10-Q 1 q12012fhlbsf.htm Q1 2012 FHLBSF
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
  ____________________________________
FORM 10-Q
____________________________________
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2012
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 000-51398
FEDERAL HOME LOAN BANK OF SAN FRANCISCO
(Exact name of registrant as specified in its charter)
  ____________________________________
 
 
Federally chartered corporation
 
94-6000630
 
 
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. employer
identification number)
 
 
 
 
 
 
 
600 California Street
San Francisco, CA
 
94108
 
 
(Address of principal executive offices)
 
(Zip code)
 
(415) 616-1000
(Registrant's telephone number, including area code)
  ____________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing for the past 90 days.    x  Yes    o  No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  Yes    o  No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
o
  
Accelerated filer
 
o
 
 
 
 
Non-accelerated filer
 
x  (Do not check if a smaller reporting company)
  
Smaller reporting company
 
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    o  Yes    x  No
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
 
Shares Outstanding as of April 30, 2012

Class B Stock, par value $100
101,080,502




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


i


PART I. FINANCIAL INFORMATION

ITEM 1.        FINANCIAL STATEMENTS

Federal Home Loan Bank of San Francisco
Statements of Condition
(Unaudited)

(In millions-except par value)
March 31,
2012

 
December 31,
2011

Assets:
 
 
 
Cash and due from banks
$
3,486

 
$
3,494

Securities purchased under agreements to resell
1,100

 

Federal funds sold
8,641

 
5,366

Trading securities(a)
3,321

 
2,808

Available-for-sale securities(a)
9,015

 
9,613

Held-to-maturity securities (fair values were $20,061 and $21,414, respectively)(b)
20,100

 
21,581

Advances (includes $7,911 and $8,684 at fair value under the fair value option, respectively)
62,040

 
68,164

Mortgage loans held for portfolio, net of allowance for credit losses of $6 and $6, respectively
1,686

 
1,829

Accrued interest receivable
152

 
180

Premises, software, and equipment, net
28

 
30

Derivative assets, net
433

 
400

Other assets
85

 
87

Total Assets
$
110,087

 
$
113,552

Liabilities:
 
 
 
Deposits
$
166

 
$
156

Consolidated obligations:
 
 
 
Bonds (includes $11,823 and $15,712 at fair value under the fair value option, respectively)
74,579

 
83,350

Discount notes
23,318

 
19,152

Total consolidated obligations
97,897

 
102,502

Mandatorily redeemable capital stock
5,307

 
5,578

Accrued interest payable
293

 
241

Affordable Housing Program payable
154

 
150

Derivative liabilities, net
61

 
73

Other liabilities
1,151

 
147

Total Liabilities
105,029

 
108,847

Commitments and Contingencies (Note 17)

 

Capital:
 
 
 
Capital stock—Class B—Putable ($100 par value) issued and outstanding:
 
 
 
47 shares and 48 shares, respectively
4,717

 
4,795

Unrestricted retained earnings
3

 

Restricted retained earnings
1,963

 
1,803

Total Retained Earnings
1,966

 
1,803

Accumulated other comprehensive income/(loss)
(1,625
)
 
(1,893
)
Total Capital
5,058

 
4,705

Total Liabilities and Capital
$
110,087

 
$
113,552


(a)
At March 31, 2012, and at December 31, 2011, none of these securities were pledged as collateral that may be repledged.
(b)
Includes $22 at March 31, 2012, and $33 at December 31, 2011, pledged as collateral that may be repledged.
The accompanying notes are an integral part of these financial statements.

1


Federal Home Loan Bank of San Francisco
Statements of Income
(Unaudited)
 
 
For the Three Months Ended March 31,
(In millions)
 
2012

 
2011

Interest Income:
 
 
 
 
Advances
 
$
155

 
$
186

Prepayment fees on advances, net
 
22

 
6

Federal funds sold
 
3

 
8

Trading securities
 
6

 
5

Available-for-sale securities
 
83

 
1

Held-to-maturity securities
 
128

 
227

Mortgage loans held for portfolio
 
20

 
28

Total Interest Income
 
417

 
461

Interest Expense:
 
 
 
 
Consolidated obligations:
 
 
 
 
Bonds
 
162

 
191

Discount notes
 
6

 
11

Mandatorily redeemable capital stock
 
7

 
3

Total Interest Expense
 
175

 
205

Net Interest Income
 
242

 
256

Provision for credit losses on mortgage loans
 
1

 

Net Interest Income After Mortgage Loan Loss Provision
 
241

 
256

Other Income/(Loss):
 
 
 
 
Net gain/(loss) on trading securities
 
(3
)
 
(1
)
Total other-than-temporary impairment (OTTI) loss
 
(11
)
 
(88
)
Net amount of OTTI loss reclassified to/(from) accumulated other comprehensive income/(loss)
 
2

 
(21
)
Net OTTI loss, credit portion
 
(9
)
 
(109
)
Net gain/(loss) on advances and consolidated obligation bonds held under fair value option
 
(13
)
 
(54
)
Net gain/(loss) on derivatives and hedging activities
 
3

 
20

Other
 
2

 
2

Total Other Income/(Loss)
 
(20
)
 
(142
)
Other Expense:
 
 
 
 
Compensation and benefits
 
16

 
17

Other operating expense
 
11

 
10

Federal Housing Finance Agency
 
4

 
3

Office of Finance
 
1

 
2

Total Other Expense
 
32

 
32

Income/(Loss) Before Assessments
 
189

 
82

REFCORP
 

 
15

Affordable Housing Program
 
20

 
7

Total Assessments
 
20

 
22

Net Income/(Loss)
 
$
169

 
$
60

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

2


Federal Home Loan Bank of San Francisco
Statements of Comprehensive Income
(Unaudited)
 
 
For the Three Months Ended March 31,
(In millions)
 
2012

 
2011

Net Income/(Loss)
 
$
169

 
$
60

Other Comprehensive Income/(Loss):
 
 
 
 
Net unrealized gain/(loss) on available-for-sale securities
 

 
1

Net non-credit-related OTTI loss on available-for-sale securities:
 
 
 
 
Non-credit-related OTTI loss transferred from held-to-maturity securities
 
(6
)
 
(1,768
)
Net change in fair value of other-than-temporarily impaired securities
 
268

 
689

Reclassification of non-credit-related OTTI loss included in net income/(loss)
 
1

 

Total net non-credit-related OTTI loss on available-for-sale securities
 
263

 
(1,079
)
Net non-credit-related OTTI loss on held-to-maturity securities:
 
 
 
 
Non-credit-related OTTI loss
 
(3
)
 
(83
)
Reclassification of non-credit-related OTTI loss included in net income/(loss)
 

 
104

Accretion of non-credit-related OTTI loss
 
2

 
193

Non-credit-related OTTI loss transferred to available-for-sale securities
 
6

 
1,768

Total net non-credit-related OTTI loss on held-to-maturity securities
 
5

 
1,982

Total other comprehensive income/(loss)
 
268

 
904

Total Comprehensive Income/(Loss)
 
$
437

 
$
964


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



3


Federal Home Loan Bank of San Francisco
Statements of Capital
(Unaudited)
 
Capital Stock
Class B—Putable
 
Retained Earnings
 
Accumulated
Other
Comprehensive

 
Total
Capital

(In millions)
Shares

  
Par Value

 
Restricted

  
Unrestricted

 
Total

 
Income/(Loss)

 
Balance, December 31, 2010
83

  
$
8,282


$
1,609

  
$


$
1,609


$
(2,943
)

$
6,948

Issuance of capital stock

  
34



 
 

 



34

Repurchase/redemption of capital stock
(3
)
 
(317
)
 

 
 
 
 
 

 
(317
)
Capital stock reclassified from/(to) mandatorily redeemable capital stock, net
5

  
497



 
 

 



497

Comprehensive income/(loss)
 
  
 
 
54

  
6

 
60

 
904

 
964

Cash dividends paid on capital stock (0.29%)

 
 
 
 
 
(6
)
 
(6
)
 

 
(6
)
Balance, March 31, 2011
85

  
$
8,496

 
$
1,663

 
$

 
$
1,663

 
$
(2,039
)
 
$
8,120

Balance, December 31, 2011
48

  
$
4,795

 
$
1,803

 
$

 
$
1,803

 
$
(1,893
)
 
$
4,705

Issuance of capital stock
1

  
101

 

 
 
 
 
 
 
 
101

Repurchase/redemption of capital stock
(2
)
 
(179
)
 

 
 
 
 
 
 
 
(179
)
Comprehensive income/(loss)
 
  
 
 
160

  
9

 
169

 
268

 
437

Cash dividends paid on capital stock (0.48%)

  


 
 
 
(6
)
 
(6
)
 

 
(6
)
Balance, March 31, 2012
47

  
$
4,717

 
$
1,963

 
$
3

 
$
1,966

 
$
(1,625
)
 
$
5,058


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

4


Federal Home Loan Bank of San Francisco
Statements of Cash Flows
(Unaudited)
 
 
For the Three Months Ended March 31,
(In millions)
2012

 
2011

Cash Flows from Operating Activities:
 
 
 
Net Income/(Loss)
$
169

 
$
60

Adjustments to reconcile net income/(loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization
(5
)
 
(4
)
Provision for credit losses on mortgage loans
1

 

Change in net fair value adjustment on trading securities
3

 
1

Change in net fair value adjustment on advances and consolidated obligation bonds held under fair value option
13

 
54

Change in net derivatives and hedging activities
(114
)
 
(148
)
Net OTTI loss recognized in income, credit-related
9

 
109

Net change in:
 
 
 
Accrued interest receivable
32

 
64

Other assets

 
3

Accrued interest payable
46

 
35

Other liabilities
(1
)
 
(31
)
Total adjustments
(16
)
 
83

Net cash provided by/(used in) operating activities
153

 
143

Cash Flows from Investing Activities:
 
 
 
Net change in:
 
 
 
Interest-bearing deposits
39

 

Securities purchased under agreements to resell
(1,100
)
 

Federal funds sold
(3,275
)
 
1,346

Premises, software, and equipment
(1
)
 
(2
)
Trading securities:
 
 
 
Proceeds from maturities of long-term
584

 
1

Purchases of long-term
(1,100
)
 
(1,033
)
Available-for-sale securities:
 
 
 
Proceeds from maturities of long-term
886

 

Held-to-maturity securities:
 
 
 
Net (increase)/decrease in short-term
2,276

 
2,524

Proceeds from maturities of long-term
931

 
1,737

Purchases of long-term
(751
)
 
(2,860
)
Advances:
 
 
 
Principal collected
84,035

 
44,738

Made to members
(78,041
)
 
(41,319
)
Mortgage loans held for portfolio:
 
 
 
Principal collected
142

 
177

Net cash provided by/(used in) investing activities
4,625

 
5,309

 

5



Federal Home Loan Bank of San Francisco
Statements of Cash Flows (continued)
(Unaudited) 
 
For the Three Months Ended March 31,
(In millions)
2012

 
2011

Cash Flows from Financing Activities:
 
 
 
Net change in:
 
 
 
Deposits
51

 
(119
)
Net (payments)/proceeds on derivatives contracts with financing elements
22

 
24

Net proceeds from issuance of consolidated obligations:
 
 
 
Bonds
13,691

 
12,914

Discount notes
15,185

 
18,148

Payments for matured and retired consolidated obligations:
 
 
 
Bonds
(22,363
)
 
(18,245
)
Discount notes
(11,017
)
 
(14,728
)
Proceeds from issuance of capital stock
101

 
34

Payments for repurchase/redemption of mandatorily redeemable capital stock
(271
)
 
(150
)
Payments for repurchase/redemption of capital stock
(179
)
 
(317
)
Cash dividends paid
(6
)
 
(6
)
Net cash provided by/(used in) financing activities
(4,786
)
 
(2,445
)
Net increase/(decrease) in cash and due from banks
(8
)
 
3,007

Cash and due from banks at beginning of the period
3,494

 
755

Cash and due from banks at end of the period
$
3,486

 
$
3,762

Supplemental Disclosures:
 
 
 
Interest paid
$
136

 
$
181

Affordable Housing Program payments
16

 
12

REFCORP payments

 
34

Supplemental Disclosures of Noncash Investing Activities:
 
 
 
Transfers of mortgage loans to real estate owned
1

 
1

Transfers of OTTI held-to-maturity securities to available-for-sale securities
36

 
5,322

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


6


Federal Home Loan Bank of San Francisco
Notes to Financial Statements
(Unaudited)
(Dollars in millions except per share amounts)

Note 1 — Summary of Significant Accounting Policies

The information about the Federal Home Loan Bank of San Francisco (Bank) included in these unaudited financial statements reflects all adjustments that, in the opinion of the Bank, are necessary for a fair statement of results for the periods presented. These adjustments are of a normal recurring nature, unless otherwise disclosed. The results of operations in these interim statements are not necessarily indicative of the results to be expected for any subsequent period or for the entire year ending December 31, 2012. These unaudited financial statements should be read in conjunction with the Bank's Annual Report on Form 10-K for the year ended December 31, 2011 (2011 Form 10‑K).

Use of Estimates. The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) requires management to make a number of judgments, estimates, and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, if applicable, and the reported amounts of income, expenses, gains, and losses during the reporting period. The most significant of these estimates include the determination of other-than-temporary impairment (OTTI) of securities and fair value of derivatives, certain advances, certain investment securities, and certain consolidated obligations that are reported at fair value in the Statements of Condition. Actual results could differ significantly from these estimates.

Variable Interest Entities. The Bank's investments in variable interest entities (VIEs) are limited to private-label residential mortgage-backed securities (PLRMBS). On an ongoing basis, the Bank performs a quarterly evaluation
to determine whether it is the primary beneficiary in any VIE. The Bank evaluated its investments in VIEs as of March 31, 2012, to determine whether it is a primary beneficiary of any of these investments. The primary beneficiary is required to consolidate a VIE. The Bank determined that consolidation accounting is not required because the Bank is not the primary beneficiary of these VIEs as of March 31, 2012. The Bank does not have the power to significantly affect the economic performance of any of these investments because it does not act as a key decision maker nor does it have the unilateral ability to replace a key decision maker. In addition, the Bank does not design, sponsor, transfer, service, or provide credit or liquidity support in any of its investments in VIEs. The Bank's maximum loss exposure for these investments is limited to the carrying value.

Securities Purchased under Agreements to Resell. These investments provide short-term liquidity and are carried at cost. The Bank treats securities purchased under agreements to resell as collateralized financings.

Descriptions of the Bank's significant accounting policies are included in “Item 8. Financial Statements and Supplementary Data – Note 1 – Summary of Significant Accounting Policies” in the Bank's 2011 Form 10-K. Other changes to these policies as of March 31, 2012, are discussed in Note 2 – Recently Issued and Adopted Accounting Guidance.

Note 2 — Recently Issued and Adopted Accounting Guidance

Disclosures about Offsetting Assets and Liabilities. On December 16, 2011, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (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 a company's financial position, whether a company's financial statements are prepared on the basis of GAAP or International Financial Reporting Standards (IFRS). This guidance will require the Bank to disclose both gross and net information about financial instruments, including derivative instruments, which are either offset on its Statements of Condition or are subject to an enforceable master netting arrangement or similar agreement. This guidance will be effective for the Bank for interim and annual periods beginning on January 1, 2013, and will be applied retrospectively for all comparative periods presented. The adoption of this guidance will result in

7

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


increased financial statement disclosures, but will not affect the Bank's financial condition, results of operations, or cash flows.

Presentation of Comprehensive Income. On June 16, 2011, the FASB issued guidance to increase the prominence of other comprehensive income in financial statements. This guidance requires an entity that reports items of other comprehensive income to present comprehensive income in either a single financial statement or in two consecutive financial statements. In a single continuous statement, an entity is required to present the components of net income and total net income, the components of other comprehensive income and a total for other comprehensive income, as well as a total for comprehensive income. In a two-statement approach, an entity is required to present the components of net income and total net income in its statement of net income. The statement of other comprehensive income should follow immediately and include the components of other comprehensive income as well as totals for both other comprehensive income and comprehensive income. This guidance eliminated the option to present other comprehensive income in the statement of changes in stockholders' equity. The Bank elected the two-statement approach for interim and annual periods beginning on January 1, 2012, and applied this guidance retrospectively for all periods presented. Early adoption was permitted. The adoption of this guidance was limited to the presentation of certain information contained in the Bank's financial statements and did not affect the Bank's financial condition, results of operations, or cash flows. (See Note 12 – Accumulated Other Comprehensive Income/ (Loss) for additional disclosures required under this amended guidance.)

On December 23, 2011, the FASB issued guidance to defer the effective date of the new requirement to present reclassifications of items out of accumulated other comprehensive income in the income statement. This deferral became effective for the Bank for interim and annual periods beginning on January 1, 2012, and did not affect the Bank's adoption of the remaining new accounting guidance for the presentation of comprehensive income.

Fair Value Measurements and Disclosures. On May 12, 2011, the FASB and the IASB issued substantially converged guidance on fair value measurement and disclosure requirements. This guidance clarifies how fair value accounting should be applied where its use is already required or permitted by other standards within GAAP or IFRS; these amendments do not require additional fair value measurements. This guidance generally represents clarifications to the application of existing fair value measurement and disclosure requirements, as well as some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This guidance became effective for the Bank for interim and annual periods beginning on January 1, 2012, and was applied prospectively. The adoption of this guidance resulted in increased financial statement disclosures, but did not have a material effect on the Bank's financial condition, results of operations, or cash flows. (See Note 16 – Fair Value for additional disclosures required under this amended guidance.)

Reconsideration of Effective Control for Repurchase Agreements. On April 29, 2011, the FASB issued guidance to improve the accounting for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. The new guidance removes from the assessment of effective control: (i) the criterion requiring the transferor to have the ability to repurchase or redeem financial assets before their maturity on the substantially agreed-upon terms, even in the event of the transferee's default, and (ii) the collateral maintenance implementation guidance related to that criterion. The new guidance became effective for interim or annual periods beginning on or after December 15, 2011 (January 1, 2012, for the Bank) and was applied prospectively to transactions or modifications of existing transactions that occurred on or after January 1, 2012. The adoption of this guidance did not have a material effect on the Bank's financial condition, results of operations, or cash flows.

8

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



Recently Issued Regulatory Guidance

Framework for Adversely Classifying Loans, Other Real Estate Owned, and Other Assets and Listing Assets for Special Mention. On April 9, 2012, the Federal Housing Finance Agency (Finance Agency) issued Advisory Bulletin 2012-02, Framework for Adversely Classifying Loans, Other Real Estate Owned, and Other Assets and Listing Assets for Special Mention (AB 2012-02). This guidance establishes a standard and uniform methodology for classifying assets, excluding investment securities, and prescribes the timing of asset charge-offs based on these classifications. This guidance is generally consistent with the Uniform Retail Credit Classification and Account Management Policy issued by the federal banking regulators in June 2000. AB 2012-02 was effective upon issuance. The Bank is currently assessing the impact of this advisory bulletin, and has not yet determined the effect, if any, that this guidance will have on its financial condition, results of operations, or cash flows.

Note 3 — Trading Securities

The estimated fair value of trading securities as of March 31, 2012, and December 31, 2011, was as follows:

 
March 31, 2012

 
December 31, 2011

Government-sponsored enterprises (GSEs) – Federal Farm Credit Bank (FFCB) bonds
$
2,384

 
$
1,867

Temporary Liquidity Guarantee Program (TLGP) securities(1)
920

 
923

Mortgage-backed securities (MBS):
 
 
 
Other U.S. obligations – Ginnie Mae
17

 
17

GSEs – Fannie Mae

 
1

Total
$
3,321

 
$
2,808


(1)
TLGP securities represent corporate debentures of the issuing party that are guaranteed by the Federal Deposit Insurance Corporation (FDIC) and backed by the full faith and credit of the U.S. government.

Redemption Terms. The estimated fair value of non-mortgage-backed securities (non-MBS) by contractual maturity (based on contractual final principal payment) and of mortgage-backed securities (MBS) as of March 31, 2012, and December 31, 2011, is shown below. Expected maturities of MBS will differ from contractual maturities because borrowers generally have the right to prepay the underlying obligations without prepayment fees.
Year of Contractual Maturity
March 31, 2012

 
December 31, 2011

Trading securities other than MBS:
 
 
 
Due in 1 year or less
$
1,970

 
$
2,556

Due after 1 year through 5 years
1,334

 
234

Subtotal
3,304

 
2,790

MBS:
 
 
 
Other U.S. obligations – Ginnie Mae
17

 
17

GSEs – Fannie Mae

 
1

Total MBS
17

 
18

Total
$
3,321

 
$
2,808


Interest Rate Payment Terms. Interest rate payment terms for trading securities at March 31, 2012, and December 31, 2011, are detailed in the following table:


9

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


 
March 31, 2012

 
December 31, 2011

Estimated fair value of trading securities other than MBS:
 
 
 
Fixed rate
$
793

 
$
796

Adjustable rate
2,511

 
1,994

Subtotal
3,304

 
2,790

Estimated fair value of trading MBS:
 
 
 
Passthrough securities:
 
 
 
Adjustable rate
17

 
17

Collateralized mortgage obligations:
 
 
 
Fixed rate

 
1

Subtotal
17

 
18

Total
$
3,321

 
$
2,808


At March 31, 2012, and December 31, 2011, all of the fixed rate trading securities were swapped to an adjustable rate, such as the 1-month or 3-month London Interbank Offered Rate (LIBOR). At March 31, 2012, and December 31, 2011, 85% and 81% of the adjustable rate trading securities were swapped to a different adjustable rate index, such as 1-month or 3-month LIBOR.

The net unrealized gain/(loss) on trading securities was $(3) and $(1) for the three months ended March 31, 2012 and 2011, respectively. These amounts represent the changes in the fair value of the securities during the reported periods.

Note 4 — Available-for-Sale Securities

Available-for-sale securities by major security type as of March 31, 2012, and December 31, 2011, were as follows:
 
March 31, 2012
 
 
 
 
 
 
 
 
 
  
Amortized
Cost(1)

  
OTTI
Recognized in
Accumulated Other
Comprehensive
Income/(Loss)(AOCI)

  
Gross
Unrealized
Gains

  
Gross
Unrealized
Losses

 
Estimated Fair Value

TLGP securities
$
1,332

  
$

  
$
1

  
$

 
$
1,333

PLRMBS:
 
 
 
 
 
 
 
 
 
Prime
945

 
(120
)
 
3

 
(9
)
 
819

Alt-A, option ARM
1,367

 
(382
)
 
2

 
(15
)
 
972

Alt-A, other
6,943

 
(1,014
)
 
3

 
(41
)
 
5,891

Total PLRMBS
9,255

 
(1,516
)
 
8

 
(65
)
 
7,682

Total
$
10,587

 
$
(1,516
)
 
$
9

 
$
(65
)
 
$
9,015

 
 
 
 
 
 
 
 
 
 
December 31, 2011
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
TLGP securities
$
1,924

  
$

  
$
2

  
$

 
$
1,926

PLRMBS:
 
 
 
 
 
 
 
 
 
Prime
977

 
(132
)
 

 
(13
)
 
832

Alt-A, option ARM
1,413

 
(410
)
 
2

 
(36
)
 
969

Alt-A, other
7,133

 
(1,117
)
 

 
(130
)
 
5,886

Total PLRMBS
9,523

 
(1,659
)
 
2

 
(179
)
 
7,687

Total
$
11,447

 
$
(1,659
)
 
$
4

 
$
(179
)
 
$
9,613


10

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


 
(1)
Amortized cost includes unpaid principal balance and unamortized premiums and discounts, and previous other-than-temporary impairments recognized in earnings.

Securities Transferred. Beginning in the first quarter of 2011, the Bank elected to transfer any PLRMBS that incurred a credit-related OTTI charge during the applicable period from the Bank's held-to-maturity to its available-for-sale portfolio at their fair values. These transfers allow the Bank the option to divest these securities prior to maturity in response to changes in interest rates, changes in prepayment risk, or other factors, while acknowledging its intent to hold these securities for an indefinite period of time. For additional information on the transferred securities, see Note 6 – Other-Than-Temporary Impairment Analysis.

The following table summarizes the available-for-sale securities with unrealized losses as of March 31, 2012, and December 31, 2011. The unrealized losses are aggregated by major security type and the length of time that individual securities have been in a continuous unrealized loss position. Total unrealized losses in the following table will not agree to the total gross unrealized losses in the table above. The unrealized losses in the following table also include non-credit-related OTTI losses recognized in accumulated other comprehensive income/loss (AOCI) net of subsequent unrealized gains, up to the amount of non-credit-related OTTI in AOCI. For OTTI analysis of available-for-sale securities, see Note 6 – Other-Than-Temporary Impairment Analysis.

March 31, 2012
 
 
 
 
 
 
 
 
 
 
 
  
Less Than 12 Months
  
12 Months or More
  
Total
  
Estimated
Fair Value

  
Unrealized
Losses

  
Estimated
Fair Value

  
Unrealized
Losses

  
Estimated
Fair Value

  
Unrealized
Losses

PLRMBS:
 
 
 
 
 
 
 
 
 
 
 
Prime
$
86

 
$
4

 
$
654

 
$
125

 
$
740

 
$
129

Alt-A, option ARM

 

 
954

 
397

 
954

 
397

Alt-A, other
160

 
3

 
5,638

 
1,052

 
5,798

 
1,055

Total PLRMBS
246

 
7

 
7,246

 
1,574

 
7,492

 
1,581

Total
$
246

 
$
7

 
$
7,246

 
$
1,574

 
$
7,492

 
$
1,581

 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2011
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
TLGP securities
$
274

  
$

  
$

  
$

  
$
274

  
$

PLRMBS:
 
 
 
 
 
 
 
 
 
 
 
Prime
96

 
2

 
736

 
143

 
832

 
145

Alt-A, option ARM

 

 
950

 
446

 
950

 
446

Alt-A, other
240

 
10

 
5,634

 
1,237

 
5,874

 
1,247

Total PLRMBS
336

 
12

 
7,320

 
1,826

 
7,656

 
1,838

Total
$
610

 
$
12

 
$
7,320

 
$
1,826

 
$
7,930

 
$
1,838


As indicated in the tables above, as of March 31, 2012, the Bank's investments classified as available-for-sale had gross unrealized losses totaling $1,581, all of which related to PLRMBS. The gross unrealized losses associated with the PLRMBS were primarily due to illiquidity in the MBS market, uncertainty about the future condition of the housing and mortgage markets and the economy, and market expectations of the credit performance of loan collateral underlying these securities, which caused these assets to be valued at significant discounts to their acquisition cost.

Redemption Terms. The amortized cost and estimated fair value of non-MBS securities by contractual maturity (based on contractual final principal payment) and of PLRMBS as of March 31, 2012, and December 31, 2011, are shown below. Expected maturities of PLRMBS will differ from contractual maturities because borrowers generally have the right to prepay the underlying obligations without prepayment fees.

11

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



 
March 31, 2012
 
December 31, 2011
Year of Contractual Maturity
Amortized
Cost

 
Estimated
Fair Value

 
Amortized
Cost

 
Estimated
Fair Value

Available-for-sale securities other than PLRMBS:
 
 
 
 
 
 
 
Due in 1 year or less
$
1,332

 
$
1,333

 
$
1,924

 
$
1,926

PLRMBS:
 
 
 
 
 
 
 
Prime
945

 
819

 
977

 
832

Alt-A, option ARM
1,367

 
972

 
1,413

 
969

Alt-A, other
6,943

 
5,891

 
7,133

 
5,886

Total PLRMBS
9,255

 
7,682

 
9,523

 
7,687

Total
$
10,587

 
$
9,015

 
$
11,447

 
$
9,613


The amortized cost of the TLGP securities, which are classified as available-for-sale, included net premiums of a de minimis amount at March 31, 2012, and net premiums of $1 at December 31, 2011. At March 31, 2012, the amortized cost of the Bank's PLRMBS classified as available-for-sale included net premiums of $8 and credit-related OTTI of $1,435 (including interest accretion adjustments of $56). At December 31, 2011, the amortized cost of the Bank's PLRMBS classified as available-for-sale included net premiums of $7 and credit-related OTTI of $1,419 (including interest accretion adjustments of $50).

Interest Rate Payment Terms. Interest rate payment terms for available-for-sale securities at March 31, 2012, and December 31, 2011, are shown in the following table:

  
March 31, 2012

 
December 31, 2011

Amortized cost of available-for-sale securities other than PLRMBS:
 
  
 
Adjustable rate
$
1,332

 
$
1,924

Subtotal
1,332

 
1,924

Amortized cost of available-for-sale PLRMBS:
 
 
 
Collateralized mortgage obligations:
 
 
 
Fixed rate
4,344

 
4,542

Adjustable rate
4,911

 
4,981

Subtotal
9,255

 
9,523

Total
$
10,587

 
$
11,447


Certain MBS classified as fixed rate collateralized mortgage obligations have an initial fixed interest rate that subsequently converts to an adjustable interest rate on a specified date as follows:

 
March 31, 2012

 
December 31, 2011

Collateralized mortgage obligations:
 
 
 
Converts in 1 year or less
$
921

 
$
920

Converts after 1 year through 5 years
768

 
748

Converts after 5 years through 10 years
52

 
175

Total
$
1,741

 
$
1,843



Note 5 — Held-to-Maturity Securities

The Bank classifies the following securities as held-to-maturity because the Bank has the positive intent and ability to hold these securities to maturity:

12

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


 
March 31, 2012
 
 
 
 
 
 
 
 
 
 
 
  
Amortized
Cost(1)

  
OTTI
Recognized
in AOCI(1)

 
Carrying
Value(1)

  
Gross
Unrecognized
Holding
Gains(2)

  
Gross
Unrecognized
Holding
Losses(2)

 
Estimated
Fair Value

Interest-bearing deposits
$
2,555

  
$

 
$
2,555

  
$

  
$

 
$
2,555

Commercial paper
1,009

  

 
1,009

  

  

 
1,009

Housing finance agency bonds
609

  

 
609

  

  
(127
)
 
482

Subtotal
4,173

  

 
4,173

  

  
(127
)
 
4,046

MBS:
 
  
 
 
 
  
 
  
 
 
 
Other U.S. obligations – Ginnie Mae
206

  

 
206

  
9

  

 
215

GSEs:
 
  
 
 
 
  
 
  
 
 
 
Freddie Mac
3,961

  

 
3,961

  
134

  

 
4,095

Fannie Mae
8,261

  

 
8,261

  
301

  
(10
)
 
8,552

Subtotal GSEs
12,222

 

 
12,222

 
435

 
(10
)
 
12,647

PLRMBS:
 
  
 
 
 
  
 
  
 
 
 
Prime
2,083

  


 
2,083

  
1

 
(177
)
 
1,907

Alt-A, option ARM
45

 

 
45

 

 
(14
)
 
31

Alt-A, other
1,412

 
(41
)
 
1,371

 
17

 
(173
)
 
1,215

Subtotal PLRMBS
3,540

 
(41
)
 
3,499

 
18

 
(364
)
 
3,153

Total MBS
15,968

  
(41
)
 
15,927

  
462

  
(374
)
 
16,015

Total
$
20,141

  
$
(41
)
 
$
20,100

  
$
462

  
$
(501
)
 
$
20,061

 
December 31, 2011
 
 
 
 
 
 
 
 
 
 
 
  
Amortized
Cost(1)

  
OTTI
Recognized
in AOCI(1)

 
Carrying
Value(1)

  
Gross
Unrecognized
Holding
Gains(2)

  
Gross
Unrecognized
Holding
Losses(2)

 
Estimated
Fair Value

Interest-bearing deposits
$
3,539

  
$

 
$
3,539

  
$

  
$

 
$
3,539

Commercial paper
1,800

  

 
1,800

  

  

 
1,800

Housing finance agency bonds
646

  

 
646

  

  
(136
)
 
510

Subtotal
5,985

  

 
5,985

  

  
(136
)
 
5,849

MBS:
 
  
 
 
 
  
 
  
 
 
 
Other U.S. obligations – Ginnie Mae
217

  

 
217

  
9

  

 
226

GSEs:
 
  
 
 
 
  
 
  
 
 
 
Freddie Mac
3,374

  

 
3,374

  
133

  

 
3,507

Fannie Mae
8,314

  

 
8,314

  
316

  
(12
)
 
8,618

Subtotal GSEs
11,688

 

 
11,688

 
449

 
(12
)
 
12,125

PLRMBS:
 
 
 
 
 
 
 
 
 
 
 
Prime
2,201

 

 
2,201

 
1

 
(249
)
 
1,953

Alt-A, option ARM
46

 

 
46

 

 
(17
)
 
29

Alt-A, other
1,489

 
(45
)
 
1,444

 
14

 
(226
)
 
1,232

Subtotal PLRMBS
3,736

  
(45
)
 
3,691

  
15

  
(492
)
 
3,214

Total MBS
15,641

  
(45
)
 
15,596

  
473

  
(504
)
 
15,565

Total
$
21,626

  
$
(45
)
 
$
21,581

  
$
473

  
$
(640
)
 
$
21,414


(1)
Amortized cost includes unpaid principal balance, unamortized premiums and discounts, and previous OTTI recognized in earnings. The carrying value of held-to-maturity securities represents amortized cost after adjustment for non-credit-related OTTI recognized in AOCI.
(2)
Gross unrecognized holding gains/(losses) represent the difference between estimated fair value and carrying value.


13

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


Securities Transferred. Beginning in the first quarter of 2011, the Bank elected to transfer any PLRMBS that incurred a credit-related OTTI charge during the applicable period from the Bank's held-to-maturity portfolio to its available-for-sale portfolio at their fair values. These transfers allow the Bank the option to divest these securities prior to maturity in response to changes in interest rates, changes in prepayment risk, or other factors, while acknowledging its intent to hold these securities for an indefinite period of time. For additional information on the transferred securities, see Note 4 – Available-for-Sale Securities and Note 6 – Other-Than-Temporary Impairment Analysis.

The following tables summarize the held-to-maturity securities with unrealized losses as of March 31, 2012, and December 31, 2011. The unrealized losses are aggregated by major security type and the length of time that individual securities have been in a continuous unrealized loss position. Total unrealized losses in the following table will not agree to the total gross unrecognized losses in the table above. The unrealized losses in the following table also include non-credit-related OTTI losses recognized in AOCI. For OTTI analysis of held-to-maturity securities, see Note 6 – Other-Than-Temporary Impairment Analysis.

March 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
Less Than 12 Months
  
12 Months or More
  
Total
 
Estimated
Fair Value

  
Unrealized
Losses

  
Estimated
Fair Value

  
Unrealized
Losses

  
Estimated
Fair Value

  
Unrealized
Losses

Interest-bearing deposits
$
2,055

  
$

  
$

  
$

  
$
2,055

  
$

Commercial paper
500

  

  

  

  
500

  

Housing finance agency bonds

  

  
482

  
127

  
482

  
127

Subtotal
2,555

  

  
482

  
127

  
3,037

  
127

MBS:
 
  
 
  
 
  
 
  
 
  
 
Other U.S. obligations – Ginnie Mae

  

  
4

  

  
4

  

GSEs:
 
  
 
  
 
  
 
  
 
  
 
Freddie Mac
1

  

  
22

  

  
23

  

Fannie Mae
303

  
3

  
194

  
7

  
497

  
10

Subtotal GSEs
304

 
3

 
216

 
7

 
520

 
10

     PLRMBS:
 
  
 
  
 
  
 
  
 
  
 
Prime
109

 
1

 
1,736

 
176

 
1,845

 
177

Alt-A, option ARM

 

 
30

 
14

 
30

 
14

Alt-A, other

 

 
1,192

 
214

 
1,192

 
214

Subtotal PLRMBS
109

  
1

  
2,958

  
404

  
3,067

  
405

Total MBS
413

  
4

  
3,178

  
411

  
3,591

  
415

Total
$
2,968

  
$
4

  
$
3,660

  
$
538

  
$
6,628

  
$
542

 

14

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


December 31, 2011
 
 
 
 
 
 
 
 
 
 
 
 
Less Than 12 Months
  
12 Months or More
  
Total
 
Estimated
Fair Value

  
Unrealized
Losses

  
Estimated
Fair Value

  
Unrealized
Losses

  
Estimated
Fair Value

  
Unrealized
Losses

Interest-bearing deposits
$
3,539

  
$

  
$

  
$

  
$
3,539

  
$

Commercial paper
300

  

  

  

  
300

  

Housing finance agency bonds

  

  
510

  
136

  
510

  
136

Subtotal
3,839

  

  
510

  
136

  
4,349

  
136

MBS:
 
  
 
  
 
  
 
  
 
  
 
Other U.S. obligations – Ginnie Mae

  

  
4

  

  
4

  

GSEs:
 
  
 
  
 
  
 
  
 
  
 
Freddie Mac
1

  

  
24

  

  
25

  

Fannie Mae
223

  
3

  
201

  
9

  
424

  
12

Subtotal GSEs
224

 
3

 
225

 
9

 
449

 
12

     PLRMBS:
 
  
 
  
 
  
 
  
 
  
 
Prime
180

 
5

 
1,676

 
244

 
1,856

 
249

Alt-A, option ARM

 

 
29

 
17

 
29

 
17

Alt-A, other

 

 
1,206

 
271

 
1,206

 
271

Subtotal PLRMBS
180

  
5

  
2,911

  
532

  
3,091

  
537

Total MBS
404

  
8

  
3,140

  
541

  
3,544

  
549

Total
$
4,243

  
$
8

  
$
3,650

  
$
677

  
$
7,893

  
$
685



As indicated in the tables above, as of March 31, 2012, the Bank's investments classified as held-to-maturity had gross unrealized losses totaling $542, primarily relating to PLRMBS. The gross unrealized losses associated with the PLRMBS were primarily due to illiquidity in the MBS market, uncertainty about the future condition of the housing and mortgage markets and the economy, and market expectations of the credit performance of the loan collateral underlying these securities, which caused these assets to be valued at significant discounts to their acquisition cost.

Redemption Terms. The amortized cost, carrying value, and estimated fair value of non-MBS securities by contractual maturity (based on contractual final principal payment) and of MBS as of March 31, 2012, and December 31, 2011, are shown below. Expected maturities of MBS will differ from contractual maturities because borrowers generally have the right to prepay the underlying obligations without prepayment fees.


15

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


March 31, 2012
 
 
 
 
 
Year of Contractual Maturity
Amortized
Cost(1)

  
Carrying
Value(1)

  
Estimated
Fair Value

Held-to-maturity securities other than MBS:
 
  
 
  
 
Due in 1 year or less
$
3,564

  
$
3,564

  
$
3,564

Due after 1 year through 5 years
21

  
21

  
19

Due after 5 years through 10 years

  

  

Due after 10 years
588

  
588

  
463

Subtotal
4,173

  
4,173

  
4,046

MBS:
 
  
 
  
 
Other U.S. obligations – Ginnie Mae
206

  
206

  
215

GSEs:
 
  
 
  
 
Freddie Mac
3,961

  
3,961

  
4,095

Fannie Mae
8,261

  
8,261

  
8,552

Subtotal GSEs
12,222

 
12,222

 
12,647

PLRMBS:
 
  
 
  
 
Prime
2,083

 
2,083

 
1,907

Alt-A, option ARM
45

 
45

 
31

Alt-A, other
1,412

 
1,371

 
1,215

Subtotal PLRMBS
3,540

  
3,499

  
3,153

Total MBS
15,968

  
15,927

  
16,015

Total
$
20,141

  
$
20,100

  
$
20,061

 
December 31, 2011
 
 
 
 
 
Year of Contractual Maturity
Amortized
Cost(1)

  
Carrying
Value(1)

  
Estimated
Fair Value

Held-to-maturity securities other than MBS:
 
  
 
  
 
Due in 1 year or less
$
5,342

  
$
5,342

  
$
5,342

Due after 1 year through 5 years

  

  

Due after 5 years through 10 years
23

  
23

  
21

Due after 10 years
620

  
620

  
486

Subtotal
5,985

  
5,985

  
5,849

MBS:
 
  
 
  
 
Other U.S. obligations – Ginnie Mae
217

  
217

  
226

GSEs:
 
  
 
  
 
Freddie Mac
3,374

  
3,374

  
3,507

Fannie Mae
8,314

  
8,314

  
8,618

Subtotal GSEs
11,688

 
11,688

 
12,125

PLRMBS:
 
  
 
  
 
Prime
2,201

 
2,201

 
1,953

Alt-A, option ARM
46

 
46

 
29

Alt-A, other
1,489

 
1,444

 
1,232

Subtotal PLRMBS
3,736

  
3,691

  
3,214

Total MBS
15,641

  
15,596

  
15,565

Total
$
21,626

  
$
21,581

  
$
21,414


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

At March 31, 2012, the amortized cost of the Bank's MBS classified as held-to-maturity included net premiums of

16

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


$44 and credit-related OTTI of $5 (including interest accretion adjustments of $4). At December 31, 2011, the amortized cost of the Bank's MBS classified as held-to-maturity included net premiums of $41 and credit-related OTTI of $5 (including interest accretion adjustments of $4).

