To the Board of Directors of the Federal Reserve Bank of Atlanta
The management of the Federal Reserve Bank of Atlanta ("FRB Atlanta") is responsible for the preparation and fair presentation of the Statement of Financial Condition, Statement of Income, and Statement of Changes in Capital as of December 31, 2004 (the "Financial Statements"). The Financial Statements have been prepared in conformity with the accounting principles, policies, and practices established by the Board of Governors of the Federal Reserve System and as set forth in the Financial Accounting Manual for Federal Reserve Banks ("Manual") and, as such, include amounts, some of which are based on judgments and estimates of management. To our knowledge, the Financial Statements are, in all material respects, fairly presented in conformity with the accounting principles, policies, and practices documented in the Manual and include all disclosures necessary for such fair presentation.
The management of the FRB Atlanta is responsible for maintaining an effective process of internal controls over financial reporting, including the safeguarding of assets as they relate to the Financial Statements. Such internal controls are designed to provide reasonable assurance to management and to the Board of Directors regarding the preparation of reliable Financial Statements. This process of internal controls contains self-monitoring mechanisms, including, but not limited to, divisions of responsibility and a code of conduct. Once identified, any material deficiencies in the process of internal controls are reported to management, and appropriate corrective measures are implemented.
Even an effective process of internal controls, no matter how well designed, has inherent limitations, including the possibility of human error, and therefore can provide only reasonable assurance with respect to the preparation of reliable financial statements.
The management of the FRB Atlanta assessed its process of internal controls over financial reporting, including the safeguarding of assets reflected in the Financial Statements, based upon the criteria established in the Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, we believe that the FRB Atlanta maintained an effective process of internal controls over financial reporting, including the safeguarding of assets as they relate to the Financial Statements.
Federal Reserve Bank of Atlanta
President and Chief Executive Officer
Patrick K. Barron
First Vice President and Chief Operating Officer
Christopher G. Brown
Senior Vice President and Chief Financial Officer
March 10, 2005 Atlanta, Georgia
Report of Independent Accountants
To the Board of Directors of the Federal Reserve Bank of Atlanta
We have examined management's assertion, included in the accompanying Management Assertion, that the Federal Reserve Bank of Atlanta ("FRBA") maintained effective internal control over financial reporting and the safeguarding of assets as they relate to the financial statements as of December 31, 2004, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. FRBA's management is responsible for maintaining effective internal control over financial reporting and safeguarding of assets as they relate to the financial statements. Our responsibility is to express an opinion on management's assertion based on our examination.
Our examination was conducted in accordance with attestation standards established by the American Institute of Certified Public Accountants and, accordingly, included obtaining an understanding of internal control over financial reporting, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our examination provides a reasonable basis for our opinion.
Because of inherent limitations in any internal control, misstatements due to error or fraud may occur and not be detected. Also, projections of any evaluation of internal control over financial reporting to future periods are subject to the risk that the internal control may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assertion that FRBA maintained effective internal control over financial reporting and over the safeguarding of assets as they relate to the financial statements as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
This report is intended solely for the information and use of management and the Board of Directors and Audit Committee of FRBA and any organization with legally defined oversight responsibilities and is not intended to be and should not be used by anyone other than these specified parties.
March 16, 2005 Atlanta, Georgia
Report of Independent Auditors
To the Board of Governors of the Federal Reserve System and the Board of Directors of the Federal Reserve Bank of Atlanta
We have audited the accompanying statements of condition of the Federal Reserve Bank of Atlanta (the "Bank") as of December 31, 2004 and 2003, and the related statements of income and changes in capital for the years then ended, which have been prepared in conformity with the accounting principles, policies, and practices established by the Board of Governors of the Federal Reserve System. These financial statements are the responsibility of the Bank's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As described in Note 3, these financial statements were prepared in conformity with the accounting principles, policies, and practices established by the Board of Governors of the Federal Reserve System. These principles, policies, and practices, which were designed to meet the specialized accounting and reporting needs of the Federal Reserve System, are set forth in the Financial Accounting Manual for Federal Reserve Banks and constitute a comprehensive basis of accounting other than accounting principles generally accepted in the United States of America.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Bank as of December 31, 2004 and 2003, and results of its operations for the years then ended, on the basis of accounting described in Note 3.
