10-Q 1 d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

 

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, 2009

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File No. 000-51406

 

 

FEDERAL HOME LOAN BANK OF SEATTLE

(Exact name of registrant as specified in its charter)

 

 

 

Federally chartered corporation   91-0852005

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

1501 Fourth Avenue, Suite 1800, Seattle, WA   98101-1693
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (206) 340-2300

 

 

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 requirements for the past 90 days.    Yes  x    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).    Yes  ¨    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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨

   Accelerated filer  ¨
Non-accelerated filer x  (Do not check if a smaller reporting company)    Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Rule 12b-2 of the Act).    Yes  ¨    No  x

The registrant’s stock is not publicly traded and is generally only issued to members of the registrant. Such stock is issued and redeemed at par value, $100 per share, and subject to certain regulatory and statutory limits. As of April 30, 2009, the registrant had 1,585,622 shares of Class A stock and 26,326,365 shares of Class B stock outstanding.

 

 

 


Table of Contents

FEDERAL HOME LOAN BANK OF SEATTLE

Form 10-Q for the quarterly period ended March 31, 2009

TABLE OF CONTENTS

 

          Page

PART I. FINANCIAL INFORMATION

  

Item 1.

   Financial Statements:   
   Statements of Condition – As of March 31, 2009 (unaudited) and December 31, 2008    3
   Statements of Operations – For the three months ended March 31, 2009 and 2008 (unaudited)    4
   Statements of Capital – For the three months ended March 31, 2009 and 2008 (unaudited)    5
   Statements of Cash Flows – For the three months ended March 31, 2009 and 2008 (unaudited)    6
   Condensed Notes to Financial Statements (unaudited)    8

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    38

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk    77

Item 4T.

   Controls and Procedures    81

PART II. OTHER INFORMATION

  

Item 1.

   Legal Proceedings    85

Item 1A.

   Risk Factors    85

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds    87

Item 3.

   Defaults Upon Senior Securities    87

Item 4.

   Submission of Matters to a Vote of Security Holders    87

Item 5.

   Other Information    87

Item 6.

   Exhibits    88

SIGNATURES

   89

 

2


Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

Federal Home Loan Bank of Seattle

Statements of Condition

 

     As of
March 31, 2009
    As of
December 31, 2008
 
(in thousands, except par value)    (unaudited)        

Assets

    

Cash and due from banks

   $ 1,423     $ 1,395  

Interest-bearing deposits

     65    

Securities purchased under agreements to resell

     5,000,000       3,900,000  

Federal funds sold

     4,191,500       2,320,300  

Held-to-maturity securities* (Note 2)

     10,771,909       9,784,891  

Advances (Note 3)

     31,848,395       36,943,851  

Mortgage loans held for portfolio (Note 4)

     4,898,886       5,087,323  

Accrued interest receivable

     141,903       241,124  

Premises, software, and equipment, net

     15,543       14,228  

Derivative assets (Note 7)

     37,831       31,984  

Other assets

     39,971       36,594  
                

Total Assets

   $ 56,947,426     $ 58,361,690  
                

Liabilities and Capital

    

Liabilities

    

Deposits:

    

Interest-bearing

   $ 671,446     $ 582,258  
                

Total deposits

     671,446       582,258  
                

Consolidated obligations, net (Note 5):

    

Discount notes

     22,023,488       15,878,281  

Bonds

     31,457,464       38,590,399  
                

Total consolidated obligations, net

     53,480,952       54,468,680  
                

Mandatorily redeemable capital stock (Note 6)

     920,972       917,876  

Accrued interest payable

     218,073       337,303  

Affordable Housing Program

     15,302       16,210  

Derivative liabilities (Note 7)

     263,583       235,417  

Other liabilities

     416,467       37,621  
                

Total liabilities

     55,986,795       56,595,365  
                

Commitments and contingencies (Note 11)

    

Capital (Note 6)

    

Capital stock:

    

Class B capital stock putable ($100 par value) - issued and outstanding shares: 17,330 shares as of March 31, 2009 and 17,302 shares as of December 31, 2008

     1,733,093       1,730,287  

Class A capital stock putable ($100 par value) - issued and outstanding shares: 1,345 shares as of March 31, 2009 and 1,179 shares as of December 31, 2008

     134,420       117,853  
                

Total capital stock

     1,867,513       1,848,140  
                

Retained earnings (accumulated deficit)

     198,314       (78,876 )

Accumulated other comprehensive loss:

    

Non-credit portion of other-than-temporary impairment loss on held-to-maturity securities

     (1,102,296 )  

Pension benefits (Note 8)

     (2,900 )     (2,939 )
                

Total accumulated other comprehensive loss

     (1,105,196 )     (2,939 )
                

Total capital

     960,631       1,766,325  
                

Total Liabilities and Capital

   $ 56,947,426     $ 58,361,690  
                

 

*

Fair values of held-to-maturity securities were $9,470,236 and $7,857,197 as of March 31, 2009 and December 31, 2008.

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

 

3


Table of Contents

Federal Home Loan Bank of Seattle

Statements of Operations

(Unaudited)

 

     For the Three Months Ended
March 31,
 
     2009     2008  
(in thousands)     

Interest Income

    

Advances

   $ 175,245     $ 424,589  

Prepayment fees on advances, net

     3,988       14,471  

Interest-bearing deposits

     27    

Securities purchased under agreements to resell

     2,591    

Federal funds sold

     1,448       72,937  

Held-to-maturity securities (Other FHLBanks’ consolidated obligations - $0 and $19,697 for the three months ended March 31, 2009 and 2008)

     68,293       125,430  

Mortgage loans held for portfolio

     63,640       68,446  

Loans to other FHLBanks

       14  
                

Total interest income

     315,232       705,887  
                

Interest Expense

    

Consolidated obligations - discount notes

     31,615       145,990  

Consolidated obligations - bonds

     208,772       485,644  

Deposits

     481       9,255  

Securities sold under agreements to repurchase

       3  

Mandatorily redeemable capital stock and other borrowings

       245  
                

Total interest expense

     240,868       641,137  
                

Net Interest Income

     74,364       64,750  

Other Loss

    

Service fees

     572       449  

Total other-than-temporary impairment loss on held-to-maturity securities

     (895,195 )  

Less: Non-credit portion of other-than-temporary impairment loss on held-to-maturity securities

     823,527    
          

Net other-than-temporary impairment loss on held-to-maturity securities

     (71,668 )  

Net (loss) gain on derivatives and hedging activities

     (2,941 )     6,001  

Net realized loss on early extinguishment of consolidated obligations

     (4,526 )     (16,177 )

Other income (loss), net

     13       (106 )
                

Total other loss

     (78,550 )     (9,833 )
                

Other Expense

    

Operating:

    

Compensation and benefits

     6,652       6,358  

Other operating

     4,229       4,512  

Finance Agency/Finance Board

     496       503  

Office of Finance

     484       470  

Other, net

     145       165  
                

Total other expense

     12,006       12,008  
                

(Loss) Income Before Assessments

     (16,192 )     42,909  

Assessments

    

Affordable Housing Program

       3,528  

REFCORP

     33       7,876  
                

Total assessments

     33       11,404  
                

Net (Loss) Income

   $ (16,225 )   $ 31,505  
                

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

 

4


Table of Contents

Federal Home Loan Bank of Seattle

Statements of Capital

(Unaudited)

 

     For the Three Months Ended March 31, 2009 and 2008  
     Class A Capital Stock*     Class B Capital Stock*     Retained Earnings
(Accumulated

Deficit)
    Accumulated
Other
Comprehensive
Loss
    Total
Capital
 
     Shares     Par Value     Shares     Par Value        
(amounts and shares in thousands)                                           

Balance, December 31, 2007

   2,874     $ 287,449     21,411     $ 2,141,141     $ 148,723     $ (1,420 )   $ 2,575,893  

Proceeds from sale of capital stock

   2,534       253,387     34       3,398           256,785  

Repurchase/redemption of capital stock

   (970 )     (97,001 )             (97,001 )

Comprehensive income:

              

Net income

             31,505         31,505  
                                

Total comprehensive income

             31,505         31,505  

Dividends on capital stock:

              

Cash

             (8,371 )       (8,371 )
                                                    

Balance, March 31, 2008

   4,438     $ 443,835     21,445     $ 2,144,539     $ 171,857     $ (1,420 )   $ 2,758,811  
                                                    

Balance, December 31, 2008

   1,179     $ 117,853     17,302     $ 1,730,287     $ (78,876 )   $ (2,939 )   $ 1,766,325  

Cumulative effect of adjustments to opening balance relating to FSP FAS 115-2

             293,415       (293,415 )  

Proceeds from sale of capital stock

   188       18,820     43       4,318           23,138  

Net shares reclassified to mandatorily redeemable capital stock

   (22 )     (2,253 )   (15 )     (1,512 )         (3,765 )

Comprehensive loss:

              

Net loss

             (16,225 )       (16,225 )

Non-credit portion of other-than-temporary impairment loss on held-to-maturity securities, net

               (823,527 )     (823,527 )

Accretion of non-credit portion of other-than-temporary impairment loss on held-to-maturity securities

               14,646       14,646  

Pension benefits

               39       39  
                                

Total comprehensive loss

             277,190       (1,102,257 )     (825,067 )
                                                    

Balance, March 31, 2009

   1,345     $ 134,420     17,330     $ 1,733,093     $ 198,314     $ (1,105,196 )   $ 960,631  
                                                    

 

*

Putable.

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

 

5


Table of Contents

Federal Home Loan Bank of Seattle

Statements of Cash Flows

(Unaudited)

 

     For the Three Months Ended
March 31,
 
     2009     2008  
(in thousands)             

Operating Activities

    

Net (loss) income

   $ (16,225 )   $ 31,505  

Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:

    

Depreciation and amortization

     (59,371 )     4,548  

Change in net fair value adjustment on derivative and hedging activities

     (28,414 )     75,941  

Loss on extinguishment of consolidated obligations

     4,526       16,158  

Net other-than-temporary impairment loss on held-to-maturity securities

     71,668    

Other

     (3 )     131  

Net change in:

    

Accrued interest receivable

     99,219       51,126  

Other assets

     (568 )     6,661  

Accrued interest payable

     (119,230 )     (102,020 )

Other liabilities

     (3,787 )     2,949  
                

Total adjustments

     (35,960 )     55,494  
                

Net cash (used in) provided by operating activities

     (52,185 )     86,999  
                

Investing Activities

    

Net change in:

    

Interest-bearing deposits

     43,845    

Deposits with other FHLBanks

     (65 )  

Securities purchased under agreements to resell

     (1,100,000 )  

Federal funds sold

     (1,871,200 )     (9,847,800 )

Premises, software and equipment

     (2,196 )     (542 )

Held-to-maturity securities:

    

Net increase in short-term

     (1,845,000 )     (4,460,200 )

Proceeds from maturities

     545,002       2,272,191  

Purchases of long-term

     (178,672 )     (597,666 )

Advances:

    

Proceeds

     26,133,145       39,055,516  

Made

     (21,112,400 )     (31,049,733 )

Mortgage loans held for portfolio:

    

Principal collections

     186,762       141,295  
                

Net cash provided by (used in) investing activities

     799,221       (4,486,939 )
                

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

 

6


Table of Contents

Federal Home Loan Bank of Seattle

Statements of Cash Flows – (Continued)

(Unaudited)

 

     For the Three Months Ended
March 31,
 
     2009     2008  
(in thousands)             

Financing Activities

    

Net change in:

    

Deposits

   $ 89,188     $ 331,838  

Net proceeds from issuance of consolidated obligations:

    

Discount notes

     141,514,120       264,620,585  

Bonds

     11,314,822       13,182,044  

Payments for maturing and retiring consolidated obligations:

    

Discount notes

     (135,315,357 )     (259,531,300 )

Bonds

     (18,372,250 )     (14,355,071 )

Proceeds from issuance of capital stock

     23,138       256,785  

Payments for interest on mandatorily redeemable capital stock

       204  

Payments for repurchase of capital stock

       (97,001 )

Payments for redemption of mandatorily redeemable capital stock

     (669 )  

Cash dividends paid

       (8,371 )
                

Net cash (used in) provided by financing activities

     (747,008 )     4,399,713  
                

Net increase (decrease) in cash and cash equivalents

     28       (227 )

Cash and cash equivalents at beginning of the period

     1,395       1,197  
                

Cash and cash equivalents at end of the period

   $ 1,423     $ 970  
                

Supplemental Disclosures

    

Interest paid

   $ 360,099     $ 742,954  

AHP payments

   $ 908     $ 1,627  

REFCORP payments

   $       $ 4,687  

Real-estate owned

   $ 266     $    

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

 

7


Table of Contents

Federal Home Loan Bank of Seattle

Condensed Notes to Financial Statements – (Unaudited)

 

Note 1. Basis of Presentation, Adoptions of Accounting Principles, and Recently Issued Accounting Standards and Interpretations

Basis of Presentation

These unaudited financial statements and condensed notes should be read in conjunction with the 2008 audited financial statements and related notes (2008 Audited Financials) included in the 2008 annual report on Form 10-K of the Federal Home Loan Bank of Seattle (Seattle Bank). These unaudited financial statements and condensed notes have been prepared in conformity with accounting principles generally accepted in the United States (GAAP) for interim financial information. Certain financial information that is required in the annual financial statements may not be required for interim financial reporting purposes and has been condensed or omitted. In the opinion of management, all adjustments (consisting only of normal recurring accruals), considered necessary for a fair statement have been included. The financial condition as of and the operating results for the three months ended March 31, 2009 are not necessarily indicative of the condition or results that may be expected as of or for the year ending December 31, 2009.

Use of Estimates

The preparation of financial statements in accordance with GAAP requires management to make assumptions and estimates. These assumptions and estimates affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of income and expenses. Actual results could differ from these estimates.

Reclassifications

During the third quarter of 2008, on a retrospective basis, we reclassified our investments in negotiable certificates of deposit, previously reported as interest-bearing deposits, as held-to-maturity securities in our Statements of Condition and Operations based on the definition of a debt security under Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities. This reclassification had no effect on total assets, net interest income, or net income. The effect of this reclassification on our Statement of Operations for the three months ended March 31, 2008 was $14.0 million moving from interest income on interest-bearing deposits to interest income on held-to-maturity securities.

Adoptions of Accounting Principles and Recently Issued Accounting Standards and Interpretations

FSP No. FAS 157-2, Effective Date of FASB Statement No. 157 (FSP FAS 157-2)

In February 2008, the Financial Accounting Standards Board (FASB) issued FSP FAS 157-2, which delayed the effective date of SFAS No. 157, Fair Value Measurements (SFAS 157) by one year (January 1, 2009 for the Seattle Bank) for non-financial assets and liabilities, except for items that are recognized or disclosed in the financial statements on a recurring basis. Application of SFAS 157 as of January 1, 2009 to our non-financial assets and liabilities, which consist primarily of real-estate owned, did not have a significant effect on our financial condition, results of operations, or cash flows.

SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities – an Amendment of FASB Statement No. 133 (SFAS 161)

In March 2008, the FASB issued SFAS 161, which requires enhanced disclosures on the effects of derivative instruments and hedging activities on an entity’s financial position, financial performance, and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008 (January 1, 2009 for the Seattle Bank). Our adoption of SFAS 161 as of January 1, 2009 resulted in additional financial statement disclosures (see Note 7) but did not impact our results of operations, financial condition, or cash flows.

FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (FSP FAS

115-2)

On April 9, 2009, the FASB issued FSP FAS 115-2, which is intended to provide greater clarity to investors about the credit and noncredit components of other-than-temporary impairments (OTTI) of debt securities and to more effectively communicate

 

8


Table of Contents

when an OTTI event has occurred. FSP FAS 115-2 amends the OTTI guidance in GAAP for debt securities to make the guidance more operational, improves the presentation and disclosure of OTTI on debt and equity securities, and changes the calculation for the amount of OTTI recognized in earnings in the financial statements. FSP FAS 115-2 does not amend existing recognition and measurement guidance related to OTTI of equity securities. For debt securities where the fair value of a security is less than its amortized cost basis, FSP FAS 115-2 requires an entity to assess whether (a) it has the intent to sell the debt security or (b) it is more likely than not that it will be required to sell the debt security before the security’s anticipated recovery. If either of these conditions is met, an OTTI on the security must be recognized in the statement of income for the difference between the fair value of the debt security and its amortized cost basis.

In instances in which a determination is made that a credit loss (defined by FSP FAS 115-2 as the difference between the present value of the cash flows expected to be collected and the amortized cost basis) exists but the entity does not intend to sell the debt security and it is not more likely than not that the entity will be required to sell the debt security before the anticipated recovery of its amortized cost basis (i.e., the previous amortized cost basis less any current-period credit loss), FSP FAS 115-2 changes the presentation and amount of the OTTI recognized in the statement of income. In these instances, the impairment is separated into (a) the amount of the total impairment related to the credit loss and (b) the amount of the total impairment related to all other factors. The amount of the total OTTI related to the credit loss is recognized in earnings. The amount of the total impairment related to all other factors is recognized in other comprehensive income and is amortized over the remaining life of the debt security as an increase in the carrying value of the security (with no effect on earnings unless the security is subsequently sold or there is additional OTTI recognized). The total OTTI is presented in the statement of income with an offset for the portion of the total OTTI that is recognized in other comprehensive income. Previously, in all cases, if an impairment was determined to be other-than-temporary, an impairment loss was recognized in earnings in an amount equal to the entire difference between the security’s amortized cost basis and its fair value at the statement of condition date of the reporting period for which the assessment was made. The new presentation provides additional information about the amounts that the entity does not expect to collect related to a debt security.

FSP FAS 115-2 is effective and should be applied prospectively for financial statements issued for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for reporting periods ending after March 15, 2009. Early adoption of FSP FAS 115-2 also requires early adoption of FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. When adopting FSP FAS 115-2, an entity is required to record a cumulative-effect adjustment as of the beginning of the period of adoption to reclassify the non-credit component of a previously recognized OTTI from retained earnings to accumulated other comprehensive income if the entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis.

We adopted FSP FAS 115-2 as of January 1, 2009, and recognized the effects of applying FSP FAS 115-2 as a change in accounting principle. We recognized the $293.4 million cumulative effect of initially applying FSP FAS 115-2 as an increase to our retained earnings at January 1, 2009, with a corresponding adjustment to accumulated other comprehensive loss. Had we elected not to early adopt FSP FAS 115-2, we would have recognized the entire first quarter 2009 OTTI amount of $895.2 million in net loss. The adoption of FSP FAS 115-2 also increased financial statement disclosures (see Note 2).

FSP No. FAS 157-4, Determining Fair Value When Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions that are Not Orderly (FSP FAS 157-4)

On April 9, 2009, the FASB issued FSP FAS 157-4, which clarifies the application of SFAS 157 when there is no active market or where the price inputs being used represent distressed sales. FSP FAS 157-4 provides additional guidance for estimating the fair value of an asset or liability (financial and non-financial) when the volume and level of activity for the asset or liability have significantly decreased and for identifying transactions that are not orderly. FSP FAS 157-4 is effective for periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. We elected to adopt FSP FAS 157-4 for the quarter ended March 31, 2009, and adoption did not have a material impact on our financial condition, results of operations, or cash flows.

