c. Calculate lost income on FHLB pledgeable collateral vs. Fed Discount windowpledgeable investments (e.g., Treasuries): Member's equity holding in FHLBS Amount converted: $2B- this is excess equity vs. needed amounts to draw down Advances for liquidity purposes Spread between System-wide dividend yield (4.5%)1.2 and yield on 5-year Treasuries (3.11%) 3: 140 bp Option-adjusted spread in lost income: 114 bp OAS is used instead of the simple bond yield differential between whole loans and Treasuries The 15-year Fannie Mae MBS priced closest to par has a yield of 4.51% and an OAS* of 94 bp Lost income = $41B 114 bp = $467mm The total cost to Members would be about $500mm. This is composed of $28mm (for redeemed equity used to purchase Treasuries) + $467mm (for lower amounts of whole loans used to purchase Treasuries). Using the System average dividend rate per FHLB Combined Annual Report, 2002, issued by Office of Finance To be conservative we assumed that FHLBank dividends are fully taxable. According to Michael Wilson, FHLB Boston, it is, however, possible for Members to defer their tax liability -if dividends are paid in stock, the tax liability can be deferred indefinitely as long as the Member does not redeem such stock 3 5-year Treasury rate, Federal Reserve, as of 9/19/2003 The assumptions in the OAS computation are Bloomberg prepayment model, 20% volatility and 3% mean reversion in interest rates 4 5 The weighted average life (WAL) of the MBS is 4.4 years FMCG.com em_FFHS 01_09-25 App A2 A-17 Appendix B: The Methodology For Calculating The Potential Increase In Funding Costs Related To SEC Registration Of FHLBS' Stock The methodology used to estimate the potential effects of the SEC registration on the FHLB's cost of funds consists of the following four steps: 1. Evaluate the factors determining how the FHLB debt is likely to trade upon SEC registration: As some traditional investors in FHLB debt use the absence of a need to register with the SEC as a definition of GSE status, they may, therefore, for a time, be prevented from buying new issues and may have to sell current holdings At a minimum, there could be little or no effect on spreads Barring changes in credit quality of FHLBS, a potential worst-case effect could be that, upon SEC registration, FHLB debt for a time trades more like AAA-rated Bank/Finance bonds1 1 After the FHLB System is able to adjust its indicia, FHLB debt would return back to normal GSE yields 1 Currently COs carry a credit rating of AAA from major rating agencies based on the GSE status of the FHLB System FMCG.COM em_FFHS 01_09-25 App B2 2. Estimate the potential increase in the cost of funds: Compare the term structure of FHLB and AAA Bank/Finance issues. As Exhibit 1 below shows, 3. Determine the run-off schedule for Consolidated Obligations: Determine the term structure of outstanding balances and assume that new issuances follow the same maturity/call schedule • The term structure of outstanding balances for consolidated bonds is provided below by term to maturity or next call date1 The term structure of outstanding balances for discount notes is provided below by term to 1 FHLB Combined Annual Report, 2002, issued by Office of Finance, FMCG analytics 2 FHLB System Discount Note maturity summary prepared by the Office of Finance as of 7/31/03, FMCG analytics FMCG.COM em_FFHS 01_09-25 App B2 • For consolidated bonds, average issuance per month = (Annual consolidated bond issuance1)+12 = $435B+12 = $36B For discount notes, average issuance per month = (Outstanding DNs2 x %DNs maturing within 1-month3) = $147B × 57% = $83B Apply the term structure of DNs and consolidated bonds to average monthly issuance to estimate the run-off schedule: Annual consolidated bond issuance in 2002. Source: Debt issuance statistics, Office of Finance Outstanding DN balances as of Dec 31, 2002. Source: Annual Report FHLB System Discount Notes maturity summary prepared by the Office of Finance FMCG.COM em_FFHS 01-09-25 App B2 B-4 |