Interest Rate Payment Terms. Interest rate payment terms for held-to-maturity securities at March 31, 2012, and December 31, 2011, are detailed in the following table:
 
  
March 31, 2012

  
December 31, 2011

Amortized cost of held-to-maturity securities other than MBS:
 
  
 
Fixed rate
$
3,564

  
$
5,339

Adjustable rate
609

  
646

Subtotal
4,173

  
5,985

Amortized cost of held-to-maturity MBS:
 
  
 
Passthrough securities:
 
  
 
Fixed rate
1,643

  
1,778

Adjustable rate
161

  
158

Collateralized mortgage obligations:
 
  
 
Fixed rate
9,626

  
8,955

Adjustable rate
4,538

  
4,750

Subtotal
15,968

  
15,641

Total
$
20,141

  
$
21,626


Certain MBS classified as fixed rate passthrough securities and fixed rate collateralized mortgage obligations have an initial fixed interest rate that subsequently converts to an adjustable interest rate on a specified date as follows:

 
March 31, 2012

 
December 31, 2011

Passthrough securities:
 
 
 
Converts in 1 year or less
$
516

 
$
504

Converts after 1 year through 5 years
623

 
712

Converts after 5 years through 10 years
486

 
543

Total
$
1,625

 
$
1,759

Collateralized mortgage obligations:
 
 
 
Converts in 1 year or less
$
479

 
$
519

Converts after 1 year through 5 years
729

 
804

Converts after 5 years through 10 years
30

 
30

Total
$
1,238

 
$
1,353



Note 6 — Other-Than-Temporary Impairment Analysis

On a quarterly basis, the Bank evaluates its individual available-for-sale and held-to-maturity investment securities in an unrealized loss position for OTTI. As part of this evaluation, the Bank considers whether it intends to sell each debt security and whether it is more likely than not that it will be required to sell the security before its anticipated recovery of the amortized cost basis. If either of these conditions is met, the Bank recognizes an OTTI charge to earnings equal to the entire difference between the security's amortized cost basis and its fair value at the balance sheet date. For securities in an unrealized loss position that meet neither of these conditions, the Bank considers whether it expects to recover the entire amortized cost basis of the security by comparing its best estimate of the present value of the cash flows expected to be collected from the security with the amortized cost basis of the security. If the Bank's best estimate of the present value of the cash flows expected to be collected is less than the

17

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


amortized cost basis, the difference is considered the credit loss.

PLRMBS. To assess whether it expects to recover the entire amortized cost basis of its PLRMBS, the Bank performed a cash flow analysis for all of its PLRMBS as of March 31, 2012, using two third-party models. The first model projects prepayments, default rates, and loss severities based on borrower characteristics and the particular attributes of the loans underlying the Bank's securities, in conjunction with assumptions related primarily to future changes in home prices and interest rates. Certain assumptions in the first model were updated in 2011 and the first quarter of 2012, resulting in a change in the timing of projected borrower defaults, including the impact of longer foreclosure and property liquidation timelines. As a result, borrower defaults and collateral losses are projected to occur over a longer time period compared to prior projections. The change in the timing of projected borrower defaults and collateral losses also had an impact on the amount and timing of security-level projected losses that is unique to the waterfall structure of each security. In general, these timing changes caused credit-related charges to be somewhat lower than they would have been without a change in the timing of collateral losses. Another significant input to the first model is the forecast of future housing price changes for the relevant states and core-based statistical areas (CBSAs), which are based on an assessment of the individual housing markets. CBSA refers collectively to metropolitan and micropolitan statistical areas as defined by the United States Office of Management and Budget. As currently defined, a CBSA must contain at least one urban area with a population of 10,000 or more people. The Bank's housing price forecast as of March 31, 2012, assumed current-to-trough home price declines ranging from 0% (for those housing markets that are believed to have reached their trough) to 8% over the 3- to 9-month periods beginning January 1, 2012. Thereafter, home prices were projected to recover using one of five different recovery paths that vary by housing market. The housing price forecast in the first quarter included an acceleration of recovery timelines compared to the fourth quarter, such that the average level of projected housing prices was approximately 7.3% higher by the end of the 30-year forecast horizon. The table below presents the ranges of projected home price recovery by month at March 31, 2012.

Months
March 31, 2012
1 - 6
0.0% - 2.8%
7 - 18
0.0% - 3.0%
19 - 24
1.0% - 4.0%
25 - 30
2.0% - 4.0%
31 - 42
2.0% - 5.0%
43 - 66
2.0% - 6.0%
Thereafter
2.3% - 5.6%

The month-by-month projections of future loan performance derived from the first model, which reflect projected prepayments, default rates, and loss severities, are then input into a second model that allocates the projected loan level cash flows and losses to the various security classes in each securitization structure in accordance with the structure's prescribed cash flow and loss allocation rules. When the credit enhancement for the senior securities in a securitization is derived from the presence of subordinated securities, losses are generally allocated first to the subordinated 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.

At each quarter end, the Bank compares the present value of the cash flows expected to be collected on its PLRMBS to the amortized cost basis of the securities to determine whether a credit loss exists. For the Bank's variable rate and hybrid PLRMBS, the Bank uses the effective interest rate derived from a variable rate index (for example, 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. As the implied forward curve of the index changes over time, the effective interest rates derived from that index will also change over time. The Bank then uses the effective interest

18

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


rate for the security prior to impairment for determining the present value of the future estimated cash flows. For all securities, including securities previously identified as other-than-temporarily impaired, the Bank updates its estimate of future estimated cash flows on a quarterly basis.

For all the PLRMBS in its available-for-sale and held-to-maturity portfolios, the Bank does not intend to sell any security and it is not more likely than not that the Bank will be required to sell any security before its anticipated recovery of the remaining amortized cost basis.

For securities determined to be other-than-temporarily impaired as of March 31, 2012 (that is, securities for which the Bank determined that it does not expect to recover the entire amortized cost basis), the following table presents a summary of the significant inputs used in measuring the amount of credit loss recognized in earnings in the first quarter of 2012.

March 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Significant Inputs for Other-Than-Temporarily Impaired PLRMBS
 
Current
 
Prepayment Rates
 
Default Rates
 
Loss Severities
 
Credit Enhancement
Year of Securitization
Weighted
Average %
 
Range %
 
Weighted
Average %
 
Range %
 
Weighted
Average %
 
Range %
 
Weighted
Average %
 
Range %
Prime
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2006
7.6
 
7.4-12.0
 
32.0
 
23.2-33.0
 
47.1
 
47.0-51.0
 
19.4
 
2.6-20.1
Total Prime
7.6
 
7.4-12.0
 
32.0
 
23.2-33.0
 
47.1
 
47.0-51.0
 
19.4
 
2.6-20.1
Alt-A, option ARM
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2005
3.5
 
3.5
 
63.1
 
63.1
 
40.2
 
40.2
 
16.9
 
16.9
Total Alt-A, option ARM
3.5
 
3.5
 
63.1
 
63.1
 
40.2
 
40.2
 
16.9
 
16.9
Alt-A, other
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2007
7.3
 
5.1-8.4
 
48.2
 
36.9-71.6
 
48.1
 
46.5-51.2
 
15.8
 
2.6-43.1
2006
6.9
 
2.9-7.7
 
47.0
 
40.9-71.5
 
51.0
 
47.8-55.2
 
24.4
 
0.0-34.4
2005
7.8
 
6.0-10.4
 
32.2
 
17.9-47.9
 
48.3
 
37.8-56.7
 
12.4
 
3.0-18.5
2004 and earlier
9.4
 
6.4-10.9
 
24.2
 
10.4-43.4
 
35.1
 
20.1-46.9
 
14.0
 
9.7-21.5
Total Alt-A, other
7.5
 
2.9-10.9
 
40.2
 
10.4-71.6
 
48.6
 
20.1-56.7
 
18.1
 
0.0-43.1
Total
7.4
 
2.9-12.0
 
40.1
 
10.4-71.6
 
48.5
 
20.1-56.7
 
18.1
 
0.0-43.1

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

The following tables present the Bank's credit- and non-credit-related OTTI on its other-than-temporarily impaired PLRMBS during the three months ended March 31, 2012 and 2011:


19

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


 
Three Months Ended
 
March 31, 2012
 
March 31, 2011
 
Credit-
Related
OTTI

 
Non-Credit-
Related
OTTI

 
Total
 OTTI

 
Credit-
Related
OTTI

 
Non-Credit-
Related
OTTI

 
Total
OTTI

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

 
$

 
$

 
$
11

 
$
(2
)
 
$
9

Alt-A, option ARM

 

 

 
24

 
(18
)
 
6

Alt-A, other
9

 
2

 
11

 
74

 
(1
)
 
73

Total
$
9

 
$
2

 
$
11

 
$
109

 
$
(21
)
 
$
88


For each security classified as held-to-maturity, the estimated non-credit-related OTTI is accreted prospectively, based on the amount and timing of future estimated cash flows, over the remaining life of the security as an increase in the carrying value of the security (with no effect on earnings unless the security is subsequently sold or there are additional decreases in the cash flows expected to be collected). The Bank accreted $2 and $193 from AOCI to increase the carrying value of the respective PLRMBS classified as held-to-maturity for the three months ended March 31, 2012 and 2011, respectively. The Bank does not intend to sell these securities and it is not more likely than not that the Bank will be required to sell these securities before its anticipated recovery of the remaining amortized cost basis.

The following table presents the credit-related OTTI, which is recognized in earnings, for the three months ended March 31, 2012 and 2011.
 
 
Three Months Ended
 
March 31, 2012

 
March 31, 2011

Balance, beginning of the period
$
1,362

 
$
952

Additional charges on securities for which OTTI was previously recognized(1)
9

 
109

Balance, end of the period
$
1,371

 
$
1,061


(1)
For the three months ended March 31, 2012, “securities for which OTTI was previously recognized” represents all securities that were also other-than-temporarily impaired prior to January 1, 2012. For the three months ended March 31, 2011, “securities for which OTTI was previously recognized” represents all securities that were also previously other-than-temporarily impaired prior to January 1, 2011.

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

Beginning in the first quarter of 2011, the Bank elected to transfer any PLRMBS that incurred a credit-related OTTI charge during the applicable period from the Bank's held-to-maturity portfolio to its available-for-sale portfolio at their fair values. The Bank recognized an OTTI credit loss on these held-to-maturity PLRMBS, which the Bank believes is evidence of a significant decline in the issuers' creditworthiness. The decline in the issuers' creditworthiness is the basis for the transfers to its available-for-sale portfolio. These transfers allow the Bank the option to sell these securities prior to maturity in response to changes in interest rates, changes in prepayment risk, or other factors, while recognizing the Bank's intent to hold these securities for an indefinite period of time. The Bank does not intend to sell its other-than-temporarily impaired securities and it is not more likely than not that the Bank will be required to sell any security before its anticipated recovery of the remaining amortized cost basis.


20

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


The following tables summarize the PLRMBS transferred from the Bank's held-to-maturity portfolio to its available-for-sale portfolio during the three months ended March 31, 2012 and 2011. The amounts shown represent the values when the securities were transferred from the held-to-maturity portfolio to the available-for-sale portfolio.

 
Three Months Ended March 31, 2012
 
Amortized
Cost

 
OTTI
Recognized
in AOCI

 
Gross
Unrecognized
Holding
Gains 

 
Estimated
Fair Value

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:
 
 
 
 
 
 
 
PLRMBS:
 
 
 
 
 
 
 
Prime
$
3

 
$

 
$

 
$
3

Alt-A, other
39

 
(6
)
 

 
33

Total
$
42

  
$
(6
)
 
$

 
$
36


 
Three Months Ended March 31, 2011
 
Amortized
Cost

 
OTTI
Recognized
in AOCI

 
Gross
Unrecognized
Holding
Gains 

 
Estimated
Fair Value

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:
 
 
 
 
 
 
 
PLRMBS:
 
 
 
 
 
 
 
Prime
$
668

 
$
(192
)
 
$
99

 
$
575

Alt-A, option ARM
352

 
(105
)
 
16

 
263

Alt-A, other
6,070

 
(1,471
)
 
574

 
5,173

Total
$
7,090

  
$
(1,768
)
 
$
689

 
$
6,011



The following tables present the Bank's other-than-temporarily impaired PLRMBS that incurred OTTI charges during the three months ended March 31, 2012 and 2011, by loan collateral type:

March 31, 2012
 
 
 
 
 
 
Available-for-Sale Securities
 
Unpaid
Principal
Balance

  
Amortized
Cost

 
Estimated
Fair Value

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:
 
 
 
 
 
Prime
$
3

 
$
3

 
$
3

Alt-A, option ARM
18

 
8

 
6

Alt-A, other
2,093

 
1,935

 
1,639

Total
$
2,114

 
$
1,946

 
$
1,648

 
 
 
 
 
 
March 31, 2011
 
 
 
 
 
 
Available-for-Sale Securities
 
Unpaid
Principal
Balance

  
Amortized
Cost

 
Estimated
Fair Value

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:
 
 
 
 
 
Prime
$
740

 
$
668

 
$
575

Alt-A, option ARM
533

 
352

 
263

Alt-A, other
6,633

 
6,070

 
5,173

Total
$
7,906

 
$
7,090

 
$
6,011


21

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



The following tables present the Bank's other-than-temporarily impaired PLRMBS that incurred OTTI charges anytime during the life of the securities at March 31, 2012, and December 31, 2011, by loan collateral type:

March 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available-for-Sale Securities
 
Held-to-Maturity Securities
 
Unpaid
Principal
Balance

 
Amortized
Cost

 
Estimated
Fair Value

 
Unpaid
Principal
Balance

  
Amortized
Cost

  
Carrying
Value

  
Estimated
Fair Value

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:
 
 
 
 
 
 
 
  
 
  
 
  
 
Prime
$
1,093

 
$
945

 
$
818

 
$
15

 
$
14

 
$
14

 
$
15

Alt-A, option ARM
1,786

 
1,367

 
973

 

 

 

 

Alt-A, other
7,803

 
6,943

 
5,891

 
187

 
186

 
145

 
158

Total
$
10,682

 
$
9,255

 
$
7,682

 
$
202

 
$
200

 
$
159

 
$
173

 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2011
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available-for-Sale Securities
 
Held-to-Maturity Securities
 
Unpaid
Principal
Balance

 
Amortized
Cost

 
Estimated
Fair Value

 
Unpaid
Principal
Balance

  
Amortized
Cost

  
Carrying
Value

  
Estimated
Fair Value

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:
 
 
 
 
 
 
 
  
 
  
 
  
 
Prime
$
1,125

 
$
977

 
$
832

 
$
27

 
$
27

 
$
26

 
$
27

Alt-A, option ARM
1,834

 
1,414

 
969

 

 

 

 

Alt-A, other
7,977

 
7,133

 
5,886

 
209

 
207

 
162

 
165

Total
$
10,936

 
$
9,524

 
$
7,687

 
$
236

 
$
234

 
$
188

 
$
192


For the Bank's PLRMBS that were not other-than-temporarily impaired as of March 31, 2012, the Bank has experienced net unrealized losses and a decrease in fair value primarily because of illiquidity in the MBS market, uncertainty about the future condition of the housing and mortgage markets and the economy, and market expectations of the credit performance of loan collateral underlying these securities, which caused these assets to be valued at significant discounts to their acquisition cost. The Bank does not intend to sell these securities, it is not more likely than not that the Bank will be required to sell these securities before its anticipated recovery of the remaining amortized cost basis, and the Bank expects to recover the entire amortized cost basis of these securities. As a result, the Bank determined that, as of March 31, 2012, the gross unrealized losses on these remaining PLRMBS are temporary. These securities were included in the securities that the Bank reviewed and analyzed for OTTI as discussed above, and the analyses performed indicated that these securities were not other-than-temporarily impaired. .

All Other Available-for-Sale and Held-to-Maturity Investments. The Bank determined that, as of March 31, 2012, the de minimis gross unrealized losses on its interest-bearing deposits and commercial paper were temporary because the gross unrealized losses were caused by movements in interest rates and not by the deterioration of the issuers' creditworthiness. The interest-bearing deposits and commercial paper were all with issuers that had credit ratings of at least A at March 31, 2012. As a result, the Bank expects to recover the entire amortized cost basis of these securities.

As of March 31, 2012, the Bank's investments in housing finance agency bonds, which were issued by the California Housing Finance Agency (CalHFA), had gross unrealized losses totaling $127. These gross unrealized losses were mainly due to an illiquid market, credit concerns regarding the underlying mortgage collateral, and credit concerns regarding the monoline insurance providers, causing these investments to be valued at a discount to

22

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


their acquisition cost. The Bank independently modeled cash flows for the underlying collateral, using assumptions for default rates and loss severity that a market participant would deem reasonable, and concluded that the available credit support within the CalHFA structure more than offset the projected underlying collateral losses. The Bank determined that, as of March 31, 2012, all of the gross unrealized losses on the bonds are temporary because the underlying collateral and credit enhancements were sufficient to protect the Bank from losses. As a result, the Bank expects to recover the entire amortized cost basis of these securities.

For its agency MBS, the Bank expects to recover the entire amortized cost basis of these securities because the Bank determined that the strength of the issuers' guarantees through direct obligations or support from the U.S. government is sufficient to protect the Bank from losses. As a result, the Bank determined that, as of March 31, 2012, all of the gross unrealized losses on its agency MBS are temporary.

Note 7 — Advances

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

Redemption Terms. The Bank had advances outstanding, excluding overdrawn demand deposit accounts, at interest rates ranging from 0.09% to 8.57% at March 31, 2012, and 0.05% to 8.57% at December 31, 2011, as summarized below.
 
 
March 31, 2012
 
December 31, 2011
Contractual Maturity
Amount
Outstanding

  
Weighted
Average
Interest Rate

 
Amount
Outstanding

  
Weighted
Average
Interest Rate

Within 1 year
$
23,358

  
0.71
%
 
$
26,432

  
0.88
%
After 1 year through 2 years
17,080

  
1.06

 
20,608

  
1.03

After 2 years through 3 years
6,411

  
1.73

 
5,840

  
1.73

After 3 years through 4 years
5,331

  
1.99

 
5,686

  
2.02

After 4 years through 5 years
5,407

  
1.28

 
5,634

  
1.46

After 5 years
3,854

  
2.24

 
3,236

  
2.78

Total par amount
61,441

  
1.17
%
 
67,436

  
1.24
%
Valuation adjustments for hedging activities
271

  
 
 
302

  
 
Valuation adjustments under fair value option
328

  
 
 
426

  
 
Total
$
62,040

  
 
 
$
68,164

  
 

Many of the Bank's advances are prepayable at the member's option. However, when advances are prepaid, the member is generally charged a prepayment fee intended to make the Bank financially indifferent to the prepayment. In addition, for certain advances with partial prepayment symmetry, the Bank may charge the member a prepayment fee or pay the member a prepayment credit, depending on certain circumstances, such as movements in interest rates, when the advance is prepaid. The Bank had advances with partial prepayment symmetry outstanding totaling $6,662 at March 31, 2012, and $6,875 at December 31, 2011. Some advances may be repaid on pertinent call dates without prepayment fees (callable advances). The Bank had callable advances outstanding totaling $215 at March 31, 2012, and $328 at December 31, 2011.

The Bank's advances at March 31, 2012, and December 31, 2011, included $740 and $1,461, respectively, of putable advances. At the Bank's discretion, the Bank may terminate these advances on predetermined exercise dates, and offer, subject to certain conditions, replacement funding at prevailing market rates. The Bank would typically exercise such termination rights when interest rates increase.


23

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


The following table summarizes advances at March 31, 2012, and December 31, 2011, by the earlier of the year of contractual maturity or next call date for callable advances and by the earlier of the year of contractual maturity or next put date for putable advances.
 
 
Earlier of Contractual
Maturity or Next Call Date
 
Earlier of Contractual
Maturity or Next Put Date
 
March 31, 2012

  
December 31, 2011

 
March 31, 2012

 
December 31, 2011

Within 1 year
$
23,573

  
$
26,755

 
$
23,943

 
$
27,566

After 1 year through 2 years
17,080

  
20,602

 
17,065

 
20,513

After 2 years through 3 years
6,395

  
5,805

 
6,269

 
5,748

After 3 years through 4 years
5,318

  
5,665

 
5,181

 
5,416

After 4 years through 5 years
5,373

  
5,583

 
5,302

 
5,559

After 5 years
3,702

  
3,026

 
3,681

 
2,634

Total par amount
$
61,441

  
$
67,436

 
$
61,441

 
$
67,436


Credit and Concentration Risk. The following tables present the concentration in advances to the top five borrowers and their affiliates at March 31, 2012, and March 31, 2011. The tables also present the interest income from these advances before the impact of interest rate exchange agreements associated with these advances for the three months ended March 31, 2012 and 2011.

 
March 31, 2012
 
Three Months Ended March 31, 2012
Name of Borrower
Advances
Outstanding(1)

 
Percentage of
Total
Advances
Outstanding

 
Interest
Income from
Advances(2)

  
Percentage of
Total Interest
Income from
Advances

Citibank, N.A.(3)
$
15,808

 
26
%
 
$
15

 
7
%
JPMorgan Chase & Co.:
 
 
 
 
 
 
 
JPMorgan Bank & Trust Company, National Association
11,600

 
19

 
27

 
14

JPMorgan Chase Bank, National Association(3)
1,554

 
3

 
4

 
2

Subtotal JPMorgan Chase & Co.
13,154

 
22

 
31

 
16

Union Bank, N.A.
5,500

 
9

 
14

 
7

Bank of the West
4,610

 
8

 
27

 
14

Bank of America California, N.A.
3,700

 
6

 
7

 
3

     Subtotal
42,772

 
71

 
94

 
47

Others
18,669

 
29

 
104

 
53

Total
$
61,441

 
100
%
 
$
198

 
100
%
 

24

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


 
March 31, 2011
 
Three Months Ended March 31, 2011
Name of Borrower
Advances
Outstanding(1)

 
Percentage of
Total
Advances
Outstanding

 
Interest
Income from
Advances(4)

  
Percentage of
Total Interest
Income from
Advances

Citibank, N.A.
$
26,692

 
29
%
 
$
18

 
6
%
Bank of America California, N.A.
8,850

 
10

 
25

 
9

JPMorgan Chase & Co.:
 
 
 
 
 
 
 
JPMorgan Bank & Trust Company, National Association
24,200

 
26

 
31

 
11

JPMorgan Chase Bank, National Association(3)
1,571

 
2

 
9

 
3

Subtotal JPMorgan Chase & Co.
25,771

 
28

 
40

 
14

OneWest Bank, FSB
5,499

 
6

 
36

 
13

Union Bank, N.A.
4,750

 
5

 
15

 
6

     Subtotal
71,562

 
78

 
134

 
48

Others
19,928

 
22

 
145

 
52

Total
$
91,490

 
100
%
 
$
279

 
100
%

(1)
Borrower advance amounts and total advance amounts are at par value, and total advance amounts will not agree to carrying value amounts shown in the Statements of Condition. The differences between the par and carrying value amounts primarily relate to unrealized gains or losses associated with hedged advances resulting from valuation adjustments related to hedging activities and under the fair value option.
(2)
Interest income amounts exclude the interest effect of interest rate exchange agreements with derivatives counterparties; as a result, the total interest income amounts will not agree to the Statements of Income. The amount of interest income from advances can vary depending on the amount outstanding, terms to maturity, interest rates, and repricing characteristics.
(3)
Nonmember institution.


The Bank held a security interest in collateral from each of the top five advances borrowers and their affiliates sufficient to support their respective advances outstanding, and the Bank does not expect to incur any credit losses on these advances. As of March 31, 2012, two of the advances borrowers and their affiliates (JPMorgan Chase & Co. and Citibank, N.A.) each owned more than 10% of the Bank's outstanding capital stock, including mandatorily redeemable capital stock.

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

Interest Rate Payment Terms. Interest rate payment terms for advances at March 31, 2012, and December 31, 2011, are detailed below:
 
  
March 31, 2012

 
December 31, 2011

Par amount of advances:
 
 
 
Fixed rate:
 
 
 
Due within 1 year
$
9,516

 
$
11,606

Due after 1 year
20,671

 
20,577

Total fixed rate
30,187

 
32,183

Adjustable rate
 
 
 
Due within 1 year
13,842

 
14,826

Due after 1 year
17,412

 
20,427

Total adjustable rate
31,254

 
35,253

Total par amount
$
61,441

  
$
67,436


The Bank may use derivatives to adjust the repricing and/or options characteristics of advances to more closely match the characteristics of the Bank's funding liabilities. In general, whenever a member executes a fixed rate advance or a variable rate advance with embedded options, the Bank will simultaneously execute an interest rate

25

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


exchange agreement with terms that offset the terms and embedded options, if any, in the advance. The combination of the advance and the interest rate exchange agreement effectively creates a variable rate asset. This type of hedge is treated as a fair value hedge. In addition, for certain advances for which the Bank has elected the fair value option, the Bank will simultaneously execute an interest rate exchange agreement with terms that economically offset the terms of the advance. However, this type of hedge is treated as an economic hedge because these combinations generally do not meet the requirements for fair value hedge accounting treatment. For more information, see Note 15 – Derivatives and Hedging Activities and Note 16 – Fair Value.

At March 31, 2012, and December 31, 2011, the Bank used derivatives to effectively convert 67% and 75% of the fixed rate advances to an adjustable rate, such as LIBOR, and 1% and 0% of the adjustable rate advances to a different adjustable rate index, such as 1-month or 3-month LIBOR.

The Bank did not have any advances with embedded features that met the requirements to separate the embedded feature from the host contract and designate the embedded feature as a stand-alone derivative at March 31, 2012, and December 31, 2011.

Prepayment Fees, Net. The Bank charges borrowers prepayment fees or pays borrowers prepayment credits when the principal on certain advances is paid prior to original maturity. The Bank records prepayment fees net of any associated fair value adjustments related to prepaid advances that were hedged. The net amount of prepayment fees is reflected as interest income in the Statements of Income, as follows:

 
Three Months Ended
 
March 31, 2012

 
March 31, 2011

Prepayment fees received
$
95

 
$
33

Fair value adjustments
(73
)
 
(27
)
Net
$
22

 
$
6

Advance principal prepaid
$
1,353

 
$
675


Note 8 — Mortgage Loans Held for Portfolio

Under the Mortgage Partnership Finance® (MPF®) Program, the Bank purchased conventional conforming fixed rate residential mortgage loans directly from its participating members from May 2002 through October 2006. (“Mortgage Partnership Finance” and “MPF” are registered trademarks of the Federal Home Loan Bank of Chicago.) The mortgage loans are held-for-portfolio loans. Participating members originated or purchased the mortgage loans, credit-enhanced them and sold them to the Bank, and generally retained the servicing of the loans.
 
The following table presents information as of March 31, 2012, and December 31, 2011, on mortgage loans, all of which are secured by one- to four-unit residential properties and single-unit second homes.
 
  
March 31, 2012

 
December 31, 2011

Fixed rate medium-term mortgage loans
$
475

 
$
519

Fixed rate long-term mortgage loans
1,224

 
1,322

Subtotal
1,699

 
1,841

Unamortized premiums
15

 
15

Unamortized discounts
(22
)
 
(21
)
Mortgage loans held for portfolio
1,692

 
1,835

Less: Allowance for credit losses
(6
)
 
(6
)
Total mortgage loans held for portfolio, net
$
1,686

 
$
1,829


Medium-term loans have original contractual terms of 15 years or less, and long-term loans have contractual terms

26

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


of more than 15 years.

Concentration Risk. The Bank had the following concentration in MPF loans with institutions whose outstanding total of mortgage loans sold to the Bank represented 10% or more of the Bank's total outstanding mortgage loans at March 31, 2012, and December 31, 2011.
 
March 31, 2012
 
 
 
 
 
 
 
Name of Institution
Mortgage
Loan Balances
Outstanding

  
Percentage of 
Total
Mortgage
Loan Balances
Outstanding

 
Number of
Mortgage Loans
Outstanding

  
Percentage of
Total Number
of Mortgage 
Loans
Outstanding

JPMorgan Chase Bank, National Association
$
1,339

  
79
%
 
11,939

  
71
%
OneWest Bank, FSB
221

  
13

 
3,482

  
21

Subtotal
1,560

  
92

 
15,421

  
92

Others
139

  
8

 
1,363

  
8

Total
$
1,699

  
100
%
 
16,784

  
100
%
 
 
 
 
 
 
 
 
December 31, 2011
 
  
 
 
 
  
 
Name of Institution
Mortgage
Loan Balances
Outstanding

  
Percentage of 
Total
Mortgage
Loan Balances
Outstanding

 
Number of
Mortgage Loans
Outstanding

  
Percentage of
Total Number
of Mortgage 
Loans
Outstanding

JPMorgan Chase Bank, National Association
$
1,454

  
79
%
 
12,729

  
72
%
OneWest Bank, FSB
238

  
13

 
3,625

  
20

Subtotal
1,692

  
92

 
16,354

  
92

Others
149

  
8

 
1,431

  
8

Total
$
1,841

  
100
%
 
17,785

  
100
%

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

Note 9 — Allowance for Credit Losses

The Bank has established an allowance methodology for each of its portfolio segments: credit products, mortgage loans held for portfolio, securities purchased under agreements to resell, and Federal funds sold.

Credit Products. Under the Federal Home Loan Bank Act of 1932, as amended (FHLBank Act), the Bank is required to obtain sufficient collateral for credit products to protect the Bank from credit losses. Collateral eligible to secure credit products includes certain investment securities, residential mortgage loans, cash or deposits with the Bank, and other eligible real estate-related assets. The Bank may also accept secured small business, small farm, and small agribusiness loans, and securities representing a whole interest in such secured loans, as collateral from members that are community financial institutions. The Bank evaluates the creditworthiness of its members and nonmember borrowers on an ongoing basis. For more information on security terms, see “Item 8. Financial Statements and Supplementary Data – Note 10 – Allowance for Credit Losses” in the Bank's 2011 Form 10-K.

The Bank classifies as impaired any advance with respect to which the Bank believes it is probable that all principal and interest due will not be collected according to its contractual terms. Impaired advances are valued using the present value of expected future cash flows discounted at the advance's effective interest rate, the advance's observable market price or, if collateral-dependent, the fair value of the advance's underlying collateral. When an advance is classified as impaired, the accrual of interest is discontinued and unpaid accrued interest is reversed. Advances do not return to accrual status until they are brought current with respect to both principal and interest

27

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


and until the Bank believes future principal payments are no longer in doubt. No advances were classified as impaired during the periods presented.
 
The Bank manages its credit exposure relating to credit products through an integrated approach that generally provides for a credit limit to be established for each borrower, includes an ongoing review of each borrower's financial condition, and is coupled with conservative collateral and lending policies to limit the risk of loss while taking into account borrowers' needs for a reliable funding source. At March 31, 2012, and December 31, 2011, none of the Bank's credit products were past due, on nonaccrual status, or considered impaired. There were no troubled debt restructurings related to credit products during the three months ended March 31, 2012, or during 2011.

Based on the collateral pledged as security for advances, the Bank's credit analyses of members' financial condition, and the Bank's credit extension and collateral policies as of March 31, 2012, the Bank expects to collect all amounts due according to the contractual terms. Therefore, no allowance for losses on credit products was deemed necessary by the Bank. The Bank has never experienced any credit losses on its credit products.

During the first three months of 2012, no member institutions were placed into receivership or liquidation.

From April 1, 2012, to April 30, 2012, one member institution was placed into receivership. There were no advances outstanding at the time the member was placed into receivership. The capital stock held by the member institution was transferred to another member.


Mortgage Loans Held for Portfolio. A mortgage loan is considered to be impaired when it is reported 90 days or more past due (nonaccrual) or when it is probable, based on current information and events, that the Bank will be unable to collect all principal and interest amounts due according to the contractual terms of the mortgage 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 noted below.
 
The Bank places a mortgage loan on nonaccrual status when the collection of the contractual principal or interest from the participating institution is reported 90 days or more past due. When a mortgage loan is placed on nonaccrual status, accrued but uncollected interest is reversed against interest income. The Bank records cash payments received on nonaccrual loans first as interest income and then as a reduction of principal as specified in the contractual agreement, unless the collection of the remaining principal amount due is considered doubtful.
The following table presents information on delinquent mortgage loans as of March 31, 2012, and December 31, 2011.


28

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


 
March 31, 2012

 
December 31, 2011

 
Recorded
Investment(1)

 
Recorded
Investment(1)

30 – 59 days delinquent
$
22

 
$
24

60 – 89 days delinquent
9

 
9

90 days or more delinquent
36

 
34

Total past due
67

 
67

Total current loans
1,633

 
1,777

Total mortgage loans
$
1,700

 
$
1,844

In process of foreclosure, included above(2)
$
23

 
$
21

Nonaccrual loans
$
36

 
$
34

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

 
$

Serious delinquencies(3) as a percentage of total mortgage loans outstanding
2.10
%
 
1.83
%

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

The Bank's average recorded investment in impaired loans totaled $38 and $36 for the first quarter of 2012 and 2011, respectively. The Bank's unpaid principal balance in impaired loans totaled $35 at March 31, 2012, and $40 at December 31, 2011.

Mortgage Loans Evaluated at the Individual Master Commitment Level. The credit risk analysis of all conventional MPF loans is performed at the individual master commitment level to determine the credit enhancements available to recover losses on MPF loans under each individual master commitment.

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 expected to be provided only 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 on those loans on an individual loan basis. The Bank estimates the fair value of collateral using real estate broker price opinions based on recent market sales and current listings. The resulting incurred loss, if any, 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. The credit risk analysis of conventional loans evaluated collectively for impairment considers loan pool-specific attribute data, applies estimated loss severities, and incorporates the credit enhancements of the mortgage loan programs to determine the Bank's best estimate of probable incurred losses. Migration analysis is a methodology for determining, through the Bank's experience over a historical period, the default rate on pools of similar loans.

The allowance for credit losses on the mortgage loan portfolio was as follows:


29

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


 
Three Months Ended
 
March 31, 2012

 
March 31, 2011

Balance, beginning of the period
$
6

 
$
3

Charge-offs – transferred to real estate owned (REO)
(1
)
 

Provision for credit losses
1

 

Balance, end of the period
$
6

 
$
3

Ratio of net charge-offs during the period to average loans outstanding during the period
(0.02
)%
 
(0.02
)%
Ending balance, individually evaluated for impairment
$
5

 
$
3

Ending balance, collectively evaluated for impairment
$
1

 
$

Recorded investment, end of the period
$
1,700

 
$
2,218

Individually evaluated for impairment(1)
$
35

 
$
38

Collectively evaluated for impairment
$
1,665

 
$
2,180


(1)
The recorded investment on loans individually evaluated for impairment with no related allowance totaled $16 and $26 for the three months ended March 31, 2012 and 2011, respectively. The recorded investment on loans individually evaluated for impairment with a related allowance totaled $19 and $12 for the three months ended March 31, 2012 and 2011, respectively.

The Bank and any participating institution share in the credit risk of the loans sold by that institution as specified in a master agreement. Loans purchased under the MPF Program generally had a credit risk exposure at the time of purchase equivalent to AA-rated assets taking into consideration the credit risk sharing structure mandated by the Finance Agency's acquired member assets (AMA) regulation. The Bank holds additional risk-based capital when it determines that purchased loans do not have a credit risk exposure equivalent to AA-rated assets. The MPF Program structures potential credit losses on conventional MPF loans into layers with respect to each pool of loans purchased by the Bank under a single Master Commitment for the member selling the loans:

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

The Bank calculates its estimated allowance for credit losses on mortgage loans acquired under its two MPF products, Original MPF and MPF Plus, as described below.
 
Allowance for Credit Losses on MPF Loans - The Bank evaluates the allowance for credit losses on MPF mortgage loans based on two components. The first component applies to each individual loan that is specifically identified as impaired. The Bank evaluates the exposure on these loans by considering the first layer of loss protection (the liquidation value of the real property securing the loan) and the availability and collectability of credit enhancements under the terms of each Master Commitment and records a provision for credit losses. For this component, the Bank established an allowance for credit losses for Original MPF loans totaling de minimis amounts as of March 31, 2012, and December 31, 2011, and for MPF Plus loans totaling $5 as of March 31, 2012, and $4 as of December 31, 2011.
 
The second component applies to loans that are not specifically identified as impaired and is based on the Bank's estimate of probable credit losses on those loans as of the financial statement date. The Bank evaluates the credit loss exposure on a loan pool basis considering various observable data, such as delinquency statistics, past performance, current performance, loan portfolio characteristics, collateral valuations, industry data, and prevailing

30

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


economic conditions. The availability and collectability of credit enhancements from institutions or from mortgage insurers under the terms of each Master Commitment are also considered. For this component, the Bank established an allowance for credit losses for Original MPF loans totaling de minimis amounts as of March 31, 2012, and as of December 31, 2011, and for MPF Plus loans totaling $1 as of March 31, 2012, and $2 as of December 31, 2011.

Troubled Debt Restructurings. Troubled debt restructuring is considered to have occurred when a concession is granted to the debtor for economic or legal reasons related to the debtor's financial difficulties and that concession would not have been considered otherwise. An MPF loan considered a troubled debt restructuring is individually evaluated for impairment when determining its related allowance for credit losses. Credit loss is measured by factoring in expected cash shortfalls incurred as of the reporting date as well as the economic loss attributable to delaying the original contractual principal and interest due dates, if applicable.

The Bank's MPF loan troubled debt restructurings primarily involve modifying the borrower's monthly payment for a period of up to 36 months to reflect a housing expense ratio that is no more than 31% of the borrower's monthly income. The outstanding principal balance is re-amortized to reflect a principal and interest payment for a term not to exceed 40 years from the original note date and a housing expense ratio not to exceed 31%. 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 is unchanged. If the 31% ratio is still not met, the interest rate is reduced for up to 36 months in 0.125% increments below the original note rate, to a floor rate of 3.00%, resulting in reduced principal and interest payments, until the target 31% housing expense ratio is met.

During the three months ended March 31, 2012, and the year ended December 31, 2011, a de minimis amount of the Bank's MPF loans were classified as troubled debt restructurings.

Term Securities Purchased Under Agreements to Resell. The Bank did not have any term securities purchased under agreements to resell at March 31, 2012, and December 31, 2011

Term Federal Funds Sold. The Bank invests in Federal funds sold with highly rated counterparties, and these investments are evaluated for purposes of an allowance for credit losses if the investment is not paid when due. All investments in Federal funds sold as of March 31, 2012, and December 31, 2011, were repaid or are expected to be repaid according to the contractual terms.

Note 10 — Deposits

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

Deposits as of March 31, 2012, and December 31, 2011, were as follows:

 
March 31, 2012

 
December 31, 2011

Interest-bearing deposits:
 
 
 
Demand and overnight
$
161

 
$
151

Term
2

 
1

Other
1

 
3

Total interest-bearing deposits
164

 
155

Non-interest-bearing deposits
2

 
1

Total
$
166

 
$
156


31

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



Interest Rate Payment Terms. Deposits classified as demand, overnight, and other, pay interest based on a daily interest rate. Term deposits pay interest based on a fixed rate determined at the issuance of the deposit. Interest rate payment terms for deposits at March 31, 2012, and December 31, 2011, are detailed in the following table:

 
March 31, 2012
 
December 31, 2011
 
Amount
Outstanding

 
Weighted
Average
Interest Rate

 
Amount
Outstanding

 
Weighted
Average
Interest Rate

Interest-bearing deposits:
 
 
 
 
 
 
 
Fixed rate
$
2

 
0.03
%
 
$
1

 
0.01
%
Adjustable rate
162

 
0.01

 
154

 
0.01

Total interest-bearing deposits
164

 
0.01

 
155

 
0.01

Non-interest-bearing deposits
2

 

 
1

 

Total
$
166

 
0.01
%
 
$
156

 
0.01
%

The aggregate amount of time deposits with a denomination of $0.1 or more was $2 at March 31, 2012, and $1 at December 31, 2011. These time deposits were scheduled to mature within six months.

Note 11 — Consolidated Obligations

Consolidated obligations, consisting of consolidated obligation bonds and discount notes, are jointly issued by the FHLBanks through the Office of Finance, which serves as the FHLBanks' agent. As provided by the FHLBank Act or by regulations governing the operations of the FHLBanks, all FHLBanks have joint and several liability for all FHLBank consolidated obligations. For a discussion of the joint and several liability regulation, see “Item 8. Financial Statements and Supplementary Data – Note 20 – Commitments and Contingencies” in the Bank's 2011 Form 10-K. In connection with each debt issuance, each FHLBank specifies the type, term, and amount of debt it requests to have issued on its behalf. The Office of Finance tracks the amount of debt issued on behalf of each FHLBank. In addition, the Bank separately tracks and records as a liability its specific portion of the consolidated obligations issued and is the primary obligor for that portion of the consolidated obligations issued. The Finance Agency and the U.S. Secretary of the Treasury have oversight over the issuance of FHLBank debt through the Office of Finance.
Redemption Terms. The following is a summary of the Bank's participation in consolidated obligation bonds at March 31, 2012, and December 31, 2011.
 

