The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
CONTENTS 2 President’s Message 6 Targeting Quality and Efficiency 9 Operating Statistics 10 Quantifying Retail Credit Risk 12 Investigating Check Fraud 14 Studying Payment Cards 16 Promoting Economic Education 18 Establishing Strong Controls 20 Board of Directors 22 Advisory Councils 25 Current Officers 26 Statement of Auditor Independence 27 Financial Reports 47 Key Bank Phone Numbers MISSION The Federal Reserve Bank of Philadelphia is one of 12 regional Reserve Banks in the United States that, together with the Board of Governors in Washington, D.C., make up the Federal Reserve System – the nation’s central bank. The System’s primary role is to ensure a sound financial system and a healthy economy. To foster this goal, the Federal Reserve Bank of Philadelphia helps formulate and implement monetary policy, supervises banks and bank holding companies, and provides financial services to depository institutions and the federal government. The Philadelphia Fed serves the Third District, which is composed of eastern Pennsylvania, southern New Jersey, and Delaware. “STRATEGY FOR CHANGING TIMES” is more than the theme of this year’s annual report. It is a basic tenet for how we do business. What worked yesterday may not be as effective tomorrow. The current business environment requires adaptation and flexibility to prepare for future needs. At the Federal Reserve Bank of Philadelphia, we adhere to a strategy that reveres stability yet allows for change, seeks innovation yet inspires confidence. This year’s annual report theme, “Strategy for Changing Times,” outlines our moves to strengthen our overall position. We trust you will find “Strategy for Changing Times” informative. As always, our strategy begins with our president… 1 PRESIDENT’S MESSAGE Our strategies evolve, but our focus on excellence remains constant. Dr. Anthony M. Santomero, President O U R T S T R AT E G Y he year 2002 was a challenging one for our is straight TO LEARN country, filled with financial uncertainty The cornerstone of our strategy is to con- and geopolitical turmoil. Economically, the rise tinue to build upon our knowledge of the finan- from recession was slower and more difficult than cial services industry and the economy at large. initially anticipated. Indeed, the future course Rapid change is a fact of life; so we constantly of the economy is still very much on everyone’s strive to develop new knowledge and new ca- mind. pacity to ensure financial system integrity and Times such as these challenge the Federal economic stability. Reserve in all its dimensions — as monetary poli- One example is the recent establishment of cymaker, as regulator, and as payments provider. the Payment Cards Center. The Center engages I am proud of the contributions the Philadelphia in intense study of evolving techniques in retail Reserve Bank makes to meet those challenges. payments. Use of credit cards, debit cards, and Our strategy for facing these trying times is other new methods of payment is growing rapidly, straightforward: to learn and to lead. Though and the Center provides meaningful insights into simple, it serves us well as a “Strategy for Chang- payments innovations and the issues they raise. ing Times.” 2 To help build knowledge and capability in the processing network that positions the Fed to regulatory arena, we recently began a project to continue delivering check services at reasonable quantify the impact of growth in retail credit on prices to its customers all across the country. the overall safety and soundness of the financial On the more technical side, the Bank system. This project leverages the expertise we continues to lead System efforts to combat check developed in our extensive analysis of consumer fraud. In partnership with both industry groups credit risk and the credit card industry concen- and the U.S. Treasury, we are finding ways to turn trated in our District. new technologies into workable solutions to this serious problem. As part of our effort to build knowledge as monetary policymakers, we held our second an- Behind the scenes, our Bank also helps the nual Policy Forum last year. The Forum brought Federal Reserve System maintain and enhance together central bankers and policy experts from the application of technology to its business pro- around the world to debate the value of interna- cesses. We oversee the System’s infrastructure for tional coordination in setting domestic monetary e-mail, videoconferencing, collaborative systems, policy. and important aspects of information security. forward: to learn and to lead TO LEAD In 2002, we also expanded our outreach to consumers of As we increase our knowledge, we increase our capacity and propensity to lead. The Philadel- financial services in the District. phia Fed has taken a leadership role in a number Educational programs developed of important Federal Reserve System initiatives, and promoted by the Philadelphia as well as pursuing some initiatives of its own here Fed help consumers make better in the District. financial decisions. In low- and moderate-income communities This past year, our Bank had the opportunity — often targets of unscrupulous to help develop and implement major changes in the business practices — we help Fed’s discount window facility. These changes make people understand risks and it easier for banks in sound financial condition to evaluate alternatives. In District obtain short-term loans from the Federal Reserve. classrooms, we help young people We also contributed to a broad review of understand the workings of the the Fed’s check clearing operations that led to economy and the financial system a substantial restructuring and consolidation of in which they are just beginning processing sites. The result is a more efficient to participate. 