FSP No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (FSP FAS 107-1 and APB 28-1)

On April 9, 2009, the FASB issued FSP FAS 107-1 and APB 28-1, which amends SFAS No. 107, Disclosures about Fair Value of Financial Instruments (SFAS 107), to require disclosures about the fair value of financial instruments within the scope of SFAS 107, including disclosure of the method(s) and significant assumptions used to estimate the fair value of financial instruments, in interim as well as in annual financial statements. The FSP also amends APB Opinion No. 28, Interim Financial Reporting, to require those disclosures in interim financial statements. FSP FAS 107-1 and APB 28-1 is effective for interim and

 

9


Table of Contents

annual periods ending after June 15, 2009, with early adoption permitted. We adopted FSP FAS 107-1 and APB 28-1 for the quarter ended March 31, 2009, with no effect on our financial condition, results of operations, cash flows, or existing interim disclosures.

 

Note 2. Held-To-Maturity Securities

For accounting policies and additional information concerning held-to-maturity securities, see Notes 1 and 5 in our 2008 Audited Financials included in our 2008 annual report on Form 10-K.

Major Security Types

The following tables summarize our held-to-maturity securities as of March 31, 2009 and December 31, 2008.

 

     As of March 31, 2009

Held-to-Maturity Securities

   Amortized
Cost Basis (1)
   OTTI
Recognized in
Other
Comprehensive
Loss
    Carrying
Value (2)
   Gross
Unrealized
Holding Gains
   Gross
Unrealized
Holding Losses
    Estimated
Fair Value
(in thousands)                                

Certificates of deposit (3)

   $ 2,377,000      $ 2,377,000    $ 229    $ (1 )   $ 2,377,228

Other U.S. agency obligations (4)

     60,311        60,311      835      (64 )     61,082

Government-sponsored enterprises (5)

     678,895        678,895      60,201        739,096

State or local housing agency obligations

     5,560        5,560         (3 )     5,557

Other (6)

     1,100,000        1,100,000      301        1,100,301
                                           

Subtotal

     4,221,766        4,221,766      61,566      (68 )     4,283,264
                                           

Residential Mortgage-Backed Securities

               

Government-sponsored enterprises (5)

     2,079,031        2,079,031      22,364      (11,638 )     2,089,757

Other U.S. agency obligations (4)

     4,629        4,629      43        4,672

Private-label

     5,568,779      (1,102,296 )     4,466,483         (1,373,940 )     3,092,543
                                           

Subtotal

     7,652,439      (1,102,296 )     6,550,143      22,407      (1,385,578 )     5,186,972
                                           

Total

   $ 11,874,205    $ (1,102,296 )   $ 10,771,909    $ 83,973    $ (1,385,646 )   $ 9,470,236
                                           
          As of December 31, 2008

Held-to-Maturity Securities

        Amortized
Cost Basis
    Carrying
Value
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Estimated
Fair Value
(in thousands)                                

Other U.S. agency obligations (4)

      $ 64,164     $ 64,164    $ 876    $ (68 )   $ 64,972

Government-sponsored enterprises (5)

        875,604       875,604      62,480        938,084

State or local housing agency obligations

        5,700       5,700      1        5,701

Other (6)

        1,250,000       1,250,000      1,118        1,251,118
                                       

Subtotal

        2,195,468       2,195,468      64,475      (68 )     2,259,875
                                       

Residential Mortgage-Backed Securities

               

Government-sponsored enterprises (5)

        1,997,942       1,997,942      12,855      (24,074 )     1,986,723

Other U.S. agency obligations (4)

        4,759       4,759      10      (19 )     4,750

Private-label

        5,586,722       5,586,722         (1,980,873 )     3,605,849
                                       

Subtotal

        7,589,423       7,589,423      12,865      (2,004,966 )     5,597,322
                                       

Total

      $ 9,784,891     $ 9,784,891    $ 77,340    $ (2,005,034 )   $ 7,857,197
                                       

 

(1)

In accordance with FSP FAS 115-2, the amortized cost basis includes unpaid principal balance, unamortized purchase premiums and discounts, and previous other-than-temporary impairments recognized in earnings (less any cumulative-effect adjustments recognized).

(2)

In accordance with FSP FAS 115-2, effective January 1, 2009, the carrying value of held-to-maturity securities represents amortized cost after adjustment for any non-credit related impairment (including subsequent accretion) recognized in other comprehensive loss.

(3)

Consists of certificates of deposit that meet the definition of a security under SFAS 115.

(4)

Primarily consists of Government National Mortgage Association (Ginnie Mae), or Small Business Association (SBA) investment pools.

(5)

Primarily consists of debt securities issued by Federal Home Loan Mortgage Corporation (Freddie Mac), Federal National Mortgage Association (Fannie Mae), or Tennessee Valley Authority (TVA).

(6)

Consists of promissory notes guaranteed by the Federal Deposit Insurance Corporation (FDIC) under the Temporary Liquidity Guarantee Program (TLGP).

As of March 31, 2009 and December 31, 2008, we held $2.0 billion and $938.8 million of held-to-maturity securities purchased from members or affiliates of members who own more than 10% of our total outstanding capital stock and outstanding mandatorily redeemable capital stock or members with representatives serving on our Board of Directors (Board). See Note 10 for additional information concerning these related parties.

Our investment in mortgage-backed securities represented 219.3% and 282.4% of our regulatory capital as of March 31, 2009 and December 31, 2008.

 

10


Table of Contents

Unrealized Losses on Held-to-Maturity Securities

The following tables summarize our held-to-maturity securities with gross unrealized losses, aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position as of March 31, 2009 and December 31, 2008.

 

     As of March 31, 2009  
     Less than 12 months     12 months or more     Total  

Held-to-Maturity Securities in Unrealized Loss Positions

   Estimated
Fair Value
   Gross
Unrealized
Losses
    Estimated
Fair Value
   Gross
Unrealized
Losses
    Estimated
Fair Value
   Gross
Unrealized
Losses
 
(in thousands)                                  

Certificates of deposit

   $ 936,999    $ (1 )   $      $       $ 936,999    $ (1 )

Other U.S. agency obligations (1)

     7,978      (64 )          7,978      (64 )

State or local housing agency obligations

     377      (3 )          377      (3 )
                                             

Subtotal

     945,354      (68 )          945,354      (68 )
                                             

Residential Mortgage-Backed Securities

               

Government-sponsored enterprises (2)

     439,951      (10,088 )     176,361      (1,550 )     616,312      (11,638 )

Temporarily impaired private-label

     348,146      (200,611 )     2,165,171      (1,173,329 )     2,513,317      (1,373,940 )

Other-than-temporarily impaired private-label

          579,226      (1,102,296 )     579,226      (1,102,296 )
                                             

Subtotal

     788,097      (210,699 )     2,920,758      (2,277,175 )     3,708,855      (2,487,874 )
                                             

Total

   $ 1,733,451    $ (210,767 )   $ 2,920,758    $ (2,277,175 )   $ 4,654,209    $ (2,487,942 )
                                             
     As of December 31, 2008  
     Less than 12 months     12 months or more     Total  

Held-to-Maturity Securities in Unrealized Loss Positions

   Estimated
Fair Value
   Gross
Unrealized
Losses
    Estimated
Fair Value
   Gross
Unrealized
Losses
    Estimated
Fair Value
   Gross
Unrealized
Losses
 
(in thousands)                                  

Other U.S. agency obligations (1)

   $ 8,107    $ (68 )   $      $       $ 8,107    $ (68 )
                                             

Subtotal

     8,107      (68 )          8,107      (68 )
                                             

Residential Mortgage-Backed Securities

               

Other U.S. agency obligations (1)

     4,118      (19 )          4,118      (19 )

Government-sponsored enterprises (2)

     536,268      (15,380 )     429,243      (8,694 )     965,511      (24,074 )

Private-label

     1,045,671      (219,697 )     2,401,023      (1,761,176 )     3,446,694      (1,980,873 )
                                             

Subtotal

     1,586,057      (235,096 )     2,830,266      (1,769,870 )     4,416,323      (2,004,966 )
                                             

Total

   $ 1,594,164    $ (235,164 )   $ 2,830,266    $ (1,769,870 )   $ 4,424,430    $ (2,005,034 )
                                             

 

(1)

Primarily consists of Ginnie Mae or SBA investment pools.

(2)

Primarily consists of securities issued by Freddie Mac, Fannie Mae, or TVA.

As of March 31, 2009, 184 of our investment positions had gross unrealized losses totaling $2.5 billion, with the total estimated fair value of these positions approximating 79.3% of their carrying value. Of these 184 positions, 150 positions had gross unrealized losses for at least 12 months. As of December 31, 2008, 186 of our investment positions had gross unrealized losses totaling $2.0 billion, with the total estimated fair value of these positions approximating 68.8% of their carrying value. Of these 186 positions, 127 positions had gross unrealized losses for at least 12 months.

Investments in government-sponsored enterprise securities, specifically debentures issued by Fannie Mae and Freddie Mac, were additionally affected by investor concerns regarding those entities’ capital levels needed to offset expected credit losses that may result from declining home prices. The Housing and Economic Recovery Act of 2008 (Housing Act) contains provisions allowing the U.S. Department of Treasury (U.S. Treasury) to provide support to Fannie Mae and Freddie Mac. Additionally, in September 2008, the U.S. Treasury and the Finance Agency announced that Fannie Mae and Freddie Mac had been placed into conservatorship, with the Finance Agency named as conservator. The Finance Agency is managing Fannie Mae and Freddie Mac in an attempt to stabilize their financial condition and their ability to support the secondary mortgage market.

Credit Risk

Our mortgage-backed security investments consist of agency-guaranteed securities and senior tranches of privately issued prime or Alt-A residential mortgage-backed securities, including hybrid adjustable-rate mortgages (ARMs), option ARMs, etc. Our exposure to the risk of loss on our investments in mortgage-backed securities increases when the loans underlying the mortgage-backed securities exhibit high rates of delinquency and foreclosure, as well as losses on the sale of foreclosed properties. In order to reduce our risk of loss on these investments, all of the mortgage-backed securities owned by the Seattle Bank contain one or more of the following forms of credit protection:

 

11


Table of Contents
   

Subordination – where the mortgage-backed security is structured such that payments to junior classes are subordinated to senior classes to ensure cash flows to the senior classes.

 

   

Excess spread – where the weighted-average coupon rate of the underlying mortgage loans in the pool is higher than the weighted-average coupon rate on the mortgage-backed security. The spread differential may be used to cover any losses that may occur.

 

   

Over-collateralization – where the total outstanding balance on the underlying mortgage loans in the pool is greater than the outstanding mortgage-backed security balance. The excess collateral is available to cover any losses that may occur.

 

   

Insurance wrap – where a third-party bond insurance company (e.g., a monoline insurer) guarantees timely payment of principal and interest on the mortgage-backed security. The bond insurance company is obligated to cover any losses that occur. As of March 31, 2009, the Seattle Bank held $3.6 million in investments with unrealized losses of $2.4 million that had been credit-enhanced by a monoline insurer, MBIA. Although we expect the insurer to be able to meet its contractual obligations, we have additional credit enhancements on these securities such that we expect to collect all amounts due according to their contractual terms. The Seattle Bank does not anticipate investing in any material amount of securities where the primary credit protection is provided by monoline insurers for the foreseeable future.

Our investments in private-label residential mortgage-backed securities were rated “AAA” (or its equivalent) by a nationally recognized statistical rating organization (NRSRO), such as Moody’s Investor Service (Moody’s) or Standard & Poor’s (S&P), at their respective purchase dates. The “AAA”-rated securities achieved their ratings through credit enhancement, primarily subordination and over-collateralization. The following tables summarize the carrying value of our long-term held-to-maturity investments by credit rating as of March 31, 2009 and December 31, 2008.

 

     As of March 31, 2009

Long-Term Investments by Credit Rating

   AAA or
Government
Agency
   AA    A    BBB    Below
Investment
Grade
   Unrated    Total
(in thousands)                                   

U.S. agency obligations

   $ 725,579    $      $      $      $      $ 13,627    $ 739,206

State or local housing investments

     380      5,180                  5,560

Residential mortgage-backed securities

                    

Government-sponsored enterprise

     2,083,660                     2,083,660

Private-label

     2,904,002      96,621      93,483      338,799      1,033,578         4,466,483
                                                

Total long-term investment securities

   $ 5,713,621    $ 101,801    $ 93,483    $ 338,799    $ 1,033,578    $ 13,627    $ 7,294,909
                                                
                    As of March 31, 2009

Long-Term Investments below Investment Grade

                  BB    B    CCC    Total
(in thousands)                                   

Private-label residential mortgage-backed securities

            $ 357,943    $ 305,947    $ 369,688    $ 1,033,578
                                    

Total securities below investment grade

            $ 357,943    $ 305,947    $ 369,688    $ 1,033,578
                                    
     As of December 31, 2008

Long-Term Investments by Credit Rating

   AAA or
Government
Agency
   AA    A    BBB    CCC    Unrated    Total
(in thousands)                                   

U.S. agency obligations

   $ 925,771    $      $      $      $      $ 13,997    $ 939,768

State or local housing investments

     380      5,320                  5,700

Residential mortgage-backed securities

                    

Government-sponsored enterprise

     2,002,701                     2,002,701

Private-label

     5,470,426      56,779      38,905      17,694      2,918         5,586,722
                                                

Total long-term investment securities

   $ 8,399,278    $ 62,099    $ 38,905    $ 17,694    $ 2,918    $ 13,997    $ 8,534,891
                                                

The following table summarizes the unpaid principal balance of our private-label residential mortgage-backed securities by credit rating and year of issuance, as well as the weighted-average credit enhancement on the applicable securities as of March 31, 2009. The current weighted-average credit enhancement is the weighted average percent of par value of subordinated tranches and over-collateralization currently in place that will absorb losses before the investments incur a loss.

 

12


Table of Contents
     As of March 31, 2009

Private-Label Mortgage-Backed Securities Ratings

   Unpaid
Principal Balance
   Amortized
Cost
   Carrying Value    Gross
Unrealized Loss
    Current
Weighted-Average
Credit Enhancement
(in thousands except percentages)                          

Prime

             

AAA

             

2004 and earlier

   $ 1,180,085    $ 1,176,681    $ 1,176,681    $ (79,810 )   6.58
                                 

Total prime

   $ 1,180,085    $ 1,176,681    $ 1,176,681    $ (79,810 )   6.58
                                 

Alt-A

             

AAA

             

2004 and earlier

   $ 615,249    $ 613,804    $ 613,804    $ (110,704 )   6.25

2005

     46,700      46,726      46,726      (19,656 )   22.21

2007

     471,046      468,255      313,750      (302,324 )   45.86

2008

     753,392      753,041      753,041      (349,821 )   34.93

AA

             

2004 and earlier

     8,031      8,031      8,031      (3,871 )   28.94

2005

     48,101      48,097      48,097      (32,221 )   46.74

2007

     40,493      40,493      40,493      (24,090 )   39.94

A

             

2004 and earlier

     2,558      2,553      2,553      (1,646 )   100.00

2005

     7,948      7,948      7,948      (4,457 )   32.35

2007

     82,982      82,982      82,982      (50,960 )   43.82

BBB

             

2005

     70,516      70,552      70,552      (43,551 )   46.50

2006

     85,123      85,123      85,123      (47,205 )   51.09

2007

     183,193      183,124      183,124      (115,941 )   40.66

BB

             

2005

     16,895      16,895      16,895      (9,719 )   27.31

2006

     248,632      239,748      110,774      (152,052 )   45.44

2007

     444,743      441,615      230,274      (299,874 )   41.97

B

             

2004 and earlier

     1,070      1,071      1,071      (720 )   100.00

2005

     49,447      49,436      18,932      (30,503 )   42.68

2006

     322,613      306,571      179,905      (189,329 )   46.24

2007

     263,285      254,820      106,039      (169,600 )   40.98

CCC

             

2005

     49,244      45,916      32,223      (25,335 )   29.99

2006

     351,183      346,173      247,402      (223,785 )   46.14

2007

     308,935      279,124      90,063      (189,062 )   17.09
                                 

Total Alt-A

   $ 4,471,379    $ 4,392,098    $ 3,289,802    $ (2,396,426 )   35.21
                                 

Total

   $ 5,651,464    $ 5,568,779    $ 4,466,483    $ (2,476,236 )   29.23
                                 

Other-Than-Temporary Impairment Assessment

We evaluate our individual held-to-maturity investments for OTTI on at least a quarterly basis. We use indicators, or screens, to determine which impaired, individual securities require additional quantitative evaluation using detailed cash flow analysis. These screens consider numerous factors, which include, but are not limited to, the credit rating; the creditworthiness of the issuers of agency debt securities; the strength of the government-sponsored enterprises’ guarantees; the type of underlying collateral; the duration and severity of the unrealized loss; any credit enhancements or insurance; and certain other collateral-related characteristics such as FICO® credit scores, delinquency rates, and the security’s performance. The relative importance of this qualitative and quantitative information may vary based on the facts and circumstances surrounding each security, as well as on the market and economic environment at the time of our assessment. As part of this process, we consider our intent to sell each debt security and whether it is more likely than not that we would be required to sell such security before its anticipated recovery. If either of these conditions is met, we recognize an OTTI in earnings equal to the entire difference between the security’s amortized cost and its fair value as of the statement of condition date. If neither condition is met, we consider whether or not we will recover the entire amortized cost of the security by comparing our 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. The difference between our best estimate

 

13


Table of Contents

of the present value of the cash flows expected to be collected and the amortized cost basis is considered to be a credit loss, which is recorded in current earnings. The portion of an other-than-temporary impairment loss that is not attributable to the credit loss is recognized through other comprehensive loss.

We determined that for GSE residential mortgage-backed securities, the strength of the issuers’ guarantees through direct obligations or U.S. government support is sufficient to protect us from losses based on current information. Further it is not more likely than not that the Seattle Bank will be required to sell impaired securities prior to their anticipated recovery. We expect to recover the entire cost basis of these securities and have thus concluded that our gross unrealized losses on GSE residential mortgage-backed securities are temporary as of March 31, 2009.

Private-label mortgage-backed securities identified as at risk of OTTI are subjected to a detailed cash flow analysis to determine the projected future cash flows that are more likely than not to be collected. Beginning in the first quarter of 2009, to ensure consistency in determination of the OTTI for private-label mortgage-backed securities among all FHLBanks, the FHLBanks used the same key modeling assumptions for purposes of their cash flow analysis. At-risk securities are evaluated by estimating projected cash that an FHLBank is likely to collect based on an assessment of all available information about each individual security, the structure of the security and certain assumptions, such as the remaining payment terms of the security, prepayment speeds, default rates, loss severity on the collateral supporting the FHLBank’s security, based on underlying loan level borrower and loan characteristics, expected housing price changes, and future interest rates, to determine whether the FHLBank will recover the entire amortized cost basis of the security. A significant input to such analysis is the forecast of housing price changes, which are based on an assessment of the housing market. In response to the ongoing deterioration in housing prices, credit market stress, and weakness in the U.S. economy in the first quarter of 2009, which continued to affect the credit quality of the collateral, the FHLBanks, including the Seattle Bank, modified certain assumptions in their cash flow analyses to reflect more adverse loss severities and more moderate rates of housing price recovery than the FHLBanks used in their analyses as of December 31, 2008. The loan level cash flows and losses are allocated to various security classes, including the security classes owned by each FHLBank, based on the cash flow and loss allocation rules of the individual security. In performing a cash flow analysis, an FHLBank identifies its best estimate of the cash flows expected to be collected. If this estimate results in a present value of expected cash flows that is less than the amortized cost basis of a security (that is, a credit loss exists), an OTTI is considered to have occurred. If there is no credit loss, the impairment is considered temporary.