32

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


 
March 31, 2012
 
December 31, 2011
Contractual Maturity
Amount
Outstanding

 
Weighted
Average
Interest Rate

 
Amount
Outstanding

 
Weighted
Average
Interest Rate

Within 1 year
$
32,864

 
0.75
%
 
$
40,924

 
0.54
%
After 1 year through 2 years
16,662

 
2.44

 
19,124

 
2.38

After 2 years through 3 years
6,151

 
1.45

 
3,731

 
1.92

After 3 years through 4 years
3,224

 
2.19

 
2,955

 
1.96

After 4 years through 5 years
7,726

 
2.95

 
8,006

 
3.15

After 5 years
6,739

 
2.98

 
7,301

 
3.37

Index amortizing notes
4

 
4.61

 
4

 
4.61

Total par amount
73,370

 
1.69
%
 
82,045

 
1.59
%
Unamortized premiums
85

 
 
 
89

 
 
Unamortized discounts
(33
)
 
 
 
(35
)
 
 
Valuation adjustments for hedging activities
1,133

 
 
 
1,208

 
 
Fair value option valuation adjustments
24

 
 
 
43

 
 
Total
$
74,579

 
 
 
$
83,350

 
 

The Bank's participation in consolidated obligation bonds outstanding includes callable bonds of $18,383 at March 31, 2012, and $17,091 at December 31, 2011. Contemporaneous with the issuance of a callable bond for which the Bank is the primary obligor, the Bank routinely enters into an interest rate swap (in which the Bank pays a variable rate and receives a fixed rate) with a call feature that mirrors the call option embedded in the bond (a sold callable swap). The Bank had notional amounts of interest rate exchange agreements hedging callable bonds of $14,508 at March 31, 2012, and $11,541 at December 31, 2011. The combined sold callable swap and callable bond enable the Bank to meet its funding needs at costs not otherwise directly attainable solely through the issuance of non-callable debt, while effectively converting the Bank's net payment to an adjustable rate.
The Bank's participation in consolidated obligation bonds was as follows:
 
  
March 31, 2012

  
December 31, 2011

Par amount of consolidated obligation bonds:
 
  
 
Non-callable
$
54,987

  
$
64,954

Callable
18,383

  
17,091

Total par amount
$
73,370

  
$
82,045


The following is a summary of the Bank's participation in consolidated obligation bonds outstanding at March 31, 2012, and December 31, 2011, by the earlier of the year of contractual maturity or next call date.
 
Earlier of Contractual
Maturity or Next Call Date
March 31, 2012

  
December 31, 2011

Within 1 year
$
46,750

  
$
51,735

After 1 year through 2 years
15,104

  
18,954

After 2 years through 3 years
2,816

  
2,661

After 3 years through 4 years
2,535

  
1,985

After 4 years through 5 years
5,158

  
5,761

After 5 years
1,003

  
945

Index amortizing notes
4

  
4

Total par amount
$
73,370

  
$
82,045

Consolidated obligation discount notes are consolidated obligations issued to raise short-term funds. These notes are issued at less than their face amount and redeemed at par value when they mature. The Bank's participation in

33

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


consolidated obligation discount notes, all of which are due within one year, was as follows:
 
 
March 31, 2012
 
December 31, 2011
 
Amount
Outstanding

 
Weighted
Average
Interest Rate

 
Amount
Outstanding

 
Weighted
Average
Interest Rate

Par amount
$
23,325

 
0.11
%
 
$
19,159

 
0.11
%
Unamortized discounts
(7
)
 
 
 
(7
)
 
 
Total
$
23,318

 
 
 
$
19,152

 
 
Interest Rate Payment Terms. Interest rate payment terms for consolidated obligations at March 31, 2012, and December 31, 2011, are detailed in the following table. For information on the general terms and types of consolidated obligations outstanding, see “Item 8. Financial Statements and Supplementary Data – Note 12 – Consolidated Obligations” in the Bank's 2011 Form 10-K.
 
  
March 31, 2012

  
December 31, 2011

Par amount of consolidated obligations:
 
  
 
Bonds:
 
  
 
Fixed rate
$
61,552

  
$
59,607

Adjustable rate
9,434

  
19,688

Step-up
2,195

  
2,221

Step-down
65

  
115

Fixed rate that converts to adjustable rate
30

  
290

Adjustable rate that converts to fixed rate
15

  
35

Adjustable rate that converts to step-up
75

 
75

Range bonds

  
10

Index amortizing notes
4

  
4

Total bonds, par
73,370

  
82,045

Discount notes, par
23,325

  
19,159

Total consolidated obligations, par
$
96,695

  
$
101,204


In general, when bonds with these structures are issued, the Bank will simultaneously execute an interest rate exchange agreement with terms that offset the terms and embedded options, if any, of the consolidated obligation bond. This combination of the consolidated obligation bond and the interest rate exchange agreement effectively creates an adjustable rate bond. The cost of this funding combination is generally lower than the cost that would be available through the issuance of an adjustable rate bond alone. These transactions generally receive fair value hedge accounting treatment. In addition, for certain consolidated obligation bonds for which the Bank has elected the fair value option, the Bank will simultaneously execute an interest rate exchange agreement with terms that economically offset the terms of the consolidated obligation bond. However, this type of hedge is treated as an economic hedge because these combinations generally do not meet the requirements for fair value hedge accounting treatment. For more information, see Note 15 – Derivatives and Hedging Activities and Note 16 – Fair Value.

At March 31, 2012, and December 31, 2011, the Bank used interest rate exchange agreements to effectively convert 81% and 80% of the fixed rate bonds to an adjustable rate, such as LIBOR, and 100% and 96% of the adjustable rate bonds to a different adjustable rate index, such as 1-month or 3-month LIBOR. At March 31, 2012, and December 31, 2011, the Bank used interest rate exchange agreements to effectively convert 75% and 61% of the fixed rate discount notes to an adjustable rate, such as LIBOR.

The Bank did not have any bonds with embedded features that met the requirements to separate the embedded feature from the host contract and designate the embedded feature as a stand-alone derivative at March 31, 2012, and December 31, 2011.

34

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




Note 12 — Accumulated Other Comprehensive Income/(Loss)

The following table summarizes the changes in accumulated other comprehensive income for the three months ended March 31, 2012 and 2011:

 
 Net unrealized gain/(loss) on available-for-sale securities

 
 Net non-credit-related OTTI loss on available-for-sale securities

 
 Net non-credit-related OTTI loss on held-to-maturity securities

 
 Pension and postretirement benefits

 
 Total accumulated other comprehensive income/(loss)

Balance, December 31, 2010
$
(2
)
 
$

 
$
(2,934
)
 
$
(7
)
 
$
(2,943
)
Current period other comprehensive income/ (loss)
1

 
(1,079
)
 
1,982

 

 
904

Balance, March 31, 2011
$
(1
)
 
$
(1,079
)
 
$
(952
)
 
$
(7
)
 
$
(2,039
)
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2011
$
1

 
$
(1,836
)
 
$
(46
)
 
$
(12
)
 
$
(1,893
)
Current period other comprehensive income/ (loss)

 
263

 
5

 

 
268

Balance, March 31, 2012
$
1

 
$
(1,573
)
 
$
(41
)
 
$
(12
)
 
$
(1,625
)

Note 13 — Capital

Capital Requirements. Under the Housing and Economic Recovery Act of 2008 (Housing Act), the Director of the Finance Agency is responsible for setting the risk-based capital standards for the FHLBanks. The FHLBank Act and regulations governing the operations of the FHLBanks require that the Bank's minimum stock requirement for members must be sufficient to enable the Bank to meet its regulatory requirements for total capital, leverage capital, and risk-based capital. The Bank must maintain: (i) total regulatory capital in an amount equal to at least 4% of its total assets, (ii) leverage capital in an amount equal to at least 5% of its total assets, and (iii) permanent capital in an amount at least equal to its regulatory risk-based capital requirement. Regulatory capital and permanent capital are defined as retained earnings and Class B stock, which includes mandatorily redeemable capital stock, which is classified as a liability for financial reporting purposes. Regulatory capital and permanent capital do not include AOCI. Leverage capital is defined as the sum of permanent capital, weighted by a 1.5 multiplier, plus non-permanent capital. Non-permanent capital consists of Class A capital stock, which is redeemable upon six months' notice. The Bank's capital plan does not provide for the issuance of Class A capital stock.

The risk-based capital requirements must be met with permanent capital, which must be at least equal to the sum of the Bank's credit risk, market risk, and operations risk capital requirements, all of which are calculated in accordance with the rules and regulations of the Finance Agency. The Finance Agency may require an FHLBank to maintain a greater amount of permanent capital than is required by the risk-based capital requirements as defined.

As of March 31, 2012, and December 31, 2011, the Bank was in compliance with these capital rules and requirements, as shown in the following table.

 
 
March 31, 2012
 
December 31, 2011
 
Required

 
Actual

 
Required

 
Actual

Risk-based capital
$
4,390

 
$
11,990

 
$
4,915

 
$
12,176

Total regulatory capital
$
4,403

 
$
11,990

 
$
4,542

 
$
12,176

Total regulatory capital ratio
4.00
%
 
10.89
%
 
4.00
%
 
10.72
%
Leverage capital
$
5,504

 
$
17,985

 
$
5,678

 
$
18,264

Leverage ratio
5.00
%
 
16.34
%
 
5.00
%
 
16.08
%

35

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



Mandatorily Redeemable Capital Stock. The Bank had mandatorily redeemable capital stock totaling $5,307 outstanding to 53 institutions at March 31, 2012, and $5,578 outstanding to 53 institutions at December 31, 2011. The change in mandatorily redeemable capital stock for the three months ended March 31, 2012 and 2011, was as follows:
 
 
Three Months Ended
 
March 31, 2012

 
March 31, 2011

Balance at the beginning of the period
$
5,578

  
$
3,749

Reclassified from/(to) capital during the period:
 
  
 
Merger with or acquisition by nonmember institution

 
1

Termination of membership

  
2

Acquired by/transferred to members(1)

 
(500
)
Redemption of mandatorily redeemable capital stock
(5
)
  
(23
)
Repurchase of excess mandatorily redeemable capital stock
(266
)
 
(127
)
Balance at the end of the period
$
5,307

  
$
3,102



(1)
During 2008, JPMorgan Chase Bank, National Association, a nonmember, assumed Washington Mutual Bank's outstanding Bank advances and acquired the associated Bank capital stock. The Bank reclassified the capital stock transferred to JPMorgan Chase Bank, National Association to mandatorily redeemable capital stock (a liability). JPMorgan Bank and Trust Company, National Association, an affiliate of JPMorgan Chase Bank, National Association, became a member of the Bank. During the first quarter of 2011, the Bank allowed the transfer of excess capital stock totaling $500 from JPMorgan Chase Bank, National Association, to JPMorgan Bank and Trust Company, National Association, to enable JPMorgan Bank and Trust Company, National Association, to satisfy its activity-based stock requirement. The capital stock transferred is no longer classified as mandatorily redeemable capital stock (a liability). However, the capital stock remaining with JPMorgan Chase Bank, National Association, remains classified as mandatorily redeemable capital stock (a liability).

Cash dividends on mandatorily redeemable capital stock in the amount of $7 and $3 were recorded as interest expense for the three months ended March 31, 2012 and 2011, respectively.

The Bank's mandatorily redeemable capital stock is discussed more fully in “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital” in the Bank's 2011 Form 10-K.
The following table presents mandatorily redeemable capital stock amounts by contractual redemption period at March 31, 2012, and December 31, 2011.

 
Contractual Redemption Period
March 31, 2012

  
December 31, 2011

Within 1 year
$
43

  
$
49

After 1 year through 2 years
1,045

  
1,086

After 2 years through 3 years
1,228

  
1,288

After 3 years through 4 years
227

  
250

After 4 years through 5 years
2,764

  
2,905

Total
$
5,307

  
$
5,578


Retained Earnings and Dividend Policy. The Bank's Retained Earnings and Dividend Policy establishes amounts to be retained in restricted retained earnings, which are not made available for dividends in the current dividend period.

Retained Earnings Related to Valuation Adjustments – In accordance with the Retained Earnings and Dividend Policy, the Bank retains in restricted retained earnings any cumulative net gains in earnings (net of applicable assessments) resulting from gains or losses on derivatives and associated hedged items and financial instruments carried at fair value (valuation adjustments). As the cumulative net valuation gains are reversed by periodic net losses and settlements of contractual interest cash flows, the amount of cumulative net gains decreases. The amount

36

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


of retained earnings under this provision of the policy is therefore decreased, and that portion of the previously restricted retained earnings becomes unrestricted and may be made available for dividends.

Other Retained Earnings – Targeted Buildup In addition to any cumulative net gains resulting from valuation adjustments, the Bank holds an additional amount in restricted retained earnings intended to protect paid-in capital from the effects of an extremely adverse credit event, an extremely adverse operations risk event, an extremely high level of quarterly losses related to the Bank's derivatives and associated hedged items and financial instruments carried at fair value, an extremely adverse change in the market value of the Bank's capital, and a significant amount of additional credit-related OTTI on PLRMBS, especially in periods of extremely low net income resulting from an adverse interest rate environment.

The Board of Directors has set the targeted amount of restricted retained earnings at $1,800. The Bank's retained earnings target may be changed at any time. The Board of Directors will periodically review the methodology and analysis to determine whether any adjustments are appropriate. As of March 31, 2012, the amount of restricted retained earnings in the Bank's targeted buildup account reached the $1.8 billion target.

Joint Capital Enhancement Agreement – In 2011, the 12 FHLBanks entered into a Joint Capital Enhancement Agreement (Agreement), as amended, which is intended to enhance the capital position of each FHLBank by allocating that portion of each FHLBank's earnings historically paid to satisfy its Resolution Funding Corporation (REFCORP) obligation to a separate retained earnings account at that FHLBank.

On August 5, 2011, the Finance Agency certified that the FHLBanks had fully satisfied their REFCORP obligation. In accordance with the Agreement, starting in the third quarter of 2011, each FHLBank is required to allocate 20% of its net income each quarter to a separate restricted retained earnings account until the balance of the account equals at least 1% of that FHLBank's average balance of outstanding consolidated obligations for the previous quarter. Under the Agreement, these restricted retained earnings will not be available to pay dividends.

The following table summarizes the activity related to restricted retained earnings for the three months ended March 31, 2012 and 2011:

 
Three Months Ended
 
March 31, 2012
 
Restricted Retained Earnings Related to:
 
Valuation Adjustments

 
Joint Capital Enhancement Agreement

 
Targeted Buildup

 
Total

Balance at beginning of the period
$
79

 
$
29

 
$
1,695

 
$
1,803

Transfers to/(from) restricted retained earnings
21

 
34

 
105

 
160

Balance at end of the period
$
100

 
$
63

 
$
1,800

 
$
1,963


 
Three Months Ended
 
March 31, 2011
 
Restricted Retained Earnings Related to:
 
Valuation Adjustments

 
Joint Capital Enhancement Agreement

 
Targeted Buildup

 
Total

Balance at beginning of the period
$
148

 
$

 
$
1,461

 
$
1,609

Transfers to/(from) restricted retained earnings
1

 

 
53

 
54

Balance at end of the period
$
149

 
$

 
$
1,514

 
$
1,663


For more information on these three categories of restricted retained earnings and the Bank's Retained Earnings and Dividend Policy, see “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital” in the Bank's 2011 Form 10-K.

37

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



Dividend Payments – Finance Agency rules state that FHLBanks may declare and pay dividends only from previously retained earnings or current net earnings, and may not declare or pay dividends based on projected or anticipated earnings. There is no requirement that the Board of Directors declare and pay any dividend. A decision by the Board of Directors to declare a dividend is a discretionary matter and is subject to the requirements and restrictions of the FHLBank Act and applicable requirements under the regulations governing the operations of the FHLBanks.

The Bank paid dividends (including dividends on mandatorily redeemable capital stock) totaling $13 at an annualized rate of 0.48% in the first quarter of 2012, and $9 at an annualized rate of 0.29% in the first quarter of 2011.

On April 27, 2012, the Bank's Board of Directors declared a cash dividend on the capital stock outstanding during the first quarter of 2012 at an annualized dividend rate of 0.51%. The Bank recorded the dividend on April 27, 2012, the day it was declared by the Board of Directors. The Bank expects to pay the dividend (including dividends on mandatorily redeemable capital stock), which will total $13, on or about May 10, 2012.

The Bank will pay the dividend in cash rather than stock to comply with Finance Agency rules, which do not permit the Bank to pay dividends in the form of capital stock if the Bank's excess stock (defined as any stock holdings in excess of a shareholder's minimum capital stock requirement, as established by the Bank's capital plan) exceeds 1% of its total assets. As of March 31, 2012, the Bank's excess capital stock totaled $6,153, or 5.59% of total assets.

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

Excess Capital Stock. The Bank may repurchase some or all of a shareholder's excess capital stock and any excess mandatorily redeemable capital stock at the Bank's discretion and subject to certain statutory and regulatory requirements. The Bank must give the shareholder 15 days' written notice; however, the shareholder may waive this notice period. The Bank may also repurchase some or all of a shareholder's excess capital stock at the shareholder's request, at the Bank's discretion and subject to certain statutory and regulatory requirements. A shareholder's excess capital stock is defined as any stock holdings in excess of the shareholder's minimum capital stock requirement, as established by the Bank's capital plan.

On a quarterly basis, the Bank determines whether it will repurchase excess capital stock. Because of a decision to preserve capital in view of the possibility of future OTTI charges on the Bank's PLRMBS portfolio, the Bank did not fully repurchase excess capital stock, created primarily by declining advances balances, in 2011 and in the first three months of 2012. The Bank opted to maintain its strong regulatory capital position, while repurchasing $446 in excess capital stock in the first quarter of 2012. The Bank repurchased excess capital stock totaling $445, $471, $460, and $469 in the first, second, third, and fourth quarters of 2011, respectively.

During the first quarter of 2012, the five-year redemption period for $5 million in mandatorily redeemable capital stock expired, and the Bank redeemed the stock at its $100 par value on the relevant expiration dates.

On April 27, 2012, the Bank announced that it plans to repurchase up to $500 in excess capital stock on May 15, 2012. The amount of excess capital stock to be repurchased from any shareholder will be based on the shareholder's pro rata ownership share of total capital stock outstanding as of the repurchase date, up to the amount of the shareholder's excess capital stock.

The Bank will continue to monitor the condition of its PLRMBS portfolio, the ratio of the estimated market value of the Bank's capital to the par value of the Bank's capital stock, its overall financial performance and retained

38

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


earnings, developments in the mortgage and credit markets, and other relevant information as the basis for determining the status of capital stock repurchases in future quarters.

Excess capital stock totaled $6,153 as of March 31, 2012, and $6,214 as of December 31, 2011.

For more information on excess capital stock, see “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital” in the Bank's 2011 Form 10-K.
Concentration. The following table presents the concentration in capital stock held by institutions whose capital stock ownership represented 10% or more of the Bank's outstanding capital stock, including mandatorily redeemable capital stock, as of March 31, 2012, and December 31, 2011.
 
 
March 31, 2012
 
December 31, 2011
Name of Institution
Capital Stock
Outstanding

  
Percentage
of Total
Capital Stock
Outstanding

 
Capital Stock
Outstanding

  
Percentage
of Total
Capital Stock
Outstanding

Citigroup Inc.:
 
 
 
 
 
 
 
Citibank, N.A.(1)(2)
$
2,746

 
28
%
 
$
2,884

 
28
%
Banamex USA
2

 

 
2

 

Subtotal Citigroup Inc.
2,748

 
28

 
2,886

 
28

JPMorgan Chase & Co.:
 
 
 
 
 
 
 
JPMorgan Bank & Trust Company, National Association
1,276

 
13

 
1,340

 
13

JPMorgan Chase Bank, National Association(2)
850

 
8

 
893

 
9

Subtotal JPMorgan Chase & Co.
2,126

 
21

 
2,233

 
22

Wells Fargo & Company:
 
 
 
 
 
 
 
Wells Fargo Bank, N.A.(2)
1,127

 
11

 
1,183

 
11

Wells Fargo Financial National Bank
4

 

 
4

 

Subtotal Wells Fargo & Company
1,131

 
11

 
1,187

 
11

Total capital stock ownership over 10%
6,005

 
60

 
6,306

 
61

Others
4,019

 
40

 
4,067

 
39

Total
$
10,024

 
100
%
 
$
10,373

 
100
%

(1)
The Bank reclassified $3,165 of capital stock to mandatorily redeemable capital stock (a liability) on June 28, 2011, as a result of the membership termination of Citibank, N.A., which became ineligible for membership in the Bank when it became a member of another Federal Home Loan Bank in connection with its merger with an affiliate outside of the Bank's district.
(2)
The capital stock held by these institutions is classified as mandatorily redeemable capital stock.

Note 14 — Segment Information

The Bank uses an analysis of financial performance based on the balances and adjusted net interest income of two operating segments, the advances-related business and the mortgage-related business, as well as other financial information, to review and assess financial performance and to determine the allocation of resources to these two major business segments. For purposes of segment reporting, adjusted net interest income includes interest income and expense associated with economic hedges that are recorded in “Net gain/loss on derivatives and hedging activities” in other income and excludes interest expense that is recorded in “Mandatorily redeemable capital stock.” Other key financial information, such as any credit-related OTTI charges on the Bank's PLRMBS, other expenses, and assessments, are not included in the segment reporting analysis, but are incorporated into the Bank's overall assessment of financial performance.

For more information on these operating segments, see “Item 8. Financial Statements and Supplementary Data – Note 17 – Segment Information” in the Bank's 2011 Form 10-K.
The following table presents the Bank's adjusted net interest income by operating segment and reconciles total

39

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


adjusted net interest income to income before assessments for the three months ended March 31, 2012 and 2011.
 
 
Advances-
Related
Business

  
Mortgage-
Related
Business(1)

  
Adjusted
Net
Interest
Income

  
Amortization
of Basis
Adjustments(2)

 
Net Interest
Expense on
Economic
Hedges(3)

 
Interest
Expense on
Mandatorily
Redeemable
Capital
Stock(4)

  
Net
Interest
Income

  
Other
Loss

 
Other
Expense

  
Income
Before
Assessments

Three months ended:
 
  
 
  
 
  
 
 
 
 
 
  
 
  
 
 
 
  
 
March 31, 2012
$
73

  
$
127

  
$
200

  
$
(37
)
 
$
(11
)
 
$
7

  
$
241

  
$
(20
)
 
$
32

  
$
189

March 31, 2011
93

  
133

  
226

  
(23
)
 
(10
)
 
3

  
256

  
(142
)
 
32

  
82


(1)
Does not include credit-related OTTI charges of $9 and $109 for the three months ended March 31, 2012 and 2011, respectively.
(2)
Represents amortization of amounts deferred for adjusted net interest income purposes only in accordance with the Bank's Retained Earnings and Dividend Policy.
(3)
The Bank includes interest income and interest expense associated with economic hedges in adjusted net interest income in its analysis of financial performance for its two operating segments. For financial reporting purposes, the Bank does not include these amounts in net interest income in the Statements of Income, but instead records them in other income in “Net gain on derivatives and hedging activities.”
(4)
The Bank excludes interest expense on mandatorily redeemable capital stock from adjusted net interest income in its analysis of financial performance for its two operating segments.

The following table presents total assets by operating segment at March 31, 2012, and December 31, 2011.
 
  
Advances-
Related Business

  
Mortgage-
Related Business

  
Total
Assets

March 31, 2012
$
84,659

  
$
25,428

  
$
110,087

December 31, 2011
88,302

  
25,250

  
113,552


Note 15 — Derivatives and Hedging Activities

General. The Bank may enter into interest rate swaps (including callable, putable, and basis swaps); swaptions; and cap, floor, corridor, and collar agreements (collectively, interest rate exchange agreements or derivatives). Most of the Bank's interest rate exchange agreements are executed in conjunction with the origination of advances and the issuance of consolidated obligation bonds to create variable rate structures. The interest rate exchange agreements are generally executed at the same time the advances and bonds are transacted and generally have the same maturity dates as the related advances and bonds.

Additional active uses of interest rate exchange agreements include: (i) offsetting embedded options in assets and liabilities, (ii) hedging the anticipated issuance of debt, (iii) matching against consolidated obligation discount notes or bonds to create the equivalent of callable or non-callable fixed rate debt, (iv) modifying the repricing frequency of assets and liabilities, (v) matching against certain advances and consolidated obligations for which the Bank elected the fair value option, and (vi) exactly offsetting other derivatives executed with members (with the Bank serving as an intermediary). The Bank's use of interest rate exchange agreements results in one of the following classifications: (i) a fair value hedge of an underlying financial instrument, (ii) a cash flow hedge of an underlying financial instrument, (iii) an economic hedge of a specific asset or liability, or (iv) an intermediary transaction for members.

Interest Rate Swaps – An interest rate swap is an agreement between two entities to exchange cash flows in the future. The agreement sets the dates on which the cash flows will be paid and the manner in which the cash flows will be calculated. One of the simplest forms of an interest rate swap involves the promise by one party to pay cash flows equivalent to the interest on a notional principal amount at a predetermined fixed rate for a given period of time. In return for this promise, the party receives cash flows equivalent to the interest on the same notional principal amount at a variable rate for the same period of time. The variable rate received or paid by the Bank in most interest rate exchange agreements is indexed to LIBOR.


40

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


Swaptions – A swaption is an option on a 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 the Bank against future interest rate changes when it is planning to lend or borrow funds in the future.

Interest Rate Caps and Floors – In a cap agreement, a cash flow is generated if the price or interest rate of an underlying variable rises above a certain threshold (or cap) price. In a floor agreement, a cash flow is generated if the price or interest rate of an underlying variable falls below a certain threshold (or floor) price. Caps may be used in conjunction with liabilities and floors may be used in conjunction with assets. Caps and floors are designed as protection against the interest rate on a variable rate asset or liability rising above or falling below a certain level.

Hedging Activities. The Bank documents all relationships between derivative hedging instruments and hedged items, its risk management objectives and strategies for undertaking various hedge transactions, and its method of assessing effectiveness. This process includes linking all derivatives that are designated as fair value or cash flow hedges to: (i) assets and liabilities on the balance sheet, (ii) firm commitments, or (iii) forecasted transactions. The Bank also formally assesses (both at the hedge's inception and at least quarterly 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 attributable to the hedged risk and whether those derivatives may be expected to remain effective in future periods. The Bank typically uses regression analyses or other statistical analyses to assess the effectiveness of its hedges. When it is determined that a derivative has not been or is not expected to be effective as a hedge, the Bank discontinues hedge accounting prospectively.

The Bank discontinues hedge accounting prospectively when: (i) it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item (including hedged items such as firm commitments or forecasted transactions); (ii) the derivative and/or the hedged item expires or is sold, terminated, or exercised; (iii) it is no longer probable that the forecasted transaction will occur in the originally expected period; (iv) a hedged firm commitment no longer meets the definition of a firm commitment; (v) it determines that designating the derivative as a hedging instrument is no longer appropriate; or (vi) it decides to use the derivative to offset changes in the fair value of other derivatives or instruments carried at fair value.

Intermediation As an additional service to its members, the Bank has in the past entered into offsetting interest rate exchange agreements, acting as an intermediary between offsetting derivatives transactions with members and other counterparties. This intermediation allows members indirect access to the derivatives market. Derivatives in which the Bank is an intermediary may also arise when the Bank enters into derivatives to offset the economic effect of other derivatives that are no longer designated to advances, investments, or consolidated obligations. The offsetting derivatives used in intermediary activities do not receive hedge accounting treatment and are separately marked to market through earnings. The net result of the accounting for these derivatives does not significantly affect the operating results of the Bank.

The notional principal of the interest rate exchange agreements associated with derivatives with members and offsetting derivatives with other counterparties was $810 at March 31, 2012, and December 31, 2011. The Bank did not have any interest rate exchange agreements outstanding at March 31, 2012, and December 31, 2011, that were used to offset the economic effect of other derivatives that were no longer designated to advances, investments, or consolidated obligations.

Investments The Bank may invest in U.S. Treasury and agency obligations, agency MBS, and the taxable portion of highly rated state or local housing finance agency obligations. In the past, the Bank has also invested in PLRMBS rated AAA at the time of acquisition. The interest rate and prepayment risk associated with these investment securities is managed through a combination of debt issuance and derivatives. The Bank may manage prepayment risk and interest rate risk by funding investment securities with consolidated obligations that have call features or by hedging the prepayment risk with a combination of consolidated obligations and callable swaps or swaptions. The Bank executes callable swaps and purchases swaptions in conjunction with the issuance of certain liabilities to create funding that is economically equivalent to fixed rate callable debt. Although these derivatives are

41

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


economic hedges against prepayment risk and are designated to individual liabilities, they do not receive either fair value or cash flow hedge accounting treatment. Investment securities may be classified as trading, available-for-sale, or held-to-maturity.

The Bank may also manage the risk arising from changing market prices or cash flows of investment securities classified as trading by entering into interest rate exchange agreements (economic hedges) that offset the changes in fair value or cash flows of the securities. The market value changes of both the trading securities and the associated interest rate exchange agreements are included in other income in the Statements of Income.

Advances The Bank offers a wide array of advances structures to meet members' funding needs. These advances may have maturities up to 30 years with fixed or adjustable rates and may include early termination features or options. The Bank may use derivatives to adjust the repricing and/or options characteristics of advances to more closely match the characteristics of the Bank's funding liabilities. In general, whenever a member executes a fixed rate advance or a variable rate advance with embedded options, the Bank will simultaneously execute an interest rate exchange agreement with terms that offset the terms and embedded options, if any, in the advance. The combination of the advance and the interest rate exchange agreement effectively creates a variable rate asset. This type of hedge is treated as a fair value hedge.

In addition, for certain advances for which the Bank has elected the fair value option, the Bank will simultaneously execute an interest rate exchange agreement with terms that economically offset the terms of the advance. However, this type of hedge is treated as an economic hedge because these combinations generally do not meet the requirements for fair value hedge accounting treatment.

Mortgage Loans The Bank's investment portfolio includes fixed rate mortgage loans. The prepayment options embedded in mortgage loans can result in extensions or contractions in the expected repayment of these investments, depending on changes in estimated prepayment speeds. The Bank manages the interest rate risk and prepayment risk associated with fixed rate mortgage loans through a combination of debt issuance and derivatives. The Bank uses both callable and non-callable debt to achieve cash flow patterns and market value sensitivities for liabilities similar to those expected on the mortgage loans. Net income could be reduced if the Bank replaces prepaid mortgages with lower-yielding assets and the Bank's higher funding costs are not reduced accordingly.

The Bank executes callable swaps and purchases swaptions in conjunction with the issuance of certain consolidated obligations to create funding that is economically equivalent to fixed rate callable bonds. Although these derivatives are economic hedges against the prepayment risk of specific loan pools and are referenced to individual liabilities, they do not receive either fair value or cash flow hedge accounting treatment.

Consolidated Obligations – Although the joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor, FHLBanks individually are counterparties to interest rate exchange agreements associated with specific debt issues. The Office of Finance acts as agent of the FHLBanks in the debt issuance process. In connection with each debt issuance, each FHLBank specifies the terms and the amount of debt it requests to have issued on its behalf. The Office of Finance tracks the amount of debt issued on behalf of each FHLBank. In addition, the Bank separately tracks and records as a liability its specific portion of consolidated obligations and is the primary obligor for its specific portion of consolidated obligations issued. Because the Bank knows the amount of consolidated obligations issued on its behalf, it has the ability to structure hedging instruments to match its specific debt. The hedge transactions may be executed upon or after the issuance of consolidated obligations and are accounted for based on the accounting for derivative instruments and hedging activities.

Consolidated obligation bonds are structured to meet the Bank's and/or investors' needs. Common structures include fixed rate bonds with or without call options and adjustable rate bonds with or without embedded options. In general, when bonds with these structures are issued, the Bank will simultaneously execute an interest rate exchange agreement with terms that offset the terms and embedded options, if any, of the consolidated obligation

42

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


bond. This combination of the consolidated obligation bond and the interest rate exchange agreement effectively creates an adjustable rate bond. The cost of this funding combination is generally lower than the cost that would be available through the issuance of an adjustable rate bond alone. These transactions generally receive fair value hedge accounting treatment.

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

The Bank did not have any consolidated obligations denominated in currencies other than U.S. dollars outstanding during the three months ended March 31, 2012, or the twelve months ended December 31, 2011.

Firm Commitments A firm commitment for a forward starting advance hedged through the use of an offsetting forward starting interest rate swap is considered a derivative. In this case, the interest rate swap functions as the hedging instrument for both the firm commitment and the subsequent advance. When the commitment is terminated and the advance is made, the current market value associated with the firm commitment is included with the basis of the advance. The basis adjustment is then amortized into interest income over the life of the advance.

Anticipated Debt Issuance The Bank may enter into interest rate swaps for the anticipated issuances of fixed rate bonds to hedge the cost of funding. These hedges are designated and accounted for as cash flow hedges. The interest rate swap is terminated upon issuance of the fixed rate bond, with the effective portion of the realized gain or loss on the interest rate swap recorded in other comprehensive income. Realized gains and losses reported in AOCI are recognized as earnings in the periods in which earnings are affected by the cash flows of the fixed rate bonds.

Credit Risk – The Bank is subject to credit risk as a result of the risk of nonperformance by counterparties to the derivatives agreements. All of the Bank's derivatives agreements contain master netting provisions to help mitigate the credit risk exposure to each counterparty. The Bank manages counterparty credit risk through credit analyses and collateral requirements and by following the requirements of the Bank's risk management policies and credit guidelines. Based on the master netting provisions in each agreement, credit analyses, and the collateral requirements in place with each counterparty, the Bank does not expect to incur any credit losses on derivatives agreements.
 
The notional amount of an interest rate exchange agreement serves as a basis for calculating periodic interest payments or cash flows and is not a measure of the amount of credit risk from that transaction. The Bank had notional amounts outstanding of $118,647 and $129,576 at March 31, 2012, and December 31, 2011, respectively. The notional amount does not represent the exposure to credit loss. The amount potentially subject to credit loss is the estimated cost of replacing an interest rate exchange agreement that has a net favorable position if the counterparty defaults; this amount is substantially less than the notional amount.

The following table presents credit risk exposure on derivative instruments, excluding a counterparty's pledged collateral that exceeds the Bank's net position with the counterparty.
 
March 31, 2012

 
December 31, 2011

Total net exposure at fair value(1)
$
984

 
$
914

Cash collateral held
551

 
514

Net exposure after cash collateral
433

 
400

Securities collateral held
394

 
381

Net exposure after collateral
$
39

 
$
19


(1)
Includes net accrued interest receivable of $169 and $86 as of March 31, 2012, and December 31, 2011, respectively.

43

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



The Bank's derivatives agreements contain provisions that link the Bank's credit rating from Moody's and Standard & Poor's to various rights and obligations. Certain of these derivatives agreements provide that, if the Bank's debt rating falls below A3/A- (and in one agreement, below A2/A), the Bank's counterparty would have the right, but not the obligation, to terminate all of its outstanding derivatives transactions with the Bank. In addition, the amount of collateral that the Bank is required to deliver to a counterparty depends on the Bank's credit rating. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a net derivative liability position (before cash collateral and related accrued interest) at March 31, 2012, was $56, for which the Bank had posted collateral with a fair value of $33 in the normal course of business. If the Bank's credit rating at March 31, 2012, had been Aa/AA (the next lower rating that might require an increase in collateral to be delivered by the Bank) instead of Aaa/AA+ (the Bank's current rating), then the Bank would have been required to deliver up to an additional $19 of collateral (at fair value) to its derivatives counterparties at March 31, 2012.

In the application of Standard & Poor's government-related entities criteria, the ratings of the FHLBank System and the FHLBanks are constrained by the long-term sovereign credit rating of the United States. On August 5, 2011, Standard & Poor's lowered its long-term sovereign credit rating of the United States from AAA to AA+ with a negative outlook and affirmed the A-1+ short-term rating. As a result, on August 8, 2011, Standard & Poor's lowered the long-term issuer credit ratings and related issuer ratings on select government-related entities. Specifically, Standard & Poor's lowered its long-term issuer credit ratings and related issuer ratings on 10 of the 12 FHLBanks and on the senior unsecured debt issued by the FHLBank System from AAA to AA+ with a negative outlook (the FHLBank of Chicago and the FHLBank of Seattle were already rated AA+) and removed the FHLBanks and relevant debt issues from CreditWatch.

On July 13, 2011, Moody's placed the Aaa bond rating of the U. S. government, and consequently the ratings of the GSEs, including the FHLBanks, on review for possible downgrade because of the risk that the statutory debt limit would not be raised in time to prevent a default on U.S. Treasury debt obligations. On August 2, 2011, Moody's confirmed the Aaa bond rating of the U.S. government following the raising of the statutory debt limit and changed the rating outlook to negative. Also on August 2, 2011, Moody's confirmed the long-term Aaa rating on the senior unsecured debt issues of the FHLBank System, the 12 FHLBanks, and other ratings Moody's considers directly linked to the U.S. government. In conjunction with the revision of the U.S. government outlook to negative, Moody's also revised the rating outlook for the FHLBank System and the 12 FHLBanks to negative.

On November 28, 2011, Fitch Ratings (Fitch) affirmed the AAA long-term rating for the Federal Home Loan Banks of Atlanta, Boston, San Francisco, and Seattle and revised their rating outlook to negative. Fitch does not issue ratings for the other eight FHLBanks. This action followed Fitch's affirmation of the U.S. government's AAA rating and revision of its rating outlook to negative.

The following table summarizes the fair value of derivative instruments without the effect of netting arrangements or collateral as of March 31, 2012, and December 31, 2011. For purposes of this disclosure, the derivatives values include the fair value of derivatives and related accrued interest.


44

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


 
March 31, 2012
 
December 31, 2011
 
Notional
Amount of
Derivatives

 
Derivative
Assets

 
Derivative
Liabilities

 
Notional
Amount of
Derivatives

  
Derivative
Assets

 
Derivative
Liabilities

Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
  
 
 
 
Interest rate swaps
$
55,060

 
$
1,228

 
$
277

 
$
56,355

 
$
1,241

 
$
309

Total
55,060

 
1,228

 
277

 
56,355

 
1,241

 
309

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
62,611

 
353

 
374

 
72,245

 
366

 
492

Interest rate caps, floors, corridors, and/or collars
976

 
4

 
10

 
976

 
4

 
11

Total
63,587

 
357

 
384

 
73,221

 
370

 
503

Total derivatives before netting and collateral adjustments
$
118,647

 
1,585

 
661

 
$
129,576

 
1,611

 
812

Netting adjustments by counterparty
 
 
(601
)
 
(601
)
 
 
 
(697
)
 
(697
)
Cash collateral and related accrued interest
 
 
(551
)
 
1

 
 
 
(514
)
 
(42
)
Total collateral and netting adjustments(1)
 
 
(1,152
)
 
(600
)
 
 
 
(1,211
)
 
(739
)
Derivative assets and derivative liabilities as reported on the Statements of Condition
 
 
$
433

 
$
61

 
 
 
$
400

 
$
73


(1)
Amounts include the netting of derivative assets and liabilities by counterparty, including cash collateral, where the Bank has the legal right to do so under its master netting agreement with each counterparty.

The following table presents the components of net gain/(loss) on derivatives and hedging activities as presented in the Statements of Income for the three months ended March 31, 2012 and 2011.
 
 
Three Months Ended
 
March 31, 2012

 
March 31, 2011

 
Gain/(Loss)

 
Gain/(Loss)

Derivatives and hedged items in fair value hedging relationships – hedge ineffectiveness by derivative type:
 
 
 
Interest rate swaps
$
(2
)
 
$
1

Total net gain/(loss) related to fair value hedge ineffectiveness
(2
)
 
1

Derivatives not designated as hedging instruments:
 
 
 
Economic hedges:
 
 
 
Interest rate swaps
16

 
28

Interest rate caps, floors, corridors, and/or collars

 
1

Net interest settlements
(11
)
 
(10
)
Total net gain/(loss) related to derivatives not designated as hedging instruments
5

 
19

Net gain/(loss) on derivatives and hedging activities
$
3

 
$
20


The following tables present, by type of hedged item, the gains and losses on derivatives and the related hedged items in fair value hedging relationships and the impact of those derivatives on the Bank's net interest income for the three months ended March 31, 2012 and 2011.