3 STRATEGY FOR CHANGING TIMES Through learning and leadership, we will do our part to advance the Fed’s mission of fostering a sound financial system and a healthy economy. In addition, we started a new project to our District has evolved into a microcosm of the broaden our public outreach, taking advantage of national economy, and it now tracks national eco- our unique location on Independence Mall. Our nomic developments quite closely. So, I expect financial exhibit, Money in Motion, will open our region to be a full participant in the national in July 2003. Using technology and interactive economic expansion that lies ahead. displays, visitors will learn about the country’s The banks of the Third District are posi- financial history, as well as the history of the tioned to support that growth. They fared well Federal Reserve System and its unique role in the through the recession and the early stages of this nation’s economy. recovery. Through prudent risk management and responsiveness to shifting customer demands, they have performed admirably in very challeng- LOOKING AHEAD ing times. I am confident they have the capacity As we move into 2003, I am optimistic about to meet District demands for credit and other the future. I see this year as one in which the financial services in the months and years ahead. economic recovery gains momentum, position- Here at the Philadelphia Fed, we look for- ing our nation for a period of sustained economic expansion. Indeed, the ultimate drivers of ward to the new challenges and new opportunities healthy growth — technology, productivity, and changing times will bring. Through learning and globalization — are very much in place. Despite leadership, we will do our part to advance the near-term uncertainty, people have confidence in Fed’s mission of fostering a sound financial system our economy’s long-term potential. Indeed, this and a healthy economy. confidence itself bolsters growth and ensures our ability to reach that potential. BOARD OF DIRECTORS The future of the Third District economy is Recent events remind us about the important equally promising. Over the past several decades, role that boards of directors play in guiding organ- 4 CLOSING THOUGHTS izations. Reserve Bank boards of directors not only oversee the operations of the Reserve Bank, In closing, and in light of our country’s but they also contribute to the formulation of Fed continued state of heightened security aware- policy on behalf of the District. It is a responsi- ness, it is important to stress that we stand ready bility they take seriously and perform admirably. to maintain the integrity of the financial system So, I want to acknowledge recent changes to the — to supply liquidity, assist financial institutions board of directors of the Federal Reserve Bank of in need, and maintain the payments system. Philadelphia: As part of the Federal Reserve System, the Glenn A. Schaeffer, president emeritus of the Philadelphia Fed is an organization with a clear Pennsylvania Building and Construction Trades calling to public service. We remain a high quality Council, has been appointed chairman of the provider of central bank services and continue our board, and Ronald J. Naples, chairman and CEO quest to be broadly recognized as an important of Quaker Chemical Corporation, was appointed center of central bank knowledge and capability. deputy chairman. As the year 2002 so clearly demonstrated, We are grateful for the guidance provided times change and our strategies must evolve. But by two directors who completed their terms of our focus on excellence remains constant. Look- service last year: our former chairman, Charisse R. ing ahead, we will continue to foster an environ- Lillie, partner at Ballard Spahr Andrews & Inger- ment of strength and growth for our region’s soll, and Frank Kaminski, Jr., chairman, president, economy. and CEO of Atlantic Central Bankers Bank. We welcome our two new board members: Garry L. Maddox, CEO of A. Pomerantz & Company, and Kenneth R. Shoemaker, president and CEO of Orrstown Bank. We look forward to the Anthony M. Santomero insights they will surely provide. President In addition, Rufus A. Fulton, Jr., chairman April 2003 and CEO of Fulton Financial Corporation, has been reappointed to represent the Third District on the Federal Advisory Council to the Board of Governors. On behalf of all of us here at the Philadelphia Fed, I thank them for their leadership and their commitment to public service. 