In accordance with Finance Agency guidance, we contracted with the FHLBank of San Francisco to provide the key modeling assumptions and cash flow analyses for certain of our private-label mortgage-backed securities. Because such assumptions are material to the determination of OTTI, we also established and performed procedures to review the documentation, assumptions, and cash flow analyses provided by the FHLBank of San Francisco in order to ensure such assumptions are reasonable. We employ the third-party risk model and a third-party loan data source specified by Finance Agency guidance to project the lifetime cash flows that would be passed through to us from our at-risk securities.

As a result of our OTTI evaluation as of March 31, 2009, we determined that the present value of the cash flows expected to be collected was less than the amortized cost basis of certain private-label mortgage-backed securities. These securities included nine securities that we identified as other-than-temporarily impaired in 2008 and 15 securities that were identified as other-than-temporarily impaired in the first quarter of 2009. As a result of their continued credit deterioration, additional impairments of $42.4 million related to credit loss and $30.5 million related to all other factors were recorded for the three months ended March 31, 2009 on the nine previously impaired private-label mortgage-backed securities. For the newly identified private-label mortgage-backed securities with OTTI, we recorded impairments of $29.3 million related to credit losses and $793.0 million related to all other factors. We do not intend to sell these securities, and it is not more likely than not that we will be required to sell these securities prior to recovery.

In accordance with FSP FAS 115-2, for the three months ended March 31, 2009, we recognized OTTI charges of $71.7 million related to credit losses on our private-label mortgage-backed securities, which are reported in our Statement of Operations as “net other-than-temporary impairment loss on held-to-maturity securities” and $823.5 million related to non-credit losses, which are reported in our Statement of Condition in accumulated other comprehensive loss as “non-credit portion of OTTI loss on held-to-maturity securities.” The OTTI recognized in accumulated other comprehensive loss will be accreted to the carrying value of each security on a prospective basis, based on the amount and timing of future cash flows, over the remaining life of each security. The accretion increases the carrying value of each security and does not affect earnings unless the security is subsequently sold or has an additional OTTI charge that is recognized in earnings.

The following table summarizes key information as of March 31, 2009 on the private-label securities on which we recorded OTTI during the first quarter of 2009.

 

14


Table of Contents
     As of March 31, 2009    For the Three Months Ended March 31, 2009  

Other-than-Temporarily Impaired Securities

   Unpaid
Principal
Balance
   Amortized
Cost
   Gross
Unrealized
Losses
    Fair
Value
   OTTI
Related to
Credit Loss
    OTTI
Related to
Non-Credit Loss
    Total
OTTI
Loss
 
(in thousands)                  

Alt-A private-label mortgage-backed securities

   $ 1,758,993    $ 1,681,522    $ (1,102,296 )   $ 579,226    $ (71,668 )   $ (823,527 )   $ (895,195 )

Key inputs and assumptions used to measure the amount of credit loss related to private-label mortgage-backed securities include, among other things, prepayments, default rates, and loss severity. To discount expected cash flows, we use the interest rate in effect prior to other-than-temporary impairment.

The following table summarizes the credit loss components of our OTTI charges recognized in earnings for the three months ended March 31, 2009.

 

Credit Loss Component of Other-Than-Temporary Impairment Losses

   For the Three Months Ended
March 31, 2009
(in thousands)     

Balance, January 1, 2009 (1)

   $ 8,693

Additions

  

Credit losses on securities for which OTTI was not previously recognized

     29,234

Additional OTTI credit losses on securities for which an OTTI charge was previously recognized

     42,434
      

Balance, March 31, 2009

   $ 80,361
      

 

(1)

We adopted FSP FAS 115-2 as of January 1, 2009 and recognized the cumulative effect of initially applying this guidance, totaling $293.4 million, as an adjustment to our retained earnings at January 1, 2009, with a corresponding adjustment to other comprehensive loss. This amount represents credit losses remaining in retained earnings related to the adoption of FSP FAS 115-2.

The remaining portion of our held-to-maturity security portfolio has experienced unrealized losses and a decrease in fair value due to market volatility, illiquidity in the marketplace, and credit deterioration in the U.S. mortgage markets. However, the decline is considered temporary as we expect to recover the entire amortized cost basis of the remaining held-to-maturity securities in unrealized loss positions and neither intend to sell these securities nor believe it is more likely than not that we will be required to sell these securities before the anticipated recovery of their amortized cost basis.

Redemption Terms

The amortized cost, carrying value, and estimated fair value, as applicable, of held-to-maturity securities by contractual maturity as of March 31, 2009 and December 31, 2008 are shown below. Expected maturities of some securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.

 

     As of March 31, 2009    As of December 31, 2008

Year of Maturity

   Amortized
Cost Basis
   Carrying
Value
   Estimated
Fair Value
   Amortized
Cost Basis
   Estimated
Fair Value
(in thousands)               

Non-Mortgage-Backed Securities

              

Due in one year or less

   $ 3,560,353    $ 3,560,353    $ 3,561,058    $ 1,524,889    $ 1,527,528

Due after one year through five years

     619,860      619,860      680,426      628,059      689,602

Due after five years through 10 years

     4,924      4,924      4,941      4,622      4,636

Due after 10 years

     36,629      36,629      36,839      37,898      38,109
                                  

Subtotal

     4,221,766      4,221,766      4,283,264      2,195,468      2,259,875
                                  

Mortgage-Backed Securities

     7,652,439      6,550,143      5,186,972      7,589,423      5,597,322
                                  

Total

   $ 11,874,205    $ 10,771,909    $ 9,470,236    $ 9,784,891    $ 7,857,197
                                  

The amortized cost of our mortgage-backed securities classified as held-to-maturity includes net discounts of $1.2 billion and $23.0 million as of March 31, 2009 and December 31, 2008.

We generally execute interest-rate exchange agreements with major broker-dealers under bilateral collateral agreements. As of March 31, 2009, we did not have any securities pledged as collateral to broker-dealers that they cannot sell or repledge.

 

15


Table of Contents
Note 3. Advances

For accounting policies and additional information concerning advances, see Note 6 in our 2008 Audited Financials included in our 2008 annual report on Form 10-K as well as Note 11 in this report.

Redemption Terms

We had advances outstanding at interest rates ranging from 0.20% to 8.62% as of March 31, 2009 and from 0.13% to 8.62% as of December 31, 2008. Our interest rates on our AHP advances ranged from 2.80% to 5.99% as of March 31, 2009 and December 31, 2008.

The following table summarizes the amount and weighted-average interest rate of our advances by term-to-maturity as of March 31, 2009 and December 31, 2008.

 

     As of March 31, 2009    As of December 31, 2008

Term-to-Maturity and Weighted-Average Interest Rates

   Amount     Weighted-
Average
Interest

Rate
   Amount     Weighted-
Average
Interest

Rate
(in thousands, except interest rates)                      

Due in one year or less

   $ 19,777,475     1.96    $ 24,014,584     2.65

Due after one year through two years

     3,798,963     2.76      4,540,058     3.34

Due after two years through three years

     2,076,538     3.34      1,679,058     3.83

Due after three years through four years

     1,542,572     3.39      1,440,120     3.89

Due after four years through five years

     828,311     3.24      1,353,482     3.32

Thereafter

     3,251,513     4.40      3,268,677     4.41
                     

Total par value

     31,275,372     2.51      36,295,979     3.02
                     

Commitment fees

     (765 )        (803 )  

Discount on AHP advances

     (114 )        (126 )  

Discount on advances

     (4,963 )        (5,030 )  

SFAS 133 hedging adjustments

     578,865          653,831    
                     

Total

   $ 31,848,395        $ 36,943,851    
                     

Generally, advances prepaid prior to maturity are subject to a prepayment fee. The prepayment fee is required by regulation and is intended to make us financially indifferent to a borrower’s decision to prepay an advance. Prepayment fees received in connection with the restructure of an existing advance are included in “discount on advances.”

We offer putable advances, on which we have a right to terminate at par at our discretion on specific dates, and callable advances, on which our borrower has the right to terminate at par at its discretion on specific dates. We had putable advances outstanding of $4.4 billion as of March 31, 2009 and December 31, 2008. We had no callable advances outstanding as of either March 31, 2009 or December 31, 2008. We also offer convertible advances, or advances that initially are variable interest-rate advances and then, on a predetermined date, convert to fixed interest-rate advances. We have the option on specified dates to cancel the convertible advance with the borrower. We had convertible advances of $370.0 million outstanding as of March 31, 2009 and December 31, 2008.

Interest-Rate Payment Terms

The following table summarizes advances by interest-rate payment terms as of March 31, 2009 and December 31, 2008.

 

     As of March 31, 2009    As of December 31, 2008

Interest-Rate Payment Terms

   Amount    Percent of Total
Advances
   Amount    Percent of Total
Advances
(in thousands, except percentages)                    

Fixed-interest rate

   $ 23,618,986    75.5    $ 24,844,273    68.5

Variable-interest rate

     7,286,386    23.3      11,081,706    30.5

Floating-to-fixed convertible rate

     370,000    1.2      370,000    1.0
                       

Total par value

   $ 31,275,372    100.0    $ 36,295,979    100.0
                       

Credit Risk

 

16


Table of Contents

We have never experienced a credit loss on an advance. Given the current economic environment, some of our member institutions may experience financial difficulties, including failure, and our credit protection may not be sufficient to protect our security interest. For example, the number of borrowers on our internal credit watch list has trended sharply upward over the past year, generally as a result of increases in non-performing assets and the need for additional capital. Further, in the three months ended March 31, 2009, two of our member institutions failed (three additional member institutions failed subsequent to March 31, 2009, and prior to these unaudited financial statements and condensed notes). All outstanding advances to these members were collateralized and were prepaid by the acquiring institution or the FDIC.

We protect against credit risk on advances by requiring collateral on all advances we fund and may also request additional or substitute collateral during the life of an advance to protect our security interest. As of March 31, 2009 and December 31, 2008, we had rights to collateral, either loans or securities, on a borrower-by-borrower basis, with an estimated fair value in excess of outstanding advances. As a result, we do not expect to incur any credit losses on our advances.

We believe that we have policies and procedures in place to appropriately manage credit risk on advances, including requirements for physical possession or control of pledged collateral, restrictions on borrowing, specific review of each advance request, verifications of collateral, and continuous monitoring of borrowings and the member’s financial condition. The physical possession collateral arrangement reduces our credit risk and allows us to continue lending to members whose financial condition may have weakened. We continue to monitor collateral and credit-worthiness of our members. Accordingly, we have not provided any allowances for losses on advances.

Concentration Risk

As of March 31, 2009, five borrowers held 70.6% of the par value of our outstanding advances, with two borrowers holding 55.5% (JPMorgan Chase Bank N.A., formerly Washington Mutual Bank, F.S.B., with 34.2% and Bank of America Oregon, N.A. with 21.3%). As of December 31, 2008, five borrowers held 68.4% of the par value of our outstanding advances, with three borrowers holding 56.7% (JPMorgan Chase Bank with 35.0%, Bank of America Oregon, N.A. with 11.4%, and Merrill Lynch Bank USA with 10.3%). No other member institutions held advances in excess of 10% of our total advances outstanding as of March 31, 2009 or December 31, 2008.

Although the long-term impact of the BofA/Merrill Lynch merger on membership and advance levels is unknown at this time, Merrill Lynch prepaid its $2.9 billion of outstanding advances during March 2009 and had no outstanding advances as of March 31, 2009. Further, we expect that advance volumes and associated advance interest income that began to decline in the fourth quarter of 2008 will be further negatively impacted as a result of the acquisition of our formerly largest member, Washington Mutual Bank, F.S.B. by JPMorgan Chase Bank N.A., a non-member institution. The majority of this former member’s advances mature during 2009 and it is unknown whether we will be able to replace these advances or reinvest the proceeds of the maturing advances into similarly yielding investments. Because a large concentration of our advances is held by only a few members and a non-member shareholder, changes in this group’s borrowing decisions can significantly affect the amount of our advances outstanding. We expect that the concentration of advances with our largest borrowers will remain significant for the foreseeable future. In addition, the ability of our members to issue FDIC-insured unsecured debt under the TLGP, as well as expanded lending activities by the Federal Reserve, may also adversely impact demand for our advances.

 

Note 4. Mortgage Loans Held for Portfolio

For accounting policies and additional information concerning mortgage loans held for portfolio, see Note 7 in our 2008 Audited Financials included in our 2008 annual report on Form 10-K.

As of March 31, 2009 and December 31, 2008, 87.1% and 87.0% of our outstanding mortgage loans held for portfolio had been purchased from JPMorgan Chase Bank, N.A. (formerly Washington Mutual Bank, F.S.B.). This former member owned more than 10% of our total outstanding capital stock and mandatorily redeemable capital stock as of March 31, 2009 and December 31, 2008.

 

17


Table of Contents

The following table summarizes information on our mortgage loans held for portfolio as of March 31, 2009 and December 31, 2008.

 

Mortgage Loans Held for Portfolio

   As of
March 31, 2009
    As of
December 31, 2008
 
(in thousands)             

Real Estate

    

Fixed interest-rate, medium-term*, single-family mortgage loans

   $ 695,746     $ 732,644  

Fixed interest-rate, long-term*, single-family mortgage loans

     4,195,089       4,345,197  
                

Total loan principal

     4,890,835       5,077,841  

Premiums

     36,211       40,823  

Discounts

     (28,160 )     (31,341 )
                

Total

   $ 4,898,886     $ 5,087,323  
                

 

*

Medium-term is defined as a term of 15 years or less while long-term is defined as a term greater than 15 years.

We have never experienced a credit loss and our former supplemental mortgage insurance provider experienced only two loss claims on our mortgage loans (for which it was reimbursed from the lender risk accounts) prior to the cancellation of our supplemental mortgage insurance policies. Under the Mortgage Purchase Program (MPP), we previously purchased mortgage loans from members and the participating members continue to bear a portion of the credit risk on the outstanding loans. Our total principal of mortgage loans outstanding through the MPP was $4.9 billion and $5.1 billion as of March 31, 2009 and December 31, 2008, which was comprised of $4.7 billion and $4.9 billion in conventional mortgage loans and $197.1 million and $205.4 million in government-insured mortgage loans. The conventional mortgage loans were credit-enhanced at the time of purchase by our participating members to a level equivalent to at least an investment-grade rating through the lender risk account and, prior to April 25, 2008, supplemental mortgage insurance. On April 8, 2008, S&P lowered its counterparty credit and financial strength ratings on Mortgage Guaranty Insurance Corporation (MGIC), our MPP supplemental mortgage insurance provider, from “AA-” to “A” with a negative outlook. On April 25, 2008, we exercised our contractual right and notified MGIC of our intent to cancel our policies with MGIC. The policies were cancelled as of that date.

We conduct a loss reserve analysis on a quarterly basis and have determined that, based on our analysis of our mortgage loan portfolio as of March 31, 2009, the credit enhancement provided by our members in the form of the lender risk account is sufficient to absorb inherent credit losses, that an allowance for credit loss is unnecessary, and that we have the policies and procedures in place to appropriately manage this credit risk.

Credit Risk

The following table presents our mortgage loans past due 90 days or more or in foreclosure and still accruing interest, as a percentage of par, as of March 31, 2009 and December 31, 2008.

 

Mortgage Loans 90-Days Delinquent or in Foreclosure

   As of
March 31, 2009
    As of
December 31, 2008
 
(in thousands, except percentages)             

Total conventional mortgage loan delinquencies, at par

   $ 12,620     $ 8,898  

Total conventional mortgage loans outstanding, at par

     4,693,705       4,872,474  

Percent of delinquent conventional mortgage loans

     0.27 %     0.18 %

Percent of conventional mortgage loans in foreclosure

     0.11 %     0.08 %

Total government-insured mortgage loan delinquencies, at par

   $ 30,067     $ 27,540  

Total government-insured mortgage loans outstanding, at par

     197,130       205,367  

Percent of delinquent government-insured mortgage loans

     15.3 %     13.4 %

As of March 31, 2009, we had no real-estate owned. As of December 31, 2008, the Seattle Bank had one mortgage loan totaling $126,000 classified as real-estate owned.

 

18


Table of Contents
Note 5. Consolidated Obligations

For accounting policies and additional information concerning consolidated obligations, see Note 11 in our 2008 Audited Financials included in our 2008 annual report on Form 10-K.

Consolidated Obligation Discount Notes

Consolidated obligation discount notes are issued to raise short-term funds. Discount notes are consolidated obligations with original maturities up to one year. These notes are issued at less than their face amount and redeemed at par value when they mature.

The following table summarizes the book value, net of discounts and concessions, par value, and weighted-average interest rate for our consolidated obligation discount notes as of March 31, 2009 and December 31, 2008.

 

Consolidated Obligation Discount Notes

   Book Value    Par Value    Weighted-
Average
Interest
Rate*
(in thousands, except interest rates)               

As of March 31, 2009

   $ 22,023,488    $ 22,066,052    0.67
                

As of December 31, 2008

   $ 15,878,281    $ 15,899,022    1.14
                

 

*

The consolidated obligation discount notes’ weighted-average interest rate represents an implied rate.

Consolidated Obligation Bonds

Redemption Terms

The following table summarizes our participation in consolidated obligation bonds outstanding by year of contractual maturity as of March 31, 2009 and December 31, 2008.

 

     As of March 31, 2009    As of December 31, 2008

Contractual Maturity and Weighted-Average Interest Rates

   Amount     Weighted-
Average
Interest
Rate
   Amount     Weighted-
Average
Interest
Rate
(in thousands, except interest rates)                      

Due in one year or less

   $ 16,738,835     1.74    $ 22,821,835     3.01

Due after one year through two years

     1,510,985     3.97      1,904,000     3.84

Due after two years through three years

     1,859,310     4.28      2,176,535     4.27

Due after three years through four years

     2,866,500     4.54      2,609,000     4.96

Due after four years through five years

     2,249,000     3.91      2,598,000     4.25

Thereafter

     5,862,940     5.10      6,028,195     5.40
                     

Total par value

     31,087,570     3.05      38,137,565     3.72

Premiums

     14,524          15,800    

Discounts

     (28,516 )        (29,981 )  

SFAS 133 hedging adjustments

     383,886          467,015    
                     

Total

   $ 31,457,464        $ 38,590,399    
                     

The amounts in the above table reflect certain consolidated obligation bond transfers from and to other FHLBanks as of March 31, 2009 and December 31, 2008. The Seattle Bank becomes the primary obligor on consolidated obligation bonds transferred to it. We account for consolidated obligation bonds transferred out as debt extinguishments, as the receiving FHLBank becomes the primary obligor. The following table summarizes our consolidated obligation bond transfers from and to other FHLBanks as of March 31, 2009 and December 31, 2008.

 

19


Table of Contents
     As of March 31, 2009     As of December 31, 2008  

Other FHLBanks’ Consolidated Obligations

   Par Value    Net
(Discount)
Premium
    Par Value    Net
(Discount)
Premium
 
(in thousands)                       

Transfers In

          

FHLBank of Chicago

   $ 1,074,000    $ (19,602 )   $ 1,074,000    $ (19,602 )
                              

Total

   $ 1,074,000    $ (19,602 )   $ 1,074,000    $ (19,602 )
                              

Transfers Out

          

FHLBank of San Francisco

   $ 145,000    $ 94     $ 145,000    $ 94  

FHLBank of Dallas

     135,880      620       135,880      620  
                              

Total

   $ 280,880    $ 714     $ 280,880    $ 714  
                              

The following table summarizes the par value of consolidated obligation bonds outstanding by callable and putable terms as of March 31, 2009 and December 31, 2008.