45

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


 
Three Months Ended
 
March 31, 2012
 
March 31, 2011
Hedged Item Type
Gain/
(Loss) on
Derivatives

  
Gain/
(Loss) on
Hedged
Item

 
Net Fair
Value Hedge
Ineffectiveness

 
Effect of
Derivatives
on Net
Interest
Income(1)

 
Gain/
(Loss) on
Derivatives

 
Gain/
(Loss) on
Hedged
Item

 
Net Fair
Value Hedge
Ineffectiveness

 
Effect of
Derivatives
on Net
Interest
Income(1)

Advances
$
24

  
$
(23
)
 
$
1

 
$
(39
)
 
$
82

 
$
(81
)
 
$
1

 
$
(84
)
Consolidated obligation bonds
(64
)
  
61

 
(3
)
 
134

 
(314
)
 
314

 

 
330

Total
$
(40
)
  
$
38

 
$
(2
)
 
$
95

 
$
(232
)
 
$
233

 
$
1

 
$
246


(1)
The net interest on derivatives in fair value hedge relationships is presented in the interest income/expense line item of the respective hedged item.    

For the three months ended March 31, 2012 and 2011, there were no reclassifications from other comprehensive income/(loss) into earnings as a result of the discontinuance of cash flow hedges because the original forecasted transactions occurred by the end of the originally specified time period or within a two-month period thereafter.

As of March 31, 2012, the amount of unrecognized net losses on derivative instruments accumulated in other comprehensive income/(loss) expected to be reclassified to earnings during the next 12 months was de minimis. The maximum length of time over which the Bank is hedging its exposure to the variability in future cash flows for forecasted transactions, excluding those forecasted transactions related to the payment of variable interest on existing financial instruments, is less than three months.

Note 16 — Fair Value

The following fair value amounts have been determined by the Bank using available market information and the Bank's best judgment of appropriate valuation methods. These estimates are based on pertinent information available to the Bank at March 31, 2012, and December 31, 2011. Although the Bank uses its best judgment in estimating the fair value of these financial instruments, there are inherent limitations in any estimation technique or valuation methodology. For example, because an active secondary market does not exist for a portion of the Bank's financial instruments, in certain cases fair values are not subject to precise quantification or verification and may change as economic and market factors and evaluation of those factors change. Therefore, the fair values are not necessarily indicative of the amounts that would be realized in current market transactions, although they do reflect the Bank's judgment of how a market participant would estimate the fair values. The fair value summary table does not represent an estimate of the overall market value of the Bank as a going concern, which would take into account future business opportunities and the net profitability of total assets and liabilities on a combined basis.

The following tables present the carrying value and the estimated fair value of the Bank's financial instruments at March 31, 2012, and December 31, 2011.


46

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


 
March 31, 2012
  
Carrying
Value

  
Estimated Fair Value

 
Level 1

 
Level 2

 
Level 3

 
Netting Adjustments(1)

Assets
 
  
 
  
 
  
 
 
 
 
 
Cash and due from banks
$
3,486

  
$
3,486

  
$
3,486

  
$

 
$

 
$

Securities purchased under agreements to resell
1,100

 
1,100

 

 
1,100

 

 

Federal funds sold
8,641

  
8,641

  

  
8,641

 

 

Trading securities
3,321

  
3,321

  

  
3,321

 

 

Available-for-sale securities
9,015

  
9,015

  

  
1,333

 
7,682

 

Held-to-maturity securities
20,100

  
20,061

  

  
16,427

 
3,634

 

Advances
62,040

  
62,323

  

  
62,323

 

 

Mortgage loans held for portfolio, net of allowance for credit losses on mortgage loans
1,686

  
1,831

  

  
1,831

 

 

Accrued interest receivable
152

  
152

  

  
152

 

 

Derivative assets, net(1)
433

  
433

  

  
1,585

 

 
(1,152
)
Liabilities
 
  
 
  
 
  
 
 
 
 
 
Deposits
166

  
166

  

  
166

 

 

Consolidated obligations:
 
  
 
  
 
  
 
 
 
 
 
Bonds
74,579

  
74,900

  

  
74,900

 

 

Discount notes
23,318

  
23,318

  

  
23,318

 

 

Total consolidated obligations
97,897

 
98,218

 

 
98,218

 

 

Mandatorily redeemable capital stock
5,307

  
5,307

  
5,307

  

 

 

Accrued interest payable
293

  
293

  

  
293

 

 

Derivative liabilities, net(1)
61

  
61

  

  
661

 

 
(600
)
Other
 
  
 
  
 
  
 
 
 
 
 
Standby letters of credit
7

  
7

  

  
7

 

 



47

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


 
December 31, 2011
  
Carrying
Value

  
Estimated
Fair Value

Assets
 
  
 
Cash and due from banks
$
3,494

  
$
3,494

Securities purchased under agreements to resell

 

Federal funds sold
5,366

  
5,366

Trading securities
2,808

  
2,808

Available-for-sale securities
9,613

  
9,613

Held-to-maturity securities
21,581

  
21,414

Advances
68,164

  
68,584

Mortgage loans held for portfolio, net of allowance for credit losses on mortgage loans
1,829

  
1,976

Accrued interest receivable
180

  
180

Derivative assets, net(1)
400

  
400

Liabilities
 
  
 
Deposits
156

  
156

Consolidated obligations:
 
  
 
Bonds
83,350

  
83,878

Discount notes
19,152

  
19,155

Total consolidated obligations
102,502

 
103,033

Mandatorily redeemable capital stock
5,578

  
5,578

Accrued interest payable
241

  
241

Derivative liabilities, net(1)
73

  
73

Other
 
  
 
Standby letters of credit
6

  
6

(1)
Amounts include the netting of derivative assets and liabilities by counterparty, including cash collateral, where the Bank has the legal right to do so under its master netting agreement with each counterparty.

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

The application of the fair value hierarchy to the Bank's financial assets and financial liabilities that are carried at fair value either on a recurring or non-recurring basis is as follows:
Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in an active market that the reporting entity can access on the measurement date.
Level 2 – Inputs other than quoted prices within Level 1 that are observable inputs for the asset or liability, either directly or indirectly. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability. Level 2 inputs include the following: (1) quoted prices for similar assets or liabilities in active markets; (2) quoted prices for identical or similar assets or liabilities in markets that are not active; (3) inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates and yield curves that are observable at commonly quoted intervals, and implied volatilities); and (4) inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3 – Unobservable inputs for the asset or liability.

48

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



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

The following assets and liabilities, including those for which the Bank has elected the fair value option, are carried at fair value on the Statements of Condition as of March 31, 2012:
Trading securities
Available-for-sale securities
Certain advances
Derivative assets and liabilities
Certain consolidated obligation bonds

For instruments carried at fair value, the Bank reviews the fair value hierarchy classifications on a quarterly basis. Changes in the observability of the valuation inputs may result in a reclassification of certain assets or liabilities. Such reclassifications are reported as transfers in or out as of the beginning of the quarter in which the changes occur. For the periods presented, the Bank did not have any reclassifications for transfers in or out of the fair value hierarchy levels.

Summary of Valuation Methodologies and Primary Inputs. The valuation methodologies and primary inputs used in estimating the fair values of the Bank's financial instruments are discussed below.

Cash and Due from Banks The estimated fair value approximates the carrying value.

Federal Funds Sold and Securities Purchased Under Agreements to Resell The estimated fair value of overnight Federal funds sold and securities purchased under agreements to resell approximates the carrying value. The estimated fair value of term Federal funds sold and securities purchased under agreements to resell has been determined by calculating the present value of expected cash flows for the instruments, excluding accrued interest. The discount rates used in these calculations are the replacement rates for comparable instruments with similar terms.

Investment Securities Commercial Paper and Interest-Bearing Deposits The estimated fair values of these investments are determined by calculating the present value of expected cash flows, excluding accrued interest, using market-observable inputs as of the last business day of the period or using industry standard analytical models and certain actual and estimated market information. The discount rates used in these calculations are the replacement rates for comparable instruments with similar terms.

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

Recently, the Bank conducted reviews of the four pricing vendors to update and confirm its understanding of the vendors' pricing processes, methodologies, and control procedures.

The Bank's valuation technique for estimating the fair values of its MBS first requires the establishment of a “median” price for each security. If four prices are received, the average of the middle two prices is the median price; if three prices are received, the middle price is the median price; if two prices are received, the average of the two prices is the median price; and if one price is received, it is the median price (and also the default fair value)

49

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


subject to additional validation. All vendor prices that are within a specified tolerance threshold of the median price are included in the cluster of vendor prices that are averaged to establish a default fair value. All vendor prices that are outside the threshold (outliers) are subject to further analysis including, but not limited to, comparison to prices provided by an additional third-party valuation service, prices for similar securities and/or dealer estimates, or use of internal model prices, which are deemed to be reflective of all relevant facts and circumstances that a market participant would consider. Such analysis is also applied in those limited instances where no third-party vendor price or only one third-party vendor price is available in order to arrive at an estimated fair value. If an outlier (or some other price identified in the analysis) is determined to be a better estimate of fair value, then the outlier (or the other price, as appropriate) is used as the fair value rather than the default fair value. If, instead, the analysis confirms that an outlier is (or outliers are) not representative of fair value and the default fair value is the best estimate, then the default fair value is used as the fair value.

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

As an additional step, the Bank reviewed the fair value estimates of its PLRMBS as of March 31, 2012, for reasonableness using an implied yield test. The Bank calculated an implied yield for each of its PLRMBS using the estimated fair value derived from the process described above and the security's projected cash flows from the Bank's OTTI process and compared the implied yield to the yields for comparable securities according to dealers and other third-party sources to the extent comparable market yield data was available. This analysis did not indicate that any adjustments to the fair value estimates were necessary.

As of March 31, 2012, four vendor prices were received for most of the Bank's MBS, and the fair value estimates for most of those securities were determined by averaging the four vendor prices. Based on the Bank's reviews of the pricing methods employed by the third-party pricing vendors and the relative lack of dispersion among the vendor prices (or, in those instances in which there were outliers or significant yield variances, the Bank's additional analyses), the Bank believes that its fair value estimates are reasonable and that the fair value measurements are classified appropriately in the fair value hierarchy.

Investment Securities – FFCB bonds, TLGP securities, and Housing Finance Agency Bonds – The Bank estimates the fair values of these securities using the same methodology as described above for MBS.

Advances Because quoted prices are not available for advances, the fair values are measured using model-based valuation techniques (such as the present value of future cash flows excluding the amount of the accrued interest receivable).

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

Mortgage Loans Held for Portfolio – The estimated fair value for mortgage loans represents modeled prices based on observable market prices for agency commitment rates adjusted for differences in coupon, average loan rate,

50

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


seasoning, and cash flow remittance between the Bank's mortgage loans and the referenced mortgage loans. Market prices are highly dependent on the underlying prepayment assumptions. Changes in the prepayment speeds often have a material effect on the fair value estimates. These underlying prepayment assumptions are susceptible to material changes in the near term because they are made at a specific point in time.

Loans to Other FHLBanks Because these are overnight transactions, the estimated fair value approximates the recorded carrying value.

Accrued Interest Receivable and Payable – The estimated fair value approximates the carrying value of accrued interest receivable and accrued interest payable.

Derivative Assets and Liabilities In general, derivative instruments held by the Bank for risk management activities are traded in over-the-counter markets where quoted market prices are not readily available. These derivatives are interest rate-related. For these derivatives, the Bank measures fair value using internally developed discounted cash flow models that use market-observable inputs, such as the LIBOR swap yield curve, option volatilities adjusted for counterparty credit risk, as necessary, and prepayment assumptions.

The Bank is subject to credit risk in derivatives transactions because of potential nonperformance by the derivatives counterparties. To mitigate this risk, the Bank only executes transactions with highly rated derivatives dealers and major banks (derivatives dealer counterparties) that meet the Bank's eligibility criteria. In addition, the Bank has entered into master netting agreements and bilateral security agreements with all active derivatives dealer counterparties that provide for delivery of collateral at specified levels to limit the Bank's net unsecured credit exposure to these counterparties. Under these policies and agreements, the amount of unsecured credit exposure to an individual derivatives dealer counterparty is limited to an absolute dollar credit exposure limit according to the counterparty's credit rating, as determined by rating agency long-term credit ratings of the counterparty's debt securities or deposits. All credit exposure from derivatives transactions entered into by the Bank with member counterparties that are not derivatives dealers must be fully secured by eligible collateral. The Bank evaluated the potential for the fair value of the instruments to be affected by counterparty credit risk and determined that no adjustments to the overall fair value measurements were required.

The fair values of the derivative assets and liabilities include accrued interest receivable/payable and cash collateral remitted to/received from counterparties. The estimated fair values of the accrued interest receivable/payable and cash collateral approximate their carrying values because of their short-term nature. The fair values of derivatives are netted by counterparty pursuant to the provisions of each master netting agreement. If these netted amounts are positive, they are classified as an asset and, if negative, they are classified as a liability.

Deposits and Other Borrowings The fair value of deposits is generally equal to the carrying value of the deposits because the deposits are primarily overnight deposits or due on demand. The Bank determines the fair values of term deposits and other borrowings by calculating the present value of expected future cash flows from the deposits, excluding accrued interest. The discount rates used in these calculations are the cost of deposits with similar terms.

Consolidated Obligations Because quoted prices in active markets are not generally available for identical liabilities, the Bank measures fair values using internally developed models that use primarily market-observable inputs. The Bank's primary inputs for measuring the fair value of consolidated obligation bonds are market-based CO Curve inputs obtained from the Office of Finance and provided to the Bank. The Office of Finance constructs a market-observable curve, referred to as the CO Curve, using the Treasury yield curve as a base curve, which may be adjusted by indicative spreads obtained from market-observable sources. These market indications are generally derived from pricing indications from dealers, historical pricing relationships, and market activity for similar liabilities such as recent GSE trades, or secondary market activity. For consolidated obligation bonds with embedded options, the Bank also obtains market-observable quotes and inputs from derivatives dealers. The Bank uses these swaption volatilities as significant inputs for measuring the fair value of consolidated obligations.


51

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


Adjustments may be necessary to reflect the Bank's credit quality or the credit quality of the FHLBank System when valuing consolidated obligation bonds measured at fair value. The Bank monitors its own creditworthiness, the creditworthiness of the other 11 FHLBanks, and the FHLBank System to determine whether any adjustments are necessary for creditworthiness in its fair value measurement of consolidated obligation bonds. The credit ratings of the FHLBank System and any changes to the credit ratings are the basis for the Bank to determine whether the fair values of consolidated obligations have been significantly affected during the reporting period by changes in the instrument-specific credit risk.

Mandatorily Redeemable Capital Stock The estimated fair value of capital stock subject to mandatory redemption is generally at par value as indicated by member contemporaneous purchases and sales at par value. Fair value includes estimated dividends earned at the time of reclassification from capital to liabilities, until such amount is paid, and any subsequently declared stock dividend. The Bank's stock can only be acquired by members at par value and redeemed or repurchased at par value, subject to statutory and regulatory requirements. The Bank's stock is not traded, and no market mechanism exists for the exchange of Bank stock outside the cooperative ownership structure.

Commitments – The estimated fair value of the Bank's commitments to extend credit was de minimis at March 31, 2012, and December 31, 2011. The estimated fair value of standby letters of credit is based on the present value of fees currently charged for similar agreements. The value of the Bank's standby letters of credit is recorded in other liabilities.

Subjectivity of Estimates Related to Fair Values of Financial Instruments. Estimates of the fair value of financial assets and liabilities using the methodologies described above are highly subjective and require judgments regarding significant matters such as the amount and timing of future cash flows, prepayment speed assumptions, expected interest rate volatility, methods to determine possible distributions of future interest rates used to value options, and the selection of discount rates that appropriately reflect market and credit risks. Changes in these judgments often have a material effect on the fair value estimates.

Fair Value Measurements. The tables below present the fair value of assets and liabilities, which are recorded on a recurring or nonrecurring basis at March 31, 2012, and December 31, 2011, by level within the fair value hierarchy.


52

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


March 31, 2012
 
 
 
 
 
 
 
 
 
 
Fair Value Measurement Using:
 
Netting

 
 
 
Level 1

 
Level 2

 
Level 3

 
Adjustments(1)

 
Total

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

 
$
2,384

 
$

 
$

 
$
2,384

TLGP securities

 
920

 

 

 
920

MBS:
 
 
 
 
 
 
 
 
 
Other U.S. obligations – Ginnie Mae

 
17

 

 

 
17

GSEs – Fannie Mae

 

 

 

 

Total trading securities

 
3,321

 

 

 
3,321

Available-for-sale securities:
 
 
 
 
 
 
 
 
 
TLGP securities

 
1,333

 

 

 
1,333

PLRMBS

 

 
7,682

 

 
7,682

Total available-for-sale securities

 
1,333

 
7,682

 

 
9,015

Advances(2)

 
7,950

 

 

 
7,950

Derivative assets, net: interest rate-related

 
1,585

 

 
(1,152
)
 
433

Total recurring fair value measurements – Assets
$

 
$
14,189

 
$
7,682

 
$
(1,152
)
 
$
20,719

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

 
$
11,823

 
$

 
$

 
$
11,823

Derivative liabilities, net: interest rate-related

 
661

 

 
(600
)
 
61

Total recurring fair value measurements – Liabilities
$

 
$
12,484

 
$

 
$
(600
)
 
$
11,884

Nonrecurring fair value measurements – Assets:
 
 
 
 
 
 
 
 
 
REO
$

 
$

 
$
2

 
 
 
 




53

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


December 31, 2011
 
 
 
 
 
 
 
 
 
 
Fair Value Measurement Using:
 
Netting

 
 
 
Level 1

 
Level 2

 
Level 3

 
Adjustments(1)

 
Total

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

 
$
1,867

 
$

 
$

 
$
1,867

TLGP securities

 
923

 

 

 
923

MBS:
 
 
 
 
 
 
 
 
 
Other U.S. obligations – Ginnie Mae

 
17

 

 

 
17

GSEs – Fannie Mae

 
1

 

 

 
1

Total trading securities

 
2,808

 

 

 
2,808

Available-for-sale securities:
 
 
 
 
 
 
 
 
 
TLGP securities

 
1,926

 

 

 
1,926

PLRMBS

 

 
7,687

 

 
7,687

Total available-for-sale securities

 
1,926

 
7,687

 

 
9,613

Advances(2)

 
8,728

 

 

 
8,728

Derivative assets, net: interest rate-related

 
1,611

 

 
(1,211
)
 
400

Total recurring fair value measurements – Assets
$

 
$
15,073

 
$
7,687

 
$
(1,211
)
 
$
21,549

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

 
$
15,712

 
$

 
$

 
$
15,712

Derivative liabilities, net: interest rate-related

 
812

 

 
(739
)
 
73

Total recurring fair value measurements – Liabilities
$

 
$
16,524

 
$

 
$
(739
)
 
$
15,785

Nonrecurring fair value measurements – Assets:
 
 
 
 
 
 
 
 
 
REO
$

 
$

 
$
2

 
 
 
 

(1)
Amounts represent the netting of derivative assets and liabilities by counterparty, including cash collateral, where the Bank has the legal right to do so under its master netting agreement with each counterparty.
(2)
Includes $7,911 and $8,684 of advances recorded under the fair value option at March 31, 2012, and December 31, 2011, respectively, and $39 and $44 of advances recorded at fair value at March 31, 2012, and December 31, 2011, respectively, where the exposure to overall changes in fair value was hedged in accordance with the accounting for derivative instruments and hedging activities.
(3)
Includes $11,823 and $15,712 of consolidated obligation bonds recorded under the fair value option at March 31, 2012, and December 31, 2011, respectively. There were no consolidated obligation bonds recorded at fair value at March 31, 2012, and December 31, 2011, where the exposure to overall changes in fair value was hedged in accordance with the accounting for derivative instruments and hedging activities.

The following table presents a reconciliation of the Bank's available-for-sale PLRMBS that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2012 and 2011.

 
Three Months Ended
 
March 31, 2012
 
March 31, 2011
Balance, beginning of period
$
7,687

 
$

Total gain/(loss) realized and unrealized:
 
 
 
Net OTTI loss, credit portion
(15
)
 

Included in net change in fair value of other-than-temporarily impaired securities included in AOCI
269

 
689

Settlements
(295
)
 

Transfers of held-to-maturity to available-for-sale securities
36

 
5,322

Balance, end of period
$
7,682

 
$
6,011

Total amount of gain/(loss) for the period included in earnings attributable to the change in unrealized gains/losses relating to assets and liabilities still held at the end of the period
$
(15
)
 
$


54

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



Fair Value Option. The fair value option provides an entity with an irrevocable option to elect fair value as an alternative measurement for selected financial assets, financial liabilities, unrecognized firm commitments, and written loan commitments not previously carried at fair value. It requires an entity to display the fair value of those assets and liabilities for which the entity has chosen to use fair value on the face of the Statements of Condition. Fair value is used for both the initial and subsequent measurement of the designated assets, liabilities, and commitments, with the changes in fair value recognized in net income. Interest income and interest expense carried on advances and consolidated bonds at fair value are recognized solely on the contractual amount of interest due or unpaid. Any transaction fees or costs are immediately recognized in non-interest income or non-interest expense. For more information on the Bank's election of the fair value option, see “Item 8. Financial Statements and Supplementary Data – Note 19 – Fair Values” in the Bank's 2011 Form 10-K.

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

The following table summarizes the activity related to financial assets and liabilities for which the Bank elected the fair value option during the three months ended March 31, 2012 and 2011:

 
Three Months Ended
 
March 31, 2012
 
March 31, 2011
 
Advances

Consolidated
Obligation Bonds

 
Advances

Consolidated
Obligation Bonds

Balance, beginning of the period
$
8,684

$
15,712

 
$
10,490

$
20,872

New transactions elected for fair value option
226

1,176

 
516

5,160

Maturities and terminations
(970
)
(5,046
)
 
(1,240
)
(1,096
)
Net gain/(loss) on advances and net (gain)/loss on consolidated obligation bonds held under fair value option
(26
)
(13
)
 
(51
)
3

Change in accrued interest
(3
)
(6
)
 
(7
)
4

Balance, end of the period
$
7,911

$
11,823

 
$
9,708

$
24,943


For instruments for which the fair value option has been elected, the related contractual interest income and contractual interest expense are recorded as part of net interest income on the Statements of Income. The remaining changes in fair value for instruments for which the fair value option has been elected are recorded as net gains/ (losses) on financial instruments held under the fair value option in the Statements of Income. The change in fair value does not include changes in instrument-specific credit risk. For advances and consolidated obligations recorded under the fair value option, the estimated impact of changes in credit risk for the three months ended March 31, 2012 and 2011, was de minimis.

The following table presents the difference between the aggregate remaining contractual principal balance outstanding and aggregate fair value of advances and consolidated obligation bonds for which the Bank elected the fair value option at March 31, 2012, and December 31, 2011:

55

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



 
At March 31, 2012
 
At December 31, 2011
 
Principal Balance

 
Fair Value

 
Fair Value
Over/(Under)
Principal Balance

 
Principal Balance

 
Fair Value

 
Fair Value
Over/(Under)
Principal Balance

Advances(1)
$
7,583

 
$
7,911

 
$
328

 
$
8,258

 
$
8,684

 
$
426

Consolidated obligation bonds
11,799

 
11,823

 
24

 
15,669

 
15,712

 
43


(1)
At March 31, 2012, and December 31, 2011, none of these advances were 90 days or more past due or had been placed on nonaccrual status.

Note 17 — Commitments and Contingencies

As provided by the FHLBank Act or regulations governing the operations of the FHLBanks, all FHLBanks have joint and several liability for all FHLBank consolidated obligations, which are backed only by the financial resources of the FHLBanks. The joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor. The regulations provide a general framework for addressing the possibility that an FHLBank may be unable to repay the consolidated obligations for which it is the primary obligor. The Bank has never been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank, and as of March 31, 2012, and through the filing date of this report, does not believe that it is probable that it will be asked to do so. The par amount of the outstanding consolidated obligations of all 12 FHLBanks was $658,015 at March 31, 2012, and $691,868 at December 31, 2011. The par value of the Bank's participation in consolidated obligations was $96,695 at March 31, 2012, and $101,204 at December 31, 2011. For more information on the joint and several liability regulation, see “Item 8. Financial Statements and Supplementary Data – Note 20 – Commitments and Contingencies” in the Bank's 2011 Form 10-K.

Off-balance sheet commitments as of March 31, 2012, and December 31, 2011, were as follows:

 
March 31, 2012
 
December 31, 2011
 
Expire Within
One Year

 
Expire After
One Year

 
Total

 
Expire Within
One Year

 
Expire After
One Year

 
Total

Standby letters of credit outstanding
$
2,362

 
$
1,310

 
$
3,672

 
$
4,227

 
$
1,087

 
$
5,314

Commitments to fund additional advances(1)
1

 
3

 
4

 
100

 
2

 
102

Unsettled consolidated obligation bonds, par(2)
1,620

 

 
1,620

 
200

 

 
200

Interest rate exchange agreements, traded but not yet settled
1,540

 

 
1,540

 
705

 

 
705


(1)
At March 31, 2012, none of the commitments to fund additional advances were hedged with associated interest rate swaps. At December 31, 2011, $100 was hedged with associated interest rate swaps.
(2)
At March 31, 2012, $1,520 of the unsettled consolidated obligation bonds were hedged with associated interest rate swaps. At December 31, 2011, $200 of the unsettled consolidated obligation bonds were hedged with associated interest rate swaps.

Standby letters of credit are generally issued for a fee on behalf of members to support their obligations to third parties. If the Bank is required to make payment for a beneficiary's drawing under a letter of credit, the amount is immediately due and payable by the member to the Bank and is charged to the member's demand deposit account with the Bank. The original terms of these standby letters of credit range from 88 days to 10 years, including a final expiration in 2022.

The value of the Bank's obligations related to standby letters of credit is recorded in other liabilities and amounted to $7 at March 31, 2012, and $6 at December 31, 2011. Letters of credit are fully collateralized at the time of issuance. Based on the Bank's credit analyses of members' financial condition and collateral requirements, the Bank deemed it unnecessary to record any additional liability on the letters of credit outstanding as of March 31, 2012, and December 31, 2011.

56

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



Commitments to fund additional advances totaled $4 and $102 at March 31, 2012, and December 31, 2011. Advances funded under advance commitments are fully collateralized at the time of funding (see Note 9 – Allowance for Credit Losses). Based on the Bank's credit analyses of members' financial condition and collateral requirements, the Bank deemed it unnecessary to record any additional liability on the advance commitments outstanding as of March 31, 2012, and December 31, 2011 The estimated fair value of advance commitments was de minimis to the balance sheet as of March 31, 2012, and December 31, 2011.

Commitments to participate in the issuance of consolidated obligations totaled $1,620 and $200 at March 31, 2012, and December 31, 2011. The estimated fair value of the consolidated obligation commitments was de minimis to the balance sheet as of March 31, 2012, and December 31, 2011.

The Bank executes interest rate exchange agreements with major banks and derivatives entities affiliated with broker-dealers that have, or are supported by guarantees from related entities that have, long-term unsecured, unsubordinated debt or deposit ratings from Moody's and Standard & Poor's, where the lowest rating is A3/A- or better. The Bank also executes interest rate exchange agreements with its members. The Bank enters into master agreements with netting provisions with all counterparties and into bilateral security agreements with all active derivatives dealer counterparties. All member counterparty master agreements, excluding those with derivatives dealers, are subject to the terms of the Bank's Advances and Security Agreement with members, and all member counterparties (except for those that are derivatives dealers) must fully collateralize the Bank's net credit exposure. As of March 31, 2012, the Bank had pledged total collateral of $33, including securities with a carrying value of $22, all of which could be sold or repledged, and cash of $11 to counterparties that had market risk exposure to the Bank related to derivatives. As of December 31, 2011, the Bank had pledged total collateral of $82, including securities with a carrying value of $33, all of which could be sold or repledged, and cash of $49 to counterparties that had market risk exposure to the Bank related to derivatives.

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


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

Transactions with Certain Members and Certain Nonmembers. The following tables set forth information at the dates and for the periods indicated with respect to transactions with: (i) members and nonmembers holding more than 10% of the outstanding shares of the Bank's capital stock, including mandatorily redeemable capital stock, at each respective period end, (ii) members that had an officer or director serving on the Bank's Board of Directors at any time during the periods indicated, and (iii) affiliates of the foregoing members and nonmembers. All transactions with members, the nonmembers described in the preceding sentence, and their respective affiliates are entered into in the normal course of business. The tables include securities transactions where certain members, nonmembers and their affiliates (as described above) are the issuers or obligors of the securities, but do not include securities purchased, sold or issued through, or otherwise underwritten by, affiliates of certain members and nonmembers. The tables also do not include any AHP awards. Securities purchased, sold or issued through, or otherwise underwritten by, and AHP awards provided to the affiliates of certain members and nonmembers are in the ordinary course of the Bank's business.


57

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


  
March 31, 2012

  
December 31, 2011

Assets:
 
  
 
Cash and due from banks
$
1

 
$
1

Investments(1)
3,980

  
1,367

Advances
32,936

  
36,689

Mortgage loans held for portfolio
1,411

  
1,454

Accrued interest receivable
26

  
33

Derivative assets, net
525

  
522

Total
$
38,879

  
$
40,066

Liabilities:
 
  
 
Deposits
$
538

  
$
527

Mandatorily redeemable capital stock
4,723

  
4,960

Derivative liabilities, net
3

 
3

Total
$
5,264

  
$
5,490

Notional amount of derivatives
$
26,167

  
$
31,033

Standby letters of credit
745

  
2,736


(1)
Investments consist of securities purchased under agreements to resell, Federal funds sold, available-for-sale securities, and held-to-maturity securities issued by and/or purchased from the members or nonmembers described in this section or their affiliates.
  
 
Three Months Ended
 
March 31, 2012

 
March 31, 2011

Interest Income:
 
 
 
Investments(1)
$
10

 
$
16

Advances(2) 
49

 
49

Mortgage loans held for portfolio
18

 
22

Total
$
77

 
$
87

Interest Expense:
 
 
 
Mandatorily redeemable capital stock
$
6

 
$
3

Consolidated obligations(2)
(57
)
 
(124
)
Total
$
(51
)
 
$
(121
)
Other Income/(Loss):
 
 
 
Net gain/(loss) on derivatives and hedging activities
$
(24
)
 
$
(101
)
Other income
1

 
1

Total
$
(23
)
 
$
(100
)

(1)
Investments consist of securities purchased under agreements to resell, Federal funds sold, available-for-sale securities, and held-to-maturity securities issued by and/or purchased from the members or nonmembers described in this section or their affiliates.
(2)
Reflects the effect of associated derivatives with the members or nonmembers described in this section or their affiliates.


Transactions with Other FHLBanks. Transactions with other FHLBanks are identified on the face of the Bank's financial statements.

Note 19 — Subsequent Events

The Bank evaluated events subsequent to March 31, 2012, until the time of the Form 10-Q filing with the Securities and Exchange Commission, and no material subsequent events were identified.





58


ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Statements contained in this quarterly report on Form 10-Q, including statements describing the objectives, projections, estimates, or predictions of the future of the Federal Home Loan Bank of San Francisco (Bank) or the Federal Home Loan Bank System, are “forward-looking statements.” These statements may use forward-looking terms, such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “likely,” “may,” “probable,” “project,” “should,” “will,” or their negatives or other variations on these terms, and include statements related to, among others, gains and losses on derivatives, plans to pay dividends and repurchase excess capital stock, future other-than-temporary impairment charges, future classification of securities, and reform legislation. The Bank cautions that by their nature, forward-looking statements involve risk or uncertainty that could cause actual results to differ materially from those expressed or implied in these forward-looking statements or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. These risks and uncertainties include, among others, the following:
changes in economic and market conditions, including conditions in the mortgage, housing, and capital markets;
the volatility of market prices, rates, and indices;
the timing and volume of market activity;
political events, including legislative, regulatory, judicial, or other developments that affect the Bank, its members, counterparties, or investors in the consolidated obligations of the Federal Home Loan Banks (FHLBanks), such as the impact of any government-sponsored enterprises (GSE) legislative reforms, changes in the Federal Home Loan Bank Act of 1932, as amended (FHLBank Act), changes in applicable sections of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, or changes in regulations applicable to the FHLBanks;
changes in the Bank's capital structure;
the ability of the Bank to pay dividends or redeem or repurchase capital stock;
membership changes, including changes resulting from mergers or changes in the principal place of business of Bank members;
the soundness of other financial institutions, including Bank members, nonmember borrowers, other counterparties, and the other FHLBanks;
changes in Bank members' demand for Bank advances;
changes in the value or liquidity of collateral underlying advances to Bank members or nonmember borrowers or collateral pledged by the Bank's derivatives counterparties;
changes in the fair value and economic value of, impairments of, and risks associated with the Bank's investments in mortgage loans and mortgage-backed securities (MBS) or other assets and the related credit enhancement protections;
changes in the Bank's ability or intent to hold MBS and mortgage loans to maturity;
competitive forces, including the availability of other sources of funding for Bank members;
the willingness of the Bank's members to do business with the Bank whether or not the Bank is paying dividends or repurchasing excess capital stock;
changes in investor demand for consolidated obligations and/or the terms of interest rate exchange or similar agreements;
the ability of the Bank to introduce new products and services to meet market demand and to manage the risks associated with new products and services successfully;
the ability of each of the other FHLBanks to repay the principal and interest on consolidated obligations for which it is the primary obligor and with respect to which the Bank has joint and several liability;
designation of the Bank as a “nonbank financial company” by the Financial Stability Oversight Council;
technological changes and enhancements, and the Bank's ability to develop and support technology and information systems sufficient to manage the risks of the Bank's business effectively; and
changes in the FHLBanks' long-term credit ratings.

Readers of this report should not rely solely on the forward-looking statements and should consider all risks and uncertainties addressed throughout this report, as well as those discussed under “Item 1A. Risk Factors” in the

59


Bank's Annual Report on Form 10-K for the year ended December 31, 2011 (2011 Form 10-K).

This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Bank's interim financial statements and notes and the Bank's 2011 Form 10-K.


Quarterly Overview

Nationwide, economic growth continued to expand modestly during the first quarter of 2012. Employment growth accelerated moderately, and the unemployment rate fell slightly. Despite continued low interest rates, housing market activity remained subdued, and home prices were still depressed by a high level of discounted distressed property sales. Home foreclosures began to increase in the quarter, although the inventory of troubled mortgage loans remains very large. Recent rapid deposit growth at the members of the Federal Home Loan Bank of San Francisco (Bank) appeared to slow, with some institutions reporting increases in demand for business and commercial real estate loans. In general, liquidity remained high for many Bank members and demand for Bank advances remained low.
 
Net income for the first quarter of 2012 was $169 million, compared to net income of $60 million for the first quarter of 2011. The increase in net income primarily reflected the impact of a lower credit-related other-than-temporary impairment (OTTI) charge on private-label residential mortgage-backed securities (PLRMBS) and lower net losses associated with derivatives, hedged items, and financial instruments carried at fair value, partially offset by a $14 million decline in net interest income.

Net interest income for the first quarter of 2012 was $242 million, down from $256 million for the first quarter of 2011. The decrease in net interest income was due, in part, to lower balances of advances, MBS, and mortgage loans and to a decline in earnings on invested capital because of lower capital balances and the lower interest rate environment, partially offset by an increase in advance prepayment fees.

Total other income/(loss) for the first quarter of 2012 was a loss of $20 million, compared to a loss of $142 million for the first quarter of 2011. The loss for the first quarter of 2012 reflected a credit-related OTTI charge of $9 million on certain PLRMBS, compared to a credit-related OTTI charge of $109 million for the first quarter of 2011. The net loss associated with derivatives, hedged items, and financial instruments carried at fair value was $2 million for the first quarter of 2012, compared to a net loss of $25 million for the first quarter of 2011. Net interest expense on derivative instruments used in economic hedges (which was generally offset by net interest income on the economically hedged assets and liabilities), totaled $11 million in the first quarter of 2012, compared to $10 million in the first quarter of 2011.

The $2 million net loss associated with derivatives, hedged items, and financial instruments carried at fair value for the first quarter of 2012 reflected losses primarily associated with reversals of prior period gains and the effects of changes in interest rates. Net valuation gains and losses on these financial instruments are primarily a matter of timing and will generally reverse through changes in future valuations and settlements of contractual interest cash flows over the remaining contractual terms to maturity or by the exercised call or put dates. However, the Bank may have instances in which hedging relationships are terminated prior to maturity or prior to the call or put dates. Terminating the hedging relationship may result in a realized gain or loss. In addition, the Bank may have instances in which it may sell trading securities prior to maturity, which may also result in a realized gain or loss. In anticipation of the subsequent reversal of any net gains on these financial instruments, the Bank retains in restricted retained earnings any cumulative net gains in earnings (net of applicable assessments) resulting from valuation gains or losses on these instruments. As of March 31, 2012, the Bank's retained earnings included a cumulative net gain of $100 million associated with derivatives, hedged items, and financial instruments carried at fair value.

The credit-related OTTI charge of $9 million for the first quarter of 2012 reflected the Bank's OTTI analysis for the quarter, which showed a modest increase in expected borrower default rates on PLRMBS backed by Alt-A fixed rate loan collateral. Each quarter, the Bank updates its OTTI analysis to reflect current housing market conditions, changes in anticipated housing market conditions, observed and anticipated borrower behavior, and updated

60


information on the loans supporting the Bank's PLRMBS.

Accumulated other comprehensive loss declined $0.3 billion during the first three months of 2012, from $1.9 billion at December 31, 2011, to $1.6 billion at March 31, 2012, primarily as a result of improvement in the fair value of PLRMBS classified as available-for-sale. The net change in the fair value of other-than-temporarily impaired PLRMBS classified as available-for-sale was $268 million.

Additional information about investments and OTTI charges associated with the Bank's PLRMBS is provided in “Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Investments” and in “Item 1. Financial Statements – Note 6 – Other-Than-Temporary Impairment Analysis.” Additional information about the Bank's PLRMBS is also provided in “Part II. Item 1. Legal Proceedings.”

On April 27, 2012, the Bank's Board of Directors declared a cash dividend on the capital stock outstanding during the first quarter of 2012 at an annualized rate of 0.51%. The Bank recorded the dividend on April 27, 2012, the day it was declared by the Board of Directors. The Bank expects to pay the dividend (including dividends on mandatorily redeemable capital stock), which will total $13 million, on or about May 10, 2012. The Bank will pay the dividend in cash rather than stock to comply with the rules of the Federal Housing Finance Agency (Finance Agency), which do not permit the Bank to pay dividends in the form of capital stock if the Bank's excess capital stock exceeds 1% of its total assets. As of March 31, 2012, the Bank's excess capital stock totaled $6.2 billion, or 5.59% of total assets.

As of March 31, 2012, the Bank was in compliance with all of its regulatory capital requirements. The Bank's total regulatory capital ratio was 10.89%, exceeding the 4.00% requirement. The Bank had $12.0 billion in regulatory capital, well in excess of its risk-based capital requirement of $4.4 billion.
 
In light of the Bank's strong regulatory capital position, the Bank plans to repurchase up to $500 million in excess capital stock on May 15, 2012. The amount of excess capital stock to be repurchased from any shareholder will be based on the shareholder's pro rata ownership share of total capital stock outstanding as of the repurchase date, up to the amount of the shareholder's excess capital stock.
 
The Bank will continue to monitor the condition of the Bank's PLRMBS portfolio, the ratio of the estimated market value of the Bank's capital to the par value of the Bank's capital stock, its overall financial performance and retained earnings, developments in the mortgage and credit markets, and other relevant information as the basis for determining the status of dividends and excess capital stock repurchases in future quarters.

During the first three months of 2012, total assets decreased $3.5 billion, or 3%, to $110.1 billion at March 31, 2012, from $113.6 billion at December 31, 2011. Total advances declined $6.1 billion, or 9%, to $62.0 billion at March 31, 2012, from $68.2 billion at December 31, 2011. The continued decrease in advances was primarily attributable to reduced use of Bank advances by the Bank's largest borrowers. In total, 83 members reduced their use of Bank advances during the first quarter of 2012, while 34 members increased their advances borrowings. Held-to-maturity and available-for-sale securities combined decreased to $29.1 billion at March 31, 2012, from $31.2 billion at December 31, 2011, primarily because of principal payments, prepayments, and maturities in the MBS portfolio. During the first three months of 2012, Federal funds sold increased $3.3 billion, to $8.6 billion at March 31, 2012, from $5.4 billion at December 31, 2011.

All advances made by the Bank are required to be fully collateralized in accordance with the Bank's credit and collateral requirements. The Bank monitors the creditworthiness of its members on an ongoing basis. In addition, the Bank has a comprehensive process for assigning values to collateral and determining how much it will lend against the collateral pledged. During the first quarter of 2012, the Bank continued to review and adjust its lending parameters based on market conditions. Based on the Bank's risk assessments of housing and mortgage market conditions and of individual members and their collateral, the Bank also continued to adjust collateral terms for individual members during the first quarter of 2012.

On March 16, 2012, the Finance Agency issued a final rule that will restrict the Bank from purchasing, investing in,

61


accepting as collateral or otherwise dealing in any mortgages on properties encumbered by private transfer fee covenants, securities backed by such mortgages, and securities backed by the income stream from such covenants, except for certain excepted transfer fee covenants. The rule will become effective on July 16, 2012, and will apply to covenants created on or after February 8, 2011.

No member institutions were placed into receivership during the first quarter of 2012.