5 TARGETING QUALITY AND EFFICIENCY A s the financial environment evolves and Philadelphia area researchers are more interested new technologies emerge, the Federal in factors influencing the health-care industry and Reserve focuses on the most efficient and ef- payment card providers because of the predomi- fective ways to fulfill its missions. First Vice nance of these activities in the District. President Bill Stone offers his insights on the Financial institutions, too, have specialized evolution of the Federal Reserve System and and expanded into new financial vehicles. From the Philadelphia Fed’s key role. a supervision and regulation perspective, uniform expertise is not required in every Federal Reserve SPECIALIZATION AND EFFICIENT District. Rather, sharing expertise across District USE OF RESOURCES lines ensures we are using resources effectively to Each of the 12 Reserve Banks in the Federal Reserve System expends great effort on issues best serve our financial institutions. In providing services to the financial com- concerning national monetary policy. Each munity and the U.S. Treasury, we have found Reserve Bank also does specialized research that not all aspects of a service can be provided unique to its regional environment. For example, efficiently on a local basis. This is particularly true CHANGING TIMES demand new with changes in technology and the reduced reliance on paper transactions and documents. An example of this is the Fed’s participation in the ownership of government securities by individuals. U.S. Treasury securities are often purchased by consumers through TreasuryDirectSM, the first Systemwide consolidation of services, which found its home at the Philadelphia Fed back in the mid-1980s. Holding these securities in book-entry form made maintaining accounts at a single site a logical option. Payments activities have also been in transition. As large-dollar payments and automated clearinghouse payments have become more electronic, geographic proximity has become less important. This consolidated processing brings significant improvements in efficiency. William H. Stone, Jr., First Vice President CHANGES IN CHECK INFRASTRUCTURE them electronically, and create During the early 1970s check payments were machine-readable substitute being influenced by a strong set of demands. Faster checks that would be the legal funds availability led to an expansion in Federal Re- equivalent of the original checks. serve facilities as regional check processing centers The act, now in Congress waiting opened to offer later deposit deadlines and improved consideration, would remove funds availability. Despite predictions of their certain legal impediments and demise, check payments increased at a brisk pace. would enhance the efficiency of the payments system. Then, the mid-1980s ushered in electronic means for banks to provide information about check payments prior to processing the physi- OPPORTUNITIES cal paper. Customers gained the advantage of FOR LEADERSHIP earlier quality information, while banks avoided When consolidation and the demands of expensive additional processing centralization take place, they of- equipment. fer the opportunity for leadership strategies for quality and efficiency In the late 1990s, image processing furthered and capitalization on special capabilities. This has the decline in reliance on the physical check. In been the case for a number of Fed services, such addition, the accelerating growth of electronic as collateral management for financial institutions payments has led to declines in check volumes. and special payments applications for the U.S. Consequently, the Federal Reserve is re-examin- Treasury. ing its check infrastructure and reducing the Within the Federal Reserve System, the number of processing sites. Philadelphia Fed has an outstanding reputation The changes in check infrastructure are still for leading System projects and an impressive limited by geographic constraints. Check service portfolio of current leadership assignments. For levels must be maintained, and the requirements example, we have earned a central role in the for physical delivery of checks, although lessen- Fed’s technology initiatives through our oversight ing, are still the primary limiting factor. Passage of the planning, implementation, and functional of the Check Truncation Act would open many enhancements to the shared technology — or additional opportunities for innovation in check Groupware — for the entire Federal Reserve processing and remove many of the geographic System. Philadelphia also was asked to provide restraints. Banks would then be able to trun- analysis on how to improve the effectiveness cate — or stop the flow of — checks, process and efficiency of information security across our 7 distributed processing platforms. ties with the entire Fed System. When financial institutions access the services of their regional As the largest single Fed site for check pro- Reserve Bank, they do so with the confidence cessing and also one of the most sophisticated and that the full arsenal of Fed resources and capabili- efficient operations in the System, Philadelphia ties is behind them. This way, the power of shar- is a major source of innovation and leadership. ing best practices is put to use to deliver superior, Philadelphia was asked to lead the effort and high quality customer