offer equity-based compensation. Additional information regarding these plans can be found with the Pension Benefits and Nonqualified Deferred Compensation tables below.
All benefits payable under the Pension BEP and Thrift BEP are paid solely out of our general assets, or from assets set aside in rabbi trusts subject to the claims of our creditors in the event of our insolvency.
Perquisites
Perquisites for the named executive officers may include supplemental life insurance (Mr. Nitkiewicz and Ms. Elliott only), airline program memberships, spouse travel during business, child care when traveling on business, parking, or a 100 percent mass transportation subsidy. Mr. Hjerpe is also eligible for the personal use of an automobile. The Compensation Committee believes that the perquisites offered to the named executive officers are reasonable and are necessary for the total compensation package to remain competitive in recruiting and retaining them.
Change-in-Control Agreement
We have a change-in-control agreement with Mr. Hjerpe. The board of directors had determined that having the change in control agreement in place would be an effective recruitment and retention tool since the events under which we provide
payment to Mr. Hjerpe would provide a measure of protection to Mr. Hjerpe in the instance of our relocation in excess of 50 miles or his termination of employment or material diminution in duties or base compensation resulting from merger, consolidation, reorganization, sale of all or substantially all of our assets, or our liquidation or dissolution. Under the terms of the change of control agreement, in the event that either:
•
Mr. Hjerpe terminates his employment with us for a Good Reason (as defined in the change in control agreement) that is not remedied within certain cure periods by us; or
•
we (or our successor in the event of a reorganization) terminate Mr. Hjerpe's employment without Cause (as defined by the change in control agreement).
We have agreed to pay Mr. Hjerpe an amount equal to his annualized base salary at the time of such termination to be paid in equal installments over the following 12 months according to our regular payroll cycle during such period. Notwithstanding the foregoing, our obligation to pay Mr. Hjerpe such amount will be subject to Mr. Hjerpe's execution of our standard release of claims agreement and our compliance with applicable statutory and regulatory requirements at the time such payment would otherwise be made. Payments to Mr. Hjerpe under the change-in-control agreement are in lieu of any severance payments that would be otherwise payable to him.
Employment Status and Severance Benefits
Pursuant to the FHLBank Act, our employees, including the named executive officers as of December 31, 2013, are "at will" employees. Each may resign his or her employment at any time and we may terminate his or her employment at any time for any reason or no reason, with or without cause, and with or without notice. Under our severance policy, all regular full- and part-time employees who work at least 1,000 hours per year whose employment is terminated involuntarily for reasons other than "cause," (as determined by us at our sole discretion), are provided with severance packages reflecting their status in the organization and tenure. Severance packages for employees leaving by mutual agreement or terminated for cause is at our sole discretion, provided that such severance shall not exceed that paid to employees terminated involuntarily for reasons other than cause. The severance policy does not constitute a contractual relationship between the Bank and the named executive officers, and we reserve the right to modify, revoke, suspend, terminate, or change the severance policy at any time without notice.
To receive this severance benefit, individuals must agree to execute our standard release of claims agreement. In addition and at our sole discretion, we may provide outplacement and/or such other services as may assist in ensuring a smooth career transition.
As chief executive officer, Mr. Hjerpe is eligible for 12 months of base pay under the severance policy unless he has received payments under the change in control agreement in lieu of any severance payments that would otherwise be payable to him by us. Based on their statuses as executive officers, Mr. Nitkiewicz, Ms. Elliott, Mr. Collins, Ms. Pratt, and Mr. Barrett are eligible for a minimum of six months and a maximum of 12 months of base pay under the severance policy, depending on their tenure of employment. All severance packages for executive officers, including the named executive officers, must have the approval of the chief executive officer and the Compensation Committee prior to making any award under the severance policy.