From April 1, 2012, to April 30, 2012, one member institution was placed into receivership. There were no advances outstanding at the time the member was placed into receivership. The capital stock held by the member institution was transferred to another member.

As a result of its downgrade of the long-term sovereign credit rating of the United States from AAA to AA+ with a negative outlook in August 2011, Standard & Poor's Ratings Services (Standard & Poor's) also lowered the long-term issuer credit ratings and related issuer ratings of the Bank, of the nine other FHLBanks that had AAA ratings, and of the senior unsecured debt issued by the FHLBank System from AAA to AA+ with a negative outlook. Moody's Investors Service (Moody's) and Fitch Ratings (Fitch) did not lower the credit ratings of any individual FHLBanks or of FHLBank System debt in 2011, but changed their rating outlooks to negative. The Bank has not observed and does not expect any measurable impact on its operations, financial position, or liquidity resulting from these downgrades.




62


Financial Highlights

The following table presents a summary of certain financial information for the Bank for the periods indicated.

Financial Highlights
(Unaudited)

(Dollars in millions)
March 31,
2012

 
December 31,
2011

 
September 30,
2011

 
June 30,
2011

 
March 31,
2011

Selected Balance Sheet Items at Quarter End
 
 
 
 
 
 
 
 
 
Total Assets
$
110,087

 
$
113,552

 
$
128,308

 
$
144,438

 
$
151,444

Advances
62,040

 
68,164

 
78,462

 
82,745

 
92,005

Mortgage Loans Held for Portfolio, Net
1,686

 
1,829

 
1,990

 
2,097

 
2,205

Investments(1)
42,177

 
39,368

 
44,607

 
51,222

 
52,413

Consolidated Obligations:(2) 
 
 
 
 
 
 
 
 
 
Bonds
74,579

 
83,350

 
99,118

 
111,709

 
115,464

Discount Notes
23,318

 
19,152

 
17,390

 
20,406

 
22,951

Mandatorily Redeemable Capital Stock
5,307

 
5,578

 
5,853

 
6,144

 
3,102

Capital Stock —Class B —Putable
4,717

 
4,795

 
4,934

 
5,046

 
8,496

Unrestricted Retained Earnings
3

 

 

 

 

Restricted Retained Earnings
1,963

 
1,803

 
1,695

 
1,665

 
1,663

Accumulated Other Comprehensive Income/(Loss)

(1,625
)
 
(1,893
)
 
(1,772
)
 
(1,692
)
 
(2,039
)
Total Capital
5,058

 
4,705

 
4,857

 
5,019

 
8,120

Selected Operating Results for the Quarter
 
 
 
 
 
 
 
 
 
Net Interest Income
$
242

 
$
245

 
$
268

 
$
264

 
$
256

Provision for Credit Losses on Mortgage Loans
1

 
1

 

 
3

 

Other Income/(Loss)
(20
)
 
(87
)
 
(197
)
 
(219
)
 
(142
)
Other Expense
32

 
33

 
31

 
30

 
32

Assessments
20

 
13

 
4

 
3

 
22

Net Income/(Loss)
$
169

 
$
111

 
$
36

 
$
9

 
$
60

Selected Other Data for the Quarter
 
 
 
 
 
 
 
 
 
Net Interest Margin(3)
0.88
%
 
0.80
%
 
0.77
%
 
0.72
%
 
0.69
%
Operating Expenses as a Percent of Average Assets
0.10

 
0.09

 
0.07

 
0.07

 
0.07

Return on Average Assets
0.62

 
0.36

 
0.10

 
0.03

 
0.16

Return on Average Equity
13.99

 
9.14

 
2.81

 
0.48

 
3.26

Annualized Dividend Rate
0.48

 
0.30

 
0.26

 
0.31

 
0.29

Dividend Payout Ratio(4)
3.48

 
3.40

 
15.07

 
69.44

 
10.36

Average Equity to Average Assets Ratio
4.40

 
3.95

 
3.57

 
5.38

 
4.92

Selected Other Data at Quarter End
 
 
 
 
 
 
 
 
 
Regulatory Capital Ratio(5)
10.89

 
10.72

 
9.73

 
8.90

 
8.76

Duration Gap (in months)

 
2

 

 
1

 
1

(1)
Investments consist of securities purchased under agreements to resell, Federal funds sold, trading securities, available-for-sale securities, held-to-maturity securities, securities purchased under agreements to resell, and loans to other Federal Home Loan Banks (FHLBanks).
(2)
As provided by the FHLBank Act or regulations governing the operations of the FHLBanks, all of the FHLBanks have joint and several liability for FHLBank consolidated obligations, which are backed only by the financial resources of the FHLBanks. The joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor. The Bank has never been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank, and as of March 31, 2012, and through the filing date of this report, does not believe that it is probable that it will be asked to do so. The par amount of the outstanding consolidated obligations of all 12 FHLBanks at the dates indicated was as follows:


63


  
Par Amount
(In millions)

March 31, 2012
$
658,015

December 31, 2011
691,868

September 30, 2011
696,606

June 30, 2011
727,475

March 31, 2011
765,980


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

Results of Operations

The primary source of Bank earnings is net interest income, which is the interest earned on advances, mortgage loans, and investments, less interest paid on consolidated obligations, deposits, and other borrowings. The Average Balance Sheets table that follows presents the average balances of earning asset categories and the sources that funded those earning assets (liabilities and capital) for the three months ended March 31, 2012 and 2011, together with the related interest income and expense. It also presents the average rates on total earning assets and the average costs of total funding sources.


64


First Quarter of 2012 Compared to First Quarter of 2011

Average Balance Sheets
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended
 
March 31, 2012
 
March 31, 2011
(Dollars in millions)
Average
Balance

 
Interest
Income/
Expense

  
Average
Rate

 
Average
Balance

 
Interest
Income/
Expense

 
Average
Rate

Assets
 
 
 
  
 
 
 
 
 
  
 
Interest-earning assets:
 
 
 
  
 
 
 
 
 
  
 
Interest-bearing deposits
$
28

 
$

 
0.10
%
 
$

 
$

 
%
Securities purchased under agreements to resell
816

 

 
0.12

 

 

 

Federal funds sold
8,831

 
3

  
0.12

 
16,575

 
8

  
0.20

Trading securities:
 
 
 
  
 
 
 
 
 
  
 
MBS
18

 

  
2.05

 
24

 

  
3.16

Other investments
2,766

 
6

  
0.85

 
3,061

 
5

  
0.66

Available-for-sale securities:(1)
 
 
 
 
 
 
 
 
 
 
 
MBS
9,359

 
81

 
3.48

 
79

 

 

Other investments
1,717

 
2

 
0.50

 
1,928

 
1

 
0.27

Held-to-maturity securities:(1)
 
 
 
  
 
 
 
 
 
  
 
MBS
15,417

 
126

  
3.28

 
24,521

 
222

  
3.67

Other investments
4,881

 
2

  
0.20

 
8,769

 
5

  
0.25

Mortgage loans held for portfolio
1,762

 
20

  
4.64

 
2,288

 
28

  
4.98

Deposits with other FHLBanks

 

 
0.03

 

 

 
0.09

Advances(2)
64,420

 
177

  
1.10

 
93,400

 
192

  
0.83

Loans to other FHLBanks
2

 

  
0.09

 
1

 

  
0.17

Total interest-earning assets
110,017

 
417

  
1.52

 
150,646

 
461

  
1.24

Other assets(3)(4)(5)
407

 

  

 
380

 

  

Total Assets
$
110,424

 
$
417

  
1.52
%
 
$
151,026

 
$
461

  
1.24
%
Liabilities and Capital
 
 
 
  
 
 
 
 
 
  
 
Interest-bearing liabilities:
 
 
 
  
 
 
 
 
 
  
 
Consolidated obligations:
 
 
 
  
 
 
 
 
 
  
 
Bonds(2)
$
76,143

 
$
162

  
0.86
%
 
$
117,762

 
$
191

 
0.66
%
Discount notes
22,130

 
6

  
0.11

 
19,536

 
11

 
0.23

Deposits(3)
751

 

  
0.01

 
943

 

 
0.03

Borrowings from other FHLBanks
8

 

  
0.10

 
7

 

 
0.18

Mandatorily redeemable capital stock
5,530

 
7

  
0.50

 
3,334

 
3

 
0.34

Total interest-bearing liabilities
104,562

 
175

  
0.68

 
141,582

 
205

  
0.59

Other liabilities(3)(4)
1,004

 

  

 
2,017

 

 

Total Liabilities
105,566

 
175

  
0.67

 
143,599

 
205

  
0.58

Total Capital
4,858

 

  

 
7,427

 

 

Total Liabilities and Capital
$
110,424

 
$
175

  
0.64
%
 
$
151,026

 
$
205

  
0.55
%
Net Interest Income
 
 
$
242

  
 
 
 
 
$
256

  
 
Net Interest Spread(6)
 
 
 
  
0.84
%
 
 
 
 
  
0.65
%
Net Interest Margin(7)
 
 
 
  
0.88
%
 
 
 
 
  
0.69
%
Interest-earning Assets/Interest-bearing Liabilities
105.22
%
 
 
  
 
 
106.40
%
 
 
  
 

(1)
The average balances of available-for-sale securities and held-to-maturity securities are reflected at amortized cost. As a result, the average rates do not reflect changes in fair value or non-credit-related OTTI charges.

65


(2)
Interest income/expense and average rates include the effect of associated interest rate exchange agreements, as follows:

 
Three Months Ended
 
March 31, 2012
 
March 31, 2011
(In millions)
(Amortization)/
Accretion of
Hedging
Activities

 
Net Interest
Settlements

 
Total Net Interest
Income/(Expense)

 
(Amortization)/
Accretion of
Hedging
Activities

 
Net Interest
Settlements

 
Total Net Interest
Income/(Expense)

Advances
$
(4
)
 
$
(39
)
 
$
(43
)
 
$
(9
)
 
$
(84
)
 
$
(93
)
Consolidated obligation bonds
15

 
134

 
149

 
22

 
330

 
352


(3)
Average balances do not reflect the effect of reclassifications of cash collateral.
(4)
Includes forward settling transactions and valuation adjustments for certain cash items.
(5)
Includes non-credit-related OTTI charges on available-for-sale and held-to-maturity securities.
(6)
Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities.
(7)
Net interest margin is net interest income (annualized) divided by average interest-earning assets.
 
Net interest income in the first quarter of 2012 was $242 million, a 5% decrease from $256 million in the first quarter of 2011. The following table details the changes in interest income and interest expense for the first quarter of 2012 compared to the first quarter of 2011. Changes in both volume and interest rates influence changes in net interest income, net interest spread, and net interest margin.

Change in Net Interest Income: Rate/Volume Analysis
Three Months Ended March 31, 2012, Compared to Three Months Ended March 31, 2011
 
 
 
 
 
 
 
Increase/
(Decrease)

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

 
Average Rate

Interest-earning assets:
 
 
 
 
 
Federal funds sold
$
(5
)
 
$
(3
)
 
$
(2
)
Trading securities:
 
 
 
 
 
MBS

 

 

Other investments
1

 

 
1

Available-for-sale securities:
 
 
 
 
 
MBS
81

 
81

 

Other investments
1

 

 
1

Held-to-maturity securities:
 
 
 
 
 
MBS
(96
)
 
(74
)
 
(22
)
Other investments
(3
)
 
(2
)
 
(1
)
Mortgage loans held for portfolio
(8
)
 
(6
)
 
(2
)
Advances(2) 
(15
)
 
(69
)
 
54

Total interest-earning assets
(44
)
 
(73
)
 
29

Interest-bearing liabilities:
 
 
 
 
 
Consolidated obligations:
 
 
 
 
 
Bonds(2)
(29
)
 
(78
)
 
49

Discount notes
(5
)
 
1

 
(6
)
Mandatorily redeemable capital stock
4

 
2

 
2

Total interest-bearing liabilities
(30
)
 
(75
)
 
45

Net interest income
$
(14
)
 
$
2

 
$
(16
)

(1)
Combined rate/volume variances, a third element of the calculation, are allocated to the rate and volume variances based on their relative sizes.
(2)
Interest income/expense and average rates include the interest effect of associated interest rate exchange agreements.

Net interest income included advance prepayment fees of $22 million in the first quarter of 2012 compared to $6 million in the first quarter of 2011.


66


The net interest margin for the first quarter of 2012 was 88 basis points, 19 basis points higher than the net interest margin for the first quarter of 2011, which was 69 basis points. The net interest spread for the first quarter of 2012 was 84 basis points, 19 basis points higher than the net interest spread for the first quarter of 2011, which was 65 basis points. These increases were primarily due to a shift in the asset mix. The ratio of advances and non-MBS investments to total interest-earning assets declined while the ratio of the combined MBS and mortgage loan portfolios to total interest-earning assets increased. In addition, the increase in prepayment fees contributed to the increases in the net interest margin and spread.

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

Other Income/(Loss)

The following table presents the components of “Other Income/(Loss)” for the three months ended March 31, 2012 and 2011.
 
Other Income/(Loss)
 
 
 
 
 
Three Months Ended
(In millions)
March 31, 2012

 
March 31, 2011

Other Income/(Loss):
 
 
 
Net gain/(loss) on trading securities(1)
$
(3
)
 
$
(1
)
Total OTTI loss
(11
)
 
(88
)
Net amount of OTTI loss reclassified to/(from) accumulated other comprehensive income/(loss)
2

 
(21
)
Net OTTI loss, credit portion
(9
)
 
(109
)
Net gain/(loss) on advances and consolidated obligation bonds held under fair value option
(13
)
 
(54
)
Net gain/(loss) on derivatives and hedging activities
3

 
20

Other
2

 
2

Total Other Income/(Loss)
$
(20
)
 
$
(142
)

(1)
The net gain/(loss) on trading securities that were economically hedged totaled $(3) million and was de minimis for the three months ended March 31, 2012 and 2011, respectively.

Net Other-Than-Temporary Impairment Loss, Credit Portion – Each quarter, the Bank updates its OTTI analysis to reflect current housing market conditions, changes in anticipated housing market conditions, observed and anticipated borrower behavior, and updated information on the loans supporting the Bank's PLRMBS. The $9 million credit-related OTTI charge reflected the Bank's OTTI analysis for the first quarter of 2012, which showed a modest increase in expected borrower default rates on PLRMBS backed by Alt-A fixed rate loan collateral. The following table presents the net OTTI loss for the three months ended March 31, 2012 and 2011:
 

67


Net Other-Than-Temporary Impairment Loss
 
 
 
 
 
Three Months Ended
 
March 31, 2012
 
March 31, 2011
(In millions)
Credit-
Related
OTTI

 
Non-Credit-
Related
OTTI

 
Total
 OTTI

 
Credit-
Related
OTTI

 
Non-Credit-
Related
OTTI

 
Total
OTTI

Securities newly impaired during the period
$

  
$
3

  
$
3

  
$

  
$
77

  
$
77

Securities previously impaired prior to current period(1)
9

  
(1
)
  
8

  
109

  
(98
)
  
11

Total
$
9

  
$
2

  
$
11

  
$
109

  
$
(21
)
  
$
88


(1)
For the three months ended March 31, 2012, “securities previously impaired prior to current period” represents all securities that were also other-than-temporarily impaired prior to January 1, 2012. For the three months ended March 31, 2011, “securities previously impaired prior to current period” represents all securities that were also other-than-temporarily impaired prior to January 1, 2011.

Additional information about the OTTI charge is provided in “Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Investments” and in “Item 1. Financial Statements – Note 6 – Other-Than-Temporary Impairment Analysis.”
Net Gain/(Loss) on Advances and Consolidated Obligation Bonds Held Under Fair Value Option The following table presents the net gain/(loss) on advances and consolidated obligation bonds held under the fair value option for the three months ended March 31, 2012 and 2011.
 
Net Gain/(Loss) on Advances and Consolidated Obligation Bonds Held Under Fair Value Option
 
 
 
 
 
Three Months Ended
(In millions)
March 31, 2012

 
March 31, 2011

Advances
$
(26
)
 
$
(51
)
Consolidated obligation bonds
13

 
(3
)
Total
$
(13
)
 
$
(54
)

In general, transactions elected for the fair value option are in economic hedge relationships. Gains or losses on these transactions are generally offset by losses or gains on derivatives that economically hedge these instruments.

For the first quarter of 2012, the unrealized net fair value losses on advances and gains on consolidated obligation bonds were primarily driven by the increased interest rate environment relative to the actual coupon rates on the advances and consolidated obligation bonds and decreased swaption volatilities.

For the first quarter of 2011, the unrealized net fair value losses on advances were primarily driven by the increased interest rate environment relative to the actual coupon rates on the Bank's advances and by lower swaption volatilities used in pricing fair value option putable advances during the first quarter of 2011. The unrealized net fair value losses on consolidated obligation bonds were primarily driven by decreased interest rate spreads on consolidated obligation bonds relative to the actual spreads on the Bank's outstanding consolidated obligation bonds and by lower swaption volatilities used in pricing fair value option callable bonds during the first quarter of 2011.

Net Gain/(Loss) on Derivatives and Hedging Activities – The following table shows the components of the gains and losses on derivatives and hedged items that were recorded in “Net gain/(loss) on derivatives and hedging activities” in the first quarter of 2012 and 2011.

 

68


Sources of Gains/(Losses) Recorded in Net Gain/(Loss) on Derivatives and Hedging Activities
Three Months Ended March 31, 2012, Compared to Three Months Ended March 31, 2011
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(In millions)
March 31, 2012
 
March 31, 2011
 
Gain/(Loss)
 
Net Interest
Income/
(Expense) on

 
Total

 
Gain/(Loss)
 
Net Interest
Income/
(Expense) on

 
Total

Hedged Item
Fair Value
Hedges, Net

 
Economic
Hedges

 
Economic
Hedges

 
 
Fair Value
Hedges, Net

 
Economic
Hedges

 
Economic
Hedges

 
Advances:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Held under the fair value option

$

 
$
12

 
$
(36
)
 
$
(24
)
 
$

 
$
64

 
$
(57
)
 
$
7

Not held under the fair value option

1

 
3

 
(5
)
 
(1
)
 
1

 
8

 
(8
)
 
1

Consolidated obligation bonds:

 

 

 
 
 

 

 

 
 
Held under the fair value option


 
12

 
7

 
19

 

 
(7
)
 
25

 
18

Not held under the fair value option

(3
)
 
(25
)
 
38

 
10

 

 
(41
)
 
42

 
1

Consolidated obligation discount notes:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Not held under the fair value option


 
13

 
(12
)
 
1

 

 
5

 
(10
)
 
(5
)
Non-mortgage-backed securities (non-MBS) investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Not held under the fair value option


 
1

 
(3
)
 
(2
)
 

 

 
(2
)
 
(2
)
Total
$
(2
)
 
$
16

 
$
(11
)
 
$
3

 
$
1

 
$
29

 
$
(10
)
 
$
20


During the first quarter of 2012, net gains on derivatives and hedging activities totaled $3 million compared to net gains of $20 million in the first quarter of 2011. These amounts included net interest expense on derivative instruments used in economic hedges of $11 million in the first quarter of 2012, compared to net interest expense on derivative instruments used in economic hedges of $10 million in the first quarter of 2011. The increase in net interest expense was primarily due to the impact of higher interest rates throughout the first quarter of 2012 on the adjustable rate leg of the interest rate swaps.

Excluding the $11 million impact from net interest expense on derivative instruments used in economic hedges, net gains for the first quarter of 2012 totaled $14 million as detailed above. The $14 million in net gains were primarily attributable to changes in interest rates and decreased swaption volatilities during the first quarter of 2012.

Excluding the $10 million impact from net interest expense on derivative instruments used in economic hedges, net gains for the first quarter of 2011 totaled $30 million as detailed above. The $30 million in net gains were primarily attributable to changes in interest rates and decreased swaption volatilities during the first quarter of 2011.

In general, nearly all of the Bank's derivatives and hedged instruments, as well as certain assets and liabilities that are carried at fair value, are held to the maturity, call, or put date. For these financial instruments, net valuation gains or losses are primarily a matter of timing and will generally reverse through changes in future valuations and settlements of contractual interest cash flows over the remaining contractual terms to maturity, or by the exercised call or put dates. However, the Bank may have instances in which hedging relationships are terminated prior to maturity or prior to the call or put dates. Terminating the hedging relationship may result in a realized gain or loss. In addition, the Bank may have instances in which it may sell trading securities prior to maturity, which may also result in a realized gain or loss.
The ongoing impact of these valuation adjustments on the Bank cannot be predicted, and the Bank's retained earnings in the future may not be sufficient to fully offset the impact of these valuation adjustments. The effects of these valuation adjustments may lead to significant volatility in future earnings, including earnings available for dividends.

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



69


Return on Average Equity

Return on average equity (ROE) was 13.99% (annualized) for the first quarter of 2012, compared to 3.26% (annualized) for the first quarter of 2011. This increase reflected the increase in net income in the first quarter of 2012 and the decrease in average equity, which decreased 35%, to $4.9 billion in the first quarter of 2012 from $7.4 billion in the first quarter of 2011.

Dividends and Retained Earnings

By regulations governing the operations of the FHLBanks, dividends may be paid only out of current net earnings or previously retained earnings. As required by the regulations, the Bank has a formal Retained Earnings and Dividend Policy that is reviewed at least annually by the Bank's Board of Directors. The Board of Directors may amend the Retained Earnings and Dividend Policy from time to time. The Bank's Retained Earnings and Dividend Policy establishes amounts to be retained in restricted retained earnings, which are not made available for dividends in the current dividend period. The Bank may be restricted from paying dividends if it is not in compliance with any of its minimum capital requirements or if payment would cause the Bank to fail to meet any of its minimum capital requirements. In addition, the Bank may not pay dividends if any principal or interest due on any consolidated obligation has not been paid in full or is not expected to be paid in full, or, under certain circumstances, if the Bank fails to satisfy certain liquidity requirements under applicable regulations.

On May 27, 2011, the Bank's Board of Directors modified the Bank's Risk Management Policy to provide guidelines for the payment of dividends based on the ratio of the Bank's estimated market value of total capital to par value of capital stock. If this ratio at the end of any quarter is less than 100% but greater than or equal to 70%, any dividend would be limited to an annualized rate no greater than the daily average of the three-month London Interbank Offered Rate (LIBOR) for the applicable quarter (subject to certain conditions), and if this ratio is less than 70%, the Bank would be restricted from paying a dividend. The ratio of the Bank's estimated market value of total capital to par value of capital stock was 103.8% as of March 31, 2012. For more information, see “Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition – Risk Management – Market Risk.”

The regulatory liquidity requirements state that each FHLBank must: (i) maintain eligible high quality assets (advances with a maturity not exceeding five years, U.S. Treasury securities investments, and deposits in banks or trust companies) in an amount equal to or greater than the deposits received from members, and (ii) hold contingent liquidity in an amount sufficient to meet its liquidity needs for at least five business days without access to the consolidated obligations markets. At March 31, 2012, advances maturing within five years totaled $57.6 billion, significantly in excess of the $0.2 billion of member deposits on that date. At December 31, 2011, advances maturing within five years totaled $64.2 billion, also significantly in excess of the $0.2 billion of member deposits on that date. In addition, as of March 31, 2012, and December 31, 2011, the Bank's estimated total sources of funds obtainable from liquidity investments, repurchase agreement borrowings collateralized by the Bank's marketable securities, and advance repayments would have allowed the Bank to meet its liquidity needs for more than 90 days without access to the consolidated obligations markets, subject to certain conditions.

Retained Earnings Related to Valuation Adjustments In accordance with the Bank's Retained Earnings and Dividend Policy, the Bank retains in restricted retained earnings any cumulative net gains in earnings (net of applicable assessments) resulting from valuation adjustments.

In general, the Bank's derivatives and hedged instruments, as well as certain assets and liabilities that are carried at fair value, are held to the maturity, call, or put date. For these financial instruments, net valuation gains or losses are primarily a matter of timing and will generally reverse through changes in future valuations and settlements of contractual interest cash flows over the remaining contractual terms to maturity, or by the exercised call or put dates. However, the Bank may have instances in which hedging relationships are terminated prior to maturity or prior to the call or put dates. Terminating the hedging relationship may result in a realized gain or loss. In addition, the Bank may have instances in which it may sell trading securities prior to maturity, which may also result in a realized gain or loss.

70



As the cumulative net valuation gains are reversed by periodic net losses and settlements of contractual interest cash flows, the amount of the cumulative net gains decreases. The amount of retained earnings under this provision of the policy is therefore decreased, and that portion of the previously restricted retained earnings becomes unrestricted and may be made available for dividends. In this case, the potential dividend payout in a given period will be substantially the same as it would have been without the effects of valuation adjustments, provided that at the end of the period the cumulative net effect since inception remains a net gain. The purpose of the valuation adjustments category of restricted retained earnings is to provide sufficient retained earnings to offset future net losses that result from the reversal of cumulative net gains, so that potential dividend payouts in future periods are not necessarily affected by the reversals of these gains. Although restricting retained earnings in accordance with this provision of the policy may help preserve the Bank's ability to pay dividends, the reversal of cumulative net gains in any given period may result in a net loss if the reversal exceeds net earnings before the impact of valuation adjustments for that period. Also, if the net effect of valuation adjustments since inception results in a cumulative net loss, the Bank's other retained earnings at that time (if any) may not be sufficient to offset the net loss. As a result, the future effects of valuation adjustments may cause the Bank to reduce or temporarily suspend dividend payments.

Other Retained Earnings – Targeted Buildup – In addition to any cumulative net gains resulting from valuation adjustments, the Bank holds an additional amount in restricted retained earnings intended to protect paid-in capital from the effects of an extremely adverse credit event, an extremely adverse operations risk event, an extremely high level of quarterly losses related to the Bank's derivatives and associated hedged items and financial instruments carried at fair value, an extremely adverse change in the market value of the Bank's capital, and a significant amount of additional credit-related OTTI on PLRMBS, especially in periods of extremely low net income resulting from an adverse interest rate environment.
 
The Board of Directors has set the targeted amount of restricted retained earnings at $1.8 billion. The Bank's retained earnings target may be changed at any time. The Board of Directors will periodically review the methodology and analysis to determine whether any adjustments are appropriate. As of March 31, 2012, the amount of restricted retained earnings in the Bank's targeted buildup account reached the $1.8 billion target.

Joint Capital Enhancement Agreement - In 2011, the 12 FHLBanks entered into a Joint Capital Enhancement Agreement, as amended, which is intended to enhance the capital position of each FHLBank by allocating that portion of each FHLBank's earnings historically paid to satisfy its REFCORP obligation to a separate retained earnings account at that FHLBank.

The FHLBanks subsequently amended their capital plans or capital plan submissions, as applicable, to implement the provisions of the Agreement, and the Finance Agency approved the capital plan amendments on August 5, 2011. The Bank's amended capital plan became effective on September 5, 2011.

On August 5, 2011, the Finance Agency certified that the FHLBanks had fully satisfied their REFCORP obligation. In accordance with the Agreement, starting in the third quarter of 2011, each FHLBank is required to allocate 20% of its net income each quarter to a separate restricted retained earnings account until the balance of the account equals at least 1% of that FHLBank's average balance of outstanding consolidated obligations for the previous quarter. Under the Agreement, these restricted retained earnings will not be available to pay dividends.

The following table summarizes the activity related to restricted retained earnings for the three months ended March 31, 2012 and 2011:


71


 
Three Months Ended
 
March 31, 2012
 
Restricted Retained Earnings Related to:
 
Valuation Adjustments

 
Joint Capital Enhancement Agreement

 
Targeted Buildup

 
Total

Balance at beginning of the period
$
79

 
$
29

 
$
1,695

 
$
1,803

Transfers to/(from) restricted retained earnings
21

 
34

 
105

 
160

Balance at end of the period
$
100

 
$
63

 
$
1,800

 
$
1,963


 
Three Months Ended
 
March 31, 2011
 
Restricted Retained Earnings Related to:
 
Valuation Adjustments

 
Joint Capital Enhancement Agreement

 
Targeted Buildup

 
Total

Balance at beginning of the period
$
148

 
$

 
$
1,461

 
$
1,609

Transfers to/(from) restricted retained earnings
1

 

 
53

 
54

Balance at end of the period
$
149

 
$

 
$
1,514

 
$
1,663


For more information on these three categories of restricted retained earnings and the Bank's Retained Earnings and Dividend Policy, see “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital” in the Bank's 2011 Form 10-K.

Dividend Payments – Finance Agency rules state that FHLBanks may declare and pay dividends only from previously retained earnings or current net earnings, and may not declare or pay dividends based on projected or anticipated earnings. There is no requirement that the Board of Directors declare and pay any dividend. A decision by the Board of Directors to declare or not declare a dividend is a discretionary matter and is subject to the requirements and restrictions of the FHLBank Act and applicable requirements under the regulations governing the operations of the FHLBanks.

The Bank paid dividends (including dividends on mandatorily redeemable capital stock) totaling $13 million at an annualized rate of 0.48% in the first quarter of 2012, and $9 million at an annualized rate of 0.29% in the first quarter of 2011.

On April 27, 2012, the Bank's Board of Directors declared a cash dividend on the capital stock outstanding during the first quarter of 2012 at an annualized rate of 0.51%. The Bank recorded the dividend on April 27, 2012, the day it was declared by the Board of Directors. The Bank expects to pay the dividend (including dividends on mandatorily redeemable capital stock), which will total $13 million, on or about May 10, 2012.

The Bank will pay the dividend in cash rather than stock to comply with Finance Agency rules, which do not permit the Bank to pay dividends in the form of capital stock if the Bank's excess capital stock exceeds 1% of its total assets. As of March 31, 2012, the Bank's excess capital stock totaled $6.2 billion, or 5.59% of total assets.

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

For more information on the Bank's Retained Earnings and Dividend Policy, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – Comparison of 2011 to 2010 – Dividends and Retained Earnings” in the Bank's 2011 Form 10-K.




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Financial Condition

Total assets were $110.1 billion at March 31, 2012, a 3% decrease from $113.6 billion at December 31, 2011. Advances decreased by $6.1 billion, or 9%, to $62.0 billion at March 31, 2012, from $68.2 billion at December 31, 2011. Average total assets were $110.4 billion for the first quarter of 2012, a 27% decrease compared to $151.0 billion for the first quarter of 2011. Average advances were $64.4 billion for the first quarter of 2012, a 31% decrease from $93.4 billion for the first quarter of 2011.

The continued decrease in member advance demand reflected general economic conditions and conditions in the mortgage and credit markets. In general, member liquidity remained high and lending activity remained low.

Advances outstanding at March 31, 2012, included unrealized gains of $599 million, of which $271 million represented unrealized gains on advances hedged in accordance with the accounting for derivative instruments and hedging activities and $328 million represented unrealized gains on economically hedged advances that are carried at fair value in accordance with the fair value option. Advances outstanding at December 31, 2011, included unrealized gains of $728 million, of which $302 million represented unrealized gains on advances hedged in accordance with the accounting for derivative instruments and hedging activities and $426 million represented unrealized gains on economically hedged advances that are carried at fair value in accordance with the fair value option. The overall decrease in the unrealized gains of the hedged advances and advances carried at fair value from December 31, 2011, to March 31, 2012, was primarily attributable to an increase in the interest rate environment relative to the actual coupon rates on the Bank's advances.

Total liabilities were $105.0 billion at March 31, 2012, a 4% decrease from $108.8 billion at December 31, 2011, reflecting decreases in consolidated obligations outstanding from $102.5 billion at December 31, 2011, to $97.9 billion at March 31, 2012. The decrease in consolidated obligations outstanding paralleled the decrease in assets during the first three months of 2012. Average total liabilities were $105.6 billion for the first quarter of 2012, a 26% decrease compared to $143.6 billion for the first quarter of 2011. The decrease in average liabilities reflected decreases in average consolidated obligations, paralleling the decline in average assets. Average consolidated obligations were $98.3 billion in the first quarter of 2012 and $137.3 billion in the first quarter of 2011.

Consolidated obligations outstanding at March 31, 2012, included unrealized losses of $1.1 billion on consolidated obligation bonds hedged in accordance with the accounting for derivative instruments and hedging activities and unrealized losses of $24 million on economically hedged consolidated obligation bonds that are carried at fair value in accordance with the fair value option. Consolidated obligations outstanding at December 31, 2011, included unrealized losses of $1.2 billion on consolidated obligation bonds hedged in accordance with the accounting for derivative instruments and hedging activities and unrealized losses of $43 million on economically hedged consolidated obligation bonds that are carried at fair value in accordance with the fair value option. The overall decrease in the unrealized losses on the hedged consolidated obligation bonds and the consolidated obligation bonds carried at fair value from December 31, 2011, to March 31, 2012, was primarily attributable to an increase in the interest rate environment relative to the actual coupon rates on the Bank's consolidated obligation bonds.

As provided by the FHLBank Act and regulations governing the operations of the FHLBanks, all FHLBanks have joint and several liability for all FHLBank consolidated obligations. The joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor. The Bank has never been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank, and as of March 31, 2012, and through the filing date of this report, does not believe that it is probable that it will be asked to do so. The par amount of the outstanding consolidated obligations of all 12 FHLBanks was $658.0 billion at March 31, 2012, and $691.9 million at December 31, 2011.

Changes in the long-term credit ratings of individual FHLBanks do not necessarily affect the credit rating of the consolidated obligations issued on behalf of the FHLBanks. Rating agencies may change a rating from time to time because of various factors, including operating results or actions taken, business developments, or changes in their opinion regarding, among other factors, the general outlook for a particular industry or the economy.

73



The Bank evaluated the publicly disclosed FHLBank regulatory actions and long-term credit ratings of other FHLBanks as of March 31, 2012, and as of each period end presented, and believes, as of the date of this report,
that it is unlikely that the Bank will be required to repay any principal or interest associated with consolidated obligations for which the Bank is not the primary obligor.

Financial condition is further discussed under “Segment Information.”

Segment Information

The Bank uses an analysis of financial performance based on the balances and adjusted net interest income of two operating segments, the advances-related business and the mortgage-related business, as well as other financial information, to review and assess financial performance and to determine the allocation of resources to these two major business segments. For purposes of segment reporting, adjusted net interest income includes interest income and expense associated with economic hedges that are recorded in “Net gain/(loss) on derivatives and hedging activities” in other income and excludes interest expense that is recorded in “Mandatorily redeemable capital stock.” Other key financial information, such as any OTTI loss on the Bank's available-for-sale and held-to-maturity PLRMBS, other expenses, and assessments, are not included in the segment reporting analysis, but are incorporated into the Bank's overall assessment of financial performance. For a reconciliation of the Bank's operating segment adjusted net interest income to the Bank's total net interest income, see “Item 1. Financial Statements – Note 14 – Segment Information.”

Advances-Related Business. The advances-related business consists of advances and other credit products, related financing and hedging instruments, liquidity and other non-MBS investments associated with the Bank's role as a liquidity provider, and capital stock.

Assets associated with this segment decreased to $84.7 billion (77% of total assets) at March 31, 2012, from $88.3 billion (78% of total assets) at December 31, 2011, representing a decrease of $3.6 billion, or 4%. The continued decrease in member advance demand reflected general economic conditions and conditions in the mortgage and credit markets. In general, member liquidity remained high and lending activity remained low.

Adjusted net interest income for this segment is derived primarily from the difference, or spread, between the yield on advances and non-mortgage-backed securities (non-MBS) investments and the cost of the consolidated obligations funding these assets, including the cash flows from associated interest rate exchange agreements.

Adjusted net interest income for this segment was $73 million in the first quarter of 2012, a decrease of $20 million, or 22%, compared to $93 million in the first quarter of 2011. These decreases were primarily due to lower advances balances and to a decline in earnings on invested capital because of lower capital balances and the lower interest rate environment.

Members and nonmember borrowers prepaid $1.4 billion of advances in the first quarter of 2012 compared to $0.7 billion in the first quarter of 2011. As a result, interest income was increased by net prepayment fees of $22 million in the first quarter of 2012 compared to $6 million in the first quarter of 2011.

Adjusted net interest income for this segment represented 37% and 41% of total adjusted net interest income for the first quarter of 2012 and 2011, respectively.

Advances – The par amount of advances outstanding decreased by $6.0 billion, or 9%, to $61.4 billion at March 31, 2012, from $67.4 billion at December 31, 2011. The decrease in advances outstanding was primarily attributable to the $5.3 billion decline in advances outstanding to the Bank's top five borrowers and their affiliates. Advances to the top five borrowers decreased to $42.8 billion at March 31, 2012, from $48.1 billion at December 31, 2011. (See “Item 1. Financial Statements and Supplementary Data – Note 7 – Advances” for further information.) The remaining $0.7 billion decrease in total advances outstanding was attributable to a net decrease in advances to other borrowers of varying asset sizes and charter types. In total, 83 borrowers decreased their advances during the first

74


three months of 2012, while 34 borrowers increased their advances.

The $6.0 billion decrease in advances outstanding reflects a $2.0 billion decrease in fixed rate advances and a $4.7 billion decrease in adjustable rate advances, partially offset by a $0.7 billion increase in daily variable rate advances.

The components of the advances portfolio at March 31, 2012, and December 31, 2011, are presented in the following table.
Advances Portfolio by Product Type
 
 
 
 
 
 
 
 
 
March 31, 2012
 
December 31, 2011
(Dollar in millions)
Par Amount

 
Percentage of Total Par Amount

 
Par Amount

 
Percentage of Total Par Amount

Adjustable – LIBOR
$
29,281

 
48
%
 
$
34,006

 
50
 %
Adjustable – other indices
1

 

 
1

 

Adjustable – LIBOR, with caps and/or floors and PPS(1)
160

 

 
160

 

Subtotal adjustable rate advances
29,442

 
48

 
34,167

 
50

Fixed
22,727

 
37

 
24,004

 
37

Fixed – amortizing
333

 
1

 
348

 

Fixed – with PPS(1)
5,972

 
10

 
5,842

 
9

Fixed – with caps and PPS(1)
200

 

 
200

 

Fixed – callable at member's option
10

 

 
5

 

Fixed – callable at member's option with PPS(1)
205

 

 
323

 

Fixed – putable at Bank's option
615

 
1

 
1,111

 
2

Fixed – putable at Bank's option with PPS(1)
125

 

 
350

 

Subtotal fixed rate advances
30,187

 
49

 
32,183

 
48

Daily variable rate
1,812

 
3

 
1,086

 
2

Total par amount
$
61,441

 
100
%
 
$
67,436

 
100
 %

(1)
Partial prepayment symmetry (PPS) is a product feature under which the Bank may charge the borrower a prepayment fee or pay the borrower a prepayment credit, depending on certain circumstances, such as movements in interest rates, when the advance is prepaid. Any prepayment credit on an advance with PPS would be limited to the lesser of 10% of the par value of the advance or the gain recognized on the termination of the associated interest rate swap, which may also include a similar contractual gain limitation.

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

Non-MBS Investments The Bank's non-MBS investment portfolio consists of financial instruments that are used primarily to facilitate the Bank's role as a cost-effective provider of credit and liquidity to members and to support the operations of the Bank. The Bank's total non-MBS investment portfolio was $18.4 billion as of March 31, 2012, an increase of $2.3 billion, or 15%, from $16.1 billion as of December 31, 2011. The increase in the non-MBS investment portfolio was primarily due to higher balances of short-term securities purchased under agreements to resell and Federal funds sold.

Cash and Due from Banks – Cash and due from banks was $3.5 billion at March 31, 2012, essentially unchanged from December 31, 2011.

Borrowings – Consistent with the decrease in advances, total liabilities (primarily consolidated obligations) funding the advances-related business decreased $4.0 billion, or 5%, from $83.6 billion at December 31, 2011, to $79.6 billion at March 31, 2012. For further information and discussion of the Bank's joint and several liability for

75


FHLBank consolidated obligations, see “Management's Discussion and Analysis of Financial Condition and Results of Operations Financial Condition” and “Item 1. Financial Statements and Supplementary Data – Note 17 – Commitments and Contingencies.”

To meet the specific needs of certain investors, fixed and adjustable rate consolidated obligation bonds may contain embedded call options or other features that result in complex coupon payment terms. When these consolidated obligation bonds are issued on behalf of the Bank, typically the Bank simultaneously enters into interest rate exchange agreements with features that offset the complex features of the bonds and, in effect, convert the bonds to adjustable rate instruments tied to an index, primarily LIBOR. For example, the Bank uses fixed rate callable bonds that are typically offset with interest rate exchange agreements with call features that offset the call options embedded in the callable bonds. This combined financing structure enables the Bank to meet its funding needs at costs not generally attainable solely through the issuance of comparable term non-callable debt.