service. make recommendations on check infrastructure, leading to the decisions announced in early 2003. Our goal is to continue to provide the highest We are currently engaged in research for the quality service in the most efficient and effective System and the U.S. Treasury to combat check manner possible. We at the Federal Reserve Bank fraud. In addition, we are working to develop a of Philadelphia are committed to quality, innova- new check information and reconcilement system tion, and responsiveness. We will strive to make for the U.S. Treasury. strategic investments that allow us to contribute At the Philadelphia Fed, we take advan- to the System and serve our Third District stake- tage of change to leverage our strengths, pursue holders. leadership opportunities, and share our capabili- At the Philadelphia Fed We take advantage of change to leverage our strengths, pursue leadership opportunities, and share our capabilities with the entire Fed System. 8 OPERATING STATISTICS I n 2002, Philadelphia’s total volume of com- cessed increased 3 percent while the related dollar mercial checks processed decreased 4 percent. value increased 12 percent, both attributable to Conversely, the dollar value of transactions normal growth. The substantial decrease in coin increased 4 percent. Beginning in January 2002, processed was the result of the August 2002 elimi- the Bank started phasing in its newly assumed re- nation of some processing of lower denominations sponsibility for processing all government checks of coin. The substantial decrease in food coupons for the First, Second, Third, and Fourth Federal processed was a result of the consolidation of this Reserve Districts. function in January 2002. The Philadelphia Bank continued to be a In 2002, both the number and value of loans major processor of cash in the Federal Reserve to depository institutions were lower than in the System in 2002. The volume of currency pro- previous year. 2002 Volume 2002 Dollar Value 2001 Volume 2001 Dollar Value $64.5 billion 40.9 million checks $37.1 billion $2,594.7 billion 1,339.8 million checks $2,501.3 billion SERVICES TO DEPOSITORY INSTITUTIONS Check processing: U.S. government 52.8 million checks Commercial checks 1,282.6 million checks Cash operations: Currency processed 2,116.7 million notes $41.2 billion 2,053.8 million notes $36.8 billion Coin processed 23.8 thousand bags $16.4 million 52.5 thousand bags $29.9 million 68 loans $210.3 million 96 loans $503.3 million $2.8 million 6.4 million coupons $34.3 million Loans to depository institutions SERVICES TO U.S. TREASURY Food coupons processed 551 thousand coupons Note: Because of the consolidation of Federal Reserve System wire transfer of funds and electronic book-entry transfer operations to other Federal Reserve offices, related statistics are no longer shown here. 9 QUANTIFYING RETAIL CREDIT RISK A s our nation’s central bank, the Federal sophisticated credit-scoring models for measuring Reserve is responsible for the integrity retail risk. of the financial system and views risk management as a key element of bank supervision. DEVELOPING RETAIL CREDIT RISK MODELS Mike Collins, senior vice president, Supervi- The revolution in information and commu- sion, Regulation and Credit, tells how Phila- nications technology has led to the emergence delphia is establishing advanced approaches to of consumer credit-scoring models as a mainstay quantifying retail credit risk. technique. As a result, we now have more efficient means to slot individual loans into appropri- As a regulator and supervisor of financial ate risk classes. This has led to greater potential institutions, the Fed must expand its knowledge of for risk-based pricing and targeted marketing in the broad financial industry to ensure its integrity retail lending; however, there is much ground still and stability. The Philadelphia Fed is leading a to be covered. Systemwide effort to develop a supervisory frame- While the sophistication of automated credit work to evaluate bank practices in retail credit risk scoring has increased, only recently have some management, including internal risk rating systems. institutions put resources into advanced methods CHANGING TIMES mean improved This project, which will enhance the Federal of retail portfolio credit risk modeling. Addition- Reserve’s ability to assess banking organizations’ ally, quantifying the risk in retail portfolios places retail credit risk quantification methods, responds an even greater premium on a bank’s ability to to gaps in the Basel II framework. Basel is a land- accurately differentiate the credit quality of bor- mark international agreement on bank capital rowers. It also requires an acute understanding standards and risk-based regulation. Until quite of the contributions of retail credit to both risk recently, bank and supervisory resources have and return. For example, problems in accurately concentrated on credit risk modeling of commer- predicting performance in sub-prime portfolios cial and industrial portfolios, with fewer resources proved detrimental to some institutions’ overall devoted to understanding risk in the retail credit level of risk, as we have seen in 2002. area, which includes such