March 16, 2005 Atlanta, Georgia
Statements of Condition As of December As of December (in millions) 31, 2004 31, 2003 Assets Gold certificates $894 $863 Special drawing rights certificates 166 166 Coin 82 82 Items in process of collection 637 723 Loans to depository institutions 8 5 U.S. government securities, net 48,931 45,639 Investments denominated in foreign currencies 1,181 1,127 Accrued interest receivable 343 341 Interdistrict settlement account 9,938 4,274 Bank premises and equipment, net 333 340 Other assets 42 43 Total assets $62,555 $53,603 Liabilities and Capital Liabilities Federal Reserve Notes outstanding, net $56,768 $48,296 Securities sold under agreements to repurchase 2,076 1,733 Deposits Depository institutions 1,722 1,608 Other deposits 2 2 Deferred credit items 796 855 Interest on Federal Reserve notes due U.S. Treasury 56 21 Accrued benefit costs 86 98 Other liabilities 17 12 Total liabilities $61,523 $52,625 Capital Capital paid-in $516 $489 Surplus 516 489 Total capital $1,032 $978 Total liabilities and capital $62,555 $53,603 The accompanying notes are an integral part of these financial statements. Statements of Income For the years ended December December (in millions) 31, 2004 31, 2003 Interest income Interest on U.S. government securities $1,484 $1,530 Interest on investments denominated in foreign currencies 15 15 Total interest income $1,499 $1,545 Interest expense Interest expense on securities sold under agreements to repurchase $20 $15 Net interest income $1,479 $1,530 Other operating income Income from services $161 $166 Reimbursable services to government agencies 17 18 Foreign currency gains, net 68 155 Other income 3 3 Total other operating income $249 $342 Operating expenses Salaries and other benefits $152 $166 Occupancy expense 21 20 Equipment expense 22 24 Assessments by Board of Governors 77 79 Other expenses 94 94 Total operating expenses $366 $383 Net income prior to distribution $1,362 $1,489 Distribution of net income Dividends paid to member banks $30 $29 Transferred to surplus 27 14 Payments to U.S. Treasury as interest on Federal Reserve notes 1,305 1,446 Total distribution $1,362 $1,489 The accompanying notes are an integral part of these financial statements. Statements of Changes in Capital For the years ended December 31, 2004, (in millions) and December 31, 2003 Capital Total Paid-In Surplus Capital Balance at January 1, 2003 (9.5 million shares) $475 $475 $950 Transferred to surplus 14 14 Net change in capital stock issued (0.3 million shares) 14 14 Balance at December 31, 2003 (9.8 million shares) $489 $489 $978 Transferred to surplus 27 27 Net change in capital stock issued (0.5 million shares) 27 27 Balance at December 31, 2004 (10.3 million shares) $516 $516 $1,032 The accompanying notes are an integral part of these financial statements.
Notes to Financial Statements
The Federal Reserve Bank of Atlanta ("Bank") is part of the Federal Reserve System ("System") created by Congress under the Federal Reserve Act of 1913 ("Federal Reserve Act"), which established the central bank of the United States. The System consists of the Board of Governors of the Federal Reserve System ("Board of Governors") and twelve Federal Reserve Banks ("Reserve Banks"). The Reserve Banks are chartered by the federal government and possess a unique set of governmental, corporate, and central bank characteristics. The Bank and its branches in Birmingham, Alabama; Jacksonville, Florida; Nashville, Tennessee; New Orleans, Louisiana; and Miami, Florida, serve the Sixth Federal Reserve District, which includes Georgia, Florida, Alabama, and portions of Louisiana, Tennessee, and Mississippi. Other major elements of the System are the Federal Open Market Committee ("FOMC") and the Federal Advisory Council. The FOMC is composed of members of the Board of Governors, the president of the Federal Reserve Bank of New York ("FRBNY"), and, on a rotating basis, four other Reserve Bank presidents. Banks that are members of the System include all national banks and any state-chartered bank that applies and is approved for membership in the System.
Board of Directors
In accordance with the Federal Reserve Act, supervision and control of the Bank are exercised by a Board of Directors. The Federal Reserve Act specifies the composition of the Board of Directors for each of the Reserve Banks. Each board is composed of nine members serving three-year terms: three directors, including those designated as Chairman and Deputy Chairman, are appointed by the Board of Governors, and six directors are elected by member banks. Of the six elected by member banks, three represent the public and three represent member banks. Member banks are divided into three classes according to size. Member banks in each class elect one director representing member banks and one representing the public. In any election of directors, each member bank receives one vote, regardless of the number of shares of Reserve Bank stock it holds.
2. OPERATIONS AND SERVICES
The System performs a variety of services and operations. Functions include formulating and conducting monetary policy; participating actively in the payments mechanism, including large-dollar transfers of funds, automated clearinghouse ("ACH") operations, and check processing; distributing coin and currency; performing fiscal agency functions for the U.S. Treasury and certain federal agencies; serving as the federal government's bank; providing short-term loans to depository institutions; serving the consumer and the community by providing educational materials and information regarding consumer laws; supervising bank holding companies and state member banks; and administering other regulations of the Board of Governors. The Board of Governors' operating costs are funded through assessments on the Reserve Banks.
The FOMC establishes policy regarding open market operations, oversees these operations, and issues authorizations and directives to the FRBNY for its execution of transactions. Authorized transaction types include direct purchase and sale of securities, the purchase of securities under agreements to resell, the sale of securities under agreements to repurchase, and the lending of U.S. government securities. The FRBNY is also authorized by the FOMC to hold balances of, and to execute spot and forward foreign exchange ("F/X") and securities contracts in, nine foreign currencies and to invest such foreign currency holdings ensuring adequate liquidity is maintained. In addition, FRBNY is authorized to maintain reciprocal currency arrangements ("F/X swaps") with various central banks and "warehouse" foreign currencies for the U.S. Treasury and Exchange Stabilization Fund ("ESF") through the Reserve Banks.