At March 31, 2012, the notional amount of interest rate exchange agreements associated with the advances-related business totaled $106.0 billion, of which $20.4 billion were hedging advances, $81.9 billion were hedging consolidated obligations, $2.9 billion were economically hedging trading securities, and $0.8 billion were interest rate exchange agreements that the Bank entered into as an intermediary between offsetting derivatives transactions with members and other counterparties. At December 31, 2011, the notional amount of interest rate exchange agreements associated with the advances-related business totaled $114.8 billion, of which $24.4 billion were hedging advances, $87.2 billion were hedging consolidated obligations, $2.4 billion were economically hedging trading securities, and $0.8 billion were interest rate exchange agreements that the Bank entered into as an intermediary between offsetting derivatives transactions with members and other counterparties. The hedges associated with advances and consolidated obligations were primarily used to convert the fixed rate cash flows and non-LIBOR-indexed cash flows of the advances and consolidated obligations to adjustable rate LIBOR-indexed cash flows or to manage the interest rate sensitivity and net repricing gaps of assets, liabilities, and interest rate exchange agreements.

FHLBank System consolidated obligation bonds and discount notes, along with similar debt securities issued by other GSEs such as Fannie Mae and Freddie Mac, are generally referred to as agency debt. The agency debt market is a large sector of the debt capital markets. The costs of debt issued by the FHLBanks and the other GSEs generally rise and fall with increases and decreases in general market interest rates. For more information, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources” in the Bank's 2011 Form 10-K.

Since December 16, 2008, the Federal Open Market Committee has not changed the target Federal funds rate. During the first three months of 2012, yields on intermediate-term U.S. Treasury securities increased. Stronger U.S. economic data during the first quarter of 2012 and renewed expectations that economic conditions were gradually improving contributed to higher yields. The following table provides selected market interest rates as of the dates shown.
 
Selected Market Interest Rates
 
 
 
 
 
 
 
 
 
 
 
 
Market Instrument
March 31, 2012
 
December 31, 2011
 
March 31, 2011
 
December 31, 2010
Federal Reserve target rate for overnight Federal funds
0-0.25

%
 
0-0.25

%
 
0-0.25

%
 
0-0.25

%
3-month Treasury bill
0.07

 
 
0.01

 
 
0.10

 
 
0.13

 
3-month LIBOR
0.47

 
 
0.58

 
 
0.30

 
 
0.30

 
2-year Treasury note
0.33

 
 
0.24

 
 
0.83

 
 
0.60

 
5-year Treasury note
1.04

 
 
0.83

 
 
2.28

 
 
2.01

 

The following table presents a comparison of the average cost of FHLBank System consolidated obligation bonds relative to 3-month LIBOR and discount notes relative to comparable term LIBOR in the first three months of 2012 and 2011. The factors that contributed to lower borrowing costs for FHLBank System consolidated obligation

76


bonds and discount notes relative to LIBOR were: higher three-month LIBOR rates in the first three months of 2012 compared to the same period in 2011 (in part because of increased sovereign and financial risks in Europe) and continued investor demand for FHLBank debt.
 
 
Spread to LIBOR of Average Cost of
Consolidated Obligations for the Nine Months Ended
(In basis points)
March 31, 2012
  
March 31, 2011
Consolidated obligation bonds
–30.8
  
–15.2
Consolidated obligation discount notes (one month and greater)
–32.0
  
–15.4

Mortgage-Related Business. The mortgage-related business consists of mortgage-backed securities (MBS) investments, mortgage loans acquired through the Mortgage Partnership Finance® (MPF®) Program, and the related financing and hedging instruments. (“Mortgage Partnership Finance” and “MPF” are registered trademarks of the FHLBank of Chicago.) Adjusted net interest income for this segment is derived primarily from the difference, or spread, between the yield on the MBS and mortgage loans and the cost of the consolidated obligations funding those assets, including the cash flows from associated interest rate exchange agreements.

At March 31, 2012, assets associated with this segment were $25.4 billion (23% of total assets), an increase of $0.1 billion from $25.3 billion at December 31, 2011 (22% of total assets). The MBS portfolio increased $0.4 billion to $23.7 billion at March 31, 2012, from $23.3 billion at December 31, 2011, primarily because of purchases of agency residential MBS, and mortgage loan balances decreased $0.1 billion to $1.7 billion at March 31, 2012, from $1.8 billion at December 31, 2011. In the first quarter of 2012, average MBS investments were $24.8 billion compared to $24.6 billion in the first quarter of 2011. Average mortgage loans were $1.8 billion in the first quarter of 2012, a decrease of $0.5 billion from $2.3 billion in the first quarter of 2011.

Adjusted net interest income for this segment was $127 million in the first quarter of 2012, a decrease of $6 million, or 5%, from $133 million in the first quarter of 2011. This decrease was primarily due to lower average unpaid principal balances of MBS and mortgage loans.

Adjusted net interest income for this segment represented 63% and 59% of total adjusted net interest income for the first quarter of 2012 and 2011, respectively.

MPF Program – Under the MPF Program, the Bank purchased conventional conforming fixed rate residential mortgage loans directly from eligible members. Participating members originated or purchased the mortgage loans, credit-enhanced them and sold them to the Bank, and generally retained the servicing of the loans. The Bank manages the interest rate risk, prepayment risk, and liquidity risk of each loan in its portfolio. The Bank and the member that sold the loan share in the credit risk of the loan. The Bank has not purchased any new loans since October 2006. For more information regarding credit risk, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – MPF Program” in the Bank's 2011 Form 10-K.

At March 31, 2012, and December 31, 2011, the Bank held conventional conforming fixed rate mortgage loans purchased under one of two MPF products, MPF Plus or Original MPF, which are described in greater detail in “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – MPF Program” in the Bank's 2011 Form 10-K. Mortgage loan balances at March 31, 2012, and December 31, 2011, were as follows:


77


Mortgage Loan Balances by MPF Product Type
 
 
 
 
(In millions)
March 31, 2012

 
December 31, 2011

MPF Plus
$
1,559

 
$
1,692

Original MPF
140

 
149

Subtotal
1,699

 
1,841

Unamortized premiums
15

 
15

Unamortized discounts
(22
)
 
(21
)
Mortgage loans held for portfolio
1,692

 
1,835

Less: Allowance for credit losses
(6
)
 
(6
)
Mortgage loans held for portfolio, net
$
1,686

 
$
1,829


The Bank performs periodic reviews of its mortgage loan portfolio to identify probable credit losses in the portfolio and to determine the likelihood of collection of the loans in the portfolio. For more information on how the Bank determines its estimated allowance for credit losses on mortgage loans, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – MPF Program” and “Item 1. Financial Statements – Note 9 – Allowance for Credit Losses.”

MBS Investments – The Bank's MBS portfolio was $23.7 billion at March 31, 2012, compared to $23.3 billion, at December 31, 2011. During the first three months of 2012, the Bank's MBS portfolio increased because of purchases of agency residential MBS. For a discussion of the composition of the Bank's MBS portfolio and the Bank's OTTI analysis of that portfolio, see “Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Investments” and “Item 1. Financial Statements – Note 6 – Other-Than-Temporary Impairment Analysis.”

Intermediate-term and long-term fixed rate MBS investments are subject to prepayment risk, and intermediate-term and long-term adjustable rate MBS investments are subject to interest rate cap risk. The Bank has managed these risks primarily by purchasing intermediate-term fixed rate MBS (rather than long-term fixed rate MBS), funding the fixed rate MBS with a mix of non-callable and callable debt, and using interest rate exchange agreements with interest rate risk characteristics similar to callable debt.

Borrowings – Total consolidated obligations funding the mortgage-related business increased $0.1 billion to $25.4 billion at March 31, 2012, from $25.3 billion at December 31, 2011, paralleling the increase in mortgage portfolio assets. For further information and discussion of the Bank's joint and several liability for FHLBank consolidated obligations, see “Management's Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition” and “Item 1. Financial Statements and Supplementary Data – Note 16 – Commitments and Contingencies.”

The notional amount of interest rate exchange agreements associated with the mortgage-related business, almost all of which hedged or was associated with consolidated obligations funding the mortgage portfolio, totaled $12.6 billion and $14.8 billion at March 31, 2012, and December 31, 2011, respectively.

Interest Rate Exchange Agreements

A derivatives transaction or interest rate exchange agreement is a financial contract whose fair value is generally derived from changes in the value of an underlying asset or liability. The Bank uses interest rate swaps; options to enter into interest rate swaps (swaptions); interest rate cap, floor, corridor, and collar agreements; and callable and putable interest rate swaps (collectively, interest rate exchange agreements) to manage its exposure to interest rate risks inherent in its normal course of business—lending, investment, and funding activities. For more information on the primary strategies that the Bank employs for using interest rate exchange agreements and the associated market risks, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Market Risk – Interest Rate Exchange Agreements” in the Bank's 2011 Form 10-K. The

78


following table summarizes the Bank's interest rate exchange agreements by type of hedged item, hedging instrument, associated hedging strategy, accounting designation as specified under the accounting for derivative instruments and hedging activities, and notional amount as of March 31, 2012, and December 31, 2011.

Interest Rate Exchange Agreements
 
 
 
 
 
 
 
 
 
(In millions)
  
 
  
 
 
Notional Amount
Hedging Instrument
  
Hedging Strategy
  
Accounting Designation
 
March 31,
2012

  
December 31,
2011

Hedged Item: Advances
  
 
  
 
 
 
  
 
Pay fixed, receive adjustable interest rate swap
  
Fixed rate advance converted to a LIBOR adjustable rate
  
Fair Value Hedge
 
$
10,562

 
$
15,014

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

 
1

Pay fixed, receive adjustable interest rate swap
  
Fixed rate advance converted to a LIBOR adjustable rate
  
Economic Hedge(1)
 
2,291

 
1,091

Pay fixed, receive adjustable interest rate swap; swap may be callable at the Bank's option or putable at the counterparty's option
  
Fixed rate advance (with or without an embedded cap) converted to a LIBOR adjustable rate; advance and swap may be callable or putable; matched to advance accounted for under the fair value option
  
Economic Hedge(1)
 
7,412

 
8,092

Interest rate cap, floor, corridor, and/or collar
  
Interest rate cap, floor, corridor, and/or collar embedded in an adjustable rate advance; matched to advance accounted for under the fair value option
  
Economic Hedge(1)
 
166

 
166

Subtotal Economic Hedges(1)
 
 
  
 
 
9,870

  
9,350

Total
  
 
  
 
 
20,432

  
24,364

Hedged Item: Non-Callable Bonds
 
 
  
 
 
 
  
 
Receive fixed or structured, pay adjustable interest rate swap
  
Fixed rate or structured rate non-callable bond converted to a LIBOR adjustable rate
  
Fair Value Hedge
 
34,601

 
33,996

Receive fixed or structured, pay adjustable interest rate swap
  
Fixed rate or structured rate non-callable bond converted to a LIBOR adjustable rate
  
Economic Hedge(1)
 
4,208

 
4,608

Receive fixed or structured, pay adjustable interest rate swap
  
Fixed rate or structured rate non-callable bond converted to a LIBOR adjustable rate; matched to non-callable bond accounted for under the fair value option
  
Economic Hedge(1)
  
1,385

 
1,385

Basis swap
  
Non-LIBOR adjustable rate non-callable bond converted to a LIBOR adjustable rate; matched to non-callable bond accounted for under the fair value option
  
Economic Hedge(1)
  
7,993

 
11,478

Basis swap
  
Adjustable rate non-callable bond converted to another adjustable rate index to reduce interest rate sensitivity and repricing gaps
  
Economic Hedge(1)
  

 
6,000

Basis swap
 
Fixed rate or adjustable rate non-callable bond previously converted to an adjustable rate index, converted to another adjustable rate to reduce interest rate sensitivity and repricing gaps
 
Economic Hedge(1)
 
8,240

 
14,300

Pay fixed, receive adjustable interest rate swap
  
Fixed rate or adjustable rate non-callable bond, which may have been previously converted to LIBOR, converted to fixed rate debt that offsets the interest rate risk of mortgage assets
  
Economic Hedge(1)
  
365

 
470

Subtotal Economic Hedges(1)
 
 
  
 
  
22,191

  
38,241

Total
  
 
  
 
  
56,792

  
72,237



79


Interest Rate Exchange Agreements (continued)
 
 
 
 
 
 
 
 
 
(In millions)
  
 
  
 
  
Notional Amount
Hedging Instrument
  
Hedging Strategy
  
Accounting Designation
  
March 31,
2012

  
December 31,
2011

Hedged Item: Callable Bonds
 
 
  
 
  
 
  
 
Receive fixed or structured, pay adjustable interest rate swap with an option to call at the counterparty's option
  
Fixed or structured rate callable bond converted to a LIBOR adjustable rate; swap is callable
  
Fair Value Hedge
  
9,897

 
7,345

Receive fixed or structured, pay adjustable interest rate swap with an option to call at the counterparty's option
  
Fixed or structured rate callable bond converted to a LIBOR adjustable rate; swap is callable
  
Economic Hedge(1)
  
1,505

 
1,390

Receive fixed or structured, pay adjustable interest rate swap with an option to call at the counterparty's option
  
Fixed or structured rate callable bond converted to a LIBOR adjustable rate; swap is callable; matched to callable bond accounted for under the fair value option
  
Economic Hedge(1)
  
3,106

 
2,806

Subtotal Economic Hedges(1)
 
 
  
 
  
4,611

  
4,196

Total
  
 
  
 
  
14,508

  
11,541

Hedged Item: Discount Notes
 
 
  
 
  
 
  
 
Pay fixed, receive adjustable callable interest rate swap
  
Discount note, which may have been previously converted to LIBOR, converted to fixed rate callable debt that offsets the prepayment risk of mortgage assets
  
Economic Hedge(1)
  
1,875

 
1,865

Basis swap or receive fixed, pay adjustable interest rate swap
  
Discount note converted to one-month LIBOR or other short-term adjustable rate to hedge repricing gaps
  
Economic Hedge(1)
  
20,700

 
14,760

Pay fixed, receive adjustable non-callable interest rate swap
  
Discount note, which may have been previously converted to LIBOR, converted to fixed rate non-callable debt that offsets the interest rate risk of mortgage assets
  
Economic Hedge(1)
  
595

 
1,580

Total
  
 
  
 
  
23,170

  
18,205

Hedged Item: Trading Securities
 
 
  
 
  
 
  
 
Pay MBS rate, receive adjustable interest rate swap
  
MBS rate converted to a LIBOR adjustable rate
  
Economic Hedge(1)
  

 
1

Basis swap
 
Basis swap hedging adjustable rate Federal Farm Credit Bank (FFCB) bonds
 
Economic Hedge(1)
 
2,150

 
1,633

Pay fixed, receive adjustable interest rate swap
 
Fixed rate Temporary Liquidity Guarantee Program (TLGP) securities converted to a LIBOR adjustable rate
 
Economic Hedge(1)
 
785

 
785

Total
 
 
 
 
 
2,935

 
2,419

Hedged Item: Intermediary Positions
  
 
  
 
  
 
Interest rate cap/floor
  
Stand-alone interest rate cap and/or floor executed with a member offset by executing an interest rate cap and/or floor with derivatives dealer counterparties
  
Economic Hedge(1)
  
810

 
810

Total
  
 
  
 
  
810

  
810

Total Notional Amount
 
 
  
 
  
$
118,647

 
$
129,576


(1)
Economic hedges are derivatives that are matched to balance sheet instruments or other derivatives that do not meet the requirements for hedge accounting under the accounting for derivative instruments and hedging activities.

At March 31, 2012, the total notional amount of interest rate exchange agreements outstanding was $118.6 billion, compared with $129.6 billion at December 31, 2011. The $11.0 billion decrease in the notional amount of derivatives during the first three months of 2012 was due to a net $12.5 billion decrease in interest rate exchange agreements hedging consolidated obligation bonds and a net $3.9 billion decrease in interest rate exchange agreements hedging advances, partially offset by a net $5.0 billion increase in interest rate exchange agreements hedging discount notes and a net $0.5 billion increase in interest rate exchange agreements hedging trading securities. The notional amount serves as a basis for calculating periodic interest payments or cash flows received

80


and paid and is not a measure of the amount of credit risk in that transaction.

The following tables categorize the notional amounts and estimated fair values of the Bank’s interest rate exchange agreements, unrealized gains and losses from the related hedged items, and estimated fair value gains and losses from financial instruments carried at fair value by type of accounting treatment and product as of March 31, 2012, and December 31, 2011.

Interest Rate Exchange Agreements
Notional Amounts and Estimated Fair Values
 
 
 
 
 
 
 
 
 
 
March 31, 2012
 
  
 
 
 
 
 
  
 
(In millions)
Notional
Amount

  
Fair Value of
Derivatives

 
Unrealized
Gain/(Loss)
on Hedged
Items

 
Financial
Instruments
Carried at
Fair Value

  
Difference

Fair value hedges:
 
  
 
 
 
 
 
  
 
Advances
$
10,562

  
$
(243
)
 
$
244

 
$

  
$
1

Non-callable bonds
34,601

  
1,026

 
(1,030
)
 

  
(4
)
Callable bonds
9,897

  
26

 
(2
)
 

  
24

Subtotal
55,060

  
809

 
(788
)
 

  
21

Not qualifying for hedge accounting (economic hedges):
  
 
 
 
 
 
  
 
Advances
9,870

  
(314
)
 

 
306

  
(8
)
Non-callable bonds
22,191

  
279

 

 
(30
)
  
249

Callable bonds
4,611

  

 

 
15

  
15

Discount notes
23,170

  
(13
)
 

 

  
(13
)
MBS – trading

  

 

 

  

FFCB bonds and TLGP securities
2,935

 
(7
)
 

 

 
(7
)
Intermediated
810

  

 

 

  

Subtotal
63,587

  
(55
)
 

 
291

  
236

Total excluding accrued interest
118,647

  
754

 
(788
)
 
291

  
257

Accrued interest

  
170

 
(182
)
 
12

  

Total
$
118,647

  
$
924

 
$
(970
)
 
$
303

  
$
257



81


December 31, 2011
 
  
 
 
 
 
 
 
 
(In millions)
Notional
Amount

  
Fair Value of
Derivatives

 
Unrealized
Gain/(Loss)
on Hedged
Items

 
Financial
Instruments
Carried at
Fair Value

 
Difference

Fair value hedges:
 
  
 
 
 
 
 
 
 
Advances
$
15,014

 
$
(271
)
 
$
270

 
$

 
$
(1
)
Non-callable bonds
33,996

 
1,076

 
(1,083
)
 

 
(7
)
Callable bonds
7,345

 
32

 
(9
)
 

 
23

Subtotal
56,355

  
837

 
(822
)
 

 
15

Not qualifying for hedge accounting (economic hedges):
  
 
 
 
 
 
 
 
Advances
9,350

 
(396
)
 

 
401

 
5

Non-callable bonds
38,241

 
289

 

 
(31
)
 
258

Non-callable bonds with embedded derivatives

 

 

 

 

Callable bonds
4,196

 
4

 

 
3

 
7

Discount notes
18,205

 
(26
)
 

 

 
(26
)
FFCB bonds and TLGP securities
2,418

 
(8
)
 

 

 
(8
)
MBS – trading
1

 

 

 

 

Intermediated
810

 

 

 

 

Subtotal
73,221

  
(137
)
 

 
373

 
236

Total excluding accrued interest
129,576

  
700

 
(822
)
 
373

 
251

Accrued interest

  
99

 
(105
)
 
9

 
3

Total
$
129,576

  
$
799

 
$
(927
)
 
$
382

 
$
254


Because the periodic and cumulative net valuation gains or losses on the Bank’s derivatives, hedged instruments, and certain assets and liabilities that are carried at fair value are primarily a matter of timing, the net gains or losses will generally reverse through changes in future valuations and settlements of contractual interest cash flows over the remaining contractual term to maturity, call date, or put date of the hedged financial instruments, associated interest rate exchange agreements, and financial instruments carried at fair value. However, the Bank may have instances in which the financial instruments or hedging relationships are terminated prior to maturity or prior to the call or put date. Terminating the financial instruments or hedging relationships may result in a realized gain or loss. In addition, the Bank may have instances in which it may sell trading securities prior to maturity, which may also result in a realized gain or loss.

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

Concentration Risk. The following table presents the concentration in derivatives with derivatives counterparties whose outstanding notional balances represented 10% or more of the Bank's total notional amount of derivatives outstanding as of March 31, 2012, and December 31, 2011.
 

82


Concentration of Derivatives Counterparties
 
 
 
 
 
 
 
 
 
 
(Dollars in millions)
 
  
March 31, 2012
 
December 31, 2011
Derivatives Counterparty
Credit  
Rating(1)  
  
Notional
Amount

  
Percentage of
Total
Notional Amount

 
Notional
Amount

  
Percentage of
Total
Notional Amount

BNP Paribas
A
  
$
26,345

  
22
%
 
$
25,836

  
20
%
Deutsche Bank AG
A
  
22,190

  
19

 
24,055

  
19

JPMorgan Chase Bank, National Association
A
  
11,542

  
10

 
15,961

  
12

UBS AG
A
 
11,356

 
9

 
15,398

 
12

Citigroup Inc.:
 
 
 
 
 
 
 
 
 
Citibank, N.A.
A
 
12,523

 
11

 
11,779

 
9

Citigroup Financial Products
A
 
26

 

 
27

 

Subtotal Citigroup Inc.
 
 
12,549

 
11

 
11,806

 
9

Subtotal
 
  
83,982

 
71

 
93,056

  
72

Others
At least A
  
34,665

  
29

 
36,520

  
28

Total
 
  
$
118,647

  
100
%
 
$
129,576

  
100
%

(1)
The credit ratings used by the Bank are based on the lowest of Moody's and Standard & Poor's ratings at March 31, 2012 . 
    
Liquidity and Capital Resources

The Bank's financial strategies are designed to enable the Bank to expand and contract its assets, liabilities, and capital in response to changes in membership composition and member credit needs. The Bank's liquidity and capital resources are designed to support its financial strategies. The Bank's primary source of liquidity is its access to the capital markets through consolidated obligation issuance. The Bank's equity capital resources are governed by its capital plan.

Since the beginning of 2010, the combination of declining FHLBank funding needs and continued investor demand for FHLBank debt has enabled the FHLBanks to issue debt at reasonable costs. During the first three months of 2012, the FHLBanks issued $17 billion in global bonds, $49 billion in callable bonds, and $200 billion in auctioned discount notes.

Liquidity

The Bank strives to maintain the liquidity necessary to meet member credit demands, repay maturing consolidated obligations for which it is the primary obligor, meet other obligations and commitments, and respond to significant changes in membership composition. The Bank monitors its financial position in an effort to ensure that it has ready access to sufficient liquid funds to meet normal transaction requirements, take advantage of appropriate investment opportunities, and cover unforeseen liquidity demands.

The Bank generally manages operational, contingent, and structural liquidity risks using a portfolio of cash and short-term investments—which include commercial paper, interest-bearing deposits, and Federal funds sold to highly rated counterparties—and access to the debt capital markets. In addition, the Bank maintains alternate sources of funds, detailed in its contingent liquidity plan, which also includes an explanation of how sources of funds may be allocated under stressed market conditions. The Bank maintains short-term, high-quality money market investments and government and agency securities in amounts that may average up to three times the Bank's capital as a primary source of funds to satisfy these requirements and objectives.

The Bank maintains a contingent liquidity plan to meet its obligations and the liquidity needs of members in the event of short-term operational disruptions at the Bank or the Office of Finance or short-term disruptions in the debt capital markets. In 2009, the Finance Agency established liquidity guidelines that require each FHLBank to maintain sufficient on-balance sheet liquidity in an amount at least equal to its anticipated cash outflows for two different scenarios, both of which assume no capital markets access and no reliance on repurchase agreements or

83


the sale of existing held-to-maturity and available-for-sale investments. The two scenarios differ only in the treatment of maturing advances. One scenario assumes that the Bank does not renew any maturing advances; for this scenario, the Bank must have sufficient liquidity to meet its obligations for 15 calendar days. The second scenario requires the Bank to renew maturing advances for certain members based on specific criteria established by the Finance Agency. For this scenario, the Bank must have sufficient liquidity to meet its obligations for 5 calendar days.

The Bank has a regulatory contingency liquidity requirement to maintain at least five business days of liquidity to enable it to meet its obligations without issuance of new consolidated obligations. In addition to the regulatory requirement and the Finance Agency's guidelines on contingent liquidity, the Bank's asset-liability management committee has established an operational guideline for the Bank to maintain at least 90 days of liquidity to enable the Bank to meet its obligations in the event of a longer-term consolidated obligations market disruption. This operational guideline assumes that the Bank can obtain funds by using MBS as collateral in the repurchase agreement markets. Under this guideline, the Bank maintained at least 90 days of liquidity at all times during the first three months of 2012. On a daily basis, the Bank models its cash commitments and expected cash flows for the next 90 days to determine its projected liquidity position. If a market or operational disruption occurred that prevented the issuance of new consolidated obligation bonds or discount notes through the capital markets, the Bank could meet its obligations by: (i) allowing short-term liquid investments to mature, (ii) using eligible securities as collateral for repurchase agreement borrowings, and (iii) if necessary, allowing advances to mature without renewal. In addition, the Bank may be able to borrow on a short-term unsecured basis from financial institutions (Federal funds purchased) or other FHLBanks (inter-FHLBank borrowings).

The Bank actively monitors and manages structural liquidity risks, which the Bank defines as maturity mismatches greater than 90 days for all sources and uses of funds. Structural liquidity maturity mismatches are identified using maturity gap analysis and valuation sensitivity metrics that quantify the risk associated with the Bank's structural liquidity position.

The following table shows the Bank's principal financial obligations due, estimated sources of funds available to meet those obligations, and the net difference between funds available and funds needed for the 5-business-day and 90-day periods following March 31, 2012, and December 31, 2011. Also shown are additional contingent sources of funds from on-balance sheet collateral available for repurchase agreement borrowings.


84


Principal Financial Obligations Due and Funds Available for Selected Periods
 
 
 
 
 
 
 
 
 
As of March 31, 2012
  
As of December 31, 2011
(In millions)
5 Business
Days

  
90 Days

  
5 Business
Days

  
90 Days

Obligations due:
 
  
 
  
 
  
 
Commitments for new advances
$

  
$

  
$
100

  
$
100

Commitments to purchase investments
500

 
1,066

 

 
54

Demand deposits
727

  
727

  
628

  
628

Maturing member term deposits
1

  
1

  
1

  
1

Discount note and bond maturities and expected exercises of bond call options
705

  
18,863

  
820

  
24,691

Subtotal obligations
1,933

  
20,657

  
1,549

  
25,474

Sources of available funds:
 
  
 
  
 
  
 
Maturing investments
3,871

  
14,392

  
1,250

  
11,879

Cash at Federal Reserve Bank of San Francisco
3,484

  
3,484

  
3,493

  
3,493

Proceeds from scheduled settlements of discount notes and bonds
580

  
1,620

  
200

  
200

Maturing MBS

 

 

 
1

Maturing advances and scheduled prepayments
2,541

  
12,575

  
1,463

  
13,126

Subtotal sources
10,476

  
32,071

  
6,406

  
28,699

Net funds available
8,543

  
11,414

  
4,857

  
3,225

Additional contingent sources of funds:(1)
 
  
 
  
 
  
 
Estimated borrowing capacity of securities available for repurchase agreement borrowings:
 
  
 
  
 
  
 
MBS

  
20,004

  

  
20,278

Marketable money market investments

  

  

  

TLGP securities
2,185

  
1,189

  
2,763

  
2,189

FFCB bonds
2,313

 
2,264

 
1,811

 
1,245

Subtotal contingent sources
4,498

  
23,457

  
4,574

  
23,712

Total contingent funds available
$
13,041

  
$
34,871

  
$
9,431

  
$
26,937

 

(1)
The estimated amount of repurchase agreement borrowings obtainable from authorized securities dealers is subject to market conditions and the ability of securities dealers to obtain financing for the securities and transactions entered into with the Bank. The estimated maximum amount of repurchase agreement borrowings obtainable is based on the current par amount and estimated market value of MBS and other investments (not included in above figures) that are not pledged at the beginning of the period and is subject to estimated collateral discounts taken by securities dealers.

For more information, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources – Liquidity” and “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Liquidity Risk” in the Bank's 2011 Form
10-K.

Regulatory Capital

The FHLBank Act and Finance Agency regulations specify that each FHLBank must meet certain minimum regulatory capital standards. The Bank must maintain: (i) total regulatory capital in an amount equal to at least 4% of its total assets, (ii) leverage capital in an amount equal to at least 5% of its total assets, and (iii) permanent capital in an amount at least equal to its regulatory risk-based capital requirement. Regulatory capital and permanent capital are both defined as total capital stock outstanding, including mandatorily redeemable capital stock, and retained earnings. Regulatory capital and permanent capital do not include accumulated other comprehensive income/(loss). Leverage capital is defined as the sum of permanent capital weighted by a 1.5 multiplier plus non-permanent capital. (Non-permanent capital consists of Class A capital stock, which is redeemable upon six months' notice. The Bank's capital plan does not provide for the issuance of Class A capital stock.) The risk-based capital requirements must be met with permanent capital, which must be at least equal to the sum of the Bank's credit risk, market risk, and operations risk capital requirements, all of which are calculated in accordance with the rules of the

85


Finance Agency.

The following table shows the Bank's compliance with the Finance Agency's capital requirements at March 31, 2012, and December 31, 2011. During the first three months of 2012, the Bank's risk-based capital requirement decreased from $4.9 billion at December 31, 2011, to $4.4 billion at March 31, 2012. The decrease was primarily due to a lower market risk requirement as a result of the improvement in the Bank's market value of capital.
 
Regulatory Capital Requirements
 
 
 
 
 
 
 
 
 
March 31, 2012
 
December 31, 2011
(Dollars in millions)
Required

 
Actual

 
Required

 
Actual

Risk-based capital
$
4,390

 
$
11,990

 
$
4,915

 
$
12,176

Total regulatory capital
$
4,403

 
$
11,990

 
$
4,542

 
$
12,176

Total regulatory capital ratio
4.00
%
 
10.89
%
 
4.00
%
 
10.72
%
Leverage capital
$
5,504

 
$
17,985

 
$
5,678

 
$
18,264

Leverage ratio
5.00
%
 
16.34
%
 
5.00
%
 
16.08
%

In light of the Bank's strong regulatory capital position, the Bank plans to repurchase up to $500 million in excess capital stock on May 15, 2012. This repurchase, combined with the scheduled redemption of $2 million in mandatorily redeemable capital stock during the second quarter of 2012, will reduce the Bank's excess capital stock by up to $502 million. The amount of excess capital stock to be repurchased from any shareholder will be based on the shareholder's pro rata ownership share of total capital stock outstanding as of the repurchase date, up to the amount of the shareholder's excess capital stock.

The Bank's capital requirements are more fully discussed in “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital” in the Bank's 2011 Form 10-K.

Risk Management

The Bank has an integrated corporate governance and internal control framework designed to support effective management of the Bank's business activities and the risks inherent in these activities. As part of this framework, the Bank's Board of Directors has adopted a Risk Management Policy and a Member Products Policy, which are reviewed regularly and reapproved at least annually. The Risk Management Policy establishes risk guidelines, limits (if applicable), and standards for credit risk, market risk, liquidity risk, operations risk, concentration risk, and business risk in accordance with Finance Agency regulations, the risk profile established by the Board of Directors, and other applicable guidelines in connection with the Bank's capital plan and overall risk management. For more detailed information, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management” in the Bank's 2011 Form 10‑K.

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

The Bank determines the maximum amount and maximum term of the advances it will make to a member based on the member's creditworthiness and eligible collateral pledged in accordance with the Bank's credit and collateral policies and regulatory requirements. The Bank may review and change the maximum amount and maximum term at any time. The maximum amount a member may borrow is also limited by the amount and type of collateral

86


pledged because all advances must be fully collateralized.

To identify the credit strength of each borrower, other than community development financial institutions (CDFIs), the Bank assigns each member and nonmember borrower an internal credit quality rating from one to ten, with one as the highest credit quality rating. These ratings are based on results from the Bank's credit model, which considers financial, regulatory, and other qualitative information, including regulatory examination reports. The internal ratings are reviewed on an ongoing basis using current available information, and are revised, if necessary, to reflect the borrower's current financial position. Credit and collateral terms may be adjusted based on the results of this credit analysis.

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

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

When a nonmember financial institution acquires some or all of the assets and liabilities of a member, including outstanding advances and Bank capital stock, the Bank may allow the advances to remain outstanding, at its discretion. The nonmember borrower is required to meet all the Bank's credit, collateral, and capital stock requirements, including requirements regarding creditworthiness and collateral borrowing capacity.

The following tables present a summary of the status of the credit outstanding and overall collateral borrowing capacity of the Bank's member and nonmember borrowers as of March 31, 2012, and December 31, 2011.


87


Member and Nonmember Credit Outstanding and Collateral Borrowing Capacity
by Credit Quality Rating
 
 
 
 
 
 
 
 
 
 
(Dollars in millions)
 
 
 
 
 
 
 
 
 
March 31, 2012
 
 
 
 
 
 
 
 
 
  
All Members and
Nonmembers
  
Members and Nonmembers with Credit Outstanding
 
 
  
 
  
 
  
Collateral Borrowing Capacity(2)
Member or Nonmember
Credit Quality Rating
Number

  
Number

  
Credit
Outstanding(1)

  
Total

  
Used

1-3
139

  
82

  
$
38,488

  
$
120,930

  
32
%
4-6
196

  
106

  
25,646

  
48,537

  
53

7-10
50

  
25

  
967

  
2,413

  
40

Subtotal
385

  
213

  
65,101

  
171,880

  
38

CDFIs
2

 
2

 
21

 
29

 
72

Total
387

 
215

 
$
65,122

 
$
171,909

 
38
%
 
 
 
 
 
 
 
 
 
 
December 31, 2011
 
 
 
 
 
 
 
 
 
 
All Members and
Nonmembers
  
Members and Nonmembers with Credit Outstanding
 
 
  
 
  
 
  
Collateral Borrowing Capacity(2)
Member or Nonmember
Credit Quality Rating
Number

  
Number

  
Credit
Outstanding(1)

  
Total

  
Used

1-3
120

  
78

  
$
41,276

  
$
117,959

  
35
%
4-6
204

  
112

  
30,302

  
53,120

  
57

7-10
60

  
31

  
1,158

  
3,147

  
37

Total
384

  
221

  
$
72,736

  
$
174,226

  
42

CDFIs
2

 
2

 
21

 
28

 
75

Total
386

 
223

 
$
72,757

 
$
174,254

 
42
%
 
(1)
Includes advances, letters of credit, the market value of swaps, estimated prepayment fees for certain borrowers, and the credit enhancement obligation on MPF loans.
(2)
Collateral borrowing capacity does not represent any commitment to lend on the part of the Bank.

Member and Nonmember Credit Outstanding and Collateral Borrowing Capacity
by Unused Borrowing Capacity
 
 
 
 
 
 
(Dollars in millions)
 
 
 
 
 
March 31, 2012
 
 
 
 
 
Unused Borrowing Capacity
Number of Members and Nonmembers with
Credit Outstanding

  
Credit
Outstanding(1)

  
Collateral
Borrowing
Capacity(2)

0% – 10%
7

  
$
138

  
$
151

11% – 25%
10

  
19,411

  
23,074

26% – 50%
31

  
2,392

  
3,934

More than 50%
167

  
43,181

  
144,750

Total
215

  
$
65,122

  
$
171,909

 
 
 
 
 
 
December 31, 2011
 
 
 
 
 
Unused Borrowing Capacity
Number of Members and Nonmembers with
Credit Outstanding(3)

  
Credit
Outstanding(1)(3)

  
Collateral
Borrowing
Capacity(2)

0% – 10%
9

  
$
238

  
$
247

11% – 25%
10

  
19,404

  
22,512

26% – 50%
32

  
19,791

  
32,519

More than 50%
172

  
33,324

  
118,976

Total
223

  
$
72,757

  
$
174,254

 

(1)
Includes advances, letters of credit, the market value of swaps, estimated prepayment fees for certain borrowers, and the credit enhancement obligation on

88


MPF loans.
(2)
Collateral borrowing capacity does not represent any commitment to lend on the part of the Bank.

Securities pledged as collateral are assigned borrowing capacities that reflect the securities' pricing volatility and market liquidity risks. Securities are delivered to the Bank's custodian when they are pledged. The Bank prices securities collateral on a daily basis or twice a month, depending on the availability and reliability of external pricing sources. Securities that are normally priced twice a month may be priced more frequently in volatile market conditions. The Bank benchmarks the borrowing capacities for securities collateral to the market on a periodic basis and may review and change the borrowing capacity for any security type at any time. As of March 31, 2012, the borrowing capacities assigned to U.S. Treasury securities and most agency securities ranged from 90% to 99% of their market value. The borrowing capacities assigned to private-label MBS, which must be rated AAA or AA when initially pledged, generally ranged from 50% to 75% of their market value, depending on the underlying collateral (residential mortgage loans, home equity loans, or commercial real estate loans), the rating, and the subordination structure of the respective securities.

The following table presents the securities collateral pledged by all members and by nonmembers with credit outstanding at March 31, 2012, and December 31, 2011.

 
Composition of Securities Collateral Pledged
by Members and by Nonmembers with Credit Outstanding
 
 
 
 
 
 
 
 
(In millions)
March 31, 2012
  
December 31, 2011
Securities Type with Current Credit Ratings
Current Par

  
Borrowing
Capacity

  
Current Par

  
Borrowing
Capacity

U.S. Treasury (bills, notes, bonds)
$
190

  
$
188

  
$
251

  
$
248

Agency (notes, subordinate debt, structured notes, indexed amortization notes, and Small Business Administration pools)
6,606

  
6,548

  
5,132

  
5,047

Agency pools and collateralized mortgage obligations
13,613

  
13,419

  
12,697

  
12,469

PLRMBS – publicly registered AAA-rated senior tranches
8

  
6

  
49

  
33

PLRMBS – publicly registered AA-rated senior tranches
3

  
2

  
10

  
6

PLRMBS – publicly registered A-rated senior tranches
2

  

  
9

  
2

PLRMBS – publicly registered BBB-rated senior tranches
2

  

  
54

  
12

Private-label commercial MBS – publicly registered AAA-rated subordinate tranches
7

  
6

  
8

  
6

Term deposits with the Bank
2

  
2

  
1

  
1

Total
$
20,433

  
$
20,171

  
$
18,211

  
$
17,824


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

The Bank may require certain borrowers to deliver pledged loan collateral to the Bank for one or more reasons, including the following: the borrower is a de novo institution (chartered within the last three years), the Bank is concerned about the borrower's creditworthiness, or the Bank is concerned about the maintenance of its collateral or the priority of its security interest. Borrowers required to deliver loan collateral must pledge those loans under the blanket lien method with detailed reporting. The Bank's largest borrowers are required to report detailed data on a monthly basis and may pledge loan collateral using either the specific identification method or the blanket lien method with detailed reporting.


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As of March 31, 2012, 57% of the loan collateral pledged to the Bank was pledged by 35 institutions under specific identification, 34% was pledged by 185 institutions under blanket lien with detailed reporting, and 10% was pledged by 100 institutions under blanket lien with summary reporting.

As of March 31, 2012, the Bank's maximum borrowing capacities as a percentage of the assigned market value of mortgage loan collateral pledged under blanket lien with detailed reporting were as follows: 90% for first lien residential mortgage loans, 88% for multifamily mortgage loans, 84% for commercial mortgage loans, and 81% for second lien residential mortgage loans. The maximum borrowing capacity of small business, small agribusiness, and small farm loans was 50% of the unpaid principal balance. The highest borrowing capacities are available to borrowers that pledge under blanket lien with detailed reporting because the detailed loan information allows the Bank to assess the value of the collateral more precisely and because additional collateral is pledged under the blanket lien that may not receive borrowing capacity but may be liquidated to repay advances in the event of default. The Bank may review and change the maximum borrowing capacity for any type of loan collateral at any time.

The table below presents the mortgage loan collateral pledged by all members and by nonmembers with credit outstanding at March 31, 2012, and December 31, 2011.
 
Composition of Loan Collateral Pledged
by Members and by Nonmembers with Credit Outstanding
 
 
 
 
 
 
 
 
(In millions)
March 31, 2012
  
December 31, 2011
Loan Type
Unpaid Principal
Balance

  
Borrowing
Capacity

  
Unpaid Principal
Balance

  
Borrowing
Capacity

First lien residential mortgage loans
$
112,527

  
$
77,217

  
$
119,089

  
$
78,938

Second lien residential mortgage loans and home equity lines of credit
39,261

  
9,506

  
40,154

  
9,668

Multifamily mortgage loans
36,684

  
29,304

  
36,865

  
28,953

Commercial mortgage loans
44,019

  
27,053

  
47,582

  
29,417

Loan participations(1)
12,160

  
7,892

  
13,138

  
8,637

Small business, small farm, and small agribusiness loans
2,894

  
666

  
3,046

  
710

Other
701

  
100

  
764

  
107

Total
$
248,246

  
$
151,738

  
$
260,638

  
$
156,430


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

The Bank holds a security interest in subprime residential mortgage loans pledged as collateral. Subprime loans are defined as loans with a borrower FICO score of 660 or less at origination, or if the original FICO score is not available, as loans with a current borrower FICO score of 660 or less. At March 31, 2012, and December 31, 2011, the amount of these loans totaled $18 billion and $19 billion, respectively. The Bank reviews and assigns borrowing capacities to subprime mortgage loans as it does for all other types of loan collateral, taking into account the known credit attributes in the pricing of the loans. In addition, borrowers with concentrations in nontraditional and subprime mortgage loans are subject to more frequent analysis to assess the credit quality and value of the loans. All advances, including those made to borrowers pledging subprime mortgage loans, are required to be fully collateralized. The Bank limits the amount of borrowing capacity that may be supported by subprime collateral.