common consumer instruments as mortgages, credit cards, and auto THE PHILADELPHIA FED’S PROJECT loans. Given the recent developments in the retail However, despite the emphasis on the com- sector, regulators must gain a greater understand- mercial side, retail credit is a substantial part of ing of current industry practices and areas for the risk borne by the banking industry. Recogniz- potential improvement. The Philadelphia Fed has ing this, the industry has begun to develop more distinguished itself as an expert hub of emerging 10 industry issues and a vital resource in identifying and implementing industry best practices. Consequently, we have the important System responsibility to expand the Fed’s knowledge of advanced approaches to quantifying retail credit risk. Our efforts focus on three main goals: First, we document existing policies and practices among institutions capable of effectively measuring retail credit risk. Toward this goal, we have joined with other U.S. regulators in conducting interviews at several large banking organizations. These interviews help us identify current practices in evaluating retail credit risk and improve our knowledge of current industry practices. We are using this information to compare banks’ current Michael E. Collins, Senior Vice President and Lending Officer practices with the Basel II proposal for an internal practices and increased responsibilities ratings-based (IRB) approach to retail credit. strengths and weaknesses of existing retail risk Our second goal is to analyze the reliability quantification standards at large U.S. banks. Our of current practices and assess their weaknesses findings will be presented at various forums to or gaps. That way, we can spot problems supervi- educate the industry on these issues. We will also sors need to address in assessing internal risk and lead efforts of the Federal Reserve System and capital adequacy in the retail credit area. other U.S. banking regulators to develop training Our third goal is to identify major analytical is- curricula for supervisory staff on IRB standards sues in quantifying retail credit risk and to generate and examination guidance. relevant research. In this way, we can identify pri- Constructive dialogue between financial ority policy issues for the Federal Reserve and other institutions and their regulators means standards banking regulators and make recommendations progress and practices improve. With more ex- on how to tackle them. Philadelphia’s work is the perience and better information, risk parameters beginning of a necessary and important long-term will change and models will get stronger and effort in the retail credit arena. more efficient. Rather than a uniform regulatory Throughout 2003, Philadelphia will develop standard, financial institutions will develop their a research agenda on retail credit risk quantifica- own assessments and procedures that accurately tion. We are now preparing research analyzing capture retail credit risk. 11 INVESTIGATING CHECK FRAUD W hile technology has brought about Basically, detecting check fraud has two innovations in the financial services facets: the application of fraud-prevention tech- industry, it has also enabled more sophisticated nology and machines that can read new security methods of fraud. Consequently, we need features. Right now, there are four types of tech- increasingly sophisticated technology to detect nologies in this area: laser ink, two-dimensional fraud. That’s why the Retail Payments Office barcodes, seal encoding, and digital watermarking. (RPO) asked Philadelphia to lead an investiga- Our pilot programs involved these last two tech- tion into ways to prevent check fraud. Arun nologies. Initially, we used test checks from the Jain, vice president, Retail Payments, talked Treasury. The seal encoding pilot used produc- about the Bank’s role in two pilot programs. tion checks issued by the Federal Reserve Bank of Philadelphia for Treasury-related payments, and Since Philadelphia has a close working rela- the digital watermarking pilot used simulated test tionship with the Treasury Department, it made checks. sense for us to jointly undertake this project. Seal encoding technology conceals informa- Furthermore, Treasury checks are a major target tion (for example, the dollar amount, account for fraud. number, payee name, or issue date) within the CHANGING TIMES mean new ways body of the check in order to detect altered or counterfeit checks. It’s similar to two-dimensional barcoding, but not as visible. (See sidebar.) For instance, you can hide data in a corporate logo on a check. Someone looking at the check may not see a difference, but the right detection software can read the hidden information and match it to what is on the magnetic ink character recognition (MICR) line that’s printed on the bottom of a check. The pilot showed that seal encoding works in some situations, but not all. The second pilot applied a digital watermark to the body of the check. The idea is that photocopiers and high-resolution scanners won’t pick up and subsequently print the watermark, High speed sorters such as this one process checks using magnetic ink character recognition. thus making it harder for counterfeiters to copy checks. 