 

Par Value of Consolidated Obligation Bonds

   As of
March 31, 2009
   As of
December 31, 2008
(in thousands)          

Non-callable and non-putable

   $ 24,363,570    $ 29,609,310

Callable

     6,724,000      8,528,255
             

Total par value

   $ 31,087,570    $ 38,137,565
             

The following table summarizes the par value of consolidated obligation bonds outstanding by year of contractual maturity or next call date as of March 31, 2009 and December 31, 2008.

 

Contractual Maturity or Next Call Date

   As of
March 31, 2009
   As of
December 31, 2008
(in thousands)          

Due in one year or less

   $ 22,267,835    $ 29,220,090

Due after one year through two years

     2,115,985      2,174,000

Due after two years through three years

     1,019,310      1,036,535

Due after three years through four years

     1,411,500      1,234,000

Due after four years through five years

     1,118,000      1,217,000

Thereafter

     3,154,940      3,255,940
             

Total par value

   $ 31,087,570    $ 38,137,565
             

Interest-Rate Payment Terms

The following table summarizes the par value of consolidated obligation bonds outstanding by interest-rate payment terms as of March 31, 2009 and December 31, 2008.

 

Interest-Rate Payment Terms

   As of
March 31, 2009
   As of
December 31, 2008
(in thousands)          

Fixed interest rate

   $ 25,123,570    $ 24,856,565

Step-up interest rate

     50,000      50,000

Variable interest rate

     5,894,000      13,171,000

Range interest rate

     20,000      60,000
             

Total par value

   $ 31,087,570    $ 38,137,565
             

 

20


Table of Contents
Note 6. Capital

For accounting policies and additional information concerning capital, including applicable regulatory capital requirements, see Note 14 in our 2008 Audited Financials included in our 2008 annual report on Form 10-K.

Capital Requirements

As of March 31, 2009 and December 31, 2008, due to increases in the market-risk and credit-risk components of our risk-based capital, we were out of compliance with our risk-based capital requirement. Under Finance Agency regulations, an FHLBank that fails to meet any regulatory capital requirement may not declare a dividend or redeem or repurchase capital stock. The following table shows our statutory and regulatory capital requirements compared to our actual position.

 

     As of March 31, 2009     As of December 31, 2008  

Regulatory Capital Requirements

   Required     Actual     Required     Actual  
(in thousands, except for ratios)                         

Risk-based capital

   $ 3,295,374     $ 2,828,650     $ 2,707,000     $ 2,547,811  

Total capital-to-assets ratio

     4.00 %     5.24 %     4.00 %     4.60 %

Total regulatory capital*

   $ 2,277,897     $ 2,986,799     $ 2,334,468     $ 2,687,140  

Leverage capital-to-assets ratio

     5.00 %     7.73 %     5.00 %     6.79 %

Leverage capital

   $ 2,847,371     $ 4,401,124     $ 2,918,085     $ 3,961,046  

 

*

Total regulatory capital is defined as the sum of permanent capital, the amounts paid for Class A capital stock, any general allowance for losses and any other amount from sources available to absorb losses that the Finance Agency has determined to be appropriate to include in determining total capital. Total regulatory capital also includes mandatorily redeemable capital stock. Permanent capital is defined as retained earnings and Class B capital stock.

The increase in our risk-based capital requirement as of March 31, 2009, compared to December 31, 2008, primarily reflects the increased market-risk capital required as a result of the declining values of our private-label mortgage-backed securities and the increased credit-risk capital required as a result of credit rating downgrades on a significant number of our private-label mortgage-backed securities during the first quarter of 2009.

Mandatorily Redeemable Capital Stock

As of March 31, 2009 and December 31, 2008, 31 and 27 members and former members had requested redemptions of $897.2 million and $896.4 million in Class B capital stock, which is subject to mandatory redemption with a five-year waiting period from the time of the request and $23.7 million and $21.5 million in Class A capital stock subject to mandatory redemption with payment subject to a six-month waiting period from the time of the request (assuming we would meet all capital requirements following the redemption). These amounts have been classified as “mandatorily redeemable capital stock” in the Statements of Condition. Although we reported a risk-based capital deficiency as of December 31, 2008, a subsequent increase in market values on our private-label mortgage-backed securities corrected our risk-based capital deficiency as of January 31, 2009, and in February 2009, we redeemed $669,000 in Class B capital stock from a former member following the five-year redemption period. Subsequent increases in the market-risk and credit-risk components of our risk-based capital resulted in a risk-based capital deficiency as of March 31, 2009, and we are currently unable to redeem capital stock and do not know when we will be able to redeem capital stock in the future.

Dividends

Generally, under the Seattle Bank’s Capital Plan (Capital Plan), our Board can declare and pay dividends, in either cash or capital stock, from retained earnings or current net earnings. Due to our risk-based capital deficiency, we are currently precluded from declaring or paying dividends. In addition, to meet the Finance Board’s conditions for the acceptance of our business plan following execution of a written agreement with the Finance Board in December 2004, our Board adopted a policy on May 18, 2005, suspending indefinitely the declaration or payment of any Class B dividends and providing that any future dividend declaration or payment generally may be made only after prior approval of the Finance Agency. In April 2008, the Finance Board notified the Seattle Bank of its decision to allow resumption of quarterly dividends provided that dividend payments did not exceed 75% of year-to-date net income calculated in accordance with GAAP. The dividend limitations will remain in effect until we receive written approval from the Finance Agency removing such limitations. There can be no assurance of when or if the Finance Agency will allow us to resume dividend payments or if or when our Board would declare dividends in the future.

 

21


Table of Contents

For additional information on dividends, see “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital Resources and Liquidity—Capital Resources” of our 2008 annual report on Form 10-K.

Accumulated Other Comprehensive Loss

Accumulated other comprehensive loss was $1.1 billion as of March 31, 2009, compared to $2.9 million as of December 31, 2008. As a result of our adoption of FSP FAS 115-2 as of January 1, 2009, we recognized the $293.4 million cumulative effect of initially applying FSP FAS 115-2 as an increase to our retained earnings as of January 1, 2009, with a corresponding increase to accumulated other comprehensive loss. In addition, for the three months ended March 31, 2009, we recognized total OTTI charges of $895.2 million on our private-label mortgage-backed securities, of which $823.5 million were related to non-credit losses, and which are reported in our Statement of Condition in other comprehensive loss as “non-credit portion of OTTI loss on held-to-maturity securities.”

Capital Concentration

As of March 31, 2009, two members, Bank of America Oregon, N.A. and Merrill Lynch Bank USA, and one non-member, JPMorgan Chase Bank N.A. (formerly Washington Mutual Bank, F.S.B.) collectively held 49.3% of our total outstanding capital stock, including mandatorily redeemable capital stock. As of December 31, 2008, one member and one former member, Merrill Lynch Bank USA and JPMorgan Chase Bank N.A. held 40.7% of our total outstanding capital stock, including mandatorily redeemable capital stock. No other member held more than 10% of our outstanding capital stock, including mandatorily redeemable capital stock, as of these dates. See Note 10 for additional information.

 

Note 7. Derivatives and Hedging Activities

Accounting for derivatives is addressed in SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133), as amended and interpreted. We recognize derivatives on the Statement of Condition at their fair values, including net cash collateral and accrued interest from counterparties. In accordance with SFAS 133, we designate each derivative as one of the following:

 

  (i) a hedge of the fair value of a recognized asset or liability or an unrecognized firm commitment (a fair value hedge);

 

  (ii) a non-qualifying hedge of an asset or liability for asset/liability management purposes (an economic hedge); or

 

  (iii) a non-qualifying hedge of another derivative that is used to offset other derivatives with non-member counterparties (an intermediary hedge).

Changes in the fair value of a derivative that is designated and qualifies as a fair value hedge, along with changes in the fair value of the hedged asset or liability that are attributable to the hedged risk (including changes that reflect losses or gains on firm commitments), are recorded in our Statement of Operations within other loss as “net (loss) gain on derivatives and hedging activities.” For fair value hedges, any hedge ineffectiveness (which represents the amount by which the change in the fair value of the derivative differs from the change in the fair value of the hedged item attributable to the hedged risk) is recorded in “net (loss) gain on derivatives and hedging activities.”

An economic hedge is defined as a derivative hedging specific or non-specific underlying assets, liabilities, or firm commitments that does not qualify or was not designated for hedge accounting, but that is an acceptable hedging strategy under our risk management program. These economic hedging strategies also comply with Finance Agency regulatory requirements prohibiting speculative hedge transactions. An economic hedge by definition introduces the potential for earnings variability caused by the changes in the fair value of the derivatives that are recorded in our income but that are not offset by corresponding changes in the fair value of the economically hedged assets, liabilities, or firm commitments. As a result, we recognize only the net interest and the change in fair value of these derivatives in other loss as “net (loss) gain on derivatives and hedging activities” with no offsetting fair value adjustments for the assets, liabilities, or firm commitments. Cash flows associated with such standalone derivatives (derivatives not qualifying for hedge accounting) are reflected as cash flows from operating activities in the Statement of Cash Flows.

In addition to the disclosures provided herein, see Note 8 in our 2008 Audited Financials included in our 2008 annual report on Form 10-K for additional information concerning our derivatives and hedging activities.

Nature of Business Activity

We are exposed to interest-rate risk primarily from the effect of interest-rate changes on our interest-earning assets and the funding sources that finance these assets. Consistent with Finance Agency policy, we enter into interest-rate exchange agreements (derivatives) only to reduce the interest-rate exposures inherent in otherwise unhedged assets and funding positions, to achieve our

 

22


Table of Contents

risk-management objectives, and to reduce our cost of funds. Finance Agency regulation and our risk management policy prohibit trading in or the speculative use of these derivative instruments and limit credit risk arising from these instruments.

We generally use derivatives to:

 

   

reduce the interest-rate sensitivity and repricing gaps of assets and liabilities;

 

   

reduce funding costs by combining a derivative with a consolidated obligation as the cost of a combined funding structure can be lower than the cost of a comparable consolidated obligation bond (structured funding);

 

   

preserve an interest-rate spread between the yield of an asset (e.g., an advance) and the cost of the related liability (e.g., the consolidated obligation bond used to fund the advance). Without the use of derivatives, this interest-rate spread could be reduced or eliminated when a change in the interest rate on the advance does not match a change in the interest rate on the bond;

 

   

mitigate the adverse earnings effects of the shortening or extension of expected lives of certain assets (e.g., mortgage assets) and liabilities;

 

   

protect the value of existing asset or liability positions;

 

   

manage embedded options in assets and liabilities; and

 

   

enhance our overall asset/liability management.

Types of Interest-Rate Exchange Agreements

Our risk management policy establishes guidelines for the use of derivatives, including the amount of exposure to interest-rate changes we are willing to accept. The goal of our interest-rate risk management strategy is not to eliminate interest-rate risk, but to manage it within appropriate limits. We use derivatives when they are considered the most cost-effective alternative to achieve our financial- and risk-management objectives. Accordingly, we may enter into derivatives that do not necessarily qualify for hedge accounting under SFAS 133 (i.e., economic hedges). We use the following types of derivatives in our interest-rate risk management.

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, this party receives cash flows equivalent to the interest on the same notional principal amount based on a variable interest-rate index for the same period of time. The variable interest-rate index in most of our interest-rate exchange agreements is the London Interbank Offered Rate (LIBOR).

Swaptions

A swaption is an option on an interest-rate swap that gives the buyer the right to enter into a specified interest-rate swap at a certain time in the future. When used as a hedge, a swaption can protect an entity that is planning to lend or borrow funds in the future against future interest-rate changes. We purchase both payer swaptions and receiver swaptions. A payer swaption is the option to make fixed interest payments at a later date and a receiver swaption is the option to receive fixed interest payments at a later date.

Interest-Rate Caps and Floors

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

Interest-rate swaps are generally used to manage interest-rate exposures and swaptions, caps, and floors are generally used to manage interest-rate and volatility exposures.

Types of Hedged Items

We incur interest-rate risk on advances, mortgage loans held for portfolio, investments, consolidated obligations, and intermediary positions.

 

23


Table of Contents

Advances

We offer a wide variety of advance structures to meet members’ funding needs. These advances may have maturities up to 30 years with variable or fixed interest rates and may include early termination features or options. The repricing characteristics and optionality embedded in certain advances can create interest-rate risk. We may use derivatives to adjust the repricing and/or option characteristics of certain advances to more closely match the characteristics of our funding. In general, fixed interest-rate advances or variable interest-rate advances with embedded options are hedged with an interest-rate exchange agreement with terms offsetting the advance’s terms and options. For example, we may hedge a fixed interest-rate advance with an interest-rate swap where we pay a fixed rate of interest and receive a variable rate of interest, effectively converting the advance from a fixed to a variable rate of interest. This type of hedge is treated as a fair value hedge under SFAS 133.

When issuing a convertible advance, we purchase an option from a member that allows us to convert the advance from a fixed interest rate to a variable interest rate or to terminate on a specified date(s). The initial interest rate on a convertible advance is lower than a comparable maturity fixed interest-rate advance that does not have the conversion feature. When we make a putable advance, we effectively purchase a put option from the member, allowing us the right to terminate the advance at our discretion. We generally hedge a putable advance by entering into a cancelable interest-rate exchange agreement where we pay a fixed interest rate and receive a variable interest rate based on a market index, typically LIBOR. The swap counterparty can cancel the interest-rate exchange agreement on the put dates, which would normally occur in a rising interest-rate environment, at which time we would generally terminate the advance. This type of hedge is accounted for as a fair value hedge under SFAS 133.

We also offer our members capped advances, which are variable interest-rate advances with a maximum interest rate. When we make a capped advance, we typically purchase an offsetting interest-rate cap from a broker. This type of hedge is accounted for as a fair value hedge under SFAS 133.

We may hedge a firm commitment for a forward starting advance through the use of an interest-rate swap. In this case, the interest-rate swap functions as the hedging instrument for both the firm commitment and the subsequent advance. The basis movement associated with the firm commitment is rolled into the basis of the advance at the time the commitment is terminated and the advance is issued. The basis adjustment is then amortized into interest income over the life of the advance.

Mortgage Loans Held for Portfolio

The prepayment options embedded in mortgage loans can result in extensions or contractions in the expected repayment of these assets, depending on changes in estimated prepayment speeds. In addition, to the extent that we purchased mortgage loans at premiums or discounts, net income is affected by extensions or contractions in the expected maturities of these assets. We seek to manage the interest-rate and prepayment risk associated with mortgage loans primarily through debt issuance. We use both callable and noncallable debt to attempt to achieve cash flow patterns and liability durations similar to those expected on the mortgage loans. We may also purchase interest-rate exchange agreements, such as swaptions, to manage the prepayment risk embedded in the mortgage loans. Although these derivatives are valid economic hedges against the prepayment risk of the mortgage loans, they are not specifically linked to individual mortgage loans, and we account for these instruments as freestanding derivatives pursuant to SFAS 133. Since 2006, we have purchased no mortgage loans under the MPP.

 

24


Table of Contents

Investments

We currently invest in U.S. agency and GSE mortgage-backed securities, U.S. agency and GSE obligations, TLGP securities, and the taxable portion of state or local housing finance agency securities, which are classified as held-to-maturity securities. The interest-rate and prepayment risks associated with these investment securities are managed through a combination of callable and non-callable debt issuance and derivatives, such as swaptions. Derivatives used to manage these risks are considered freestanding pursuant to SFAS 133.

Consolidated Obligations

We manage the risk arising from changing market prices of a consolidated obligation by matching the cash outflows on the consolidated obligation with the cash inflows on an interest-rate exchange agreement. In a typical transaction, the Office of Finance issues a fixed interest-rate consolidated obligation for the Seattle Bank, and we concurrently enter into a matching interest-rate exchange agreement in which the counterparty pays fixed cash flows, designed to mirror in timing and amount the cash outflows we pay on the consolidated obligation. The net result of this transaction is that we pay a variable interest rate that closely matches the interest rates we receive on short-term or variable interest-rate advances. These transactions are accounted for as fair value hedges under SFAS 133. This intermediation within the financial markets permits us to raise funds at lower costs than would otherwise be available through the issuance of simple fixed or variable interest-rate consolidated obligations in the financial markets.

Intermediation

We may enter into interest-rate exchange agreements to offset the economic effect of other derivatives that are no longer designated in a hedge transaction of one or more advances, investments, or consolidated obligations. In these intermediary transactions, maturity dates, call dates, and fixed interest rates match, as do the notional amounts on the de-designated portion of the interest-rate exchange agreement and the intermediary derivative. The net result of the accounting for these derivatives does not significantly affect our operating results.

Derivative Credit-Risk Exposure and Counterparty Ratings

The Seattle Bank is subject to credit risk because of the potential nonperformance by a counterparty to our interest-rate exchange agreement. The degree of counterparty risk on interest-rate exchange agreements depends on our selection of counterparties and the extent to which we use netting procedures and other credit enhancements to mitigate the risk. We manage counterparty credit risk through credit analysis, collateral management, and other credit enhancements. We require agreements to be in place for all counterparties. These agreements must include provisions for netting exposures across all transactions with that counterparty. The agreements also require a counterparty to deliver collateral to the Seattle Bank if the total exposure to that counterparty exceeds a specific threshold limit as denoted in the agreement. As a result of these risk mitigation initiatives, we do not currently anticipate any additional credit losses on our interest-rate exchange agreements.

The contractual notional amount of derivatives reflects our involvement in the various classes of financial instruments and serves as a factor in determining periodic interest payments or cash flows received and paid. The notional amount of derivatives represents neither the actual amounts exchanged nor the overall exposure of the Seattle Bank to credit and market risk. The overall amount that could potentially be subject to credit loss is much smaller. Notional values are not meaningful measures of the risks associated with derivatives. The risks of derivatives are more appropriately measured on a hedging relationship or portfolio basis, taking into account the derivatives, the item(s) being hedged, and any offsets between the two.

Our maximum counterparty credit risk equals the estimated cost of replacing favorable interest-rate swaps, forward agreements, and purchased caps and floors, if the counterparty defaults and the related collateral, if any, is of no value to us. As of March 31, 2009 and December 31, 2008, our maximum credit risk, taking into consideration master netting arrangements, was approximately $37.8 million and $32.0 million. In determining maximum credit risk, we consider accrued interest receivables and payables and the legal right to offset derivative assets and liabilities by counterparty. Our maximum credit risk as of March 31, 2009 and December 31, 2008 include $20.4 million and $11.0 million of net accrued interest receivable. We held no cash collateral from our counterparties as of March 31, 2009 or December 31, 2008. We held investment-grade securities from our counterparties with a fair value of $20.8 million and $9.0 million, which are not included in our derivative asset or liability balances as of March 31, 2009 and December 31, 2008. Additionally, collateral with respect to derivatives with member institutions includes collateral assigned to us as evidenced by a written security agreement and held by the member institution for our benefit. Changes in credit risk and net exposure after considering collateral are primarily due to changes in market conditions, including the level and slope of the yield curve.