Investments. The Bank has adopted credit policies and exposure limits for investments that promote risk diversification and liquidity. These policies restrict the amounts and terms of the Bank's investments with any given counterparty according to the Bank's own capital position as well as the capital and creditworthiness of the counterparty.

The Bank monitors its investments for substantive changes in relevant market conditions and any declines in fair value. For securities in an unrealized loss position because of factors other than movements in interest rates, such as

90


widening of mortgage asset spreads, the Bank considers whether it expects to recover the entire amortized cost basis of the security by comparing the best estimate of the present value of the cash flows expected to be collected from the security with the amortized cost basis of the security. If the Bank's best estimate of the present value of the cash flows expected to be collected is less than the amortized cost basis, the difference is considered the credit loss.

When the fair value of an individual investment security falls below its amortized cost, the Bank evaluates whether the decline is other than temporary. The Bank recognizes an other-than-temporary impairment when it determines that it will be unable to recover the entire amortized cost basis of the security and the fair value of the investment security is less than its amortized cost. The Bank considers its intent to hold the security and whether it is more likely than not that the Bank will be required to sell the security before its anticipated recovery of the remaining cost basis, and other factors. The Bank generally views changes in the fair value of the securities caused by movements in interest rates to be temporary.

The following tables present the Bank's investment credit exposure at the dates indicated, based on the lowest of the long-term credit ratings provided by Moody's, Standard & Poor's, or comparable Fitch ratings.

Investment Credit Exposure
(In millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
Carrying Value
 
Credit Rating(1)
 
 
Investment Type
AAA

 
AA

 
A

 
BBB

 
BB

 
B

 
CCC

 
CC

 
C

 
D

 
Total

Non-MBS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$

 
$

 
$
2,555

 
$

 
$

 
$

 
$

 
$

 
$

 
$

 
$
2,555

Commercial paper(2)

 
584

 
425

 

 

 

 

 

 

 

 
1,009

Housing finance agency bonds

 
164

 

 
445

 

 

 

 

 

 

 
609

GSEs:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
FFCB bonds

 
2,384

 

 

 

 

 

 

 

 

 
2,384

TLGP securities(3)

 
2,253

 

 

 

 

 

 

 

 

 
2,253

Total non-MBS

 
5,385

 
2,980

 
445

 

 

 

 

 

 

 
8,810

MBS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ginnie Mae

 
223

 

 

 

 

 

 

 

 

 
223

GSEs:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Freddie Mac

 
3,961

 

 

 

 

 

 

 

 

 
3,961

Fannie Mae

 
8,261

 

 

 

 

 

 

 

 

 
8,261

Total GSEs

 
12,222

 

 

 

 

 

 

 

 

 
12,222

PLRMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Prime
53

 
280

 
390

 
680

 
480

 
326

 
406

 
173

 
114

 

 
2,902

Alt-A, option ARM

 

 

 

 

 

 
940

 
51

 
26

 

 
1,017

Alt-A, other
33

 
132

 
192

 
639

 
427

 
761

 
3,386

 
710

 
967

 
15

 
7,262

Total PLRMBS
86

 
412

 
582

 
1,319

 
907

 
1,087

 
4,732

 
934

 
1,107

 
15

 
11,181

Total MBS
86

 
12,857

 
582

 
1,319

 
907

 
1,087

 
4,732

 
934

 
1,107

 
15

 
23,626

Total securities
86

 
18,242

 
3,562

 
1,764

 
907

 
1,087

 
4,732

 
934

 
1,107

 
15

 
32,436

Securities purchased under agreements to resell

 

 
1,100

 

 

 

 

 

 

 

 
1,100

Federal funds sold

 
4,955

 
3,686

 

 

 

 

 

 

 

 
8,641

Total investments
$
86

 
$
23,197

 
$
8,348

 
$
1,764

 
$
907

 
$
1,087

 
$
4,732

 
$
934

 
$
1,107

 
$
15

 
$
42,177




91


Investment Credit Exposure
(In millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2011
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
Carrying Value
 
Credit Rating(1)
 
 
Investment Type
AAA

 
AA

 
A

 
BBB

 
BB

 
B

 
CCC

 
CC

 
C

 
Total

Non-MBS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$

 
$

 
$
3,539

 
$

 
$

 
$

 
$

 
$

 
$

 
$
3,539

Commercial paper(2)

 
1,500

 
300

 

 

 

 

 

 

 
1,800

Housing finance agency bonds

 
187

 

 
459

 

 

 

 

 

 
646

GSEs:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
FFCB bonds

 
1,867

 

 

 

 

 

 

 

 
1,867

TLGP securities(3)

 
2,849

 

 

 

 

 

 

 

 
2,849

Total non-MBS

 
6,403

 
3,839

 
459

 

 

 

 

 

 
10,701

MBS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ginnie Mae

 
234

 

 

 

 

 

 

 

 
234

GSEs:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Freddie Mac

 
3,374

 

 

 

 

 

 

 

 
3,374

Fannie Mae

 
8,315

 

 

 

 

 

 

 

 
8,315

Total GSEs

 
11,689

 

 

 

 

 

 

 

 
11,689

PLRMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Prime
72

 
306

 
387

 
700

 
529

 
330

 
413

 
178

 
118

 
3,033

Alt-A, option ARM

 

 

 

 

 

 
936

 
53

 
26

 
1,015

Alt-A, other
36

 
137

 
196

 
667

 
434

 
771

 
3,412

 
719

 
958

 
7,330

Total PLRMBS
108

 
443

 
583

 
1,367

 
963

 
1,101

 
4,761

 
950

 
1,102

 
11,378

Total MBS
108

 
12,366

 
583

 
1,367

 
963

 
1,101

 
4,761

 
950

 
1,102

 
23,301

Total securities
108

 
18,769

 
4,422

 
1,826

 
963

 
1,101

 
4,761

 
950

 
1,102

 
34,002

Federal funds sold

 
5,366

 

 

 

 

 

 

 

 
5,366

Total investments
$
108

 
$
24,135


$
4,422


$
1,826


$
963


$
1,101


$
4,761


$
950


$
1,102


$
39,368


(1)
Credit ratings of BB and lower are below investment grade.
(2)
The Bank's investment in commercial paper also had a short-term credit rating of A-1/P-1.
(3)
TLGP securities represent corporate debentures of the issuing party that are guaranteed by the FDIC and backed by the full faith and credit of the U.S. government.

For all the securities in its available-for-sale and held-to-maturity portfolios, for Federal funds sold, and for securities purchased under agreements to resell, the Bank does not intend to sell any security and it is not more likely than not that the Bank will be required to sell any security before its anticipated recovery of the remaining amortized cost basis.

The Bank invests in short-term unsecured Federal funds sold, securities purchased under agreements to resell, negotiable certificates of deposit (interest-bearing deposits), and commercial paper with member and nonmember counterparties. The Bank determined that, as of March 31, 2012, all of the gross unrealized losses on its interest-bearing deposits and commercial paper were temporary because the gross unrealized losses were caused by movements in interest rates and not by the deterioration of the issuers' creditworthiness. The interest-bearing deposits and commercial paper were all with issuers that had credit ratings of at least A at March 31, 2012. As a result, the Bank expects to recover the entire amortized cost basis of these securities.

The Bank's investments may also include housing finance agency bonds issued by housing finance agencies located in Arizona, California, and Nevada, the three states that make up the Bank's district. These bonds are mortgage revenue bonds (federally taxable) and are collateralized by pools of first lien residential mortgage loans and credit-enhanced by bond insurance. The bonds held by the Bank are issued by the California Housing Finance Agency (CalHFA) and insured by either Ambac Assurance Corporation (Ambac), MBIA Insurance Corporation (MBIA), or Assured Guaranty Municipal Corporation (formerly Financial Security Assurance Incorporated). At March 31,

92


2012, all of the bonds were rated at least BBB by Moody's or Standard & Poor's.

At March 31, 2012, the Bank's investments in housing finance agency bonds had gross unrealized losses totaling $127 million. These gross unrealized losses were due to an illiquid market, credit concerns regarding the underlying mortgage collateral, and credit concerns regarding the monoline insurance providers, causing these investments to be valued at a discount to their acquisition cost. The Bank independently modeled cash flows for the underlying collateral, using assumptions for default rates and loss severity that a market participant would deem reasonable, and concluded that the available credit support within the CalHFA structure more than offset the projected underlying collateral losses. The Bank determined that, as of March 31, 2012, all of the gross unrealized losses on the agency bonds are temporary because the underlying collateral and credit enhancements were sufficient to protect the Bank from losses. As a result, the Bank expects to recover the entire amortized cost basis of these securities. If conditions in the housing and mortgage markets and general business and economic conditions remain stressed or deteriorate further, the fair value of the CalHFA bonds may decline further and the Bank may experience OTTI in future periods.

The Bank's MBS investments include PLRMBS, all of which were AAA-rated at the time of purchase, and
agency residential MBS, which are backed by Fannie Mae, Freddie Mac, or Ginnie Mae. Some of the PLRMBS were issued by and/or purchased from members, former members, or their affiliates. The Bank does not have investment credit limits and terms for these investments that differ for members and nonmembers. Bank policy limits total MBS investments to three times the Bank's capital. At March 31, 2012, the Bank's MBS portfolio was 211% of Bank capital (as determined in accordance with regulations governing the operations of the FHLBanks).

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

All of the MBS purchased by the Bank are backed by pools of first lien residential mortgage loans, which may include residential mortgage loans labeled by the issuer as Alt-A. Bank policy prohibits the purchase of MBS backed by pools of mortgage loans labeled by the issuer as subprime or having certain Bank-defined subprime characteristics. The Bank has not purchased any PLRMBS since the first quarter of 2008, and current Bank policy prohibits the purchase of PLRMBS.

At March 31, 2012, PLRMBS representing 39% of the amortized cost of the Bank's MBS portfolio were labeled Alt-A by the issuer. Alt-A PLRMBS are generally collateralized by mortgage loans that are considered less risky than subprime loans but more risky than prime loans. These loans are generally made to borrowers who have sufficient credit ratings to qualify for a conforming mortgage loan but the loans may not meet all standard guidelines for documentation requirements, property type, or loan-to-value ratios.

As of March 31, 2012, the Bank's investment in MBS had gross unrealized losses totaling $2.0 billion, most of which were related to PLRMBS. These gross unrealized losses were primarily due to illiquidity in the MBS market, uncertainty about the future condition of the housing and mortgage markets and the economy, and market expectations of the credit performance of loan collateral underlying these securities, causing these assets to be valued at significant discounts to their acquisition cost.

For its agency MBS, the Bank expects to recover the entire amortized cost basis of these securities because it determined that the strength of the issuers' guarantees through direct obligations or support from the U.S. government is sufficient to protect the Bank from losses. As a result, the Bank determined that, as of March 31, 2012, all of the gross unrealized losses on its agency MBS are temporary.

To assess whether it expects to recover the entire amortized cost basis of its PLRMBS, the Bank performed a cash flow analysis for all of its PLRMBS as of March 31, 2012, using two third-party models. The first model projects prepayments, default rates, and loss severities based on borrower characteristics and the particular attributes of the loans underlying the Bank's securities, in conjunction with assumptions related primarily to future changes in home prices and interest rates. Certain assumptions in the first model were updated in 2011 and the first quarter of 2012,

93


resulting in a change in the timing of projected borrower defaults, including the impact of longer foreclosure and property liquidation timelines. As a result, borrower defaults and collateral losses are projected to occur over a longer time period compared to prior projections. The change in the timing of projected borrower defaults and collateral losses also had an impact on the amount and timing of security-level projected losses that is unique to the waterfall structure of each security. In general, these timing changes caused credit-related charges to be somewhat lower than they would have been without a change in the timing of collateral losses. Another significant input to the first model is the forecast of future housing price changes for the relevant states and core-based statistical areas (CBSAs), which are based on an assessment of the individual housing markets. CBSA refers collectively to metropolitan and micropolitan statistical areas as defined by the United States Office of Management and Budget. As currently defined, a CBSA must contain at least one urban area with a population of 10,000 or more people.

The month-by-month projections of future loan performance derived from the first model, which reflect projected prepayments, default rates, and loss severities, are then input into a second model that allocates the projected loan level cash flows and losses to the various security classes in each securitization structure in accordance with the structure's prescribed cash flow and loss allocation rules. When the credit enhancement for the senior securities in a securitization is derived from the presence of subordinated securities, losses are generally allocated first to the subordinated 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.

The Bank's housing price forecast as of March 31, 2012, assumed current-to-trough home price declines ranging from 0% (for those housing markets that are believed to have reached their trough) to 8% over the 3- to 9-month periods beginning January 1, 2012. Thereafter, home prices were projected to recover using one of five different recovery paths that vary by housing market. The housing price forecast in the first quarter included an acceleration of recovery timelines compared to the fourth quarter, such that the average level of projected housing prices was approximately 7.3% higher by the end of the 30-year forecast horizon. In addition to evaluating its PLRMBS under a base case (or best estimate) scenario, the Bank performed a cash flow analysis for each of these securities under a more adverse housing price scenario. This more adverse scenario was based on a housing price forecast that was 5 percentage points lower at the trough than the base case scenario, followed by a flatter recovery path. Under this scenario, current-to-trough home price declines were projected to range from 5% to 13% over the 3- to 9-month periods beginning January 1, 2012. The following table shows the base case scenario and what the projected home price recovery by month would have been under the more adverse housing price scenario at March 31, 2012:

Recovery in Terms of Annualized Rates of Housing Price Change Under Base Case and Adverse Case Scenarios
 
Housing Price Scenario
Months
Base Case
 
Adverse Case
1 - 6
0.0% - 2.8%
 
0.0% - 1.9%
7 - 18
0.0% - 3.0%
 
0.0% - 2.0%
19 - 24
1.0% - 4.0%
 
0.7% - 2.7%
25 - 30
2.0% - 4.0%
 
1.3% - 2.7%
31 - 42
2.0% - 5.0%
 
1.3% - 3.4%
43 - 66
2.0% - 6.0%
 
1.3% - 4.0%
Thereafter
2.3% - 5.6%
 
1.5% - 3.8%

The following table shows the base case scenario and what the OTTI charge would have been under the more adverse housing price scenario at March 31, 2012:
 

94


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

  
Unpaid
Principal
Balance

  
Credit-
Related
OTTI(1)

  
Number of
Securities

 
Unpaid
Principal
Balance

  
Credit-
Related
OTTI(1)

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:
 
  
 
  
 
  
 
 
 
  
 
Prime
2

  
$
3

  
$

  
8

 
$
562

  
$
5

Alt-A, option ARM
1

 
19

 

 
9

 
668

 
19

Alt-A, other
31

  
2,093

  
9

  
100

 
5,636

  
122

Total
34

  
$
2,115

  
$
9

  
117

 
$
6,866

  
$
146


(1)
Amounts are for the three months ended March 31, 2012.
 
For more information on the Bank's OTTI analysis and reviews, see “Item 1. Financial Statements – Note 6 – Other-Than-Temporary Impairment Analysis.”

The following table presents the ratings of the Bank's PLRMBS as of March 31, 2012, by year of securitization and by collateral type at origination.

Unpaid Principal Balance of PLRMBS by Year of Securitization and Credit Rating
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(In millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unpaid Principal Balance
 
Credit Rating(1) 
  
 
Collateral Type at Origination
and Year of Securitization
AAA

  
AA

  
A

  
BBB

  
BB

  
B

  
CCC

  
CC

  
C

 
D

  
Total

Prime
 
  
 
  
 
  
 
  
 
  
 
  
 
  
 
  
 
 
 
  
 
2008
$

 
$

 
$

 
$

 
$

 
$
87

 
$
189

 
$

 
$

 

  
$
276

2007

 

 

 
87

 

 
20

 
220

 
270

 
102

 

  
699

2006
42

 

 

 

 
14

 
142

 

 
3

 
53

 

  
254

2005

 

 
56

 

 

 
19

 
88

 

 

 

  
163

2004 and earlier
11

 
280

 
332

 
592

 
477

 
74

 
17

 

 

 

  
1,783

Total Prime
53

  
280

  
388

  
679

  
491

  
342

  
514

  
273

  
155

 

  
3,175

Alt-A, option ARM
 
  
 
  
 
  
 
  
 
  
 
  
 
  
 
  
 
 
 
  
 
2007

 

 

 

 

 

 
1,306

 

 

 

  
1,306

2006

 

 

 

 

 

 
224

 

 

 

  
224

2005

 

 

 

 

 

 
45

 
160

 
96

 

  
301

Total Alt-A, option ARM

  

  

  

  

  

  
1,575

  
160

  
96

 

  
1,831

Alt-A, other
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2008

 

 

 

 

 
188

 

 

 

 

 
188

2007

 

 

 

 
151

 

 
1,422

 
26

 
777

 

 
2,376

2006

 
73

 

 

 

 
25

 
487

 
120

 
439

 

 
1,144

2005
6

 

 
12

 
45

 
53

 
546

 
2,436

 
840

 
234

 
28

 
4,200

2004 and earlier
27

 
60

 
181

 
606

 
232

 
117

 
73

 

 

 

 
1,296

Total Alt-A, other
33

 
133

 
193

 
651

 
436

 
876

 
4,418

 
986

 
1,450

 
28

 
9,204

Total par amount
$
86

  
$
413

  
$
581

  
$
1,330

  
$
927

  
$
1,218

  
$
6,507

  
$
1,419

  
$
1,701

 
$
28

  
$
14,210


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

95


The following table presents the ratings of the Bank's other-than-temporarily impaired PLRMBS at March 31, 2012, by year of securitization and by collateral type at origination.
 
Unpaid Principal Balance of Other-Than-Temporarily Impaired PLRMBS
by Year of Securitization and Credit Rating
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(In millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unpaid Principal Balance
 
Credit Rating(1)
  
 
Collateral Type at Origination and Year of Securitization
AA

  
A

  
BBB

  
BB

  
B

  
CCC

  
CC

  
C

 
D

  
Total

Prime
 
  
 
  
 
  
 
  
 
  
 
  
 
  
 
 
 
  
 
2008
$

  
$

  
$

  
$

  
$
58

  
$
189

  
$

  
$

 
$

  
$
247

2007

  

  

  

  

  
220

  
270

  
102

 

  
592

2006

  

  

  
14

  
29

  

  
3

  
53

 

  
99

2005

  

  

  

  
19

  
34

  

  

 

  
53

2004 and earlier

  

  

  
85

  
15

  
17

  

  

 

  
117

Total Prime

  

  

  
99

  
121

  
460

  
273

  
155

 

  
1,108

Alt-A, option ARM
 
  
 
  
 
  
 
  
 
  
 
  
 
  
 
 
 
  
 
2007

  

  

  

  

  
1,306

  

  

 

  
1,306

2006

  

  

  

  

  
224

  

  

 

  
224

2005

  

  

  

  

  

  
160

  
96

 

  
256

Total Alt-A, option ARM

  

  

  

  

  
1,530

  
160

  
96

 

  
1,786

Alt-A, other
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2008

 

 

 

 
188

 

 

 

 

 
188

2007

 

 

 

 

 
1,422

 
26

 
776

 

 
2,224

2006
73

 

 

 

 
25

 
487

 
120

 
439

 

 
1,144

2005

 

 

 

 
519

 
2,436

 
840

 
234

 
28

 
4,057

2004 and earlier

 
32

 
139

 
72

 
70

 
64

 

 

 

 
377

Total Alt-A, other
73

 
32

 
139

 
72

 
802

 
4,409

 
986

 
1,449

 
28

 
7,990

Total par amount
$
73

  
$
32

  
$
139

  
$
171

  
$
923

  
$
6,399

  
$
1,419

  
$
1,700

 
$
28

  
$
10,884

 

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

For the Bank's PLRMBS, the following table shows the amortized cost, estimated fair value, credit- and non-credit-related OTTI, performance of the underlying collateral based on the classification at the time of origination, and credit enhancement statistics by type of collateral and year of securitization. Credit enhancement is defined as the percentage of subordinated tranches and over-collateralization, if any, in a security structure that will absorb losses before the Bank will experience a loss on the security, expressed as a percentage of the underlying collateral balance. The credit enhancement figures include the additional credit enhancement required by the Bank (above the amounts required for an AAA rating by the credit rating agencies) for selected securities starting in late 2004, and for all securities starting in late 2005. The calculated weighted averages represent the dollar-weighted averages of all the PLRMBS in each category shown. The classification (prime or Alt-A) is based on the model used to run the estimated cash flows for the CUSIP, which may not necessarily be the same as the classification at the time of origination.

 

96


PLRMBS Credit Characteristics
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Three Months Ended
March 31, 2012
 
Underlying Collateral Performance and
Credit Enhancement Statistics
Collateral Type at Origination and Year of Securitization
Amortized
Cost

 
Gross
Unrealized
Losses

 
Estimated
Fair
Value

 
Credit-
Related
OTTI

 
Non-
Credit-
Related
OTTI

 
Total
OTTI

 
Weighted-
Average
60+ Days
Collateral
Delinquency
Rate

 
Original
Weighted
Average
Credit
Support

 
Current
Weighted
Average
Credit
Support

Prime
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2008
$
244

 
$
17

 
$
226

 
$

 
$

 
$

 
26.13
%
 
30.00
%
 
25.13
%
2007
596

 
116

 
481

 

 

 

 
21.41

 
22.54

 
12.59

2006
241

 
1

 
242

 

 

 

 
13.02

 
11.07

 
8.72

2005
162

 
18

 
146

 

 

 

 
13.39

 
11.45

 
14.95

2004 and earlier
1,785

 
154

 
1,631

 

 

 

 
8.41

 
4.38

 
10.18

Total Prime
3,028

 
306

 
2,726

 

 

 

 
13.43

 
11.50

 
12.14

Alt-A, option ARM
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2007
1,103

 
334

 
770

 

 

 

 
44.69

 
44.14

 
36.48

2006
165

 
39

 
126

 

 

 

 
45.72

 
44.83

 
31.03

2005
144

 
38

 
107

 

 

 

 
36.95

 
22.83

 
19.56

Total Alt-A, option ARM
1,412

 
411

 
1,003

 

 

 

 
43.55

 
40.72

 
33.03

Alt-A, other
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2008
185

 
27

 
157

 

 

 

 
18.26

 
31.80

 
28.80

2007
2,096

 
331

 
1,781

 
2

 
5

 
7

 
31.29

 
26.82

 
20.02

2006
890

 
78

 
815

 
2

 
(2
)
 

 
29.65

 
18.45

 
8.33

2005
3,881

 
683

 
3,198

 
5

 
(4
)
 
1

 
19.55

 
13.70

 
12.07

2004 and earlier
1,303

 
150

 
1,155

 

 
3

 
3

 
13.12

 
7.94

 
16.09

Total Alt-A, other
8,355

 
1,269

 
7,106

 
9

 
2

 
11

 
22.90

 
17.23

 
14.57

Total
$
12,795

 
$
1,986

 
$
10,835

 
$
9

 
$
2

 
$
11

 
23.45
%
 
18.98
%
 
16.40
%

The following table presents a summary of the significant inputs used to determine potential OTTI credit losses in the Bank's PLRMBS portfolio for the three months ended March 31, 2012.


97


Significant Inputs to OTTI Credit Analysis for All PLRMBS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Significant Inputs
  
Current
 
Prepayment Rates
  
Default Rates
  
Loss Severities
  
Credit Enhancement
Year of Securitization
Weighted
Average %
  
Range %
  
Weighted
Average %
  
Range %
  
Weighted
Average %
  
Range %
  
Weighted
Average %
  
Range %
Prime
 
  
 
  
 
  
 
  
 
  
 
  
 
  
 
2008
8.9
 
6.7-10.3
 
35.7
 
28.4-40.4
 
44.7
 
42.4-50.8
 
26.6
 
24.2-28.8
2007
7.4
 
7.2-7.4
 
6.8
 
6.8-7.1
 
26.7
 
26.0-26.9
 
10.0
 
7.5-20.8
2006
9.8
 
7.4-12.0
 
18.8
 
13.0-33.0
 
38.3
 
33.3-51.0
 
11.9
 
2.6-20.1
2005
10.3
 
6.3-16.6
 
12.7
 
1.9-26.7
 
27.7
 
25.8-33.2
 
11.5
 
8.7-12.8
2004 and earlier
11.6
 
0.9-20.5
 
10.7
 
0.0-27.6
 
31.0
 
17.9-70.5
 
9.8
 
0.0-60.2
Total Prime
10.7
 
0.9-20.5
 
16.0
 
0.0-40.4
 
34.0
 
17.9-70.5
 
13.1
 
0.0-60.2
Alt-A, option ARM
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2007
2.5
 
1.2-3.9
 
78.3
 
67.6-90.9
 
51.7
 
45.1-61.5
 
36.5
 
30.4-46.9
2006
2.2
 
1.7-2.8
 
80.6
 
73.6-86.4
 
53.1
 
43.0-61.4
 
31.0
 
24.8-36.1
2005
3.5
 
2.4-5.1
 
60.7
 
30.6-75.0
 
42.2
 
35.4-49.8
 
19.6
 
8.5-33.2
Total Alt-A, option ARM
2.6
 
1.2-5.1
 
75.7
 
30.6-90.9
 
50.3
 
35.4-61.5
 
33.0
 
8.5-46.9
Alt-A, other
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2007
6.4
 
3.0-8.8
 
52.8
 
28.7-78.1
 
46.3
 
29.9-55.3
 
15.6
 
2.3-50.8
2006
6.3
 
2.2-7.9
 
50.6
 
32.0-72.6
 
50.1
 
42.6-56.3
 
15.8
 
0.0-34.4
2005
7.5
 
3.8-10.9
 
33.9
 
16.0-54.5
 
45.4
 
32.8-59.6
 
12.2
 
0.0-86.0
2004 and earlier
8.7
 
3.1-21.8
 
23.5
 
1.0-48.4
 
33.2
 
14.4-71.6
 
16.0
 
7.9-73.9
Total Alt-A, other
7.2
 
2.2-21.8
 
39.7
 
1.0-78.1
 
44.6
 
14.4-71.6
 
14.2
 
0.0-86.0
Total
7.3
 
0.9-21.8
 
40.0
 
0.0-90.9
 
43.4
 
14.4-71.6
 
16.4
 
0.0-86.0

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

The following table presents the unpaid principal balance of PLRMBS by collateral type at the time of origination at March 31, 2012, and December 31, 2011.

 
Unpaid Principal Balance of PLRMBS by Collateral Type at Origination
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2012
  
December 31, 2011
(In millions)
Fixed Rate

  
Adjustable
Rate

  
Total

  
Fixed Rate

  
Adjustable
Rate

  
Total

PLRMBS:
 
  
 
  
 
  
 
  
 
  
 
Prime
$
756

 
$
2,419

  
$
3,175

  
$
999

 
$
2,327

  
$
3,326

Alt-A, option ARM

 
1,831

 
1,831

 

 
1,880

 
1,880

Alt-A, other
4,604

 
4,600

  
9,204

  
4,899

 
4,556

  
9,455

Total
$
5,360

  
$
8,850

  
$
14,210

  
$
5,898

  
$
8,763

  
$
14,661


The following table presents credit ratings as of April 30, 2012, on PLRMBS in a loss position at March 31, 2012.



98



PLRMBS in a Loss Position at March 31, 2012,
and Credit Ratings as of April 30, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
March 31, 2012
 
April 30, 2012
Collateral Type at Origination:
  
Unpaid
Principal
Balance

  
Amortized
Cost

  
Carrying
Value

  
Gross
Unrealized
Losses

  
Weighted-
Average
60+ Days
Collateral
Delinquency
Rate

 
%
Rated
AAA

 
%
Rated
AAA

 
% Rated
AA to BBB

 
% Rated
Below
Investment
Grade

 
% on
Watchlist

Prime
  
$
3,028

  
$
2,892

  
$
2,763

  
$
306

  
13.27
%
 
0.07
%
 
0.07
%
 
35.95
%
 
63.98
%
 
11.93
%
Alt-A, option ARM
 
1,765

 
1,396

 
999

 
411

 
43.31

 

 

 

 
100.00

 

Alt-A, other
  
9,072

  
8,242

  
7,146

  
1,269

  
22.90

 
0.31

 
0.31

 
10.29

 
89.40

 
5.71

Total
  
$
13,865

  
$
12,530

  
$
10,908

  
$
1,986

  
23.40
%
 
0.21
%
 
0.21
%
 
14.59
%
 
85.20
%
 
6.34
%
 
The following table presents the fair value of the Bank's PLRMBS as a percentage of the unpaid principal balance by collateral type at origination and year of securitization.

Fair Value of PLRMBS as a Percentage of Unpaid Principal Balance by Year of Securitization
 
 
 
 
 
 
 
 
 
 
Collateral Type at Origination and Year of Securitization
March 31,
2012

 
December 31,
2011

 
September 30,
2011

 
June 30,
2011

 
March 31,
2011

Prime
 
 
 
 
 
 
 
 
 
2008
82.03
%
 
80.21
%
 
83.30
%
 
85.62
%
 
85.55
%
2007
68.71

 
68.69

 
71.65

 
73.30

 
72.06

2006
95.18

 
94.17

 
94.40

 
96.05

 
95.43

2005
89.16

 
86.25

 
87.07

 
89.53

 
86.55

2004 and earlier
91.47

 
88.18

 
89.90

 
92.55

 
93.29

Weighted average of all Prime
85.82

 
83.74

 
85.81

 
88.26

 
88.31

Alt-A, option ARM
 
 
 
 
 
 
 
 
 
2007
58.95

 
56.84

 
58.86

 
61.19

 
61.93

2006
56.11

 
55.72

 
55.38

 
58.85

 
61.09

2005
35.66

 
34.88

 
36.80

 
39.83

 
41.36

Weighted average of all Alt-A, option ARM
54.77

 
53.09

 
54.83

 
57.43

 
58.71

Alt-A, other
 
 
 
 
 
 
 
 
 
2008
83.94

 
80.26

 
81.21

 
83.69

 
80.69

2007
74.97

 
73.82

 
75.62

 
76.84

 
76.88

2006
71.23

 
69.01

 
72.49

 
73.92

 
75.77

2005
76.16

 
74.23

 
76.36

 
79.36

 
80.16

2004 and earlier
89.00

 
86.18

 
87.28

 
89.51

 
90.92

Weighted average of all Alt-A, other
77.21

 
75.28

 
77.32

 
79.55

 
80.28

Weighted average of all PLRMBS
76.24
%
 
74.36
%
 
76.43
%
 
78.82
%
 
79.58
%

The following tables summarize rating agency downgrade actions on investments that occurred from April 1, 2012, to April 30, 2012. The credit ratings used by the Bank are based on the lowest of Moody's, Standard & Poor's, or comparable Fitch ratings.


99


Investments Downgraded from April 1, 2012, to April 30, 2012
Dollar Amounts as of March 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
To A
 
To BBB
 
To Below
Investment Grade
 
Total
(In millions)
Carrying
Value

 
Fair
Value

 
Carrying
Value

 
Fair
Value

 
Carrying
Value

 
Fair
Value

 
Carrying
Value

  
Fair
Value

PLRMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Downgrade from AAA
$
2

 
$
2

 
$

 
$

 
$

 
$

 
$
2

 
$
2

Downgrade from AA
38

 
35

 

 

 

 

 
38

 
35

Downgrade from A

 

 
36

 
32

 
57

 
54

 
93

 
86

Downgrade from BBB

 

 

 

 
217

 
203

 
217

 
203

Downgrade from BB

 

 

 

 
54

 
54

 
54

 
54

Downgrade from CCC

 

 

 

 
35

 
35

 
35

 
35

Downgrade from C

 

 

 

 
11

 
11

 
11

 
11

Total
$
40

 
$
37

 
$
36

 
$
32

 
$
374

 
$
357

 
$
450

 
$
426


Investments Downgraded to Below Investment Grade from April 1, 2012, to April 30, 2012 Dollar Amounts as of March 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
To BB
  
To B
 
To D
 
Total Below Investment Grade
(In millions)
Carrying
Value

  
Fair
Value

  
Carrying
Value

 
Fair
Value

 
Carrying
Value

  
Fair
Value

 
Carrying
Value

  
Fair
Value

PLRMBS:
 
  
 
  
 
 
 
 
 
  
 
 
 
  
 
Downgrade from A
$
57

 
$
54

 
$

 
$

 
$

 
$

 
$
57

 
$
54

Downgrade from BBB
217

 
203

 

 

 

 

 
217

 
203

Downgrade from BB

 

 
54

 
54

 

 

 
54

 
54

Downgrade from CCC

 

 

 

 
35

 
35

 
35

 
35

Downgrade from C
 
 
 
 
 
 
 
 
11

 
11

 
11

 
11

Total
$
274

 
$
257

 
$
54

 
$
54

 
$
46

 
$
46

 
$
374

 
$
357


The PLRMBS that were downgraded from April 1, 2012, to April 30, 2012, were included in the Bank's OTTI analysis performed as of March 31, 2012, and no additional OTTI charge was required as a result of these downgrades.

The Bank believes that, as of March 31, 2012, the gross unrealized losses on the remaining PLRMBS that did not have an OTTI charge are primarily due to illiquidity in the MBS market, uncertainty about the future condition of the housing and mortgage markets and the economy, and market expectations of the credit performance of loan collateral underlying these securities, which caused these assets to be valued at significant discounts to their acquisition cost. The Bank does not intend to sell these securities, it is not more likely than not that the Bank will be required to sell these securities before its anticipated recovery of the remaining amortized cost basis, and the Bank expects to recover the entire amortized cost basis of these securities. As a result, the Bank determined that, as of March 31, 2012, all of the gross unrealized losses on these securities are temporary. The Bank will continue to monitor and analyze the performance of these securities to assess the likelihood of the recovery of the entire amortized cost basis of these securities as of each balance sheet date.

The following table summarizes rating agency actions for investments on negative watch as of April 30, 2012. The credit ratings used by the Bank are based on the lowest of Moody's, Standard & Poor's, or comparable Fitch ratings.


100


Investments on Negative Watch as of April 30, 2012 Dollar Amounts as of March 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
AAA
 
AA
 
A
 
BBB
 
BB
 
Total
(In millions)
Carrying
Value

Fair
Value

 
Carrying
Value

Fair
Value

 
Carrying
Value

Fair
Value

 
Carrying
Value

Fair
Value

 
Carrying
Value

Fair
Value

 
Carrying
Value

Fair
Value

Housing finance agency bonds
$

$

 
$
67

$
58

 
$

$

 
$

$

 
$

$

 
$
67

$
58

PLRMBS
18

17

 
140

125

 
139

128

 
353

326

 
226

194

 
876

790

Total
$
18

$
17

 
$
207

$
183

 
$
139

$
128

 
$
353

$
326

 
$
226

$
194

 
$
943

$
848


The housing finance agency bonds and PLRMBS that were on negative watch as of April 30, 2012, were included in the Bank's OTTI analysis performed as of March 31, 2012. These investments were determined not to be other-than-temporarily impaired and no OTTI charge was required.

If conditions in the housing and mortgage markets and general business and economic conditions remain stressed or deteriorate further, the fair value of MBS may decline further and the Bank may experience OTTI of additional PLRMBS in future periods, as well as further impairment of PLRMBS that were identified as other-than-temporarily impaired as of March 31, 2012. Additional future credit-related OTTI charges could adversely affect the Bank's earnings and retained earnings and its ability to pay dividends and repurchase capital stock. The Bank cannot predict whether it will be required to record additional OTTI charges on its PLRMBS in the future.

Federal and state government authorities, as well as private entities, such as financial institutions and the servicers of residential mortgage loans, have begun or promoted implementation of programs designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures. These loan modification programs, as well as future legislative, regulatory, or other actions, including amendments to the bankruptcy laws, that result in the modification of outstanding mortgage loans, may adversely affect the value of, and the returns on, these mortgage loans or MBS related to these mortgage loans.

Derivatives Counterparties. The Bank has also adopted credit policies and exposure limits for derivatives credit exposure. All credit exposure from derivatives transactions entered into by the Bank with member counterparties that are not derivatives dealers (including interest rate swaps, caps, floors, corridors, and collars), for which the Bank serves as an intermediary, must be fully secured by eligible collateral, and all such derivatives transactions are subject to both the Bank's Advances and Security Agreement and a master netting agreement.

The Bank selects only highly rated derivatives dealers and major banks (derivatives dealer counterparties) that meet the Bank's eligibility criteria to act as counterparties for its derivatives activities. In addition, the Bank has entered into master netting agreements and bilateral security agreements with all active derivatives dealer counterparties that provide for delivery of collateral at specified levels to limit the Bank's net unsecured credit exposure to these counterparties. Under these policies and agreements, the amount of unsecured credit exposure to an individual derivatives dealer counterparty is limited to an absolute dollar credit exposure limit according to the counterparty's credit rating, as determined by rating agency long-term credit ratings of the counterparty's debt securities or deposits. The following table presents the Bank's credit exposure to its derivatives dealer counterparties at the dates indicated.
 

101


Credit Exposure to Derivatives Dealer Counterparties
 
 
 
 
 
 
 
 
(In millions)
 
 
 
 
 
 
 
March 31, 2012
 
  
 
  
 
  
 
Counterparty Credit Rating(1)
Notional
Balance

  
Credit
Exposure Net of
Cash Collateral

  
Securities
Collateral
Held

  
Net Credit
Exposure

AA
$
2,716

  
$
10

  
$
5

  
$
5

A
115,526

  
423

  
389

  
34

Subtotal
118,242

  
433

  
394

  
39

Member institutions(2)
405

  

  

  

Total derivatives
$
118,647

  
$
433

  
$
394

  
$
39

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2011
 
  
 
  
 
  
 
Counterparty Credit Rating(1)
Notional
Balance

  
Credit
Exposure Net of
Cash Collateral

  
Securities
Collateral
Held

  
Net Credit
Exposure

AA
$
3,366

 
$
9

  
$
6

  
$
3

A
125,805

 
391

  
375

  
16

Subtotal
129,171

  
400

  
381

  
19

Member institutions(2)
405

  

  

  

Total derivatives
$
129,576

  
$
400

  
$
381

  
$
19


(1)
The credit ratings used by the Bank are based on the lowest of Moody's and Standard & Poor's ratings.
(2)
Collateral held with respect to interest rate exchange agreements with members represents either collateral physically held by or on behalf of the Bank or collateral assigned to the Bank, as evidenced by an Advances and Security Agreement, and held by the members for the benefit of the Bank.

At March 31, 2012, the Bank had a total of $118.6 billion in notional amounts of derivatives contracts outstanding. Of this total:
$118.2 billion represented notional amounts of derivatives contracts outstanding with 15 derivatives dealer counterparties. Seven of these counterparties made up 84% of the total notional amount outstanding with these derivatives dealer counterparties, individually ranging from 6% to 22% of the total. The remaining counterparties each represented less than 5% of the total. Four of these counterparties, with $45.4 billion of derivatives outstanding at March 31, 2012, were affiliates of members.
$405 million represented notional amounts of derivatives contracts with two member counterparties that are not derivatives dealers. The Bank entered into these derivatives contracts as an intermediary and entered into the same amount of exactly offsetting transactions with derivatives dealer counterparties. The Bank's intermediation in this manner allows members indirect access to the derivatives market.

Credit exposure net of cash collateral on derivatives contracts at March 31, 2012, was $433 million with nine derivatives dealer counterparties. After consideration of collateral held by the Bank, the amount of net unsecured exposure from these contracts totaled $39 million.

At December 31, 2011, the Bank had a total of $129.6 billion in notional amounts of derivatives contracts outstanding. Of this total:
$129.2 billion represented notional amounts of derivatives contracts outstanding with 15 derivatives dealer counterparties. Eight of these counterparties made up 89% of the total notional amount outstanding with these derivatives dealer counterparties, individually ranging from 5% to 20% of the total. The remaining counterparties each represented less than 5% of the total. Four of these counterparties, with $52.4 billion of derivatives outstanding at December 31, 2011, were affiliates of members.
$405 million represented notional amounts of derivatives contracts with two member counterparties that are not derivatives dealers. The Bank entered into these derivatives contracts as an intermediary and entered into the same amount of exactly offsetting transactions with derivatives dealer counterparties. The Bank's intermediation in this manner allows members indirect access to the derivatives market.

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Credit exposure net of cash collateral on derivatives contracts at December 31, 2011, was $400 million with eight derivatives dealer counterparties. After consideration of collateral held by the Bank, the amount of net unsecured exposure from these contracts totaled $19 million.