12 One advantage here is that digital watermarking can cover a wide area of the check. Since checks can be mishandled and mutilated, it’s better to have the fraud-detection feature in more than one part of the check. One problem with both of these technologies is that good Chemical Inks and Two-Dimensional Barcodes checks are sometimes flagged as altered or counterfeit, and it costs both time and money to verify the so-called false positive checks. RESULTS Working with other Reserve Banks, we tested seal encoding and digital watermarking on both IBM and Unisys sorters. That way, we could note differences between the types of sorters. of detecting fraud These pilots involved true research and development work. Although these technologies are used for fraud detection in other industries, we are trying to validate their applicability in the checks arena. Cost/benefit analyses will be important determinants of which technologies are finally adopted. Our initial report of the outcome will go to the RPO and Treasury. Subsequently, we’ll share the outcome with the banking industry. The results for these various pilot programs will determine if Treasury is ready to adopt one or both of these technologies. Our goal is to aid the banking industry by helping to develop new methods for reducing fraud, which costs the industry — and consumers — millions of dollars every year. Chemical Inks. The idea behind chemical inks is to invent a process that places an invisible mark on a check that cannot be reproduced and is manufactured only in secure printing arrangements. Testing for the chemical ink would be accomplished via special scanning devices licensed by the technology owner. Low-cost scanners would shine a special ultra-violet or laser light spectrum onto the paper to test for reflection from the chemicals. Checks expected to have this invisible chemical ink would be considered genuine if the test is positive and assumed to be counterfeit if the test fails. Two-Dimensional Barcodes. Two-dimensional barcodes are the modern equivalent of the universal product code (UPC) found on most products in grocery stores and other retail outlets. But unlike the long, varying-width lines that code eight to 12 digits of product code data, 2-D barcodes can carry a payload of hundreds of bytes of data. Low-cost digital scanners and decoding software would be used to test the 2-D barcode. Existing digital scanners on high-speed checkprocessing equipment could be used to test for the existence of a 2-D barcode and to compare it with the MICR line at the bottom of the check and visual data. STUDYING PAYMENT CARDS O ver the past decade, consumers have since 1979, consumer electronic payments have moved away from paper forms of pay- grown from approximately 5 billion transactions ment — checks and cash — to payment cards a year to about 30 billion. The pace of change is and other electronic methods. Acknowledging further accelerating as consumers become increas- this shift in consumers’ behavior, the Phila- ingly comfortable with these new payment mecha- delphia Fed established the Payment Cards nisms. Center to serve as a source of expertise on this important segment of the financial system. The USING NEW PAYMENT METHODS Center’s director, Peter Burns, elaborated on After cash and checks, credit cards are prob- the Center’s mission and achievements to date. ably the most familiar method of payment and the payment vehicle of choice for many consumers. Although cash and checks remain popular Right now, about 80 percent of Americans use methods of payment, consumers are turning more credit cards, and most carry several different cards frequently to electronic methods, such as credit in their wallets. At the same time, use of debit cards, debit cards, smart cards, stored-value cards, cards, which are directly linked to consumers’ and other emerging payment technologies. In fact, bank accounts, is growing even faster than credit CHANGING TIMES mean new Paper to Electronic Payments cards. Simultaneously, banks, retailers, and other businesses are experimenting with various other electronic payment vehicles that add convenience Migration from paper to electronic payments will drive investments in product development, operations, technology, marketing, and business infrastructure. and efficiency to the retail payments arena. HIGHLIGHTS IN 2002 To carry out its mandate to monitor trends in the industry and provide insights into this evolving field, the Payment Cards Center has launched a variety of projects over the past two years. In 2002, we held a series 14 Jeanne M. Hogarth (left), program manager, and Marianne A. Hilgert, research assistant, Consumer Policies Section, Board of Governors of the Federal Reserve System, participated in the Payment Cards Center’s workshop “Voting with Your Feet: Consumers’ Problems with Credit Cards and Exit Behaviors.” ways of making payments of workshops featuring industry experts on a Center’s web site, allowing even wider distribu- wide range of topics, including the role of credit tion. Furthermore, the Center is committed to reporting agencies, financial privacy, and credit supporting academic research on payment-card risk management practices. We