3. SIGNIFICANT ACCOUNTING POLICIES
Accounting principles for entities with the unique powers and responsibilities of the nation's central bank have not been formulated by the Financial Accounting Standards Board. The Board of Governors has developed specialized accounting principles and practices that it believes are appropriate for the significantly different nature and function of a central bank as compared with the private sector. These accounting principles and practices are documented in the Financial Accounting Manual for Federal Reserve Banks ("Financial Accounting Manual"), which is issued by the Board of Governors. All Reserve Banks are required to adopt and apply accounting policies and practices that are consistent with the Financial Accounting Manual.
The financial statements have been prepared in accordance with the Financial Accounting Manual. Differences exist between the accounting principles and practices of the System and accounting principles generally accepted in the United States of America ("GAAP"). The primary difference is the presentation of all security holdings at amortized cost, rather than at the fair value presentation requirements of GAAP. In addition, the Bank has elected not to present a Statement of Cash Flows. The Statement of Cash Flows has not been included because the liquidity and cash position of the Bank are not of primary concern to the users of these financial statements. Other information regarding the Bank's activities is provided in, or may be derived from, the Statements of Condition, Income, and Changes in Capital. A Statement of Cash Flows, therefore, would not provide any additional useful information. There are no other significant differences between the policies outlined in the Financial Accounting Manual and GAAP.
Each Reserve Bank provides services on behalf of the System for which costs are not shared. Major services provided on behalf of the System by the Bank, for which the costs were not redistributed to the other Reserve Banks, include Federal Reserve Information Technology Projects, Retail Payments Office, Retail Check-Related Projects, Accounting-Related Projects, Customer Support Projects, National Information Center for Supervision and Regulation, Audit Services, and Special Check-Related Projects.
The preparation of the financial statements in conformity with the Financial Accounting Manual requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates. Certain amounts relating to the prior year have been reclassified to conform to the current-year presentation. Unique accounts and significant accounting policies are explained below.
a. Gold Certificates
The Secretary of the Treasury is authorized to issue gold certificates to the Reserve Banks to monetize gold held by the U.S. Treasury. Payment for the gold certificates by the Reserve Banks is made by crediting equivalent amounts in dollars into the account established for the U.S. Treasury. These gold certificates held by the Reserve Banks are required to be backed by the gold of the U.S. Treasury. The U.S. Treasury may reacquire the gold certificates at any time and the Reserve Banks must deliver them to the U.S. Treasury. At such time, the U.S. Treasury's account is charged, and the Reserve Banks' gold certificate accounts are lowered. The value of gold for purposes of backing the gold certificates is set by law at $42 2/9 a fine troy ounce. The Board of Governors allocates the gold certificates among Reserve Banks once a year based on average Federal Reserve notes outstanding in each District.
b. Special Drawing Rights Certificates
Special drawing rights ("SDRs") are issued by the International Monetary Fund ("Fund") to its members in proportion to each member's quota in the Fund at the time of issuance. SDRs serve as a supplement to international monetary reserves and may be transferred from one national monetary authority to another. Under the law providing for United States participation in the SDR system, the Secretary of the U.S. Treasury is authorized to issue SDR certificates, somewhat like gold certificates, to the Reserve Banks. At such time, equivalent amounts in dollars are credited to the account established for the U.S. Treasury, and the Reserve Banks' SDR certificate accounts are increased. The Reserve Banks are required to purchase SDR certificates, at the direction of the U.S. Treasury, for the purpose of financing SDR acquisitions or for financing exchange stabilization operations. At the time SDR transactions occur, the Board of Governors allocates SDR certificate transactions among Reserve Banks based upon Federal Reserve notes outstanding in each District at the end of the preceding year. There were no SDR transactions in 2004 or 2003.
c. Loans to Depository Institutions
The Depository Institutions Deregulation and Monetary Control Act of 1980 provides that all depository institutions that maintain reservable transaction accounts or nonpersonal time deposits, as defined in Regulation D issued by the Board of Governors, have borrowing privileges at the discretion of the Reserve Bank. Borrowers execute certain lending agreements and deposit sufficient collateral before credit is extended. Loans are evaluated for collectibility, and currently all are considered collectible and fully collateralized. If loans were ever deemed to be uncollectible, an appropriate reserve would be established. Interest is accrued using the applicable discount rate established at least every fourteen days by the Board of Directors of the Reserve Bank, subject to review by the Board of Governors.
d. U.S. Government and Federal Agency Securities and Investments Denominated in Foreign Currencies The FOMC has designated the FRBNY to execute open market transactions on its behalf and to hold the resulting securities in the portfolio known as the System Open Market Account ("SOMA"). In addition to authorizing and directing operations in the domestic securities market, the FOMC authorizes and directs the FRBNY to execute operations in foreign markets for major currencies in order to counter disorderly conditions in exchange markets or to meet other needs specified by the FOMC in carrying out the System's central bank responsibilities. Such authorizations are reviewed and approved annually by the FOMC.