FHFA Oversight of Executive Compensation
The FHFA provides certain oversight of FHLBank executive officer compensation. Section 1113 of HERA requires that the Director of the FHFA prohibit an FHLBank from paying compensation to its executive officers that is not reasonable and comparable to that paid for employment in similar businesses involving similar duties and responsibilities. In connection with this responsibility, the FHFA has issued final rules on executive compensation and golden parachute payments, which provide for oversight of such compensation and payments. For information on those rules, see Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Legislative and Regulatory Developments - Significant FHFA Developments. In addition to the those rules, the FHFA has issued an advisory bulletin on principles for FHLBank executive compensation together with certain protocols for the review of proposed FHLBank compensation actions.
In addition to the foregoing, the FHFA has issued proposed rules that could further impact named executive officer compensation, including a proposed rule on incentive-based compensation that could impact our incentive compensation plans and a proposed regulation that would limit instances where we could indemnify certain of our officers, including the named executive officers.
Compensation Tables
The following table sets forth all compensation received from the Bank for the years ended December 31, 2013, 2012, and 2011, by our named executive officers.
_______________________
(1)
Amounts shown are not reduced to reflect the named executive officers' elections, if any, to defer receipt of salary into the Pentegra Defined Contribution Plan or the Thrift BEP.
(2)
Represents amounts paid under the 2013 EIP during 2014 in respect of service performed in 2013, under the 2012 EIP during 2013 in respect of service performed in 2012, and under the 2011 EIP during 2012 in respect of service performed in 2011.
(3)
Represents amounts paid under the 2011 and 2010 EIP for satisfying long-term goals based on our retained earnings at December 31, 2013 and December 31, 2012, respectively, which amounts were $722.3 million and $560.5 million, respectively. That amount resulted in awards at "excess" to each of the named executive officers participating in the 2011 and 2010 EIP, or 150 percent of the remaining incentive opportunity under that plan. This amount of retained earnings has been adjusted from the amount determined in accordance with GAAP to net out the impacts of prepayment fee income, private-label MBS litigation settlement income (2011 EIP only), and debt retirement expense, such that these "one-time" income/expense events are recognized over the original term to maturity of the affected asset or liability.
(4)
The amounts shown reflect the actuarial increase/decrease in the present value of the named executive officer's benefits under all pension plans established by us determined using interest-rate and mortality-rate assumptions consistent with those used in our financial statements. No amount of above market earnings on nonqualified deferred compensation is reported because above market rates are not possible under the Thrift BEP, the only such plan that we offer.
(5)
See the Other Compensation Table below for amounts, which include our match on employee contributions to the Thrift BEP and the Pentegra Defined Contribution Plan, insurance premiums paid by us with respect to supplemental life insurance, and perquisites.
(6)
The 2011 and 2012 bonus amounts for Mr. Nitkiewicz, Ms. Elliott, and Mr. Collins are cash awards based on their years of service (20, 30 and 15 years, respectively). The amounts of these awards are the same amounts paid to any employee that completed as many years of service in 2011 and 2012.
(7)
The change in pension values under the Pentegra Defined Benefit Plan and Pension BEP for Mr. Nitkiewicz decreased by $76,000 during 2013. In accordance with SEC guidance, the amount reported in the table is $0.
(8)
The 2013 non-equity incentive plan compensation short-term amount reflects the sum of Ms. Pratt’s short-term award and additional award of $100,000 as discussed above, each under the 2013 EIP.
_______________________
(1)
Amounts include our contributions to the Pentegra Defined Contribution Plan, as well as contributions to the Thrift BEP. Contributions to the Thrift BEP are also shown in the Nonqualified Deferred Compensation Table below.
The Pentegra Defined Contribution Plan, a 401(k) thrift plan, excludes hourly, flex staff, and short-term employees from participation, but continues to include all other employees. Employees may elect to defer one percent to 50 percent of their plan salary, as defined in the plan document. We make contributions based on the amount the employee contributes, up to the first three percent of plan salary, multiplied by the following factors:
•
100 percent during the second and third years of employment.
•
150 percent during the fourth and fifth years of employment.
•
200 percent following completion of five or more years of employment.
Participant deferrals are limited on an annual basis by Internal Revenue Code (IRC) rules. For 2013, the maximum elective deferral amount was $17,500 (or $23,000 per year for participants who attain age 50 in 2013), and the maximum matching contribution under the terms of the Pentegra Defined Contribution Plan was $15,300 (three percent multiplied by two multiplied by the $255,000 IRC compensation limit).