also co-sponsored topics and works with the Bank’s Research De- three major conferences: one with the Bank’s partment in fulfilling this part of its mission. In Research Department, one with the Wharton addition, the Center’s visiting scholars program Financial Institutions Center, and one with the brings academic researchers to the Bank, usually Electronic Funds Transfer Association’s E-Com- for one or two academic semesters, so they can merce Payments Council. These conferences pursue their research interests. brought together representatives from the aca- This past year, we expanded our programs demic, industry, and policy communities to debate and honed our expertise. Now it’s time to look critical issues in consumer payments. ahead. In the coming year, we will work to further Discussion papers, which offer business analy- engage industry practitioners and academic and ses of issues related to payment cards, constitute consumer representatives in our activities and another aspect of our work. These papers, which design programs that effectively address their are available in hard copy, are also posted on the concerns. 15 PROMOTING ECONOMIC EDUCATION E asier access to credit and increased in- TEACHING THE TEACHERS stances of predatory lending have created a In our economic education program, we want greater need to educate the public about finan- to make people aware of the Federal Reserve cial services. To meet this need, the Commu- System and the workings of the economy in nity Affairs Department at the Philadelphia Fed general. We’re also developing financial literacy has expanded its programs in economic educa- programs that target both young people and low- tion and financial literacy. The department’s and moderate-income adults. We want to keep economic education specialist, Andrew Hill, young people from getting into financial trouble described some of the new ventures. and help adults find their way out of it. So we teach them about credit, bank services, and saving. Also, we introduce such economic concepts Financial literacy is an important topic these as the allocation of scarce resources and the idea days. The headlines tell the story: Americans hold that a choice they make today may mean giving more debt than ever before, personal bankruptcies up something later. are at an all-time high, and people continue to fall Some states mandate economic education victim to financial scams and predatory lenders. at the high school level; other states voluntarily CHANGING TIMES mean a greater The proliferation of check cashing outlets has include it in their curricula. But, unfortunately, had an effect. In many low- and moderate-income many high school teachers are ill-equipped to neighborhoods, these outlets offer convenient teach economics and finance. That’s where we locations and hours. People use them in spite of hope to have an impact. We’re following a train- the very high fees they charge. Also, many people the-trainer model. Rather than being directly in our society have no regular relationship with involved with students, we’re providing significant a financial institution. Consequently, the people training to teachers so they can get the message who can least afford it are being hit with high across. fees, and sometimes high interest rates, from tax preparers, check cashing facilities, payday lenders, OUR SUCCESSES and rent-to-own furniture stores. To date, our biggest success has been in Dela- As these problems have become more ware, where a financial literacy program intro- prevalent, there has been a push to do something duced in one high school has now spread to seven about them. In response, the Community Af- other schools. Fortunately, we’ve built strong fairs Department has renewed its commitment to partnerships with the Delaware Bankers Associa- increasing financial literacy and has created some tion, the Consumer Credit Counseling Services new initiatives in economic education. of Maryland and Delaware, and the University of 16 Delaware’s Center for Economic Education and conferences. In fact, we’ve already hosted several Entrepreneurship. Although we lit the fire, our events. Last summer, the department presented partners did 95 percent of the work. day-long programs to students in the Pennsylvania We’re hoping to replicate our Delaware suc- Governor’s School for Entrepreneurship and to cess in Pennsylvania and New Jersey. To that end, teachers as part of the Summer Institute of the we’re building relationships with state councils on South Jersey Chamber of Commerce. In October, economic education and with economic educa- teachers from Philadelphia and its suburbs came tion centers at colleges and universities. to the Bank for a seminar called “Hot Topics in Economics.” COURSES AND OTHER PLANS This summer, we’ll offer teachers a gradu- Thus far, our programs have been well received by Third District teachers and consumers. ate-level course on money and banking. We’ll Our efforts also support the Bank’s goal of making also participate with the University of Delaware the Philadelphia Fed known as a center of central and Millersville University in a separate graduate bank knowledge and capability. course for teachers. Other plans include holding