The FRBNY has sole authorization by the FOMC to lend U.S. government securities held in the SOMA to U.S. government securities dealers and to banks participating in U.S. government securities clearing arrangements on behalf of the System in order to facilitate the effective functioning of the domestic securities market. These securities-lending transactions are fully collateralized by other U.S. government securities. FOMC policy requires the FRBNY to take possession of collateral in excess of the market values of the securities loaned. The market values of the collateral and the securities loaned are monitored by the FRBNY on a daily basis, with additional collateral obtained as necessary. The securities lent are accounted for in the SOMA.
F/X contracts are contractual agreements between two parties to exchange specified currencies, at a specified price, on a specified date. Spot foreign contracts normally settle two days after the trade date, whereas the settlement date on forward contracts is negotiated between the contracting parties but will extend beyond two days from the trade date. The FRBNY generally enters into spot contracts, with any forward contracts generally limited to the second leg of a swap/warehousing transaction.
The FRBNY, on behalf of the Reserve Banks, maintains renewable, short-term F/X swap arrangements with two authorized foreign central banks. The parties agree to exchange their currencies up to a pre-arranged maximum amount and for an agreed-upon period of time (up to twelve months), at an agreed-upon interest rate. These arrangements give the FOMC temporary access to foreign currencies it may need for intervention operations to support the dollar and give the partner foreign central bank temporary access to dollars it may need to support its own currency. Drawings under the F/X swap arrangements can be initiated by either the FRBNY or the partner foreign central bank and must be agreed to by the drawee. The F/X swaps are structured so that the party initiating the transaction (the drawer) bears the exchange rate risk upon maturity. The FRBNY will generally invest the foreign currency received under an F/X swap in interest-bearing instruments.
Warehousing is an arrangement under which the FOMC agrees to exchange, at the request of the Treasury, U.S. dollars for foreign currencies held by the Treasury or ESF over a limited period of time. The purpose of the warehousing facility is to supplement the U.S. dollar resources of the Treasury and ESF for financing purchases of foreign currencies and related international operations.
In connection with its foreign currency activities, the FRBNY, on behalf of the Reserve Banks, may enter into contracts that contain varying degrees of off-balance-sheet market risk because they represent contractual commitments involving future settlement and counterparty credit risk. The FRBNY controls credit risk by obtaining credit approvals, establishing transaction limits, and performing daily monitoring procedures.
While the application of current market prices to the securities currently held in the SOMA portfolio and investments denominated in foreign currencies may result in values substantially above or below their carrying values, these unrealized changes in value would have no direct effect on the quantity of reserves available to the banking system or on the prospects for future Reserve Bank earnings or capital. Both the domestic and foreign components of the SOMA portfolio from time to time involve transactions that may result in gains or losses when holdings are sold prior to maturity. Decisions regarding the securities and foreign currencies transactions, including their purchase and sale, are motivated by monetary policy objectives rather than profit. Accordingly, market values, earnings, and any gains or losses resulting from the sale of such currencies and securities are incidental to the open market operations and do not motivate its activities or policy decisions.
U.S. government securities and investments denominated in foreign currencies comprising the SOMA are recorded at cost, on a settlement-date basis, and adjusted for amortization of premiums or accretion of discounts on a straight-line basis. Securities sold under agreements to repurchase are accounted for as secured borrowing transactions with the associated interest expense recognized over the life of the transaction. Such transactions are settled by FRBNY. Interest income is accrued on a straight-line basis. Income earned on securities lending transactions is reported as a component of "Other income." Gains and losses resulting from sales of securities are determined by specific issues based on average cost. Foreign-currency-denominated assets are revalued daily at current foreign currency market exchange rates in order to report these assets in U.S. dollars. Realized and unrealized gains and losses on investments denominated in foreign currencies are reported as "Foreign currency gains, net."
Activity related to U.S. government securities bought outright, securities sold under agreements to repurchase, securities loaned, investments denominated in foreign currency, excluding those held under an F/X swap arrangement, and deposit accounts of foreign central banks and governments above core balances are allocated to each Reserve Bank. U.S. government securities purchased under agreements to resell and unrealized gains and losses on the revaluation of foreign currency holdings under F/X swaps and warehousing arrangements are allocated to the FRBNY and not to other Reserve Banks.
In 2003, additional interest income of $61 million, representing one day's interest on the SOMA portfolio, was accrued to reflect a change in interest accrual calculations, of which $4.1 million was allocated to the Bank. The effect of this change was not material; therefore, it was included in the 2003 interest income.
e. Bank Premises, Equipment, and Software
Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is calculated on a straight-line basis over estimated useful lives of assets ranging from two to fifty years. Major alterations, renovations, and improvements are capitalized at cost as additions to the asset accounts and are amortized over the remaining useful life of the asset. Maintenance, repairs, and minor replacements are charged to operations in the year incurred. Costs incurred for software, either developed internally or acquired for internal use, during the application development stage are capitalized based on the cost of direct services and materials associated with designing, coding, installing, or testing software. Capitalized software costs are amortized on a straight-line basis over the estimated useful lives of the software applications, which range from two to five years.
f. Interdistrict Settlement Account
At the close of business each day, all Reserve Banks and branches assemble the payments due to or from other Reserve Banks and branches as a result of transactions involving accounts residing in other Districts that occurred during the day's operations. Such transactions may include funds settlement, check clearing and ACH operations, and allocations of shared expenses. The cumulative net amount due to or from other Reserve Banks is reported as the "Interdistrict settlement account."
g. Federal Reserve Notes
Federal Reserve notes are the circulating currency of the United States. These notes are issued through the various Federal Reserve agents (the Chairman of the Board of Directors of each Reserve Bank) to the Reserve Banks upon deposit with such agents of certain classes of collateral security, typically U.S. government securities. These notes are identified as issued to a specific Reserve Bank. The Federal Reserve Act provides that the collateral security tendered by the Reserve Bank to the Federal Reserve agent must be equal to the sum of the notes applied for by such Reserve Bank.