A description of the Thrift BEP follows the Nonqualified Deferred Compensation Table.
(2)
Amount for Mr. Hjerpe includes the following perquisites: personal use of a Bank-owned vehicle, reimbursement for apartment expenses through mid February 2011, parking, reimbursement for mass transportation, spousal travel expenses, and airline program memberships.
The following table shows the potential payouts for our non-equity incentive plan awards under the 2013 EIP, for our named executive officers:
______________________
(1)
Amounts represent potential awards under the 2013 EIP; actual amounts awarded are reflected in the Summary Compensation Table above. See Executive Incentive Plans above for further discussion of performance goals and plan payouts.
Retirement Plan
The following table sets forth the pension benefits for the fiscal year ended December 31, 2013, for our named executive officers.
_______________________
(1)
Equals number of years of credited service as of December 31, 2013.
(2)
See Item 8 - Financial Statements and Supplementary Data - Notes to the Financial Statements - Note 18 - Employee Retirement Plans for a description of valuation methods and assumptions.
(3)
Number of years of credited service for the Pentegra Defined Benefit Plan includes 14.59 years of service at the Bank and 7.08 years of service at FIRSTFED AMERICA BANCORP, Inc., which entities are both participants in the Pentegra Defined Benefit Plan.
(4)
Number of years of credited service for the Pentegra Defined Benefit Plan includes 2.33 years of service at the FHLBank of Pittsburgh.
(5)
Number of years of credited service for the Pension BEP includes recognition of 2.83 years of service at the FHLBank of Pittsburgh.
We participate in the Pentegra Defined Benefit Plan to provide retirement benefits for eligible employees, including the named executive officers. Employees become eligible to participate in the Pentegra Defined Benefit Plan the first day of the month following satisfaction of our waiting period, which is one year of service with us. The Pentegra Defined Benefit Plan excludes hourly paid employees, flex staff, and short-term employees from participation. Participants are 20 percent vested in their retirement benefit after the completion of two years of employment and vest at an additional 20 percent per year thereafter until they are fully vested after the completion of six years of employment. Participants who have reached age 65 are automatically 100 percent vested, regardless of completed years of employment. All of the named executive officers are participants in the Pentegra Defined Benefit Plan and are 100 percent vested in their benefits pursuant to the plan's provisions except for Ms. Pratt and Mr. Barrett, who are 40 percent vested.
Benefits under the Pentegra Defined Benefit Plan are based on the participant's years of service and earnings, defined as base salary excluding the participant's voluntary contribution to the Thrift BEP, subject to the applicable IRC limits on annual earnings ($255,000 for 2013). For participants hired prior to January 9, 2006, the benefit is calculated as 2.00 percent multiplied by the participant's years of benefit service multiplied by the high three-year average salary. For the other participants, the benefit is calculated as 1.50 percent multiplied by the participant's years of benefit service multiplied by the high five-year average salary. Annual benefits provided under the plan are subject to IRC limits, which vary by age and benefit
option selected. The regular form of benefit is a straight life annuity with a 12 times initial death benefit feature. Lump sum and other additional payout options are also available. Participants are eligible for a lump sum option beginning at age 45. Benefits are payable in the event of retirement, death, disability, or termination of employment if vested. Normal retirement is age 65, but a participant may elect early retirement as early as age 45. However, if a participant elects early retirement, the normal retirement benefit is reduced by an early retirement factor based on the participant's age when beginning early retirement. If the sum of the participant's age and vesting service at the time of termination of employment is at least 70, that is, the "Rule of 70," then the benefit is reduced by an early retirement factor of one and a half percent per year for each year that payments commence before age 65. If age and vesting service do not equal at least 70, then the benefit is reduced by an early retirement factor of three percent per year for participants hired prior to January 9, 2006, and, for the other participants, the benefit is reduced by an actuarial equivalency factor for each year that payments commence before age 65.