 

25


Table of Contents

Certain of our interest-rate exchange agreements include provisions that require Federal Home Loan Bank System (FHLBank System) debt to maintain an investment-grade rating from each of the major credit rating agencies. If the FHLBank System debt were to fall below investment grade, it would be in violation of these provisions, and the counterparties to the interest-rate exchange agreements could request immediate and ongoing full overnight collateralization on derivatives in net liability positions. The aggregate fair value of all derivative instruments with credit-risk contingent features that were in a liability position as of March 31, 2009 was $301.1 million, for which we have posted collateral of $37.6 million in the normal course of business. If the Seattle Bank’s individual credit rating was lowered by one rating level, we would not have been required to deliver any additional collateral to our derivative counterparties as of March 31, 2009. Our credit rating has not changed since 2008.

We transact our interest-rate exchange agreements with large banks and major broker-dealers. Some of these banks and broker-dealers or their affiliates buy, sell, and distribute consolidated obligations. We are not a derivatives dealer and do not trade derivatives for short-term profit.

Financial Statement Effect and Additional Financial Information

The following table summarizes the notional amounts and the fair values of our derivative instruments, including the effect of netting arrangements and collateral as of March 31, 2009. For purposes of this disclosure, the derivative values include both the fair value of derivatives and related accrued interest.

 

     As of March 31, 2009  

Fair Value of Derivative Instruments

   Notional
Amount
   Derivative
Assets
    Derivative
Liabilities
 
(in thousands)                  

Derivatives designated as hedging instruments under SFAS 133

       

Interest-rate swaps

   $ 39,939,698    $ 353,071     $ (616,724 )

Interest-rate caps or floors

     45,000      3    
                       

Total derivatives designated as hedging instruments under SFAS 133

     39,984,698      353,074       (616,724 )

Derivatives not designated as hedging instruments under SFAS 133

       

Interest-rate swaps

     718,700      17,792       (17,498 )

Interest-rate caps or floors

     240,000      22    
                       

Total derivatives not designated as hedging instruments under SFAS 133

     958,700      17,814       (17,498 )
                       

Total derivatives before netting and collateral adjustments

   $ 40,943,398    $ 370,888     $ (634,222 )
                       

Netting adjustments (1)

        (333,057 )     333,057  

Cash collateral and related accrued interest

          37,582  
                   

Total derivatives before netting and collateral adjustments

        (333,057 )     370,639  
                   

Derivative assets and derivative liabilities as reported on the Statement of Condition

      $ 37,831     $ (263,583 )
                   

 

26


Table of Contents
     As of December 31, 2008  

Fair Value of Derivative Instruments

   Notional
Amount
   Derivative
Assets
    Derivative
Liabilities
 
(in thousands)                  

Derivatives designated as hedging instruments under SFAS 133

       

Interest-rate swaps

   $ 29,604,444    $ 390,117     $ (675,723 )

Interest-rate caps or floors

     65,000      19    
                       

Total derivatives designated as hedging instruments under SFAS 133

     29,669,444      390,136       (675,723 )

Derivatives not designated as hedging instruments under SFAS 133

       

Interest-rate swaps

     716,000      18,992       (18,469 )

Interest-rate caps or floors

     260,000      206    
                       

Total derivatives not designated as hedging instruments under SFAS 133

     976,000      19,198       (18,469 )
                       

Total derivatives before netting and collateral adjustments

   $ 30,645,444    $ 409,334     $ (694,192 )
                       

Netting adjustments (1)

        (377,350 )     377,350  

Cash collateral and related accrued interest

          81,425  
                   

Total derivatives before netting and collateral adjustments

        (377,350 )     458,775  
                   

Derivative assets and derivative liabilities as reported on the Statement of Condition

      $ 31,984     $ (235,417 )
                   

 

(1)

Amounts represent the effect of legally enforceable master netting agreements that allow the Seattle Bank to settle positive and negative positions.

The following table presents the components of net (loss) gain on derivatives and hedging activities as presented in the Statement of Operations for the three months ended March 31, 2009 and 2008.

 

     For the Three Months Ended March 31,  

Components of Net (Loss) Gain on Derivatives and Hedging Activities

               2009                             2008              
(in thousands)             

Derivatives and hedged items in SFAS 133 fair value hedging relationships

    

Interest-rate swaps

   $ (2,869 )   $ 2,603  
                

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

     (2,869 )     2,603  

Derivatives not designated as hedging instruments under SFAS 133

    

Economic hedges

    

Interest-rate swaps

     2       (10 )

Interest-rate swaptions

       1,629  

Interest-rate caps or floors

     (184 )     1,259  

Net interest settlements

     128       522  

Intermediary transactions

    

Interest-rate swaps

     (18 )     (2 )
                

Total net (loss) gain related to derivatives not designated as hedging instruments under SFAS 133

     (72 )     3,398  
                

Net (loss) gain on derivatives and hedging activities

   $ (2,941 )   $ 6,001  
                

The following table presents, by type of hedged item, the gains (losses) on derivatives and the related hedged items in fair value hedging relationships and the impact of those derivatives on our net interest income for the three months ended March 31, 2009 and 2008.

 

27


Table of Contents
     Three Months Ended March 31, 2009  

Gain (Loss) on Derivatives and on the
Related Hedged Items in Fair Value Hedging Relationships

   Gain/(Loss) on
Derivatives
    Gain/(Loss) on Hedged
Items
    Net Fair Value Hedge
Ineffectiveness
    Effect of Derivatives on
Net Interest Income(1)
 
(in thousands)                         

Advances

   $ 4,282     $ (8,445 )   $ (4,163 )   $ (55,491 )

Consolidated obligation bonds

     (58,897 )     58,843       (54 )     58,102  

Consolidated obligation discount notes

     (6,878 )     8,226       1,348       3,931  
                                

Total

   $ (61,493 )   $ 58,624     $ (2,869 )   $ 6,542  
                                
     Three Months Ended March 31, 2008  

Gain (Loss) on Derivatives and on the
Related Hedged Items in Fair Value Hedging Relationships

   Gain/(Loss) on
Derivatives
    Gain/(Loss) on Hedged
Items
    Net Fair Value Hedge
Ineffectiveness
    Effect of Derivatives on
Net Interest Income (1)
 
(in thousands)                         

Advances

   $ (15,413 )   $ 16,723     $ 1,310     $ (2,416 )

Consolidated obligation bonds

     128,956       (127,663 )     1,293       28,494  
                                

Total

   $ 113,543     $ (110,940 )   $ 2,603     $ 26,078  
                                

 

(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.

 

Note 8. Employee Retirement Plans

For accounting policies and additional information concerning employee retirement plans, see Note 15 in our 2008 Audited Financials included in our 2008 annual report on Form 10-K.

The Seattle Bank offers to certain highly compensated employees non-qualified supplemental retirement plans, including the Thrift Plan Benefit Equalization Plan (Thrift BEP), a defined-contribution pension plan, and the Retirement Fund Benefit Equalization Plan (Retirement BEP) and the Executive Supplemental Retirement Plan (SERP) defined-benefit pension plans.

The net periodic pension cost for the defined benefit plans were as follows for the three months ended March 31, 2009 and 2008.

 

     Three Months Ended March 31,

Net Periodic Pension Cost for the Retirement BEP and SERP

   2009    2008
(in thousands)          

Service costs

   $ 80    $ 78

Interest costs

     73      69

Amortization of prior service cost

     39   
             

Net periodic pension cost

   $ 192    $ 147
             

 

Note 9. Estimated Fair Value

For accounting policies and additional information concerning estimated fair values, see Note 16 in our 2008 Audited Financials included in our 2008 annual report on Form 10-K.

Financial Asset and Financial Liability Valuation Methodologies

Outlined below are the valuation methodologies for our financial assets and financial liabilities.

Cash and Due From Banks

The estimated fair value approximates the recorded carrying value.

 

28


Table of Contents

Federal Funds Sold

The estimated fair value of overnight Federal funds sold approximates the recorded carrying value. The estimated fair value of term Federal funds sold is determined by calculating the present value of the expected future cash flows. The discount rates used in these calculations are the rates for federal funds with similar terms.

Held-to-Maturity Securities

We use prices from independent pricing services (such as Reuters) and, to a lesser extent, non-binding dealer quotes, to determine the fair values of substantially all of our held-to-maturity securities, for disclosure and non-recurring fair value measurements. For fair values based on prices from independent pricing services, we generally receive two prices. Pricing reviews are performed by Seattle Bank personnel with knowledge of liquidity and other current conditions in the market. We have gained an understanding of the information used by these third party pricing sources to develop these estimated values.

Generally, pricing services’ values and broker quotes obtained on level 3 instruments are indications of value based on price indications, market intelligence, and proprietary cash flow modeling techniques. These values were evaluated in relation to other securities and their related characteristics (e.g. underlying product, vintage, FICO®, geographical information, etc.), other broker indications, pricing trends, as well as our independent knowledge of the security’s collateral characteristics (e.g. geographical information, delinquencies, foreclosures and real-estate owned).

Securities Sold Under Agreements to Repurchase and Securities Purchased Under Agreements to Resell

The fair value of overnight agreements approximates the recorded carrying value. The estimated fair value for agreements with terms to maturity in excess of one day is determined by calculating the present value of the expected future cash flows. The discount rates used in these calculations are the rates for agreements with similar terms.

Advances

The estimated fair value of advances is determined by calculating the present value of expected future cash flows from the advances excluding the amount of the accrued interest receivable. For advances with embedded options, additional market-based inputs are obtained from derivatives dealers. The discount rates used in these calculations are the consolidated obligation rates for instruments with similar terms as of the last business day of the period, adjusted for a target spread.

In accordance with Finance Agency regulation, advances with a maturity and repricing period greater than six months require a prepayment fee sufficient to make us financially indifferent to the borrower’s decision to prepay the advances. Therefore, the estimated fair value of advances does not assume prepayment risk.

Mortgage Loans Held for Portfolio

The estimated fair values for mortgage loans are determined based on quoted market prices for similar mortgage loans. These prices, however, can change rapidly based upon market conditions and are highly dependent upon the underlying prepayment assumptions priced in the secondary market. Changes in prepayment rates often have a material effect on the fair value estimates. Since these underlying prepayment assumptions are made at a specific point in time, they are susceptible to material changes in the near term.

Accrued Interest Receivable and Payable

The estimated fair value approximates the recorded carrying value.

Derivative Assets and Liabilities

We base the estimated fair values of interest-rate exchange agreements on instruments with similar terms or available market prices excluding accrued interest receivable and payable. However, active markets do not exist for certain types of financial instruments. Consequently, fair values for these instruments must be estimated using techniques such as discounted cash flow analysis and comparisons to similar instruments. Estimates developed using these methods are highly subjective and require judgment regarding significant matters such as the amount and timing of future cash flows, volatility of interest rates, and the selection of discount rates that appropriately reflect market and credit risks. Changes in judgment often have a material effect on the fair value estimates. Because these estimates are made at a specific point in time, they are susceptible to material near-term changes.

 

29


Table of Contents

We are subject to credit risk on derivatives due to nonperformance by the derivatives counterparties. To mitigate this risk, we enter into master netting agreements for interest-rate-exchange agreements with highly-rated institutions. In addition, we enter into bilateral security exchange agreements with all our derivatives dealer counterparties that provide for delivery of collateral at specified levels tied to long-term counterparty credit ratings to limit our net unsecured credit exposure to these counterparties. We have evaluated the potential for the fair value of the instruments to be impacted by counterparty nonperformance risk, including credit risk, and have determined that no adjustments were significant or necessary to our overall fair value measurements. The fair values are netted by counterparty where such legal right exists and offset against amounts recognized for collateral arrangements related to that counterparty. If these netted amounts are positive, they are classified as an asset and if negative, a liability.

Deposits

We determine the estimated fair values of member institution deposits by calculating the present value of expected future cash flows from the deposits and reducing this amount for accrued interest payable. The discount rates used in these calculations are the cost of deposits with similar terms.

Consolidated Obligations

We estimate the fair values of our consolidated obligations using internal valuation models with market observable inputs. We calculate the fair value of consolidated obligations without embedded options using market-based yield curve inputs obtained from the Office of Finance. For consolidated obligations with embedded options, market-based inputs are obtained from the Office of Finance and derivatives dealers. We then calculate the fair value of the consolidated obligations using the present value of expected cash flows using discount rates that are based on replacement funding rates for liabilities with similar terms.

Mandatorily Redeemable Capital Stock

The fair value of capital stock subject to mandatory redemption generally approximates par value as indicated by member contemporaneous purchases and sales at par value. Fair value also includes estimated dividends earned at the time of reclassification from equity to liabilities, until such amount is paid, and any subsequently declared stock dividend. Capital stock can only be acquired by members at par value and redeemed at par value (plus any declared but unpaid dividends). Capital stock is not traded and no market mechanism exists for the exchange of capital stock outside our cooperative.

Commitments

The estimated fair value of our commitments to extend credit is determined using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. The estimated fair value of these fixed interest-rate commitments also takes into account the difference between current and committed interest rates. The estimated fair value of standby letters of credit is based on the present value of fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations with the counterparties.

Fair Value Hierarchy

SFAS 157 established a fair value hierarchy to prioritize the inputs of valuation techniques used to measure fair value. The inputs are evaluated and an overall level for the measurement is determined. This overall level is an indication of the market observablility of the inputs to the fair value measurement. SFAS 157 clarifies fair value in terms of the price in an orderly transaction between market participants for selling an asset or transferring a liability in the principal (or most advantageous) market for the asset or liability. In order to determine the fair value, or exit price, entities must determine the unit of account, highest and best use, principal market, and market participants. These determinations allow the reporting entity to define the inputs for fair value and level of hierarchy.

The fair value hierarchy prioritizes the inputs used in valuation techniques to measure fair value into three broad levels:

 

   

Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. An active market for the asset or liability is a market in which the transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. We have classified certain money market funds that are held in a rabbi trust as level 1 assets.

 

   

Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets and model-based techniques for which all significant inputs are observable, either directly or indirectly, for substantially the full term of the asset or liability. We have classified our derivatives as level 2 assets and liabilities.

 

30


Table of Contents
   

Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs are typically supported by little or no market activity and reflect the entity’s own assumptions. We have classified certain held-to-maturity securities, for which we have recorded other-than-temporary impairment charges on a non-recurring basis, as level 3 assets.

We use valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Fair value is first based on quoted market prices or market-based prices, where available. If quoted market prices or market-based prices are not available, fair value is determined based on valuation models that use market-based information available to us as inputs to our models.

Fair Value on a Recurring Basis

The following tables present for each SFAS 157 hierarchy level, our financial assets and liabilities that are measured at fair value on a recurring basis on our Statement of Condition as of March 31, 2009 and December 31, 2008.

 

     As of March 31, 2009  

Recurring Fair Value Measurement

   Total     Level 1    Level 2     Level 3    Netting
Adjustment*
 
(in thousands)                             

Derivative assets

   $ 37,831     $      $ 370,888     $      $ (333,057 )

Other assets (rabbi trust)

     3,896       3,896        
                                      

Total assets at fair value

   $ 41,727     $ 3,896    $ 370,888     $      $ (333,057 )
                                      

Derivative liabilities

   $ (263,583 )   $      $ (634,222 )   $      $ 370,639  
                                      

Total liabilities at fair value

   $ (263,583 )   $      $ (634,222 )   $      $ 370,639  
                                      
     As of December 31, 2008  

Recurring Fair Value Measurement

   Total     Level 1    Level 2     Level 3    Netting
Adjustment*
 
(in thousands)                             

Derivative assets

   $ 31,984     $      $ 409,536     $                     $ (377,552 )

Other assets (rabbi trust)

     3,247       3,247        
                                      

Total assets at fair value

   $ 35,231     $ 3,247    $ 409,536     $      $ (377,552 )
                                      

Derivative liabilities

   $ (235,417 )   $      $ (694,192 )   $      $ 458,775  
                                      

Total liabilities at fair value

   $ (235,417 )   $                     $ (694,192 )   $      $ 458,775  
                                      

 

* Amounts represent the effect of legally enforceable master netting agreements that allow the Seattle Bank to settle positive and negative positions with cash collateral held or placed with the same counterparties. The total cash collateral was $37.6 million as of March 31, 2009 and $81.4 million as of December 31, 2008.

For instruments carried at fair value, we review the fair value hierarchy classification on a quarterly basis. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities.

Fair Value on a Nonrecurring Basis

We measure certain held-to-maturity securities and real-estate owned at fair value on a nonrecurring basis. These assets are subject to fair value adjustments only in certain circumstances (i.e., when there is evidence of OTTI). For the three months ended March 31, 2009, we recorded an OTTI credit loss of $71.7 million in earnings and an $823.5 million OTTI loss related to all other factors in other comprehensive loss on certain of our held-to-maturity securities.

The following table presents, by SFAS 157 hierarchy level, held-to-maturity securities as of March 31, 2009 for which a nonrecurring change in fair value has been recorded for the three months ended March 31, 2009. We held no real-estate owned as of March 31, 2009.

 

31


Table of Contents
     As of March 31, 2009

Non-Recurring Fair Value Measurement

   Total    Level 3
(in thousands)          

Held-to-maturity securities

   $ 579,226    $ 579,226
             

Total assets at fair value

   $ 579,226    $ 579,226
             

The fair values of the private-label mortgage-backed securities in our held-to-maturity portfolio have been determined on the basis of market-based information provided by third-party pricing services. Prior to September 30, 2008, these assets were classified as level 2, as evidenced by observable trades in the market and similar prices obtained from multiple sources. Beginning in late 2007 and continuing into 2008, the divergence among prices obtained from these sources increased, and became significant in the third quarter of 2008. The significant reduction in transaction volumes and widening credit spreads led us to conclude that the prices received from pricing services, which are derived from the third party’s proprietary models, are reflective of significant unobservable inputs. Because of the significant unobservable inputs used by the pricing services, effective September 30, 2008 we consider these to be level 3 inputs. See “—Financial Asset and Financial Liability Valuation Methodologies—Held-to-Maturity Securities” above for additional information.

Fair Value Summary Tables

The following table summarizes the carrying value and estimated fair values of our financial instruments as of March 31, 2009 and December 31, 2008.

 

     As of March 31, 2009     As of December 31, 2008  

Estimated Fair Values

   Carrying
Value
    Estimated Fair
Value
    Carrying
Value
    Estimated Fair
Value
 
(in thousands)                         

Financial Assets

        

Cash and due from banks

   $ 1,423     $ 1,423     $ 1,395     $ 1,395  

Deposit with other FHLBanks

     65       65      

Securities purchased under agreements to resell

     5,000,000       4,999,993       3,900,000       3,900,096  

Federal funds sold

     4,191,500       4,191,526       2,320,300       2,320,300  

Held-to-maturity securities

     10,771,909       9,470,236       9,784,891       7,857,197  

Advances

     31,848,395       31,851,512       36,943,851       37,110,844  

Mortgage loans held for portfolio

     4,898,886       5,069,181       5,087,323       5,207,494  

Accrued interest receivable

     141,903       141,903       241,124       241,124  

Derivative assets

     37,831       37,831       31,984       31,984  

Financial Liabilities

        

Deposits

     (671,446 )     (671,650 )     (582,258 )     (582,804 )

Securities sold under agreements to repurchase

        

Consolidated obligations, net:

        

Discount notes

     (22,023,488 )     (22,014,513 )     (15,878,281 )     (15,859,873 )

Bonds

     (31,457,464 )     (31,768,839 )     (38,590,399 )     (39,073,154 )

Mandatorily redeemable capital stock

     (920,972 )     (920,972 )     (917,876 )     (917,876 )

Accrued interest payable

     (218,073 )     (218,073 )     (337,303 )     (337,303 )

Derivative liabilities

     (263,583 )     (263,583 )     (235,417 )     (235,417 )

Other

        

Commitments to extend credit for advances

     765       765       (803 )     (803 )

Commitments to issue consolidated obligations

       1,006         35,190  

Note 10. Transactions with Related Parties and other FHLBanks

Transactions with Members

 

32


Table of Contents

We are a cooperative whose members own our capital stock and may receive dividends on their investments in our stock. Virtually all our advances are initially issued to members, and all mortgage loans held for portfolio were purchased from members or former members. We also maintain demand deposit accounts for members, primarily to facilitate settlement activities that are directly related to advances and mortgage loans purchased. Such transactions with members are entered into during the normal course of business.