Assets eligible to be pledged as collateral security include all Federal Reserve Bank assets. The collateral value is equal to the book value of the collateral tendered, with the exception of securities, whose collateral value is equal to the par value of the securities tendered. The par value of securities pledged for securities sold under agreements to repurchase is similarly deducted.
The Board of Governors may, at any time, call upon a Reserve Bank for additional security to adequately collateralize the Federal Reserve notes. To satisfy the obligation to provide sufficient collateral for outstanding Federal Reserve notes, the Reserve Banks have entered into an agreement that provides for certain assets of the Reserve Banks to be jointly pledged as collateral for the Federal Reserve notes of all Reserve Banks. In the event that this collateral is insufficient, the Federal Reserve Act provides that Federal Reserve notes become a first and paramount lien on all the assets of the Reserve Banks. Finally, as obligations of the United States, Federal Reserve notes are backed by the full faith and credit of the United States government.
The "Federal Reserve notes outstanding, net" account represents the Bank's Federal Reserve notes outstanding reduced by its currency holdings of $17,376 million, and $18,415 million at December 31, 2004 and 2003, respectively.
h. Capital Paid-In
The Federal Reserve Act requires that each member bank subscribe to the capital stock of the Reserve Bank in an amount equal to 6 percent of the capital and surplus of the member bank. As a member bank's capital and surplus changes, its holdings of Reserve Bank stock must be adjusted. Member banks are state-chartered banks that apply and are approved for membership in the System and all national banks. Currently, only one-half of the subscription is paid-in and the remainder is subject to call. These shares are nonvoting with a par value of $100. They may not be transferred or hypothecated. By law, each member bank is entitled to receive an annual dividend of 6 percent on the paid-in capital stock. This cumulative dividend is paid semiannually. A member bank is liable for Reserve Bank liabilities up to twice the par value of stock subscribed by it.
The Financial Accounting Standards Board (FASB) has deferred the implementation date for SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" for the Bank. When applicable, the Bank will determine the impact and provide the appropriate disclosures.
The Board of Governors requires Reserve Banks to maintain a surplus equal to the amount of capital paid-in as of December 31. This amount is intended to provide additional capital and reduce the possibility that the Reserve Banks would be required to call on member banks for additional capital.
Pursuant to Section 16 of the Federal Reserve Act, Reserve Banks are required by the Board of Governors to transfer to the U.S. Treasury as interest on Federal Reserve notes excess earnings, after providing for the costs of operations, payment of dividends, and reservation of an amount necessary to equate surplus with capital paid-in.
In the event of losses or an increase in capital paid-in, payments to the U.S. Treasury are suspended and earnings are retained until the surplus is equal to the capital paid-in. Weekly payments to the U.S. Treasury may vary significantly.
In the event of a decrease in capital paid-in, the excess surplus, after equating capital paid-in and surplus at December 31, is distributed to the U.S. Treasury in the following year. This amount is reported as a component of "Payments to U.S. Treasury as interest on Federal Reserve notes."
j. Income and Costs Related to Treasury Services
The Bank is required by the Federal Reserve Act to serve as fiscal agent and depository of the United States. By statute, the Department of the Treasury is permitted, but not required, to pay for these services.
The Reserve Banks are exempt from federal, state, and local taxes, except for taxes on real property. The Bank's real property taxes were $3 million for each of the years ended December 31, 2004 and 2003, and are reported as a component of "Occupancy expense."
l. Restructuring Charges
In 2003, the System started the restructuring of several operations, primarily check, cash, and Treasury services. The restructuring included streamlining the management and support structures, reducing staff, decreasing the number of processing locations, and increasing processing capacity in the remaining locations. These restructuring activities continued in 2004. Footnote 10 describes the restructuring and provides information about the Bank's costs and liabilities associated with employee separations and contract terminations. The costs associated with the write-down of certain Bank assets are discussed in footnote 6. Costs and liabilities associated with enhanced pension benefits for all Reserve Banks are recorded on the books of the FRBNY.
4. U.S. GOVERNMENT SECURITIES
Securities bought outright are held in the SOMA at the FRBNY. An undivided interest in SOMA activity and the related premiums, discounts, and income, with the exception of securities purchased under agreements to resell, is allocated to each Reserve Bank on a percentage basis derived from an annual settlement of interdistrict clearings that occurs in April of each year. The settlement equalizes Reserve Bank gold certificate holdings to Federal Reserve notes outstanding. The Bank's allocated share of SOMA balances was approximately 6.744 percent and 6.756 percent at December 31, 2004 and 2003, respectively.