The amount of pension benefits payable from the Pension BEP to a named executive officer is the amount that would be payable to the executive under the Pentegra Defined Benefit Plan:
•
ignoring the limits on benefit levels imposed by the IRC (including the limit on annual compensation discussed above);
•
including in the definition of salary any amounts deferred by a participant under the Thrift BEP in the year deferred and any incentive compensation in the year paid;
•
recognizing the participant's full tenure with us or any other employer participating in the Pentegra Defined Benefit Plan from initial date of employment to the date of membership in the Pentegra Defined Benefit Plan, for each named executive officer who was a participant before January 1, 2009, and for all other participants, recognizing only the participant's years of service with us from initial date of employment with us, but disregarding prior service of participants who were re-employed by us and received a full distribution of the Pension BEP benefit at the time of termination;
•
applying an increased benefit accrual rate of 2.375 percent of the participant's highest three-year average salary, multiplied by the participant's total benefit service, for those whose most recent date of hire by the Bank is prior to January 9, 2006, and who have continuously been an “Executive Officer” (as such term is defined by the plan) since January 1, 2008, and, for all other participants, applying the same accrual rate and average salary as the participant is eligible to receive under the Pentegra Defined Benefit Plan; and
•
reduced by the participant's actual accrued benefit from the Pentegra Defined Benefit Plan. As in the Pentegra Defined Benefit Plan for those employees hired before January 9, 2006, benefits from the Pension BEP are reduced by an early retirement factor of, for participants hired prior to January 9, 2006, three percent per year, and for the other participants, benefits are reduced by an actuarial equivalency factor for each year that payments commence before age 65, or, for all participants, benefits are reduced by an early retirement factor of one and a half percent if the participant satisfies the Rule of 70.
Total benefits payable under both the Pentegra Defined Benefit Plan and the Pension BEP are subject to an overall maximum annual benefit amount not to exceed a specified percentage of high three-year, or five-year average salary, as applicable, as follows: Mr. Hjerpe, 80 percent as president; Mr. Nitkiewicz and Ms. Elliott, 70 percent as executive vice presidents; and Mr. Collins, Ms. Pratt and Mr. Barrett 65 percent as senior vice presidents. Our only named executive officer that has reached the maximum annual benefit amount is Ms. Elliott. All benefits payable under the Pension BEP are paid solely from either our general assets or from assets held in a rabbi trust subject to the claims of our creditors in the event of the Bank's insolvency. In 2009, the Pension BEP was amended to require that we contribute at least annually to any rabbi trust so established an amount to fund participant benefits on a plan termination basis and anticipated administrative, trust and investment advisory expenses that may be paid by the trust over the next 12 months. Previously, no funding standard has been applied to the Pension BEP rabbi trust which was established in 2005. Retirement benefits from the Pentegra Defined Benefit Plan and the Pension BEP are not subject to any offset provision for Social Security benefits.
Nonqualified Deferred Compensation
The following table sets forth the nonqualified deferred compensation for the fiscal year ended December 31, 2013, for our named executive officers.
_______________________
(1)
Amounts are also reported as salary in the Summary Compensation Table above.
(2)
Amounts are also reported as contributions to defined contribution plans in the Other Compensation Table above.
Thrift BEP participants may elect to defer receipt of up to 100 percent of base salary and/or incentive compensation into the Thrift BEP. We match participant contributions based on the amount the employee contributes, typically, up to the first three percent of compensation beginning with the initial date of membership in the Thrift BEP, and then according to the same schedule as the Pentegra Defined Contribution Plan after the first year of service. However, in 2010 the board of directors adopted the Second Amendment to the Thrift BEP so that the Compensation Committee has the flexibility to modify our matching contribution rate in an offer letter, employment agreement or other writing approved by the Compensation Committee so long as our maximum matching contribution rate does not exceed the maximum matching contribution rate available to any participant under the Pentegra Defined Contribution Plan (the Contribution Limit). The Compensation Committee has granted such a modification to Ms. Pratt permitting her matching contribution rate to be at the Contribution Limit irrespective of her tenure at the Bank. Our matching contribution is immediately vested at 100 percent, as in the Pentegra Defined Contribution Plan. Participants may defer their contributions into one or more investment funds as elected by the participant. Participants may elect to receive distributions in a lump sum or in semi-annual installments over a period that does not exceed 11 years. Participants may withdraw contributions under the plan's hardship provisions and may also begin to receive distributions while still employed through scheduled distribution accounts.