In addition, we have investments in federal funds sold, interest-bearing deposits, and mortgage-backed securities with members or their affiliates. All investments are transacted at market prices and mortgage-backed securities are purchased through securities brokers or dealers.

For member transactions related to concentration of investments in held-to-maturity securities purchased from members or affiliates of certain members, see Note 2; concentration associated with advances, see Note 3; concentration associated with mortgage loans held for portfolio, see Note 4; and concentration associated with capital stock, see Note 6.

The following tables set forth information with respect to the Seattle Bank’s outstanding transactions with members and their affiliates as of March 31, 2009 and December 31, 2008 and for the three months ended March 31, 2009 and 2008. Certain disclosures concerning the December 31, 2008 held-to-maturity securities purchased from members and their affiliates have been corrected from amounts previously disclosed. Specifically, we have increased held-to-maturity securities purchased from members and their affiliates by $88.9 million to $3.3 billion as of December 31, 2008.

 

Assets and Liabilities with Members and Affiliates

   As of
March 31, 2009
   As of
December 31, 2008
(in thousands)          

Assets

     

Cash and due from banks

   $ 320    $ 386

Securities purchased under agreements to resell

     1,000,000   

Federal funds sold

     469,000      195,300

Held-to-maturity securities

     3,648,116      3,260,810

Advances*

     21,093,104      24,152,434

Mortgage loans held for portfolio

     610,370      653,712

Accrued interest receivable

     58,318      112,372
             

Total assets

   $ 26,879,228    $ 28,375,014
             

Liabilities

     

Deposits

   $ 664,699    $ 569,088

Mandatorily redeemable capital stock

     126,874      126,874

Derivative liabilities

     123,476      95,066

Other liabilities

     2,036      2,096
             

Total liabilities

   $ 917,085    $ 793,124
             

Capital

     

Accumulated other comprehensive loss:

     

Non-credit portion of other-than-temporary impairment loss on held-to-maturity securities

   $ 659,910    $  
             

Total Capital

   $ 659,910    $  
             

Other

     

Notional amount of derivatives

   $ 18,518,532    $ 12,431,629

Letters of credit

   $ 1,234,931    $ 913,858

 

* Includes the effect of associated derivatives with members or their affiliates.

 

33


Table of Contents
     For the Three Months Ended March 31,  

Income and Expense with Members and Affiliates

   2009     2008  
(in thousands)             

Interest Income

    

Advances*

   $ 129,932     $ 424,212  

Prepayment fees on advances, net

     3,558       14,471  

Securities purchased under agreements to resell

     364    

Federal funds sold

     230       3,080  

Held-to-maturity securities

     23,103       27,446  

Mortgage loans held for portfolio

     7,572       68,218  

Other income

       14  
                

Total interest income

     164,759       537,441  
                

Interest Expense

    

Deposits

     479       9,096  

Consolidated obligations*

     (22,859 )     (9,510 )

Mandatorily redeemable capital stock

       202  
                

Total interest expense

     (22,380 )     (212 )
                

Net Interest Income

   $ 187,139     $ 537,653  
                

Other Income (Loss)

    

Service fees

   $ 555     $ 449  

Net other-than-temporary impairment loss on held-to-maturity securities

     (40,643 )  

Net (loss) gain on derivatives and hedging activities

     (1,957 )     2,822  

Other loss

       7  
                

Total other income (loss)

   $ (42,045 )   $ 3,278  
                

 

*

Includes the effect of associated derivatives with members or their affiliates.

Transactions with Related Parties

For purposes of these financial statements, we define related parties as those members and former members with capital stock outstanding in excess of 10% of our total outstanding capital stock and mandatorily redeemable capital stock. We also consider instances where a member or an affiliate of a member has an officer or director who is a director of the Seattle Bank to meet the definition of a related party. Transactions with such members are subject to the same eligibility and credit criteria, as well as the same terms and conditions, as other similar transactions, although the Board has imposed certain restrictions on the repurchase of stock held by members who have officers or directors on our Board.

The following tables set forth information as of March 31, 2009 and December 31, 2008, and for the three months ended March 31, 2009 and 2008 with respect to transactions with related parties. Certain disclosures concerning the December 31, 2008 held-to-maturity securities purchased from related parties and their affiliates have been corrected from amounts previously disclosed. Specifically, we have increased held-to-maturity securities purchased from related parties and their affiliates by $701.7 million to $938.8 billion as of December 31, 2008.

 

34


Table of Contents

Assets and Liabilities with Related Parties

   As of
March 31, 2009
    As of
December 31, 2008
 
(in thousands)             

Assets

    

Cash and due from banks

   $ 320     $    

Securities purchased under agreements to resell

     3,500,000    

Held-to-maturity securities

     1,969,450       938,784  

Advances*

     19,396,249       18,923,217  

Mortgage loans held for portfolio

     4,270,745       4,421,078  

Accrued interest receivable

     84,038       142,242  
                

Total assets

   $ 29,220,802     $ 24,425,321  
                

Liabilities

    

Deposits

   $ 31,915     $ 8,676  

Mandatorily redeemable capital stock

     772,259       772,259  

Derivative liabilities

     73,867       24,119  

Other liabilities

     17,732       16,978  
                

Total liabilities

   $ 895,773     $ 822,032  
                

Capital

    

Accumulated other comprehensive loss:

    

Non-credit portion of other-than-temporary impairment loss on held-to-maturity securites

   $ 533,548     $    
                

Total Capital

   $ 533,548     $    
                

Other

    

Notional amount of derivatives

   $ 15,151,140     $ 6,977,797  

Letters of credit

   $ 779,875     $ 699,176  

 

*       Includes the effect of associated derivatives with members or their affiliates.

    
     For the Three Months Ended March 31,  

Income and Expense with Related Parties

   2009     2008  
(in thousands)             

Interest Income

    

Advances*

   $ 106,371     $ 199,598  

Prepayment fees on advances, net

     2,721       13,777  

Securities purchased under agreements to resell

     1,085    

Federal funds sold

     95       55  

Held-to-maturity securities

     11,322       2,830  

Mortgage loans held for portfolio

     55,864       59,156  
                

Total interest income

     177,458       275,416  
                

Interest Expense

    

Deposits

     13       372  

Consolidated obligations*

     (24,451 )     (1,818 )
                

Total interest expense

     (24,438 )     (1,446 )
                

Net Interest Income

   $ 201,896     $ 276,862  
                

Other Income (Loss)

    

Service fees

   $ 43     $    

Net other-than-temporary impairment loss on held-to-maturity securities

     (29,866 )  

Net (loss) gain on derivatives and hedging activities

     (2,617 )     397  
                

Total other income (loss)

   $ (32,440 )   $ 397  
                

 

*

Includes the effect of associated derivatives with members or their affiliates.

Transactions Affecting Related Parties

 

35


Table of Contents

In September 2008, Bank of America Corporation (BofA) announced that it had agreed to purchase Merrill Lynch & Co. (Merrill Lynch). The transaction closed on January 1, 2009. Bank of America Oregon, N.A., a wholly owned subsidiary of BofA, and Merrill Lynch Bank USA, a wholly owned subsidiary of Merrill Lynch, are both members of the Seattle Bank. In March 2009, Merrill Lynch Bank USA prepaid its outstanding advances totaling $2.9 billion and had no outstanding advances as of March 31, 2009.

In September 2008, in a transaction facilitated by the FDIC, Washington Mutual Bank, F.S.B. was acquired by JPMorgan Chase, a non-member. In early October 2008, JPMorgan Chase notified the Seattle Bank that it had merged Washington Mutual Bank, F.S.B. into a non-member entity, JPMorgan Chase Bank, N.A., that assumed the fully collateralized, related advances and capital stock of the Seattle Bank. Effective October 7, 2008, we reclassified the membership to that of a non-member shareholder that is no longer able to enter into new borrowing arrangements with the Seattle Bank and transferred its Class A capital stock and Class B capital stock to “mandatorily redeemable capital stock” on the Statement of Condition. Per our Capital Plan, Class A capital stock is redeemable six months after notification and Class B capital stock is redeemable five years after notification, subject to certain requirements. As a non-member, JPMorgan Chase Bank, N.A. is not eligible to initiate new advances or renew maturing advances. Approximately 83.0% of the advances outstanding as of December 31, 2008 with JPMorgan Chase Bank, N.A. mature by the end of 2009.

Transactions with Other FHLBanks

Our transactions with other FHLBanks are identified on the face of our financial statements. For additional information on our investments in other FHLBanks’ consolidated obligation bonds, see Note 2, and for debt transfers to or from other FHLBanks, see Note 5.

 

Note 11. Commitments and Contingencies

For accounting policies and additional information concerning commitments and contingencies, see Note 17 in our 2008 Audited Financials included in our 2008 annual report on Form 10-K.

We have not recognized a liability for our joint and several obligation related to other FHLBanks’ consolidated obligations as of March 31, 2009 and December 31, 2008. The par amounts of all the FHLBanks’ outstanding consolidated obligations for which we are jointly and severally liable, net of interbank holdings, were $1.1 trillion and $1.3 trillion as of March 31, 2009 and December 31, 2008.

During the third quarter of 2008, the Seattle Bank and each of the other 11 FHLBanks entered into lending agreements with the U.S. Treasury in connection with the U.S. Treasury’s establishment of a Government-Sponsored Enterprise Credit Facility (GSECF), as authorized by the Housing Act (each, a Lending Agreement). The GSECF is designed to serve as a contingent source of liquidity for the housing government-sponsored enterprises, including each of the 12 FHLBanks. Any borrowings by one or more of the FHLBanks under the GSECF are considered consolidated obligations with the same joint and several liability as all other consolidated obligations. The terms of any borrowing are agreed to at the time of issuance. Loans under a Lending Agreement are to be secured by collateral acceptable to the U.S. Treasury, which consists of FHLBank advances to members and mortgage-backed securities issued by Fannie Mae or Freddie Mac. Each FHLBank is required to submit to the Federal Reserve Bank of New York, acting as fiscal agent of the U.S. Treasury, a list of eligible collateral, updated on a weekly basis. As of March 31, 2009, the Seattle Bank had provided the U.S. Treasury with a listing of advance collateral totaling $31.3 billion, which provides for maximum borrowings of $27.2 billion. The amount of collateral can be increased or decreased (subject to the approval of the U.S. Treasury) at any time through the delivery of an updated listing of collateral. As of March 31, 2009, no FHLBank had drawn on this available source of liquidity. For additional information regarding the Lending Agreements, see “Part I. Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital Resources and Liquidity—Liquidity” in this report.

Commitments that legally bind and unconditionally obligate us for additional advances totaled $12.5 million and $20.8 million as of March 31, 2009 and December 31, 2008. Commitments generally are for periods of up to 12 months. Standby letters of credit were approximately $1.2 billion and $913.9 million as of March 31, 2009 and December 31, 2008. Standby letters of credit as of March 31, 2009 had original terms of 34 days to 10 years, with a final expiration in 2012. Based on our credit analyses and collateral requirements, we do not consider it necessary to have any provision for credit losses on these commitments.

We have entered into a standby bond purchase agreement with a state housing authority, whereby we agree to purchase and hold the authority’s bonds until the designated marketing agent can find a suitable investor or the housing authority repurchases the bond according to a schedule established by the standby agreement. The bond purchase agreement expires in May 2011. Total commitments for standby bond purchases were $51.2 million and $52.7 million as of March 31, 2009 and December 31, 2008.

 

36


Table of Contents

As of March 31, 2009, we had $382.0 million of investments that had been traded but not settled. As of December 31, 2008, we had no investment that had been traded but not settled. As of March 31, 2009, we had $221.3 million in agreements outstanding to issue consolidated obligation bonds and discount notes. As of December 31, 2008, we had entered into agreements to issue $1.1 billion par value of consolidated obligation bonds.

As of March 31, 2009, we have a fully reserved receivable of $10.4 million from Lehman Brothers Special Financing, Inc. (LBSF) recorded on our Statement of Condition. In September 2008, Lehman Brothers Holdings, Inc. (LBHI), the parent company of LBSF and a guarantor of LBSF’s obligations, filed for bankruptcy protection. LBSF was our counterparty on multiple derivative transactions under International Swap Dealers Association, Inc. master agreements with a total notional amount of $3.5 billion at the time of the LBHI bankruptcy filing. As a result, we notified LBSF of our intent to early terminate all outstanding derivative positions with LBSF, unwound such positions, and established a receivable position, netting the value of the collateral due to be returned to us with all other amounts due, which resulted in the establishment of a $10.4 million net receivable from LBSF (before provision) included in other assets in the Statement of Condition. We also established an offsetting provision for credit loss on receivable based on management’s current estimate of the probable amount that will be realized in settling our derivative transactions with LBSF.

From time to time, the Seattle Bank is subject to legal proceedings arising in the normal course of business. After consultations with legal counsel, we do not anticipate that the ultimate liability, if any, arising out of any current matters will have a material impact on our financial condition, results of operations, or cash flows.

 

Note 12. Subsequent Events

Between March 31, 2009 and May 8, 2009, three of our “AAA-rated” private-label mortgage-backed securities were downgraded by one or more NRSROs, including one investment with a par value of $15.6 million to “A” and two securities with a total par value of $268.2 million to “BBB”. Each of these securities was evaluated for other-than-temporary impairment using cash flow analysis as discussed in Note 2. In addition, four “AAA-rated” private-label mortgage-backed securities with a total par value of $191.3 million were placed on watch for possible downgrade.

On May 12, 2009, our Board suspended the issuance of Class A capital stock to support new advances, effective June 1, 2009. New advances will have to be supported by Class B capital stock, which can be used to reduce the Seattle Bank’s risk-based capital deficiency.

The Capital Plan provides that we may impose a redemption cancellation fee upon a member or a successor to a former member that has given notice of its intent to redeem Class A or Class B capital stock and subsequently revokes or cancels such redemption request. On May 12, 2009, the Board determined that, effective immediately, any member that had previously notified us of its intent to withdraw its membership and rescinds its notice of intent to withdraw from membership on or before December 31, 2009, shall not be subject to a redemption cancellation fee. The Board also determined that any redemption cancellation fees applicable to the transfer of excess Class A or Class B capital stock from a member or successor to a another member shall also be waived. Currently, ten members holding $58.9 million of mandatorily redeemable capital stock are eligible for the cancellation fee waiver should they rescind their notices of intent to withdraw from membership.

 

37


Table of Contents
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

This report contains forward-looking statements that are subject to risk and uncertainty. These statements describe the expectations of the Federal Home Loan Bank of Seattle (Seattle Bank) regarding future events and developments, including future operating results, changes in asset levels, and continued use of our products. These statements include, without limitation, statements as to future expectations, beliefs, plans, strategies, objectives, events, conditions, and financial performance. The words “will,” “believe,” “expect,” “intend,” “may,” “could,” “should,” “anticipate,” and words of similar nature are intended in part to help identify forward-looking statements.

Future results, events, and developments are difficult to predict, and the expectations described in this report, including any forward-looking statements, are subject to risk and uncertainty which may cause actual results to differ materially from those we currently anticipate. Consequently, there is no assurance that the expected events and developments will occur. See “Part II. Item 1A. Risk Factors” of this report for additional information on risks and uncertainties.

Factors that may cause actual results, events, and developments to differ materially from those discussed in this report include, among others, the following:

 

   

adverse changes in the market prices or credit quality of our financial instruments, particularly our private-label mortgage-backed securities, that could cause us to record additional other-than-temporary impairment (OTTI) charges;

 

   

changes in assumptions used to calculate estimates, particularly those related to OTTI charges, recorded in our financial statements;

 

   

our members’ willingness to do business with us despite our inability, as a result of our risk-based capital deficiency, to redeem or repurchase capital stock or pay dividends;

 

   

adverse change in our capital classification by the Federal Housing Finance Agency (Finance Agency) under its interim final rule implementing the prompt corrective action (PCA) provisions of the Housing and Economic Recovery Act of 2008 (Housing Act);

 

   

adverse changes in investor demand for consolidated obligations or increased competition from the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and other government-sponsored enterprises (GSEs), including other Federal Home Loan Banks (FHLBanks), as well as corporate, sovereign, and supranational entities, including entities issuing debt under the Federal Deposit Insurance Corporation (FDIC) Temporary Liquidity Guarantee Program (TLGP);

 

   

legislative or regulatory changes or actions initiated by the U.S. Congress, including the American Recovery and Reinvestment Act of 2009 (Stimulus Package), the Housing Act, and the Emergency Economic Stabilization Act of 2008 (Stabilization Act), or other regulatory changes by any other body, that could cause us to modify our current structure, policies, or business operations;

 

   

actions taken by the U.S. Department of the Treasury (U.S. Treasury), the Federal Reserve System (Federal Reserve), or the FDIC to stabilize the capital and credit markets;

 

   

withdrawal of one or more large members or consolidation or institutional failures among our membership, including the effects of the loss of our then-largest member, Washington Mutual Bank, F.S.B., in October 2008;

 

   

significant increases or decreases in business from or changes in business of our members, including unexpected demand for liquidity from our large members;

 

   

adverse changes in the market value or credit quality of mortgage-related assets used as collateral for advances by our members;

 

   

significant or rapid changes in market conditions, including fluctuations in interest rates, shifts in yield curves, and spreads on mortgage-related assets relative to other financial instruments, or our failure to effectively hedge these instruments;

 

   

changes in global, national, and local economic conditions;

 

   

negative changes in our credit agency ratings or ratings applicable to the FHLBanks or the Federal Home Loan Bank System (FHLBank System);

 

38


Table of Contents
   

failure to satisfy hedge accounting criteria under accounting principles generally accepted in the United States (GAAP) in hedging our interest-rate risk;

 

   

changes in bankruptcy laws or other regulation that could result in modification of the terms or principal balances of mortgage loans that we own or that are collateral underlying our mortgage-backed securities;

 

   

the need to make principal or interest payments on behalf of another FHLBank as a result of the joint and several liability of all FHLBanks for consolidated obligations; and

 

   

events such as terrorism, natural disasters, or other catastrophic events that could disrupt the financial markets where we obtain funding, our borrowers’ ability to repay advances, the value of the collateral that we hold, or our ability to conduct business in general.

These cautionary statements apply to all related forward-looking statements, wherever they appear in this report. We do not undertake to update any forward-looking statements that we make in this report or that we may make from time to time.

Overview

This discussion and analysis reviews our financial condition as of March 31, 2009 and December 31, 2008 and our results of operations for the three months ended March 31, 2009 and 2008. This discussion should be read in conjunction with our unaudited financial statements and related condensed notes for the three months ended March 31, 2009 in “Part I. Item 1. Financial Statements” in this report and with our audited financial statements and related notes for the year ended December 31, 2008 (2008 Audited Financials) included in our 2008 annual report on Form 10-K.