The Bank's allocated share of U.S. government securities, net held in the SOMA at December 31, was as follows (in millions):
2004 2003 Par value U.S. government Bills $17,734 $16,540 Notes 24,334 21,845 Bonds 6,340 6,652 Total par value 48,408 45,037 Unamortized premiums 634 662 Unaccreted discounts (111) (60) Total allocated to Bank $48,931 $45,639
The total of the U.S. government securities, net held in the SOMA was $725,584 million and $675,569 million at December 31, 2004 and 2003, respectively.
The maturity distribution of U.S. government securities bought outright and securities sold under agreements to repurchase that were allocated to the Bank at December 31, 2004, was as follows (in millions):
Securities Sold U.S. Government under Agreements Securities to Repurchase Maturities of Securities Held (par value) (contract amount) Within 15 days $2,067 $2,076 16 days to 90 days 12,028 -- 91 days to 1 year 11,492 -- Over 1 year to 5 years 14,045 -- Over 5 years to 10 years 3,667 -- Over 10 years 5,109 -- Total $48,408 $2,076
At December 31, 2004 and 2003, U.S. government securities with par values of $6,609 million and $4,426 million, respectively, were loaned from the SOMA, of which $446 million and $299 million were allocated to the Bank.
At December 31, 2004 and 2003, securities sold under agreements to repurchase with contract amounts of $30,783 million and $25,652 million, respectively, and par values of $30,808 million and $25,658 million, respectively, were outstanding. The Bank's allocated share at December 31, 2004 and 2003, was $2,076 million and $1,733 million, respectively, of the contract amount and $2,078 million and $1,733 million, respectively, of the par value.
5. INVESTMENTS DENOMINATED IN FOREIGN CURRENCIES
The FRBNY, on behalf of the Reserve Banks, holds foreign currency deposits with foreign central banks and the Bank for International Settlements and invests in foreign government debt instruments. Foreign government debt instruments held include both securities bought outright and securities purchased under agreements to resell. These investments are guaranteed as to principal and interest by the foreign governments.
Each Reserve Bank is allocated a share of foreign-currency-denominated assets, the related interest income, and realized and unrealized foreign currency gains and losses, with the exception of unrealized gains and losses on F/X swaps and warehousing transactions. This allocation is based on the ratio of each Reserve Bank's capital and surplus to aggregate capital and surplus at the preceding December 31. The Bank's allocated share of investments denominated in foreign currencies was approximately 5.528 percent and 5.671 percent at December 31, 2004 and 2003, respectively.
The Bank's allocated share of investments denominated in foreign currencies, valued at current foreign currency market exchange rates at December 31, was as follows (in millions):
2004 2003 European Union Euro Foreign currency deposits $335 $390 Securities purchased under agreements to resell 118 117 Government debt instruments 212 115 Japanese Yen Foreign currency deposits 85 84 Government debt instruments 424 416 Accrued interest 7 5 Total $1,181 $1,127
Total System investments denominated in foreign currencies were $21,368 million and $19,868 million at December 31, 2004 and 2003, respectively.
The maturity distribution of investments denominated in foreign currencies that were allocated to the Bank at December 31, 2004, was as follows (in millions):
Maturities of Investments Denominated in Foreign Currencies European Euro Japanese Yen Total Within 1 year $496 $509 $1,005 Over 1 year to 5 years 166 -- 166 Over 5 years to 10 years 10 -- 10 Over 10 years -- -- -- Total $672 $509 $1,181
At December 31, 2004 and 2003, there were no material open foreign exchange contracts.
At December 31, 2004 and 2003, the warehousing facility was $5,000 million, with no balance outstanding.
6. BANK PREMISES, EQUIPMENT, AND SOFTWARE
A summary of bank premises and equipment at December 31 is as follows (in millions):
Maximum Useful Life (in years) 2004 2003 Bank premises and equipment Land N/A $41 $40 Buildings 50 245 241 Building machinery and equipment 20 37 36 Construction in progress N/A 1 2 Furniture and equipment 10 126 161 Subtotal $450 $480 Accumulated depreciation (117) (140) Bank premises and equipment, net $333 $340 Depreciation expense for the years ended $18 $19
The Bank leases unused space to outside tenants. Those leases have terms ranging from one to ten years. Rental income from such leases was $582,000 and $647,000 for the years ended December 31, 2004 and 2003, respectively. Future minimum lease payments under noncancelable agreements in existence at December 31, 2004, were (in thousands):
2005 $391 2006 214 2007 214 2008 145 2009 111 Thereafter 666 $1,741
The Bank has capitalized software assets, net of amortization, of $3 million for each of the years ended December 31, 2004 and 2003. Amortization expense was $3 million and $1 million for the years ended December 31, 2004 and 2003, respectively.
Assets impaired as a result of the Bank's restructuring plan, as discussed in footnote 10, include software and equipment. Asset impairment losses of $287,000 and $91,000 for the periods ending December 31, 2004 and 2003, respectively, were determined using fair values based on quoted market values or other valuation techniques and are reported as a component of "Other expenses."