The Thrift BEP provides participants an opportunity to defer taxation on income and to make-up for benefits that would have been provided under the Pentegra Defined Contribution Plan except for IRC limitations on annual contributions under 401(k) thrift plans. It also provides participants with an opportunity for incentive compensation to be deferred and matched. The Compensation Committee and board of directors approve participation in the Thrift BEP. All of the named executive officers are current participants. All benefits payable under the Thrift BEP are paid solely from our general assets or from assets held in a rabbi trust subject to the claims of our creditors in the event of our insolvency. In 2009, the Thrift BEP was amended to require us to contribute at least quarterly to any rabbi trust established for the Thrift BEP an amount to fund participant benefits on a plan termination basis. A rabbi trust was established for the Thrift BEP effective January 1, 2010.
Post-Termination Payment
The following table represents the amount that would be payable to the named executive officers as of December 31, 2013, had their employment been terminated involuntarily for reasons other than "cause" on that date. Under our severance policy (and for Mr. Hjerpe, under the change in control agreement) and based on status in the organization and tenure for Mr. Hjerpe, Mr. Nitkiewicz, Ms. Elliott and Mr. Collins, the amount is equal to 12 months' base salary and for Ms. Pratt and Mr. Barrett the amount is equal to six months' base salary, all based on annual salary in effect on December 31, 2013.
_______________________
(1)
Severance payments do not result in an acceleration of retirement or other benefit plans as described above.
(2)
Severance payments to Mr. Hjerpe may consist of either payments under our severance policy or under the change in control agreement but not both. Each, however, provides for 12 months of base salary.
Director Compensation
We pay members of the board of directors fees for each board and committee meeting that they attend. FHFA regulations permit the payment of reasonable director compensation, and such compensation is subject to the FHFA's oversight. We are a cooperative and our capital stock may only be held by current and former members, so we do not provide compensation to our directors in the form of stock or stock options. The amounts paid to the members of the board of directors for attendance at board and committee meetings during the year ended December 31, 2013, along with the annual maximum compensation amounts are detailed in the following table:
The aggregate amounts earned or paid to individual members of the board of directors for attendance at board and committee meetings during 2013 are detailed in the following table:
Directors may elect to defer the receipt of meeting fees pursuant to the Thrift BEP, although there is no Bank-matching contribution for such deferred fees. For additional information on the Thrift BEP, see - Retirement and Deferred Compensation Plans above. FHFA regulations permit the payment or reimbursement of reasonable expenses incurred by directors in performing their duties, and in accordance with those regulations, we have adopted a policy governing such payment and reimbursement of expenses. Such paid and reimbursed board of director expenses aggregated to $180,000 for the year ended December 31, 2013.
The compensation payable to directors under the 2014 Directors Compensation Policy has been increased over the 2013 Directors Compensation Policy. The policy provides for the following payments and compensation caps:
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
We are a cooperative, our members or former members own all of our outstanding capital stock, and our directors are elected by and a majority are from our membership. Each member is eligible to vote for the open member directorships in the state in which its principal place of business is located and for each open independent directorship. See Item 10 - Directors, Executive
Officers and Corporate Governance for additional information on the election of our directors. Membership is voluntary, and members must give notice of their intent to withdraw from membership. Members that withdraw from membership may not be readmitted to membership for five years.
We do not offer any compensation plan under which our equity securities are authorized for issuance. Members, former members, and successors to former members, including affiliated institutions under common control of a single holding company, holding five percent or more of our outstanding capital stock as of February 28, 2014, are noted in the following table.
_______________________
(1)
BANA and CW Reinsurance Company (CWRE) are subsidiaries of Bank of America Corporation. BANA is the successor in interest to a former member and is ineligible for Bank membership. CWRE is a Bank member.