Our financial condition as of March 31, 2009 and our results of operations for the three months ended March 31, 2009 are not necessarily indicative of the financial condition and the operating results that may be expected as of or for the year ending December 31, 2009 or for any other future dates or periods.

General

The Seattle Bank is a federally chartered corporation and one of 12 FHLBanks, which along with the Finance Agency (prior to July 30, 2008, the Federal Housing Finance Board (Finance Board)) and the Office of Finance comprise the FHLBank System. The Seattle Bank is a cooperative that is owned by member financial institutions located within our district, which includes Alaska, Hawaii, Idaho, Montana, Oregon, Utah, Washington, and Wyoming, as well as the U.S. territories of American Samoa and Guam and the Commonwealth of the Northern Mariana Islands. All federally insured depository institutions, community development financial institutions, and insurance companies engaged in residential housing finance located in the Seattle Bank’s district are eligible to apply for membership. Our primary business activity is providing loans (advances) to our members and eligible housing associates. We also work with our members and a variety of other entities, including nonprofit organizations, to provide affordable housing and community economic development funds through direct subsidy grants and low- or no-interest loans, to benefit individuals and communities in need. We fund these grants and loans through the Affordable Housing Program (AHP) and the Community Investment Program (CIP).

Our revenues derive primarily from interest income from advances, investments, and mortgage loans held for portfolio. Our principal funding source is consolidated obligations issued by the Office of Finance on our behalf. We are primarily liable for repayment of consolidated obligations issued on our behalf and jointly and severally liable for the consolidated obligations issued on behalf of the other FHLBanks. We believe many variables influence our financial performance, including market interest-rate changes, yield-curve shifts, availability of credit, and general economic conditions.

Market Conditions

The turmoil in the global financial markets that began in mid-2007 and intensified during 2008 continued to negatively impact borrowing and lending activities during the first quarter of 2009. Although interbank lending began to increase somewhat during the first quarter of 2009, indicating a slight improvement in market liquidity, concerns regarding the creditworthiness and nonperformance risks of trade counterparties adversely affected the market value and capitalization of many financial institutions and in turn resulted in additional institutional failures and mergers.

Although applications for mortgage loan refinancings significantly increased in the first quarter of 2009, the U.S. mortgage market continued to deteriorate during this period, with delinquency and foreclosure rates on mortgage loans increasing nationwide. The private-label mortgage-backed securities market, which had for the most part ceased operating during much of 2008, continued its lack of activity as uncertainty over the impact of new or proposed governmental actions (including mortgage loan modification programs), further home-price deterioration, and changes in borrower, lender, and investor behavior depressed and complicated the pricing of private-label mortgage-backed securities. The uncertainty as to the depth and duration of these

 

39


Table of Contents

trends has resulted in a change in the market for private-label mortgage-backed securities, such that what had been a generally functioning market in early- to mid-2007 became highly illiquid, with prices reflecting a lack of dealer and investor sponsorship.

Specifically, the significant reduction in the market value and demand for private-label mortgage-backed securities continued to adversely impact the market value of investments for a number of FHLBanks, and as a result of the accounting rules in place in 2008, several FHLBanks, including the Seattle Bank, were forced to record losses in 2008 on these securities in excess of their expected credit losses. For the Seattle Bank, the OTTI charges recorded in 2008 resulted in an accumulated deficit and contributed to a risk-based capital deficiency, which in turn, required the suspension of dividend payments and repurchases and redemptions of capital stock. In the first quarter of 2009 (as in 2008), the credit-rating agencies downgraded a significant number of private-label mortgage-backed securities, including some owned by the Seattle Bank, which further adversely impacted the market values of these securities. As of the end of the first quarter of 2009, we continued to have a risk-based capital deficiency.

These and other factors prompted significant actions by governments, regulatory agencies, and other credit market participants around the world, including in the United States, in 2008 and 2009. During this period, the U.S. Treasury, the Federal Reserve, the FDIC, and the Finance Agency announced a number of major initiatives, including new measures impacting the FHLBank System, our members, and the financial markets, to address liquidity pressures and increase confidence among credit market participants, including, for example, passing the 2009 Stimulus Package. See “—Recent Regulatory Developments” below for more information.

It is unclear how long it will take for recent legislative and regulatory initiatives to be fully implemented and, once implemented, what affect they will ultimately have on the U.S. economy. During the first quarter of 2009, the Seattle Bank’s advances continued to be a primary source of liquidity to our members, although our advance balances continued to decline as many of our members further reduced their asset balances. Demand for short-term, fixed interest-rate advances was particularly strong and we were generally able to fund these advances with short-term funding at favorable interest rates.

In April 2009, the Financial Accounting Standards Board (FASB) issued a new accounting rule for other-than-temporary impairments of securities, which is intended to provide greater clarity about OTTI and to more effectively communicate when an OTTI event has occurred. This rule requires, among other things, the separation of an OTTI charge into (a) the amount of the total impairment related to credit loss and (b) the amount of the total impairment related to all other factors. The amount of the total OTTI charge related to credit is recognized in earnings in the statement of income. The amount of the total OTTI charge related to all other factors is recognized in other comprehensive income in the statement of condition. The Seattle Bank adopted this rule, FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (FSP FAS 115-2), effective January 1, 2009 (see “—Financial Condition” for additional information). Although we recognized a cumulative effect adjustment of $293.4 million in initially applying FSP FAS 115-2 as an adjustment to our retained earnings as of January 1, 2009, with a corresponding adjustment to accumulated other comprehensive loss, adoption of FSP FAS 115-2 did not affect the market value of our private-label mortgage-backed securities or our total amount of capital. For the three months ended March 31, 2009, we recorded additional total OTTI charges of $895.2 million ($71.7 million of which related to the credit losses on certain private-label mortgage-backed securities in our held-to-maturity portfolio, as reported in our Statement of Operations, and $823.5 million of which related to all other factors, as reflected in our Statement of Condition in accumulated other comprehensive loss).

Members

So far in 2009, the Seattle Bank experienced some significant changes in our membership.

 

   

In September 2008, Bank of America (BofA) announced that it had agreed to purchase Merrill Lynch, which transaction closed on January 1, 2009. Bank of America Oregon, N.A., a wholly owned subsidiary of BofA, and Merrill Lynch Bank USA, a wholly owned subsidiary of Merrill Lynch, are both members of the Seattle Bank. In March 2009, Merrill Lynch Bank USA prepaid its outstanding advances of $2.9 billion.

 

   

Five member institutions failed. Advances to these members were fully collateralized, and all outstanding advances were prepaid by the acquiring institution or the FDIC, and their outstanding capital stock was transferred to mandatorily redeemable capital stock. We believe that the continued volatility of the markets may result in additional member institution failures during 2009.

Financial Results and Condition

The Seattle Bank recorded a net loss of $16.2 million for the three months ended March 31, 2009, a decrease of $47.7 million from net income of $31.5 million for the same period in 2008. The decrease in net income for the three months ended March 31, 2009 was primarily due to $71.7 million in OTTI credit losses on certain of our held-to-maturity securities (further discussed below), a decrease of $10.5 million in net prepayment fee income on advances, and an increased net loss on derivatives

 

40


Table of Contents

and hedging activities of $8.9 million. This decrease in net income was partially offset by a $9.6 million increase in net interest income and a decreased net realized loss on debt retirements of $11.7 million.

As of March 31, 2009, we had total assets of $56.9 billion, total outstanding capital stock (including mandatorily redeemable capital stock) of $2.8 billion, and retained earnings of $198.3 million, compared to total assets of $58.4 billion, total outstanding capital stock (including mandatorily redeemable stock) of $2.8 billion, and an accumulated deficit of $78.9 million as of December 31, 2008. The slight decrease in assets was due primarily to a lower advance balance, partially offset by increased short-term investments, including securities purchased under agreements to resell and federal funds sold. The change from our accumulated deficit as of December 31, 2008 to retained earnings as of March 31, 2009 primarily resulted from our adoption of FSP FAS 115-2, under which we recognized a cumulative-effect adjustment of $293.4 million as an increase to our retained earnings as of January 1, 2009, with a corresponding adjustment to accumulated other comprehensive loss.

As a result of our quarterly reviews of our held-to-maturity securities, including adoption of FSP FAS 115-2, we recorded OTTI charges of $895.2 million (of which $71.7 million was credit-related and recorded in earnings and $823.5 was non-credit related and recorded in other comprehensive loss) relating to certain of our private-label mortgage-backed securities for the three months ended March 31, 2009. We could recognize additional OTTI charges on our private-label mortgage-backed securities if, among other things, delinquency or loss rates on mortgages continue to increase beyond our forecasted levels or residential real estate values continue to decline beyond our forecasted levels as of March 31, 2009, further negatively impacting our earnings, other comprehensive loss, and total GAAP capital. See “—Financial Condition—Investments,” Note 2 in “Part I. Item 1. Financial Statements—Condensed Notes to Financial Statements,” and “Part II. Item 1A. Risk Factors,” for more information.

Changes in market interest rates and the considerable decline in activity in the mortgage-backed securities market since mid-2007 has had a significant net unfavorable impact on the fair value of our assets and liabilities, particularly our mortgage-backed securities. As of March 31, 2009 and December 31, 2008, our net unrealized market value losses were $1.4 billion and $2.1 billion, which, in accordance with GAAP, are not reflected in our financial position and operating results. The decrease in our unrealized market value loss is primarily the result of the recognition of $895.2 million in other-than-temporary impairment charges for the three months ended March 31, 2009. Because of our net unrealized market value losses, the ratio of the market value to the book value of our equity was estimated at 24.0% and 22.9% as of March 31, 2009 and December 31, 2008. Our unrealized market value losses as of March 31, 2009 and December 31, 2008 were primarily due to our investments in private-label mortgage-backed securities collateralized by Alt-A mortgage loans, the market value of which has significantly declined since mid-2007. We believe that the overall intrinsic value of our private-label mortgage-backed securities, which we have determined using third-party pricing services, is generally not represented by the current market value. See Note 9 in “Part I. Item 1. Financial Statements—Condensed Notes to Financial Statements,” for additional information on the estimation of fair values.

Primarily as a result of the decline in the market value of our private-label mortgage-backed securities, we reported a risk-based capital deficiency as of March 31, 2009. Because an FHLBank that fails to meet any regulatory capital requirement may not declare a dividend or redeem or repurchase capital stock, we are unable to redeem or repurchase any outstanding Class A or Class B stock until this deficiency is corrected and we comply with all of our regulatory capital requirements. Because of the instability in the mortgage-backed securities market and its impact on our risk-based capital, we cannot predict when we will or be able to resume dividend payments and stock repurchases or redemptions, and the Finance Agency or other regulatory or legislative body could, among other things, require us to take specified actions relating to any capital deficiencies.

We have elected not to hedge the basis risk of our mortgage-related assets (i.e., the spread at which our mortgage-backed securities and mortgage loans held for portfolio may be purchased relative to other financial instruments) due to the cost and lack of available derivatives that we believe can effectively hedge this risk. We expect that our market-value-of-equity ratio will continue to be depressed until the difference between the market value of our assets and liabilities improves and conditions more consistent with past experiences return to the credit markets. For additional information, see “—Financial Condition,” “Part I. Item 3. Quantitative and Qualitative Disclosures about Market Risk,” and “Part II. Item 1A. Risk Factors” in this report.

We believe the condition of the U.S. economy will continue to affect and be affected by liquidity issues in the global financial markets and the deterioration in the U.S. housing market, through at least 2009. Going forward, we expect to continue to manage our business in order to meet members’ needs, particularly for liquidity, in varying market conditions. However, the actions that we have taken and continue to take to manage these needs may negatively impact our financial condition and results of operations. For example, in September 2008, we shifted our short-term investment strategy from investing in higher-yielding unsecured investments to investing in lower-yielding secured investments in order to reduce our counterparty credit risk. In March 2009, as a result of modest improvements in the U.S. credit markets, on a limited basis, we have extended unsecured credit to a select group of financial institutions and slightly increased our unsecured short-term investment balance. However, we expect that this investment strategy will continue to negatively impact interest income from investments for the remainder of 2009. In addition, while we continue to assess the impact of legislative, regulatory, and membership changes, we believe that these changes

 

41


Table of Contents

may negatively affect advance volumes, our cost of funds, and our flexibility in managing our business, further affecting our financial condition and results of operations.

Recent Regulatory Developments

On January 30, 2009, the Finance Agency published an interim final rule that implements the prompt corrective action (PCA) provisions of the Housing Act. The interim rule establishes four capital classifications for FHLBanks and implements the PCA provisions that apply to FHLBanks that are not deemed to be adequately capitalized. Once an FHLBank is determined by the Finance Agency to be other than adequately capitalized, the FHLBank will become subject to additional supervisory authority by the Finance Agency, and a range of mandatory or discretionary restrictions may be imposed. For example, an FHLBank would need to review its operating and financial contracts and counterparty agreements to determine whether a capital deficiency or the application of the PCA requirements to the FHLBank will trigger defaults or otherwise impact the terms of those contracts and agreements.

The PCA provisions include four capital classifications for the FHLBanks:

 

   

Adequately capitalized (meets or exceeds all of its risk-based and leverage capital requirements)

 

   

Undercapitalized (does not meet one or more of its capital requirements, but it is not significantly or critically undercapitalized)

 

   

Significantly undercapitalized (permanent or total capital is less than 75% of its capital requirements, but it is not critically undercapitalized)

 

   

Critically undercapitalized (total capital is less than or equal to 2% of total assets)

The Director of the Finance Agency may at any time downgrade an FHLBank by one capital category based on specified conduct, decreases in the value of collateral pledged to it, or a determination by the Director of the Finance Agency that the FHLBank is engaging in unsafe and unsound practices or is in an unsafe and unsound condition. Before implementing a reclassification, the Director of the Finance Agency is required to provide the FHLBank with written notice of the proposed action and an opportunity to submit a response. As of May 18, 2009, we had received no notification from the Finance Agency regarding our capital adequacy classification. See “Part I. Item 1. Business—Statutory Capital Requirements” in our 2008 annual report on Form 10-K for additional information on consequences for FHLBanks that are not determined to be adequately capitalized.

In February 2009, the Stimulus Package was signed into law. The Stimulus Package does not contain any provisions that directly impact the Seattle Bank, and its indirect effects on the Seattle Bank are currently unclear. The legislation includes spending designed to increase employment, prevent home foreclosures, and increase mortgage loan refinancing.

The Seattle Bank is continuing to evaluate the implications of the new legislation and regulatory developments, including the 2009 Stimulus Package, the PCA interim final rule, and other regulations, orders, and reports on our members’ and the Seattle Bank’s businesses. See “Part II. Item 1A. Risk Factors” in this report.

 

42


Table of Contents

Financial Highlights

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

 

Selected Financial Data

   March 31,
2009
    December 31,
2008
    September 30,
2008
    June 30,
2008
    March 31,
2008
 
(in millions, except ratios)                               

Statements of Condition (at period end)

          

Total assets

   $ 56,947     $ 58,362     $ 76,195     $ 66,431     $ 68,826  

Cash and investments (1)

     19,965       16,006       24,369       24,127       25,173  

Advances

     31,848       36,944       46,331       36,635       37,748  

Mortgage loans held for portfolio

     4,899       5,087       5,211       5,355       5,521  

Deposits and other borrowings

     671       582       1,434       832       1,288  

Consolidated obligations

     53,481       54,469       70,875       62,390       64,103  

Affordable Housing Program (AHP)

     15       16       23       27       25  

Payable to Resolution Funding Corporation (REFCORP)

           7       8  

Class A stock - putable

     134       118       396       317       444  

Class B stock - putable

     1,733       1,730       2,480       2,149       2,145  

Retained earnings (2)

     198       (79 )     162       191       173  

Accumulated other comprehensive loss (2)

     (1,105 )     (3 )     (1 )     (1 )     (1 )

Total capital

     961       1,766       3,037       2,655       2,759  

Statements of Income (for the three month period ended)

          

Interest income

   $ 315     $ 485     $ 523     $ 533     $ 706  

Net interest income

     74       21       43       50       65  

Other (loss) income

     (79 )     (264 )     (47 )     2       (10 )

Other expense

     12       13       22       12       12  

(Loss) income before assessments

     (16 )     (256 )     (26 )     40       43  

AHP and REFCORP assessments

       (15 )     (7 )     11       11  

Net (loss) income

     (16 )     (241 )     (19 )     29       32  

Dividends (for the three month period ended)

          

Dividends paid in cash and stock

   $                  $                  $ 9     $ 11     $ 8  

Annualized dividend rate

          

Class A stock - putable

     0.00 %     0.00 %     2.09 %     3.21 %     4.56 %

Class B stock - putable

     0.00 %     0.00 %     1.40 %     1.40 %     1.00 %

Dividend payout ratio

     0.00 %     0.00 %     -49.38 %     36.37 %     26.60 %

Financial Statistics (for the three month period ended)

          

Return on average equity

     -3.64 %     -45.58 %     -2.75 %     4.39 %     4.71 %

Return on average assets

     -0.11 %     -1.41 %     -0.11 %     0.18 %     0.19 %

Equity-to-assets ratio (3)

     3.54 %     4.43 %     4.13 %     3.99 %     3.98 %

Total capital-to-assets ratio (4)

     5.24 %     4.60 %     4.18 %     4.12 %     4.13 %

Net interest margin (5)

     0.49 %     0.12 %     0.25 %     0.30 %     0.39 %

 

(1)

Investments may include, among other things, securities purchased under agreements to resell, federal funds sold, and held-to-maturity securities.

(2)

As a result of our adoption of FSP FAS 115-2 effective January 1, 2009, we recognized a cumulative effect adjustment of $293.4 million as an increase to our retained earnings as of January 1, 2009, with a corresponding adjustment to accumulated other comprehensive loss.

(3)

Equity-to-assets ratio is average capital stock, retained earnings, and accumulated other comprehensive loss, divided by the total average assets.

(4)

Total capital-to-assets ratio is regulatory capital stock plus retained earnings, divided by the total assets at the end of the period.

(5)

Net interest margin is net interest income divided by the average earning assets.

Financial Condition

Our assets principally consist of advances, investments, and mortgage loans held for portfolio. Our advance balance and our advances as a percentage of total assets as of March 31, 2009 declined from December 31, 2008, to $31.8 billion from $36.9 billion and to 55.9% from 63.3%. This decline primarily resulted from prepayments of $2.9 billion in advances by Merrill Lynch Bank USA, advance maturities, and an increase in our short-term investments portfolio, which includes federal funds sold and securities sold under agreements to repurchase. The increase in our short-term investments is intended to provide sufficient liquidity to meet members’ demand for advances, as well as to provide additional investment income.

The following table summarizes our major categories of assets as a percentage of total assets as of March 31, 2009 and December 31, 2008.

 

43


Table of Contents

Major Categories of Assets as a Percentage of Total Assets

   As of
March 31, 2009
   As of
December 31, 2008
(in percentages)          

Advances

   55.9    63.3

Investments

   35.1    27.4

Mortgage loans held for portfolio

   8.6    8.7

Other assets

   0.4    0.6
         

Total

   100.0    100.0
         

We obtain funding to support our business primarily through the issuance, by the Office of Finance on our behalf, of debt securities in the form of consolidated obligations. To a significantly lesser extent, we also rely on member deposits and on the issuance of our equity securities to our members in connection with their membership and their utilization of our products. In addition, during the third quarter of 2008, the Seattle Bank entered into a lending agreement with the U.S. Treasury (Lending Agreement) to serve as a contingent source of liquidity. As of March 31, 2009, we had not drawn on this available liquidity source. For additional information regarding the Lending Agreement, see “––Capital Resources and Liquidity––Liquidity.”