7. COMMITMENTS AND CONTINGENCIES
At December 31, 2004, the Bank was obligated under noncancelable leases for premises and equipment with terms ranging from one to approximately five years. These leases provide for increased rental payments based upon increases in real estate taxes, operating costs, or selected price indices.
Rental expense under operating leases for certain operating facilities, warehouses, and data processing and office equipment (including taxes, insurance and maintenance when included in rent), net of sublease rentals, was $2 million for each of the years ended December 31, 2004 and 2003. Certain of the Bank's leases have options to renew.
Future minimum rental payments under noncancelable operating leases, net of sublease rentals, with terms of one year or more, at December 31, 2004, were (in thousands):
Operating 2005 $566 2006 315 2007 315 2008 315 2009 293 Thereafter 0 $1,804
At December 31, 2004, the Bank, acting on behalf of the Reserve Banks, had contractual commitments extending through the year 2007 totaling $112 million. As of December 31, 2004, none of these commitments was recognized. Purchases of $28 million and $18 million were made against these commitments during 2004 and 2003, respectively. It is estimated that the Bank's allocated share of these commitments will be $66 million. These commitments represent air and ground transportation services for the Federal Reserve Check Transportation System, which serves all Reserve Banks. The payments for the next five years under these commitments are (in millions):
Commitment 2005 $28 2006 27 2007 11 2008 -- 2009 --
Under the Insurance Agreement of the Federal Reserve Banks dated as of March 2, 1999, each of the Reserve Banks has agreed to bear, on a per incident basis, a pro rata share of losses in excess of 1 percent of the capital paid-in of the claiming Reserve Bank, up to 50 percent of the total capital paid-in of all Reserve Banks. Losses are borne in the ratio that a Reserve Bank's capital paid-in bears to the total capital paid-in of all Reserve Banks at the beginning of the calendar year in which the loss is shared. No claims were outstanding under such agreement at December 31, 2004 or 2003.
The Bank is involved in certain legal actions and claims arising in the ordinary course of business. Although it is difficult to predict the ultimate outcome of these actions, in management's opinion, based on discussions with counsel, the aforementioned litigation and claims will be resolved without material adverse effect on the financial position or results of operations of the Bank.
8. RETIREMENT AND THRIFT PLANS
The Bank currently offers two defined benefit retirement plans to its employees, based on length of service and level of compensation. Substantially all of the Bank's employees participate in the Retirement Plan for Employees of the Federal Reserve System ("System Plan") and the Benefit Equalization Retirement Plan ("BEP"). In addition, certain Bank officers participate in the Supplemental Employee Retirement Plan ("SERP").
The System Plan is a multi-employer plan with contributions fully funded by participating employers. Participating employers are the Federal Reserve Banks, the Board of Governors of the Federal Reserve System, and the Office of Employee Benefits of the Federal Reserve Employee Benefits System. No separate accounting is maintained of assets contributed by the participating employers. The FRBNY acts as a sponsor of the Plan for the System and the costs associated with the Plan are not redistributed to the Bank. The Bank's projected benefit obligation and net pension costs for the BEP and the SERP at December 31, 2004 and 2003, and for the years then ended, are not material.
Employees of the Bank may also participate in the defined contribution Thrift Plan for Employees of the Federal Reserve System ("Thrift Plan"). The Bank's Thrift Plan contributions totaled $6 million for each of the years ended December 31, 2004 and 2003, and are reported as a component of "Salaries and other benefits."
9. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS AND POSTEMPLOYMENT BENEFITS
Postretirement Benefits Other Than Pensions
In addition to the Bank's retirement plans, employees who have met certain age and length-of-service requirements are eligible for both medical benefits and life insurance coverage during retirement.
The Bank funds benefits payable under the medical and life insurance plans as due and, accordingly, has no plan assets. Net postretirement benefit costs are actuarially determined using a January 1 measurement date.
Following is a reconciliation of beginning and ending balances of the benefit obligation (in millions):
2004 2003 Accumulated postretirement benefit obligation at January 1 $91.7 $64.8 Service cost-benefits earned during the period 2.0 2.0 Interest cost of accumulated benefit obligation 5.0 4.7 Actuarial loss 1.3 22.2 Special termination loss -- 0.2 Contributions by plan participants 0.9 0.6 Benefits paid (3.8) (2.8) Plan amendments (11.4) -- Accumulated postretirement benefit obligation at December 31 $85.7 $91.7
At December 31, 2004 and 2003, the weighted average discount rate assumptions used in developing the benefit obligation were 5.75 percent and 6.25 percent, respectively.
Following is a reconciliation of the beginning and ending balance of the plan assets, the unfunded postretirement benefit obligation, and the accrued postretirement benefit costs (in millions):
2004 2003 Fair value of plan assets at January 1 $-- $-- Actual return on plan assets -- -- Contributions by the employer 2.9 2.2 Contributions by plan participants 0.9 0.6 Benefits paid (3.8) (2.8) Fair value of plan assets at December 31 $-- $-- Unfunded postretirement benefit obligation $85.7 $91.7 Unrecognized prior service cost 15.1 20.8 Unrecognized net actuarial loss (26.7) (26.3) Accrued postretirement benefit costs $74.1 $86.2
Accrued postretirement benefit costs are reported as a component of "Accrued benefit costs."