Additionally, due to the fact that a majority of our board of directors is elected from our membership, these member directors serve as officers or directors of members that own our capital stock. The following table provides capital stock outstanding to members whose officers or directors were serving as our directors as of February 28, 2014:
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Transactions with Related Persons
We have a cooperative ownership structure. As such, capital stock ownership in the Bank is a prerequisite to transacting any member business with us. Our members and certain former members or their successors own all of our stock, the majority of our directors are elected by and from the membership, and we conduct our advances and mortgage loan business almost exclusively with members. Grants under the AHP and AHP advances are also made in partnership or in connection with our members. Therefore, in the normal course of business, we extend credit and offer services and AHP benefits to members whose officers and directors may serve as our directors, as well as to entities who hold five percent or more of our capital stock. It is our policy that extensions of credit, all other Bank products and services, and AHP benefits are offered on terms and conditions that are no more favorable to such members than the terms and conditions of comparable transactions with other members.
In addition, we may purchase short-term investments, federal funds, and MBS from, and enter into interest-rate-exchange agreements with, members or their affiliates whose officers or directors serve as directors of the Bank, as well as from members or their affiliates who hold five percent or more of our capital stock. All such purchase transactions are effected at the then-current market rate and all MBS are purchased through securities brokers or dealers, also at the then-current market rate.
For the year ended December 31, 2013, the review and approval of transactions with related persons was governed by our Conflict of Interest Policy for Bank Directors (the Conflict Policy) and our Code of Ethics and Business Conduct (Code of Ethics), both of which are in writing. Under the Conflict Policy, each director is required to disclose to the board of directors all actual or potential conflicts of interest, including any personal financial interest that he or she has, as well as such interests of any immediate family member or business associate of the director known to the director, in any matter to be considered by the board of directors or in which another person does, or proposes to do, business with the Bank. Following such disclosure, the board is empowered to determine whether an actual conflict exists. In the event the board determines the existence of a conflict with respect to any matter, the affected director is required to be recused from all further considerations relating to that matter. The Conflict Policy is administered by the Governance Committee of the board of directors.
The Code of Ethics requires that all directors and executive officers (as well as all other employees) avoid conflicts of interest, or the appearance of conflicts of interest. In particular, subject to limited exceptions for interests arising through ownership of mutual funds and certain financial interests acquired prior to employment by the Bank, no employee may have a financial interest in any of our members that is not transacted in the ordinary course of the member's business and, in the case of an extension of credit, involves more than the normal risk of repayment or of loss to the member. Employees are required to disclose annually all financial interests and financial relationships with members. These disclosures are reviewed by our ethics officer, who is principally responsible for enforcing the Code of Ethics on a day-to day basis. The ethics officer is charged with attempting to resolve any apparent conflict involving an employee other than our president and chief executive officer and, if an apparent conflict has not been resolved within 60 days, to report it to our president and chief executive officer for resolution. The ethics officer is charged with reporting any apparent conflict involving a director or our president and chief executive officer to the Governance Committee of the board of directors for resolution. Our ethics officer is Carol Hempfling Pratt, senior vice president, general counsel and corporate secretary of the Bank.
Director Independence
General
The board of directors is required to evaluate and report on the independence of the directors of the Bank under two distinct director independence standards. First, FHFA regulations establish independence criteria for directors who serve as members of the board of directors' Audit Committee. Second, SEC rules require that our board of directors apply the independence criteria of a national securities exchange or automated quotation system in assessing the independence of our directors.
As of the date of this report, our board of directors is constituted of eight member directors and six independent directors, and one vacant independent directorship, as discussed in Item 10 - Directors, Executive Officers and Corporate Governance. None of our directors is an "inside" director. That is, none of our directors is a Bank employee or officer. Further, our directors are prohibited from personally owning stock or stock options in the Bank. Each of the member directors, however, is a senior officer, director, or trustee of an institution that is a member of the Bank that is encouraged to engage in transactions with us on a regular basis, and some of the independent directors also engage in transactions either directly or indirectly with us from time to time in the ordinary course of the Bank's business.