The following table summarizes our major categories of liabilities and total capital as a percentage of total liabilities and capital as of March 31, 2009 and December 31, 2008.

 

Major Categories of Liabilities and Total Capital as a Percentage of Total Liabilities and Capital

   As of
March 31, 2009
   As of
December 31, 2008
(in percentages)          

Consolidated obligations

   93.9    93.3

Deposits

   1.2    1.0

Other liabilities*

   3.2    2.7

Total capital

   1.7    3.0
         

Total

   100.0    100.0
         

 

*

Mandatorily redeemable capital stock, representing 1.6% as of total liabilities and capital as of March 31, 2009 and December 31, 2008, is recorded in other liabilities.

We report our assets, liabilities, and commitments in accordance with GAAP, including the market value of our assets, liabilities, and commitments, which we also review for purposes of risk management. The differences between the carrying value and market value of our assets, liabilities, and commitments are unrealized market-value gains or losses. As of March 31, 2009 and December 31, 2008, we had net unrealized market value losses of $1.4 billion and $2.1 billion. Because of these net unrealized market-value losses, the ratio of the market value to book value of our equity was 24.0% and 22.9% as of March 31, 2009 and December 31, 2008. We expect that our market value of equity will continue to be depressed until the difference in the market value of our assets (most significantly our mortgage-related assets) and liabilities improve and conditions more consistent with past experience return to the credit markets. We have elected not to hedge our mortgage-related asset basis risk due to the cost and lack of effective means of hedging this risk.

We discuss the material changes in each of our principal categories of assets and liabilities and our capital stock in more detail below.

Advances

Advances decreased by 13.8%, or $5.1 billion, to $31.8 billion, as of March 31, 2009, compared to December 31, 2008. This decline primarily resulted from prepayments of $2.9 billion in advances by Merrill Lynch Bank USA and maturing advances, and generally lower advance activity across our membership.

As of March 31, 2009, five borrowers held 70.6% of the par value of our outstanding advances, with two borrowers holding 55.5% (JPMorgan Chase Bank N.A. (formerly Washington Mutual Bank, F.S.B.) with 34.2% and Bank of America Oregon, N.A. with 21.3%). As of December 31, 2008, five borrowers held 68.4% of the par value of our outstanding advances, with three borrowers holding 56.7% (JPMorgan Chase Bank N.A. with 35.0%, Bank of America Oregon, N.A. with 11.4%, and Merrill Lynch Bank USA with 10.3%). No other borrower held over 10% of our outstanding advances as of March 31, 2009 or December 31, 2008.

 

44


Table of Contents

Although the long-term impact of the BofA/Merrill Lynch merger on membership and advance levels is unknown at this time, Merrill Lynch prepaid $2.9 billion of advances during March 2009 and had no outstanding advances as of March 31, 2009. Further, we expect that advance volumes and associated advance interest income which began to decline in the fourth quarter of 2008, will be further negatively impacted as a result of the acquisition of our former largest member, Washington Mutual Bank, F.S.B. by JPMorgan Chase Bank N.A., a non-member institution. The majority of this former member’s advances mature during 2009, and it is unknown whether we will be able to replace these advances or reinvest the proceeds of the maturing advances into similarly yielding investments. Because a large concentration of our advances is held by only a few members and a non-member shareholder, changes in this group’s borrowing decisions can significantly affect the amount of our advances outstanding. We expect that the concentration of advances with our largest borrowers will remain significant for the foreseeable future. In addition, the ability of our members to issue FDIC-insured unsecured debt under the TLGP, as well as expanded lending activities by the Federal Reserve, may also adversely impact demand for our advances.

The percentage of advances maturing in one year or less slightly decreased to 63.2% as of March 31, 2009, from 66.2% as of December 31, 2008, while the percentage of variable interest-rate advances (including floating-to-fixed convertible advances) as a portion of our total advance portfolio decreased to 24.5% as of March 31, 2009, compared to 31.6% as of December 31, 2008. These changes reflect our members’ preference for short-term, fixed interest-rate liquidity given the continued volatile market conditions.

The total weighted-average interest rate on our advance portfolio declined to 2.51% as of March 31, 2009 from 3.02% as of December 31, 2008. The weighted-average interest rate on our portfolio is dependent upon the term-to-maturity and type of advances within the portfolio at the time of measurement, as well as on our cost of funds (which is the basis for our advance pricing). The lower prevailing market interest rates, as well as our overall lower cost of funds, contributed to significantly lower yields on our advances across all terms-to-maturity.

The following table summarizes our advance portfolio by remaining term-to-maturity and weighted-average interest rates as of March 31, 2009 and December 31, 2008.

 

     As of March 31, 2009    As of December 31, 2008

Term-to-Maturity and Weighted-Average Interest Rates

   Amount     Weighted-
Average
Interest Rate
   Amount     Weighted-
Average
Interest Rate
(in thousands, except interest rates)                      

Due in one year or less

   $ 19,777,475     1.96    $ 24,014,584     2.65

Due after one year through two years

     3,798,963     2.76      4,540,058     3.34

Due after two years through three years

     2,076,538     3.34      1,679,058     3.83

Due after three years through four years

     1,542,572     3.39      1,440,120     3.89

Due after four years through five years

     828,311     3.24      1,353,482     3.32

Thereafter

     3,251,513     4.40      3,268,677     4.41
                     

Total par value

     31,275,372     2.51      36,295,979     3.02

Commitment fees

     (765 )        (803 )  

Discount on AHP advances

     (114 )        (126 )  

Discount on advances

     (4,963 )        (5,030 )  

SFAS 133 hedging adjustments

     578,865          653,831    
                     

Total

   $ 31,848,395        $ 36,943,851    
                     

For additional information on advances, see Note 3 in “Part I. Item 1. Financial Statements––Condensed Notes to Financial Statements” in this report.

Member Demand for Advances

Many factors affect the demand for advances, including changes in credit markets, interest rates, collateral availability, and member funding needs. Members regularly evaluate financing options relative to our advance products and pricing. For example, as a result of the continuing significant volatility in the global capital markets, including the U.S. credit markets, the availability of many sources of wholesale funding such as repurchase agreements, commercial paper, and certain other commercial lending arrangements were either constrained or more expensive than FHLBank advances during the first quarter of 2009. However, as member banks continued to reduce their asset balances during the first quarter of 2009, we experienced a further reduction in demand for advances (following a similar decline in the fourth quarter of 2008).

 

45


Table of Contents

The Seattle Bank’s advance pricing alternatives include differential pricing, daily market-based pricing, and auction pricing (which is generally offered two times per week and for limited terms). We may also offer featured advances from time to time, where advances of specific maturities are offered at lower rates than our daily market-based pricing. The following table summarizes our advance pricing as a percentage of new advance activity, excluding cash management advances.

 

     For the Three Months Ended March 31,

Advance Pricing

               2009                            2008            
(in percentages)          

Differential pricing

   62.2    58.3

Daily market-based pricing

   36.8    34.2

Auction pricing

   1.0    7.5
         

Total

   100.0    100.0
         

We believe that the use of differential pricing gives us greater flexibility to compete for advance business. The use of differential pricing means that interest rates on our advances may be lower for some members requesting advances within specified criteria than for others, so that we can compete with lower interest rates available to those members that have alternative wholesale or other funding sources. Although the percentage of differentially priced advances was slightly higher in the first quarter of 2009 than for the same period in 2008, differentially priced advance activity increased significantly in the first quarter of 2009 compared to the fourth quarter of 2008, indicating increased alternative wholesale funding sources for our members. In general, our larger members have more alternative funding sources and are able to access funding at lower interest rates than our smaller members. Overall, we believe that the use of differential pricing has helped to increase our advance balance and improve our ability to generate net income and lending capacity for the benefit of all our members.

The demand for advances also may be affected by the manner in which members support their advances with capital stock, the dividends we pay on our capital stock, and our members’ ability to have capital stock repurchased or redeemed by us. In December 2006, we implemented amendments to our Capital Plan, including the ability to issue Class A stock. Overall, we believe that the availability of the Class A stock, which has a six-month redemption period, as well as our resumption of quarterly dividend payments in December 2006, contributed to our members’ use of our advances in 2008, particularly those that required new stock purchases. However, as a result of OTTI charges recorded in the third and fourth quarters of 2008 and a risk-based capital deficiency as of December 31, 2008, we suspended dividend payments and capital stock repurchases and redemptions in late 2008. We recorded additional OTTI charges and also had a risk-based capital deficiency for the period ended March 31, 2009. Because an FHLBank that fails to meet any regulatory capital requirement may not declare a dividend or redeem or repurchase capital stock, we are unable to declare a dividend or to redeem or repurchase any outstanding Class A or Class B stock until this deficiency is corrected and we comply with all of our regulatory capital requirements. Although we do not believe that these suspensions have thus far significantly adversely affected our advance volumes, we cannot predict when we will or be able to resume dividend payments and stock repurchases or redemptions or how the continuance of these suspensions will affect future advance demand.

In March 2009, the FDIC issued a final rule to raise an insured institution’s base assessment rate based upon the institution’s ratio of secured liabilities to domestic deposits. Under the rule, an institution’s ratio of secured liabilities to domestic deposits (if greater than 25%) would increase the assessment rate, with the resulting base assessment rate after any such increase never being more than 50% greater than it was before the adjustment. Because our advances are considered secured liabilities by our members, the rule will have the effect of increasing the all-in borrowing costs for our members and may tend to reduce member demand for our advances.

On May 12, 2009, the Board of Directors (Board) of the Seattle Bank suspended the issuance of Class A capital stock to support new advances, effective June 1, 2009. New advances will have to be supported by Class B capital stock, which unlike Class A capital stock, can be used to reduce the Seattle Bank’s risk-based capital deficiency.

See “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital Resources and Liquidity—Capital Resources—Capital Plan Amendments and Board Policies Regarding Seattle Bank Stock” in our 2008 annual report on Form 10-K for additional information.

Credit Risk

Our credit risk from advances is concentrated in commercial banks and savings institutions. As of March 31, 2009, we had advances of $17.3 billion outstanding to two borrowers, which represented 55.5% (34.2% and 21.3%) of our total par value of

 

46


Table of Contents

advance outstanding. As of December 31, 2008 we had advances of $20.6 billion outstanding to three borrowers, which represented 56.7% (35.0%, 11.4%, and 10.3%) of our total par value of advances outstanding. As of March 31, 2009 and December 31, 2008, we had rights to collateral, either loans or securities, on a borrower-by-borrower basis, with an estimated fair value in excess of outstanding advances. As a result, we do not expect to incur any credit losses on our advances.

We have never experienced a credit loss on an advance. Given the current economic environment, some of our borrowers may experience financial difficulties, including failure, and our credit protection may not be sufficient to protect our security interest. For example, the number of borrowers on our internal credit watch list has trended sharply upward over the past year, generally as a result of increases in non-performing assets and the need for additional capital. Further, so far in 2009, five of our member institutions have failed. All outstanding advances to these members were collateralized and were prepaid by the acquiring institution or the FDIC. We actively monitor our borrowers’ financial condition. Should the financial condition of a borrower decline or become otherwise impaired, we may take possession of a borrower’s collateral, or require that the borrower provide additional collateral to us. In the first quarter of 2009 and during the second half of 2008, due to deteriorating market conditions and pursuant to our advance agreements, we moved a number of borrowers from blanket collateral arrangements to physical possession. The physical possession collateral arrangement reduces our credit risk and allows us to continue lending to borrowers whose financial condition may have weakened. See “Part I. Item 1. Business—Our Business—Products and Services—Advances,” in our 2008 annual report on Form 10-K for additional information on advances and credit risk management.

Investments

We maintain portfolios of short- and long-term investments for liquidity purposes and to generate returns on our capital. Short-term investments generally include federal funds sold, certificates of deposit, TLGP securities, and securities purchased under agreements to resell, while long-term investments generally include mortgage-backed securities and agency obligations. Investment levels generally depend upon our liquidity and leverage needs, including demand for our advances.

The following table summarizes the carrying values of our investments as of March 31, 2009 and December 31, 2008.

 

Short- and Long-Term Investments

   As of
March 31, 2009
   As of
December 31, 2008
(in thousands)          

Short-Term Investments

     

Federal funds sold

   $ 4,191,500    $ 2,320,300

Certificates of deposit

     2,377,000   

Securities purchased under agreements to resell

     5,000,000      3,900,000

Other (TLGP securities)

     1,100,000      1,250,000
             

Total short-term investments

     12,668,500      7,470,300
             

Long-Term Investments

     

Mortgage-backed securities

     6,550,143      7,589,423

Other U.S. agency obligations

     60,311      64,164

Government-sponsored enterprise obligations

     678,895      875,604

State or local housing agency obligations

     5,560      5,700
             

Total long-term investments

   $ 7,294,909    $ 8,534,891
             

In September 2008, in order to reduce our unsecured counterparty exposure, we modified our investment strategy and began replacing our unsecured short-term investments with secured short-term investments and overnight federal funds sold. In March 2009, as a result of modest improvements in the U.S. credit markets, on a limited basis, we have extended unsecured credit to a select group of financial institutions and slightly increased our unsecured short-term investment balance. In addition, we are currently purchasing only GSE or U.S. agency mortgage-backed securities for our long-term investment portfolio. Because our secured short-term investments and GSE and U.S. agency mortgage-backed securities earn lower yields than many of the unsecured short-term investments and private-label mortgage-backed securities we previously invested in, we expect our investment interest income to continue the decline that began in 2008. Further, because we were unable to fully replace the unsecured short-term investments as they matured with secured investments, our capital-to-assets ratio increased to 5.24% as of March 31, 2009. Until the capital markets begin to operate more normally, we expect to continue to manage our business to a capital-to-assets ratio target higher than our previously Board-approved 4.05%, although our actual capital-to-assets ratio will vary, possibly significantly.

Between December 31, 2008 and March 31, 2009, we significantly increased our short-term investment portfolio to provide for sufficient liquidity to meet members’ potential demand for advances by leveraging our members’ capital stock purchases and

 

47


Table of Contents

reinvesting funds from prepaid advances and maturing investments. As a result, as of March 31, 2009, our short-term investments increased by 69.6%, to $12.7 billion, from $7.5 billion as of December 31, 2008. Our long-term investment portfolio declined by 14.5%, to $7.3 billion, primarily due to principal payments. We expect that our short-term investment portfolio will continue to fluctuate based on the Seattle Bank’s liquidity and leverage needs and market conditions.

Mortgage-Backed Securities

Previously, each FHLBank’s investment in mortgage-backed securities was limited at the time a security was purchased, to 300% of the FHLBank’s regulatory capital, which in our case is comprised of capital stock, retained earnings, and mandatorily redeemable capital stock. In March 2008, the Finance Board adopted a resolution authorizing the FHLBanks to increase their purchases of agency mortgage-backed securities, effective immediately, from 300% to 600% of an FHLBank’s regulatory capital. This resolution, which remains in effect for two years, requires an FHLBank to notify the Finance Agency prior to its first acquisition under the expanded authority and to include in its notification a description of the risk management principles underlying the additional purchases. At this time, we do not expect to utilize this increased authority.

Our investment in mortgage-backed securities represented 219.3% and 282.4% of our regulatory capital as of March 31, 2009 and December 31, 2008. Mortgage-backed securities as of March 31, 2009 and December 31, 2008 included $1.4 billion and $1.3 billion in Fannie Mae mortgage-backed securities and $704.3 million and $728.0 million in Freddie Mac mortgage-backed securities. As of March 31, 2009, the carrying value of our investments in mortgage-backed securities rated “AAA” (or its equivalent) by a nationally recognized statistical rating organization (NRSRO), such as Moody’s Investor Service (Moody’s) and Standard & Poor’s (S&P), totaled $5.0 billion. See “—Credit Risk” below for credit ratings relating to our mortgage-backed securities.

Other U.S. Agency Obligations

Our investments in other U.S. agency obligations consist primarily of debt securities of government agencies whose debt is guaranteed, directly or indirectly, by the U.S. government. Our investments in other U.S. agency obligations declined slightly as of March 31, 2009 from December 31, 2008, primarily due to principal repayments.

Government-Sponsored Enterprise (GSE) Obligations

Our held-to-maturity investments in GSEs consist primarily of unsecured debt securities of Fannie Mae and Freddie Mac. Fannie Mae securities totaled $104.9 million and $300.9 million and Freddie Mac securities totaled $274.8 million and $275.6 million as of March 31, 2009 and December 31, 2008. These securities represented 1.9% and 3.6% of total investments as of such dates. Finance Agency regulations limit any investments in the debt of any one GSE to the lower of 100% of our capital or the capital of the GSE.

Credit Risk

We are subject to credit risk on some of our investments. We limit our unsecured credit exposure to any counterparty, other than the U.S. government or GSEs, based on the credit quality and capital level of the counterparty and the capital level of the Seattle Bank. As of March 31, 2009, our unsecured credit exposure was $8.1 billion, primarily consisting of $4.2 billion of federal funds sold, $1.1 billion in TLGP securities, and $2.4 billion in certificates of deposit. As of December 31, 2008, our unsecured credit exposure was $4.5 billion, primarily consisting of $2.3 billion in federal funds sold and $1.3 billion in TLGP securities. The increase in unsecured credit exposure primarily resulted from our investment in certificates of deposit and federal funds sold. For the near term, we continue to limit our investments in unsecured short-term investments to limit our counterparty credit exposure.

Our mortgage-backed security investments consist of agency guaranteed securities and senior tranches of privately issued prime or Alt-A (including, among others, hybrid adjustable–rate mortgages (ARMs) and option-ARMs) residential mortgage-backed securities. We have increased exposure to the risk of loss on our investments in mortgage-backed securities when the loans backing the mortgage-backed securities exhibit high rates of delinquency and foreclosures, as well as when there are losses on the sale of foreclosed properties. In order to reduce our risk of loss on these investments, all of the mortgage-backed securities owned by the Seattle Bank contain one or more of the following forms of credit protection:

 

   

Subordination – where the mortgage-backed security is structured such that payments to junior classes are subordinated to senior classes to ensure cash flows to the senior classes.

 

   

Excess spread – where the weighted-average coupon rate of the underlying mortgage loans in the pool is higher than the weighted-average coupon rate on the mortgage-backed security. The spread differential may be used to cover any losses that may occur.

 

48


Table of Contents
   

Over-collateralization – where the total outstanding balance on the underlying mortgage loans in the pool is greater than the outstanding mortgage-backed security balance. The excess collateral is available to cover any losses that may occur.

 

   

Insurance wrap – where a third-party bond insurance company (e.g., a monoline insurer) guarantees timely payment of principal and interest on the mortgage-backed security. The bond insurance company is obligated to cover any losses that occur. As of March 31, 2009, the Seattle Bank held $3.6 million in investments with unrealized losses of $2.4 million that had been credit-enhanced by a monoline insurer, MBIA. Although we expect the insurer to be able to meet its contractual obligations, we have additional credit enhancements on these securities such that we expect to collect all amounts due according to their contractual terms. The Seattle Bank does not anticipate investing in any material amount of securities where the primary credit protection is provided by monoline insurers for the foreseeable future.

The following table summarizes the carrying value of our long-term investments and their various credit ratings as of March 31, 2009 and December 31, 2008.

 

     As of March 31, 2009

Long-Term Investments by Credit Rating

   AAA or
Government
Agency
   AA    A    BBB