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

Based on the master netting arrangements, its credit analyses, and the collateral requirements in place with each counterparty, the Bank does not expect to incur any credit losses on its derivatives agreements.

For more information, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – Derivatives Counterparties” in the Bank's 2011 Form 10-K.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) requires management to make a number of judgments, estimates, and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, if applicable, and the reported amounts of income, expenses, gains, and losses during the reporting period. Changes in these judgments, estimates, and assumptions could potentially affect the Bank's financial position and results of operations significantly. Although the Bank believes these judgments, estimates, and assumptions to be reasonably accurate, actual results may differ.

In the Bank's 2011 Form 10-K, the following accounting policies and estimates were identified as critical because they require the Bank to make subjective or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies and estimates are: estimating the allowance for credit losses on the advances and mortgage loan portfolios; accounting for derivatives; estimating fair values of investments classified as trading and available-for-sale, derivatives and associated hedged items carried at fair value in accordance with the accounting for derivative instruments and associated hedging activities, and financial instruments carried at fair value under the fair value option, and accounting for other-than-temporary impairment for investment securities; and estimating the prepayment speeds on MBS and mortgage loans for the accounting of amortization of premiums and accretion of discounts on MBS and mortgage loans.

There have been no significant changes in the judgments and assumptions made during the first three months of 2012 in applying the Bank's critical accounting policies. These policies and the judgments, estimates, and assumptions are described in greater detail in “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” and “Item 8. Financial Statements and Supplementary Data – Note 1 – Summary of Significant Accounting Policies” in the Bank's 2011 Form 10-K and in “Item 1. Financial Statements – Note 16 – Fair Value.”

Recently Issued Accounting Guidance and Interpretations

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

Recent Developments

Dodd-Frank Act's Impact on the Bank's Derivatives Transactions. The Dodd-Frank Act provides for new statutory and regulatory requirements for derivatives transactions, including those used by the Bank to hedge its interest rate risk and other risks. As a result of these requirements, certain derivatives transactions will be required to be cleared through a third-party central clearinghouse and traded on regulated exchanges or through new swap

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execution facilities.

Mandatory Clearing of Derivatives Transactions. As further discussed in the Bank's 2011 Form 10-K, cleared swaps will be subject to new requirements, including mandatory reporting, recordkeeping, and documentation requirements established by applicable regulators and initial and variation margin requirements established by the clearinghouse and its clearing members. Under a proposed rule of the U.S. Commodity Futures Trading Commission (CFTC), the Bank would be a “category 2” entity and would have to comply with mandatory clearing requirements within 180 days after the CFTC determines that a certain type of swap must be cleared. Based on the CFTC's proposed implementation schedule and the time periods proposed for mandatory clearing determinations, it is unlikely that any of the Bank's swaps will be subject to these new clearing and trading requirements until the beginning of 2013, at the earliest.

Uncleared Derivatives Transactions. The Dodd-Frank Act will also change the regulatory landscape for derivatives transactions that are not subject to mandatory clearing requirements (uncleared trades). While it is likely that the Bank will continue to enter into uncleared trades on a bilateral basis, these trades will be subject to new requirements, including mandatory reporting, recordkeeping, documentation, and initial and variation margin and capital requirements established by applicable regulators. These requirements and their expected implementation timelines are discussed in the Bank's 2011 Form 10-K. At this time, it appears unlikely that the Bank will have to comply with such requirements until the beginning of 2013, at the earliest.
The CFTC, the SEC, the Finance Agency, and other bank regulators are expected to continue to issue final rulemakings implementing the foregoing requirements between now and the end of 2012. The Bank, together with the other FHLBanks, will continue to monitor these rulemakings and the overall regulatory process to implement derivatives reform under the Dodd-Frank Act. The Bank will also continue to work with the other FHLBanks to implement the processes and documentation necessary to comply with the Dodd-Frank Act's new requirements for derivatives.

The Dodd-Frank Act will require swap dealers and certain other large users of derivatives to register as “swap dealers” or “major swap participants,” as the case may be, with the CFTC and/or the SEC. Based on the definitions in the final rules jointly issued by the CFTC and SEC on April 18, 2012, the Bank will not be required to register as either a major swap participant or as a swap dealer based on the derivatives transactions that the Bank enters into for the purposes of hedging and managing its interest rate risk. Although the final rule has not yet been published, it also appears that the Bank will not be considered a “swap dealer” as a result of the Bank's intermediated swap activity with its members.

The CFTC and the SEC have not finalized their rules further defining “swap.” See the Bank's 2011 Form 10-K for a discussion of how these final rules could affect call and put optionality in certain Bank advances.

Final Rule and Guidance on the Supervision and Regulation of Certain Nonbank Financial Companies. On April 11, 2012, the Financial Stability Oversight Council (Oversight Council) issued a final rule and guidance on the standards and procedures the Oversight Council will follow in determining whether to designate a nonbank financial company for supervision by the Federal Reserve Board (Federal Reserve) and to be subject to certain heightened prudential standards. The rule will be effective May 11, 2012. If the Oversight Council determines the Bank to be a significant nonbank financial company, the Bank would be subject to a separate prudential standards rule that has been proposed by the Federal Reserve, but is not yet final. The guidance issued with this final rule provides that the Oversight Council expects generally to follow a process in making its determinations consisting of:

A first stage that will identify those nonbank financial companies that have $50 billion or more of total consolidated assets and exceed any one of five threshold indicators of interconnectedness or susceptibility to material financial distress, including whether a company has $20 billion or more in total debt outstanding. As of March 31, 2012, the Bank had $110 billion in total assets and $98 billion in total outstanding consolidated obligations, the Bank's principal form of outstanding debt.

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A second stage involving a robust analysis of the potential threat that the subject nonbank financial company could pose to U.S. financial stability based on additional quantitative and qualitative factors that are both industry- and company-specific.
A third stage analyzing the subject nonbank financial company using information collected directly from it.

The final rule provides that, in making its determinations, the Oversight Council will consider as one factor whether the nonbank financial company is subject to oversight by a primary financial regulatory agency (for the Bank, the Finance Agency). A nonbank financial company that the Oversight Council proposes to designate for additional supervision and prudential standards under this rule has the opportunity to contest the designation. If the Bank is designated by the Oversight Council for supervision by the Federal Reserve and becomes subject to the Federal Reserve's additional prudential standards, then the Bank's operations and business could be adversely affected by any resulting additional costs and restrictions on its business activities.

Federal Reserve Proposed Rule on Prudential Standards. On January 5, 2012, the Federal Reserve issued a proposed rule with a comment deadline of April 30, 2012, that would implement the enhanced prudential and early remediation standards required by the Dodd-Frank Act for nonbank financial companies identified by the Oversight Council as posing a threat to the financial stability of the United States. The proposed prudential standards include risk-based capital leverage and overall risk management requirements, liquidity standards, single-counterparty credit limits, stress test requirements, and a debt-to-equity limit. The capital and liquidity requirements would be implemented in phases and would be based on or exceed the Basel international capital and liquidity framework. The Bank's operations and business could be adversely affected by additional costs and business activity restrictions if the Bank is subject to the prudential standards as proposed.

Basel Committee on Banking Supervision Capital Framework. In September 2010, the Basel Committee on Banking Supervision (Basel Committee) approved a new capital framework for internationally active banks. Banks subject to the new framework will be required to have increased amounts of capital, with core capital being more strictly defined to include only common equity and other capital assets that are able to fully absorb losses. The Basel Committee also proposed a liquidity coverage ratio for short-term liquidity needs that would be phased in by 2015, as well as a net stable funding ratio for longer-term liquidity needs that would be phased in by 2018.

On January 5, 2012, the Federal Reserve announced its proposed rule on enhanced prudential standards and early remediation requirements for nonbank financial companies designated as systemically important by the Oversight Council. The proposed rule declines to finalize certain standards, such as liquidity requirements, until the Basel Committee framework gains greater international consensus, but the Federal Reserve proposes a liquidity buffer requirement that would be in addition to the final Basel Committee framework requirements. The size of the buffer would be determined through liquidity stress tests, taking into account a financial institution's structure and risk factors.

While it is still uncertain how the capital and liquidity standards being developed by the Basel Committee ultimately will be implemented by U.S. regulatory authorities, the new framework and the Federal Reserve's proposed plan could require some of the Bank's members to divest assets to comply with the more stringent capital and liquidity requirements, thereby tending to decrease their need for advances. The requirements may also adversely affect investor demand for consolidated obligations to the extent that affected institutions divest or limit their investments in consolidated obligations. On the other hand, the new requirements could motivate Bank members to borrow term advances from the Bank to create and maintain balance sheet liquidity.

Final Rule on Private Transfer Fee Covenants. On March 16, 2012, the Finance Agency issued a final rule that will restrict the Bank from purchasing, investing in, accepting as collateral, or otherwise dealing in any mortgages on properties encumbered by private transfer fee covenants, securities backed by these mortgages, and securities backed by the income stream from these covenants, except for certain excepted transfer fee covenants. The rule will be effective July 16, 2012. Excepted transfer fee covenants are covenants to pay private transfer fees to covered associations (including, among others, organizations comprising owners of homes, condominiums, cooperatives, and manufactured homes and certain other tax-exempt organizations) that use the private transfer fees exclusively

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for the direct benefit of the property. The foregoing restrictions will apply to mortgages on properties encumbered by private transfer fee covenants created on or after February 8, 2011, and to securities backed by these mortgages, and to securities issued after February 8, 2011, and backed by revenue from private transfer fees regardless of when the covenants were created. To the extent that the final rule limits the type of collateral the Bank accepts for advances and the type of investments that the Bank is eligible to make, the Bank's business and results of operations could be adversely affected.

Off-Balance Sheet Arrangements, Guarantees, and Other Commitments

In accordance with regulations governing the operations of the FHLBanks, each FHLBank, including the Bank, is jointly and severally liable for the FHLBank System's consolidated obligations issued under Section 11(a) of the FHLBank Act, and in accordance with the FHLBank Act, each FHLBank, including the Bank, is jointly and severally liable for consolidated obligations issued under Section 11(c) of the FHLBank Act. The joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor.

The Bank's joint and several contingent liability is a guarantee, but is excluded from initial recognition and measurement provisions because the joint and several obligations are mandated by the FHLBank Act or Finance Agency regulation and are not the result of arms-length transactions among the FHLBanks. The Bank has no control over the amount of the guarantee or the determination of how each FHLBank would perform under the joint and several obligations. The valuation of this contingent liability is therefore not recorded on the balance sheet of the Bank. The par amount of the outstanding consolidated obligations of all 12 FHLBanks was $658.0 billion at March 31, 2012, and $691.9 billion at December 31, 2011. The par value of the Bank's participation in consolidated obligations was $96.7 billion at March 31, 2012, and $101.2 billion at December 31, 2011. At March 31, 2012, the Bank had committed to the issuance of $1.6 billion in consolidated obligation bonds, none of which were hedged with associated interest rate swaps. At December 31, 2011, the Bank had committed to the issuance of $200 million in consolidated obligation bonds, of which $200 million were hedged with associated interest rate swaps. For additional information on the Bank's joint and several contingent liability obligation, see “Item 8. Financial Statements and Supplementary Data – Note 20 – Commitments and Contingencies” in the Bank's 2011 Form 10‑K.

In addition, in the ordinary course of business, the Bank engages in financial transactions that, in accordance with U.S. GAAP, are not recorded on the Bank's balance sheet or may be recorded on the Bank's balance sheet in amounts that are different from the full contract or notional amount of the transactions. For example, the Bank routinely enters into commitments to extend advances and issues standby letters of credit. These commitments and standby letters of credit may represent future cash requirements of the Bank, although the standby letters of credit usually expire without being drawn upon. Standby letters of credit are subject to the same underwriting and collateral requirements as advances made by the Bank. At March 31, 2012, the Bank had $4 million in advance commitments and $3.7 billion in standby letters of credit outstanding. At December 31, 2011, the Bank had $102 million in advance commitments and $5.3 billion in standby letters of credit outstanding. The estimated fair value of the advance commitments was de minimis to the balance sheet at March 31, 2012, and December 31, 2011. The estimated fair value of the letters of credit was $7 million at March 31, 2012, and $6 million at December 31, 2011.

ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Federal Home Loan Bank of San Francisco's (Bank) market risk management objective is to maintain a relatively low exposure of the value of capital and future earnings (excluding the impact of any cumulative net gains or losses on derivatives and associated hedged items and on financial instruments carried at fair value) to changes in interest rates. This profile reflects the Bank's objective of maintaining a conservative asset-liability mix and its commitment to providing value to its members through products and dividends without subjecting their investments in Bank capital stock to significant interest rate risk.

The Bank's Risk Management Policy includes a market risk management objective aimed at maintaining a relatively low exposure of the net portfolio value of capital and future earnings (excluding the impact of any cumulative net gains or losses on derivatives and associated hedged items and on financial instruments carried at

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fair value) to changes in interest rates. See “Total Bank Market Risk” below.

Market risk identification and measurement are primarily accomplished through market value of capital sensitivity analyses, net portfolio value of capital sensitivity analyses, and projected earnings and dividends sensitivity analyses. The Risk Management Policy approved by the Bank's Board of Directors establishes market risk policy limits and market risk measurement standards at the total Bank level as well as at the business segment level. Additional guidelines approved by the Bank's Enterprise Risk Committee (ERC) apply to the Bank's two business segments, the advances-related business and the mortgage-related business. These guidelines provide limits that are monitored at the segment level and are consistent with the Bank's policy limits. Interest rate risk is managed for each business segment on a daily basis, as discussed below in “Segment Market Risk.” At least monthly, compliance with Bank policies and guidelines is presented to the ERC, the asset-liability management committee (ALCO), and the Board of Directors, along with a corrective action plan if applicable.

Total Bank Market Risk

Market Value of Capital Sensitivity and Net Portfolio Value of Capital Sensitivity

The Bank uses market value of capital sensitivity (the interest rate sensitivity of the net fair value of all assets, liabilities, and interest rate exchange agreements) as an important measure of the Bank's exposure to changes in interest rates. As explained below, the Bank continues to measure, monitor, and report on market value of capital sensitivity, but does not have a policy limit for this measure.

Since 2008, the Bank has used net portfolio value of capital sensitivity as the primary market value metric for measuring the Bank's exposure to changes in interest rates and has established a policy limit on net portfolio value of capital sensitivity. This approach uses valuation methods that estimate the value of mortgage-backed securities (MBS) and mortgage loans in alternative interest rate environments based on valuation spreads that existed at the time the Bank acquired the MBS and mortgage loans (acquisition spreads), rather than valuation spreads implied by the current market prices of MBS and mortgage loans (market spreads). Risk metrics based on spreads existing at the time of acquisition of mortgage assets better reflect the interest rate risk of the Bank because the Bank does not intend to sell its mortgage assets and the use of market spreads calculated from estimates of current market prices (which include large embedded liquidity spreads) would not reflect the actual risks faced by the Bank. Beginning in the third quarter of 2009, in the case of specific PLRMBS for which the Bank expects loss of principal in future periods, the par amount of the other-than-temporarily impaired security is reduced by the amount of the projected principal shortfall and the asset price is calculated based on the acquisition spread. This approach directly takes into consideration the impact of projected principal (credit) losses from PLRMBS on the net portfolio value of capital, but eliminates the impact of large liquidity spreads inherent in the prior treatment of other-than-temporarily impaired securities. The Bank continues to monitor both the market value of capital sensitivity and the net portfolio value of capital sensitivity.

The Bank's net portfolio value of capital sensitivity policy limits the potential adverse impact of an instantaneous parallel shift of a plus or minus 100-basis-point change in interest rates from current rates (base case) to no worse than –3% of the estimated net portfolio value of capital. In addition, the policy limits the potential adverse impact of an instantaneous plus or minus 100-basis-point change in interest rates measured from interest rates that are 200 basis points above or below the base case to no worse than –4% of the estimated net portfolio value of capital. In the case where a market risk sensitivity compliance metric cannot be estimated with a parallel shift in interest rates because of prevailing low interest rates, the sensitivity metric is not reported. The Bank's measured net portfolio value of capital sensitivity was within the policy limits as of March 31, 2012.

To determine the Bank's estimated risk sensitivities to interest rates for both the market value of capital sensitivity and the net portfolio value of capital sensitivity, the Bank uses a third-party proprietary asset and liability system to calculate estimated net portfolio values under alternative interest rate scenarios. The system analyzes all of the Bank's financial instruments, including derivatives, on a transaction-level basis using sophisticated valuation models with consistent and appropriate behavioral assumptions and current position data. The system also includes a third-party mortgage prepayment model.

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At least annually, the Bank reexamines the major assumptions and methodologies used in the model, including interest rate curves, spreads for discounting, and prepayment assumptions. The Bank also compares the prepayment assumptions in the third-party model to other sources, including actual prepayment history.

The Market Value of Capital Sensitivity table below presents the sensitivity of the market value of capital (the market value of all of the Bank's assets, liabilities, and associated interest rate exchange agreements, with mortgage assets valued using market spreads implied by current market prices) to changes in interest rates. The table presents the estimated percentage change in the Bank's market value of capital that would be expected to result from changes in interest rates under different interest rate scenarios, using market spread assumptions.
 

Market Value of Capital Sensitivity
Estimated Percentage Change in Market Value of Bank Capital
for Various Changes in Interest Rates
 
 
 
 
 
Interest Rate Scenario(1)
March 31, 2012
 
December 31, 2011
 
+200 basis-point change above current rates
–2.2
%
–3.6
%
+100 basis-point change above current rates
–1.0
 
–2.0
 
–100 basis-point change below current rates(2)
+2.8
 
+5.0
 
–200 basis-point change below current rates(2)
+6.6
 
+9.3
 

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

The Bank's estimates of the sensitivity of the market value of capital to changes in interest rates as of March 31, 2012, show a decline in sensitivity in both the rising rate and declining rate scenarios compared to the estimates as of December 31, 2011. Because of the current low interest rate environment, rates cannot move in a parallel fashion in the declining rate scenarios as they can in the rising rate scenarios. Compared to interest rates as of December 31, 2011, interest rates as of March 31, 2012, were 17 basis points lower for terms of 1 year, 4 basis points higher for terms of 5 years, and 25 basis points higher for terms of 10 years.

As indicated by the table above, the market value of capital sensitivity is adversely affected when rates increase. In general, mortgage assets, including MBS, are expected to remain outstanding for a longer period of time when interest rates increase and prepayment speeds decline as a result of reduced incentives to refinance. Because most of the Bank's MBS were purchased when mortgage asset spreads to pricing benchmarks were significantly lower than what is currently required by investors, the adverse spread difference causes an embedded negative impact on the market value of MBS, which directly reduces the estimated market value of Bank capital. If interest rates increase and MBS consequently remain outstanding for a longer period of time, the adverse spread difference will exist for a longer period of time, causing an even larger embedded negative market value impact than at current interest rate levels. This creates additional downward pressure on the measured market value of capital. As a result, the Bank's measured market value of capital sensitivity to changes in rates is higher than it would be if it were measured based on the fundamental underlying repricing and option risks (a greater decline in the market value of capital when rates increase and a greater increase in the market value of capital when rates decrease). Based on the liquidity premium investors require for these assets and the Bank's intent and ability to hold the assets to maturity, the Bank determined that the market value of capital sensitivity is not the best indication of risk, and the Bank has therefore developed an alternative way to measure that risk, based on estimates of the sensitivity of the net portfolio value of capital.

The Net Portfolio Value of Capital Sensitivity table below presents the sensitivity of the net portfolio value of capital (the net value of the Bank's assets, liabilities, and hedges, with mortgage assets valued using acquisition valuation spreads) to changes in interest rates. The table presents the estimated percentage change in the Bank's net portfolio value of capital that would be expected to result from changes in interest rates under different interest rate

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scenarios based on pricing mortgage assets at spreads that existed at the time of purchase rather than current market spreads. The Bank's estimates of the net portfolio value of capital sensitivity to changes in interest rates as of March 31, 2012, show similar sensitivity compared to the estimates as of December 31, 2011.

Net Portfolio Value of Capital Sensitivity
Estimated Percentage Change in Net Portfolio Value of Bank Capital
for Various Changes in Interest Rates Based on Acquisition Spreads
 
 
 
 
 
Interest Rate Scenario(1)
March 31, 2012
 
December 31, 2011
 
+200 basis-point change above current rates
–2.7
%
–3.3
%
+100 basis-point change above current rates
–1.1
 
–1.5
 
–100 basis-point change below current rates(2)
+1.3
 
+2.0
 
–200 basis-point change below current rates(2)
+1.0
 
+1.8
 

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

On May 27, 2011, the Bank's Board of Directors modified the Bank's Risk Management Policy to provide guidelines for the payment of dividends and the repurchase of excess stock based on the ratio of the Bank's estimated market value of total capital to par value of capital stock. If this ratio at the end of any quarter is: (i) less than 100% but greater than or equal to 90%, any dividend would be limited to an annualized rate no greater than the daily average of the three-month London Interbank Offered Rate (LIBOR) for the applicable quarter (subject to certain conditions), and any excess capital stock repurchases would not exceed $500 million (subject to certain conditions); (ii) less than 90% but greater than or equal to 70%, any dividend and any excess capital stock repurchases would be subject to the same limitations and conditions as in (i) above, except that any excess capital stock repurchases would not exceed 4% of the Bank's outstanding capital stock as of the repurchase date; and (iii) less than 70%, the Bank would not pay a dividend, not repurchase excess capital stock (but continue to redeem excess capital stock as provided in the Bank's Capital Plan), limit the acquisition of certain assets, and review the Bank's risk policies. A decision by the Board of Directors to declare or not declare any dividend or repurchase any excess capital stock is a discretionary matter and is subject to the requirements and restrictions of the Federal Home Loan Bank Act and applicable requirements under the regulations governing the operations of the Federal Home Loan Banks. The ratio of the Bank's estimated market value of total capital to par value of capital stock was 103.8% as of March 31, 2012.

Potential Dividend Yield

The potential dividend yield is a measure used by the Bank to assess financial performance. The potential dividend yield is based on current period economic earnings that exclude the effects of unrealized net gains or losses resulting from the Bank's derivatives and associated hedged items and from financial instruments carried at fair value, which will generally reverse through changes in future valuations and settlements of contractual interest cash flows over the remaining contractual terms to maturity or by the call or put date of the assets and liabilities held under the fair value option, hedged assets and liabilities, and derivatives. Economic earnings also exclude the interest expense on mandatorily redeemable capital stock.

The Bank limits the sensitivity of projected financial performance through a Board of Directors' policy limit on projected adverse changes in the potential dividend yield. The Bank's potential dividend yield sensitivity policy limits the potential adverse impact of an instantaneous parallel shift of a plus or minus 200-basis-point change in interest rates from current rates (base case) to no worse than –120 basis points from the base case projected potential dividend yield. In the downward shift, the change in interest rates was limited so that interest rates did not go below zero. With the indicated interest rate shifts, the potential dividend yield for the projected 12-month horizon would be expected to decrease by 25 basis points, well within the policy limit of –120 basis points.


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Duration Gap

Duration gap is the difference between the estimated durations (market value sensitivity) of assets and liabilities (including the impact of interest rate exchange agreements) and reflects the extent to which estimated maturity and repricing cash flows for assets and liabilities are matched. The Bank monitors duration gap analysis at the total Bank level and does not have a policy limit. The Bank's duration gap was less than one month at March 31, 2012, and two months at December 31, 2011.

Total Bank Duration Gap Analysis
 
 
 
 
 
 
 
 
 
March 31, 2012
  
December 31, 2011
  
Amount
(In millions)

  
Duration Gap(1)(2)
(In months)

  
Amount
(In millions)

  
Duration Gap(1)(2)
(In months) 

Assets
$
110,087

  
8

  
$
113,552

  
8

Liabilities
105,029

  
8

  
108,847

  
6

Net
$
5,058

  

  
$
4,705

  
2


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

The duration gap as of March 31, 2012, declined compared to the duration gap as of December 31, 2011. Since duration gap is a measure of market value sensitivity, the impact of the extraordinarily wide mortgage asset spreads on duration gap is the same as described in the analysis in “Market Value of Capital Sensitivity” above. As a result of the liquidity premium investors require for these assets and the Bank's intent and ability to hold its mortgage assets to maturity, the Bank does not believe that market value-based sensitivity risk measures provide a fundamental indication of risk.

Segment Market Risk

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

Advances-Related Business

Interest rate risk arises from the advances-related business primarily through the use of shareholder-contributed capital to fund fixed rate investments of targeted amounts and maturities. In general, advances result in very little net interest rate risk for the Bank because most fixed rate advances with original maturities greater than three months and all advances with embedded options are hedged contemporaneously with an interest rate swap or option with terms offsetting the advance. The interest rate swap or option generally is maintained as a hedge for the life of the advance. These hedged advances effectively create a pool of variable rate assets, which, in combination with the strategy of raising debt swapped to variable rate liabilities, creates an advances portfolio with low net interest rate risk.

Non-MBS investments used for liquidity management generally have maturities of less than three months or are variable rate investments. These investments effectively match the interest rate risk of the Bank's variable rate funding. To leverage the Bank's capital stock, the Bank also invests in agency or TLGP securities, generally with terms of less than two years. These investments may be variable rate or fixed rate, and the interest rate risk resulting from the fixed rate coupon is hedged with an interest rate swap or fixed rate debt.

The interest rate risk in the advances-related business is primarily associated with the Bank's strategy for investing shareholders' contributed capital stock (including mandatorily redeemable capital stock). The Bank's strategy is to generally invest 50% of capital stock in short-term investments (maturities of three months or less) and 50% in intermediate-term investments (laddered portfolio of investments with maturities of up to four years). However, this

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strategy may be altered from time to time depending on market conditions. The strategy to invest 50% of capital stock in short-term assets is intended to mitigate the market value of capital risks associated with the potential repurchase or redemption of excess capital stock. Excess capital stock primarily results from a decline in a borrower's advances or from a membership termination. Under the Bank's capital plan, capital stock, when repurchased or redeemed, is required to be repurchased or redeemed at its par value of $100 per share, subject to certain regulatory and statutory limits. The strategy to invest 50% of capital stock in a laddered portfolio of instruments with short to intermediate maturities is intended to take advantage of the higher earnings available from a generally positively sloped yield curve, when intermediate-term investments generally have higher yields than short-term investments.

The Bank updates the repricing and maturity gaps for actual asset, liability, and derivatives transactions that occur in the advances-related segment each day. The Bank regularly compares the targeted repricing and maturity gaps to the actual repricing and maturity gaps to identify rebalancing needs for the targeted gaps. On a weekly basis, the Bank evaluates the projected impact of expected maturities and scheduled repricings of assets, liabilities, and interest rate exchange agreements on the interest rate risk of the advances-related segment. The analyses are prepared under base case and alternate interest rate scenarios to assess the effect of put options and call options embedded in the advances, related financing, and hedges. These analyses are also used to measure and manage potential reinvestment risk (when the remaining term of advances is shorter than the remaining term of the financing) and potential refinancing risk (when the remaining term of advances is longer than the remaining term of the financing).

Because of the short-term and variable rate nature of the assets, liabilities, and derivatives of the advances-related business, the Bank's interest rate risk guidelines address the amounts of net assets that are expected to mature or reprice in a given period. Net market value sensitivity analyses and net interest income simulations are also used to identify and measure risk and variances to the target interest rate risk exposure in the advances-related segment.

Mortgage-Related Business

The Bank's mortgage assets include MBS, most of which are classified as held-to-maturity or as available-for-sale, with a small amount classified as trading, and mortgage loans held for portfolio purchased under the MPF Program. The Bank is exposed to interest rate risk from the mortgage-related business because the principal cash flows of the mortgage assets and the liabilities that fund them are not exactly matched through time and across all possible interest rate scenarios, given the uncertainty of mortgage prepayments and the existence of interest rate caps on certain adjustable rate MBS.

The Bank purchases a mix of intermediate-term fixed rate and adjustable rate MBS. Generally, purchases of long-term fixed rate MBS have been relatively small; any MPF loans that have been acquired are medium- or long-term fixed rate mortgage assets. This results in a mortgage portfolio that has a diversified set of interest rate risk attributes.

The estimated market risk of the mortgage-related business is managed both at the time an individual asset is purchased and on a total portfolio level. At the time of purchase (for all significant mortgage asset acquisitions), the Bank analyzes the estimated earnings sensitivity and estimated net market value sensitivity, taking into consideration the estimated prepayment sensitivity of the mortgage assets and anticipated funding and hedging activities under various interest rate scenarios. The related funding and hedging transactions are executed at or close to the time of purchase of a mortgage asset.

At least monthly, the Bank reviews the estimated market risk of the entire portfolio of mortgage assets and related funding and hedging transactions. The Bank then considers rebalancing strategies to modify the estimated mortgage portfolio market risks. Periodically, the Bank performs more in-depth analyses, which include the impacts of non-parallel shifts in the yield curve and assessments of unanticipated prepayment behavior. Based on these analyses, the Bank may take actions to rebalance the mortgage portfolio's risk profile. These rebalancing strategies may include entering into new funding and hedging transactions, forgoing or modifying certain funding or hedging transactions normally executed with new mortgage purchases, or terminating certain funding and hedging

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transactions for the mortgage asset portfolio.

The Bank manages the estimated interest rate risk associated with mortgage assets, including prepayment risk, through a combination of debt issuance and derivatives. The Bank may obtain funding through callable and non-callable FHLBank System debt and may execute derivatives transactions to achieve principal cash flow patterns and market value sensitivities for the liabilities and derivatives that provide a significant offset to the interest rate and prepayment risks associated with the mortgage assets. Debt issued to finance mortgage assets may be fixed rate debt, callable fixed rate debt, or adjustable rate debt. Derivatives may be used as temporary hedges of anticipated debt issuance or long-term hedges of debt used to finance the mortgage assets. The derivatives used to hedge the interest rate risk of fixed rate mortgage assets generally may be options to enter into interest rate swaps (swaptions) or callable and non-callable pay-fixed interest rate swaps.

Since 2008, the Bank has used net portfolio value of capital sensitivity as a primary market value metric for measuring the Bank's exposure to interest rates and has established a policy limit on net portfolio value of capital sensitivity. This approach uses valuation methods that estimate the value of MBS and mortgage loans in alternative interest rate environments based on valuation spreads that existed at the time the Bank acquired the MBS and mortgage loans (acquisition spreads), rather than valuation spreads implied by the current market prices of MBS and mortgage loans (market spreads). Risk metrics based on spreads existing at the time of acquisition of the mortgage assets better reflect the interest rate risk of the Bank because the Bank does not intend to sell its mortgage assets and the use of market spreads calculated from estimates of current market prices (which include large embedded liquidity spreads) would not reflect the actual risks faced by the Bank. Beginning in the third quarter of 2009, in the case of specific PLRMBS for which the Bank expects loss of principal in future periods, the par amount of the other-than-temporarily impaired security is reduced by the amount of the projected principal shortfall and the asset price is calculated based on the acquisition spread. This approach directly takes into consideration the impact of projected principal (credit) losses from PLRMBS on the net portfolio value of capital, but eliminates the impact of large liquidity spreads inherent in the prior treatment of other-than-temporarily impaired securities. The Bank continues to monitor both the market value of capital sensitivity and the net portfolio value of capital sensitivity attributable to the mortgage-related business.

The following table presents results of the estimated market value of capital sensitivity analysis attributable to the mortgage-related business as of March 31, 2012, and December 31, 2011.
 

Market Value of Capital Sensitivity
Estimated Percentage Change in Market Value of Bank Capital
Attributable to the Mortgage-Related Business for Various Changes in Interest Rates
 
 
 
 
 
Interest Rate Scenario(1)
March 31, 2012
 
December 31, 2011
 
+200 basis-point change
–0.3
%
–1.2
%
+100 basis-point change
–0.2
 
–0.8
 
–100 basis-point change(2)
+1.4
 
+3.2
 
–200 basis-point change(2)
+4.7
 
+7.0
 

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

The Bank's estimates of the sensitivity of the market value of capital to changes in interest rates as of March 31, 2012, show a decline in sensitivity in both the rising and declining rate scenarios compared to the estimates as of December 31, 2011. Compared to interest rates as of December 31, 2011, interest rates as of March 31, 2012, were 17 basis points lower for terms of 1 year, 4 basis points higher for terms of 5 years, and 25 basis points higher for terms of 10 years.

As indicated by the table above, the market value of capital sensitivity is adversely affected when rates increase. In

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general, mortgage assets, including MBS, are expected to remain outstanding for a longer period of time when interest rates increase and prepayment speeds decline as a result of reduced incentives to refinance. Because most of the Bank's MBS were purchased when mortgage asset spreads to pricing benchmarks were significantly lower than what is currently required by investors, the adverse spread difference causes an embedded negative impact on the market value of MBS, which directly reduces the estimated market value of Bank capital. If interest rates increase and MBS consequently remain outstanding for a longer period of time, the adverse spread difference will exist for a longer period of time, causing an even larger embedded negative market value impact than exists at current interest rate levels. This creates additional downward pressure on the measured market value of capital. As a result, the Bank's measured market value of capital sensitivity to changes in rates is higher than it would be if it were measured based on the fundamental underlying repricing and option risks (a greater decline in the market value of capital when rates increase and a greater increase in the market value of capital when rates decrease). Based on the liquidity premium investors require for these assets and the Bank's intent and ability to hold the mortgage assets to maturity, the Bank determined that the market value of capital sensitivity is not the best indication of risk, and the Bank has therefore developed an alternative way to measure that risk, based on estimates of the sensitivity of the net portfolio value of capital.
The Bank's interest rate risk policies and guidelines for the mortgage-related business address the net portfolio value of capital sensitivity of the assets, liabilities, and derivatives of the mortgage-related business. The following table presents the estimated percentage change in the value of Bank capital attributable to the mortgage-related business that would be expected to result from changes in interest rates under different interest rate scenarios based on pricing mortgage assets at spreads that existed at the time of purchase rather than current market spreads. The Bank's estimates of the net portfolio value of capital sensitivity to changes in interest rates as of March 31, 2012, show substantially the same sensitivity compared to the estimates as of December 31, 2011.

Net Portfolio Value of Capital Sensitivity
Estimated Percentage Change in Net Portfolio Value of Bank Capital
Attributable to the Mortgage-Related Business for Various Changes in
Interest Rates Based on Acquisition Spreads
 
 
 
 
 
Interest Rate Scenario(1)
March 31, 2012
 
December 31, 2011
 
+200 basis-point change above current rates
–1.2
%
–1.4
%
+100 basis-point change above current rates
–0.4
 
–0.6
 
–100 basis-point change below current rates(2)
+0.2
 
+0.6
 
–200 basis-point change below current rates(2)
–0.6
 
+0.1
 

(1)
Instantaneous change from actual rates at dates indicated.
(2)
Interest rates for each maturity are limited to non-negative interest rates.
 
ITEM 4.
CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

The senior management of the Federal Home Loan Bank of San Francisco (Bank) is responsible for establishing and maintaining a system of disclosure controls and procedures designed to ensure that information required to be disclosed by the Bank in the reports filed or submitted under the Securities Exchange Act of 1934 (1934 Act) is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. The Bank's disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Bank in the reports that it files or submits under the 1934 Act is accumulated and communicated to the Bank's management, including its principal executive officer or officers and principal financial officer or officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the Bank's disclosure controls and procedures, the Bank's management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and the Bank's management necessarily is required to apply its judgment in evaluating the cost-benefit

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relationship of controls and procedures.

Management of the Bank has evaluated the effectiveness of the design and operation of its disclosure controls and procedures with the participation of the president and chief executive officer, executive vice president and chief operating officer, and senior vice president and chief financial officer as of the end of the period covered by this report. Based on that evaluation, the Bank's president and chief executive officer, executive vice president and chief operating officer, and senior vice president and chief financial officer have concluded that the Bank's disclosure controls and procedures were effective at a reasonable assurance level as of the end of the period covered by this report.

Internal Control Over Financial Reporting

During the three months ended March 31, 2012, there were no changes in the Bank's internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Bank's internal control over financial reporting.

Consolidated Obligations

The Bank's disclosure controls and procedures include controls and procedures for accumulating and communicating information in compliance with the Bank's disclosure and financial reporting requirements relating to the joint and several liability for the consolidated obligations of other Federal Home Loan Banks (FHLBanks). Because the FHLBanks are independently managed and operated, the Bank's management relies on information that is provided or disseminated by the Federal Housing Finance Agency (Finance Agency), the Office of Finance, and the other FHLBanks, as well as on published FHLBank credit ratings, in determining whether the joint and several liability regulation is reasonably likely to result in a direct obligation for the Bank or whether it is reasonably possible that the Bank will accrue a direct liability.

The Bank's management also relies on the operation of the joint and several liability regulation, which is located in Section 1270.10 of Title 12 of the Code of Federal Regulations. The joint and several liability regulation requires that each FHLBank file with the Finance Agency a quarterly certification that it will remain capable of making full and timely payment of all of its current obligations, including direct obligations, coming due during the next quarter. In addition, if an FHLBank cannot make such a certification or if it projects that it may be unable to meet its current obligations during the next quarter on a timely basis, it must file a notice with the Finance Agency. Under the joint and several liability regulation, the Finance Agency may order any FHLBank to make principal and interest payments on any consolidated obligations of any other FHLBank, or allocate the outstanding liability of an FHLBank among all remaining FHLBanks on a pro rata basis in proportion to each FHLBank's participation in all consolidated obligations outstanding or on any other basis.

PART II. OTHER INFORMATION

ITEM 1.
LEGAL PROCEEDINGS

The Federal Home Loan Bank of San Francisco (Bank) may be subject to various legal proceedings arising in the normal course of business.
 
In 2010, the Bank filed two complaints in the Superior Court of the State of California, County of San Francisco (San Francisco Superior Court), relating to the purchase of private-label residential mortgage-backed securities (PLRMBS). The Bank seeks rescission and damages and asserts claims for and violations of the California Corporate Securities Act, negligent misrepresentation, and rescission of contract.
 
The Bank's PLRMBS litigation is now in the discovery phase.
 
In 2010, the Bank also filed a complaint in San Francisco Superior Court against Bank of America Corporation (BAC) seeking a determination that BAC or its subsidiaries are successors to the liabilities of Countrywide Financial Corporation (CFC) and other Countrywide entities that are defendants in the Bank's PLRMBS litigation.

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In 2011, the Bank filed an amended complaint that also alleges a claim for control person liability against CFC under the California Corporate Securities Act. CFC filed a demurrer (also referred to as a motion to dismiss in other jurisdictions) to the amended complaint with respect only to the control person liability claim against CFC. At a hearing on March 27, 2012, the Court sustained CFC's demurrer effectively dismissing from the amended complaint the control person liability claim against CFC. The Bank expects to appeal the Court's decision.
 
For a discussion of this litigation, see “Part I. Item 3. Legal Proceedings” in the Bank's Annual Report on Form 10-K for the year ended December 31, 2011.

After consultation with legal counsel, the Bank is not aware of any other legal proceedings that are expected to have a material effect on its financial condition or results of operations or that are otherwise material to the Bank.



ITEM 1A.
RISK FACTORS

For a discussion of risk factors, see “Part I. Item 1A. Risk Factors” in the Federal Home Loan Bank of San Francisco's (Bank's) Annual Report on Form 10-K for the year ended December 31, 2011 (2011 Form 10-K). There have been no material changes from the risk factors disclosed in the “Part I. Item 1A. Risk Factors” section of the Bank's 2011 Form 10-K.

ITEM 6.
EXHIBITS

 
 
 
31.1

  
Certification of the President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
31.2

  
Certification of the Chief Operating Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
31.3

  
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
32.1

  
Certification of the President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
32.2

  
Certification of the Chief Operating Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
32.3

  
Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
101

 
Pursuant to Rule 405 of Regulation S-T, the following financial information from the Bank's quarterly report on Form 10-Q for the period ended March 31, 2012, is formatted in XBRL interactive data files: (i) Statements of Condition at March 31, 2012, and December 31, 2011; (ii) Statements of Income for the Three Months Ended March 31, 2012 and 2011; (iii) Statements of Comprehensive Income for the Three Months Ended March 31, 2012 and 2011; (iv) Statements of Capital for the Three Months Ended March 31, 2012 and 2011; (v) Statements of Cash Flows for the Three Months Ended March 31, 2012 and 2011; and (vi) Notes to Financial Statements, tagged as blocks of text. Pursuant to Rule 406T of Regulation S-T, the interactive data files contained in Exhibit 101 are deemed not “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and are otherwise not subject to the liability of that section.


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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on May 9, 2012.
 
 
Federal Home Loan Bank of San Francisco
 
 
 
/S/ DEAN SCHULTZ
 
Dean Schultz
President and Chief Executive Officer
 
 
 
/S/ LISA B. MACMILLEN
 
Lisa B. MacMillen
Executive Vice President and Chief Operating Officer
 
 
 
/S/ KENNETH C. MILLER
 
Kenneth C. Miller Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
 


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