FHFA Regulations Regarding Independence
The FHFA regulations on director independence standards prohibit an individual from serving as a member of the board of directors' Audit Committee if he or she has one or more disqualifying relationships with us or our management that would interfere with the exercise of that individual's independent judgment. Disqualifying relationships considered by the board are: employment with the Bank at any time during the last five years; acceptance of compensation from us other than for service as a director; being a consultant, advisor, promoter, underwriter, or legal counsel for the Bank at any time within the last five years; and being an immediate family member of an individual who is or who has been within the past five years, a Bank executive officer. The board assesses the independence of each director who serves on the Audit Committee under the FHFA's regulations on these independence standards. As of March 21, 2014, all of our directors serving on the board of directors' Audit Committee were independent under these criteria.
SEC Rule Regarding Independence
SEC rules require our board of directors to adopt a standard of independence to evaluate its directors. Pursuant thereto, the board adopted the independence standards of the New York Stock Exchange (the NYSE) to determine which of its directors are independent, which members of its Audit Committee are not independent, and whether the board of directors' Audit Committee financial expert is independent.
After applying the NYSE independence standards, the board determined that, as of March 21, 2014, all of our independent (that is, nonmember) directors are independent, including Directors Calamare, Carty, Clancy, Hurley, Malcynsky, and Ragones. Based upon the fact that each member director is a senior official of an institution that is a member of the Bank (and thus is an equity holder in the Bank), that each such institution routinely engages in transactions with us, and that such transactions occur frequently and are encouraged, the board of directors has determined that for the present time it would conclude that none of the member directors meets the independence criteria under the NYSE independence standards.
It is possible that under a strict reading of the NYSE objective criteria for independence (particularly the criterion regarding the amount of business conducted with us by the director's institution), a member director could meet the independence standard on a particular day. However, because the amount of business conducted by a member director's institution may change frequently, and because we generally desire to increase the amount of business we conduct with each member, the directors deemed it inappropriate to draw distinctions among the member directors based upon the amount of business conducted with us by any director's institution at a specific time.
The board has a standing Audit Committee. For the reasons noted above, the board determined that none of the current member directors on the board's Audit Committee, including Directors Crowe (vice chair), McGeorge, and Treanor are independent under the NYSE standards for audit committee members. The board determined that all of the independent directors on the board's Audit Committee, including Directors Calamare (ex-officio), Malcynsky and Ragones (chair) are independent under the NYSE independence standards for audit committee members. The board also determined that Director Crowe is the "audit committee financial expert" within the meaning of the SEC rules, and further determined that as of March 21, 2014, is not independent under NYSE standards. As stated above, the board determined that each director on the Audit Committee is independent under the FHFA's regulations applicable to the board's Audit Committee.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The following table sets forth the aggregate fees billed by PwC for professional services rendered in connection with the audit of our financial statements for 2013 and 2012, as well as the fees billed by PwC for audit-related services rendered by PwC to us during 2013 and 2012.
_______________________
(1)
Audit fees consist of fees incurred in connection with the audit of our financial statements, including audit of internal controls over financial reporting, review of quarterly or annual management's discussion and analysis, and review of financial information filed with the SEC.
(2)
Audit-related fees consist of fees related to accounting research and consultations, operations reviews of new products and supporting processes, and fees related to participation in and presentations at conferences.
The Audit Committee selects our independent registered public accounting firm and preapproves all audit services to be provided by it to us. The Audit Committee also reviews and preapproves all audit-related and nonaudit-related services rendered by the independent registered public accounting firm in accordance with the Audit Committee's charter. In its review of these services and related fees and terms, the Audit Committee considers, among other things, the possible effect of the performance of such services on the independence of our independent registered public accounting firm.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
a) Financial Statements
Our financial statements are set forth under Item 8 - Financial Statements and Supplementary Data of this report on Form 10-K.
b) Financial Statement Schedule
None.
c) Exhibits
* Management contract or compensatory plan.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.