For measurement purposes, the assumed health care cost trend rates at December 31 are as follows:
2004 2003 Health care cost trend rate assumed for next year (percent) 9.00 10.00 Rate to which the cost trend rate is assumed to decline (the ultimate trend rate) (percent) 4.75 5.00 Year that the rate reaches the ultimate trend rate 2011 2011
Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans. A 1 percentage point change in assumed health care cost trend rates would have the following effects for the year ended December 31, 2004 (in millions):
One Percentage One Percentage Point Increase Point Decrease Effect on aggregate of service and interest cost components of net periodic postretirement benefit costs $1.4 $(1.0) Effect on accumulated postretirement benefit obligation 11.8 (9.7)
The following is a summary of the components of net periodic postretirement benefit costs for the years ended December 31 (in millions):
2004 2003 Service cost-benefits earned during the period $2.1 $2.0 Interest cost of accumulated benefit obligation 5.0 4.7 Amortization of prior service cost (2.1) (2.0) Recognized net actuarial loss 0.8 0.2 Total periodic expense $5.8 $4.9 Curtailment gain (15.0) -- Special termination loss -- 0.1 Net periodic postretirement benefit costs (9.2) $5.0
At December 31, 2004 and 2003, the weighted-average discount rate assumptions used to determine net periodic postretirement benefit costs were 6.25 percent and 6.75 percent, respectively.
Net periodic postretirement benefit costs are reported as a component of "Salaries and other benefits."
A plan amendment that modified the credited service period eligibility requirements created curtailment gains. The recognition of special termination losses is primarily the result of enhanced retirement benefits provided to employees during the restructuring described in footnote 10. Because the special termination loss is less than $50,000, the amount is not displayed in the tables above.
The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the "Act") was enacted in December 2003. The Act established a prescription drug benefit under Medicare ("Medicare Part D") and a federal subsidy to sponsors of retiree health care benefit plans that provide benefits that are at least actuarially equivalent to Medicare Part D. Following the guidance of the Financial Accounting Standards Board, the Bank elected to defer recognition of the financial effects of the Act until further guidance was issued in May 2004.
Benefits provided to certain participants are at least actuarially equivalent to Medicare Part D. The estimated effects of the subsidy, retroactive to January 1, 2004, are reflected in actuarial loss in the accumulated postretirement benefit obligation and net periodic postretirement benefit costs.
Following is a summary of the effects of the expected subsidy:
2004 Decrease in the accumulated postretirement benefit obligation $12.6 Decrease in the net periodic postretirement benefit costs $1.8 Expected benefit payments (in millions): Without Subsidy With Subsidy 2005 $3 $3 2006 3 3 2007 4 3 2008 4 4 2009 4 4 2010-2014 25 23 Total $43 $40
The Bank offers benefits to former or inactive employees. Postemployment benefit costs are actuarially determined using a December 31, 2004, measurement date and include the cost of medical and dental insurance, survivor income, and disability benefits. For 2004, the Bank changed its practices for estimating postemployment costs and used a 5.25 percent discount rate and the same health care trend rates as were used for projecting postretirement costs. Costs for 2003, however, were projected using the same discount rate and health care trend rates as were used for projecting postretirement costs. The accrued postemployment benefit costs recognized by the Bank at December 31, 2004 and 2003, were $12 million and $11 million, respectively. This cost is included as a component of "Accrued benefit costs." Net periodic postemployment benefit costs included in 2004 and 2003 operating expenses were $3 million and $2 million, respectively.
10. BUSINESS RESTRUCTURING CHARGES
In 2003, the Bank announced plans for restructuring to streamline operations and reduce costs, including consolidation of check operations and staff reductions in various functions of the Bank. In 2004, additional consolidation and restructuring initiatives were announced in the check operations. These actions resulted in the following business restructuring charges:
Major categories of expense (in millions):
Total Accrued Estimated Liability Total Costs 12/31/03 Charges Employee separation $13 $3 $7 Contract termination -- -- -- Other -- -- -- Total $13 $3 $7 Accrued Total Liability Paid 12/31/04 Employee separation $6 $4 Contract termination -- -- Other -- -- Total $6 $4
Employee separation costs are primarily severance costs related to identified staff reductions of approximately 345, including 160 staff reductions related to restructuring announced in 2003. These costs are reported as a component of "Salaries and other benefits."
Restructuring costs associated with the write-downs of certain Bank assets, including software, buildings, leasehold improvements, furniture, and equipment are discussed in footnote 6. Costs associated with enhanced pension benefits for all Reserve Banks are recorded on the books of the FRBNY as discussed in footnote 8. Costs associated with enhanced postretirement benefits are disclosed in footnote 9.
Future costs associated with the restructuring that are not estimable and are not recognized as liabilities will be incurred in 2006.
The Bank anticipates substantially completing its announced plans by March 2006.
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|Date:||Apr 1, 2005|
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