workshops and need for economic education Andrew Hill, economic education specialist, Federal Reserve Bank of Philadelphia, 17 talks to a group of teachers about the importance of economic education. ESTABLISHING STRONG CONTROLS H aving a solid financial base is crucial to controls are. Bear in mind that many of the initia- the work of the Federal Reserve Bank of tives you’ve read about in this report are possible Philadelphia. Donna Franco, vice president and because strong internal controls are in place. chief financial officer, tells why strong internal controls are an essential part of that base. REINFORCING CONTROLS How do we reinforce such controls? First, the Strong internal controls are important to the Bank’s senior management sets the tone that is financial soundness and integrity of any orga- crucial to the control environment. Since strong nization. But when you’re the entity that sets controls are an integral part of the Bank’s strategic monetary policy and fosters the integrity of the direction, there are well-documented policies and nation’s payments system, such controls are vital. procedures in place, which serve as ready references The Philadelphia Fed’s stability – indeed, that for control questions that arise. of the Federal Reserve System – is underlined by stringent internal controls. Second, in addition to our own controls, which are guided by the precepts of the Board of Governors In fact, we believe the more creative and in Washington, D.C., we also benefit from periodic innovative we want to be, the more crucial these reviews by the Board. Having dual controls gives us C H A N G I N G T I M E S m e a n a definite advantage over other organizations. Third, and equally important, is the ongoing cooperation and communication among the various departments at the Bank. For example, the Bank’s chief counsel and ethics officer provides valuable insight and support in maintaining the ethical standards so important to strong internal controls. OTHER RELATIONSHIPS Furthermore, Audit and Accounting have an important relationship. This liaison is particularly valuable when the Bank goes through its yearly evaluation process, which assesses the effectiveness of the Bank’s internal controls. It also comes into play during the year-end financial audit with the Bank’s accounting firm. Donna L. Franco, Vice President and Chief Financial Officer Internal Control System Components • Control Environment — sets the tone and serves as a foundation for internal controls • Risk Assessment — identifies and analyzes relevant risks to achievement of objectives • Control Activities — includes policies and procedures that help ensure execution of management’s directives • Information and Communication — identifies and captures pertinent information and communicates it to relevant parties • Monitoring — incorporates ongoing and periodic reviews of quality of internal controls e v e n s t r o n g e r c o n t r o l s Another important area of cooperation is tarnishing our image. With our reputation intact, between the Bank’s Board of Directors and the we can move forward and take on new strategic Bank’s management. Our Board’s Budget and Op- initiatives. erations Committee receives regular reports and Quality is another key feature of strong fun- periodic presentations, and we use these opportu- damentals. When an organization lacks quality, it nities to address financial and operational issues. spends too much time and money fixing mistakes. Similarly, the Audit Committee receives reports A lot of an organization’s success depends on on the effectiveness of controls throughout the having the right people with the right skills in the Bank. right job. RISK AND QUALITY THE BOTTOM LINE So what’s the bottom line? The Bank makes Of course, cooperation forms only part of the controls story. Controlling risk and promoting sure that all employees recognize their respon- quality are also critical aspects. sibilities in maintaining strong internal controls in their areas. Controls are a part of our normal On the risk side, a potential pitfall we face as a Federal Reserve Bank is reputational risk. routine — not a once-a-year checklist that we We must be vigilant in all our activities to avoid complete. 19 1 2 3 4 5 6 8 7 20 9 BOARD OF DIRECTORS Robert E. Chappell (4) Federal Reserve Bank of Philadelphia Board of Directors member since 2000. Member Budget and Operations and Personnel committees. Chairman and Chief Executive Officer of Penn Mutual Life Insurance Company. Member Insurance Federation of Pennsylvania and Taxation and Financial Services Steering Committee for American Council of Life Insurance. Serves on boards of Glatfelter, Quaker Chemical Corporation, South Chester Tube Company, LOMA, and Wharton Financial Institutions Center at University of Pennsylvania. on numerous boards, including Juvenile Law Center, Friends Select School, Franklin Institute, and Leadership, Inc. Ronald J. Naples (2) Federal Reserve Bank of Philadelphia Board of Directors member since January 2001. Member Audit and Research and External Affairs committees. Chairman and Chief Executive Officer of Quaker Chemical Corporation. Chairman of the Board of the University of the Arts. Serves on boards of Glatfelter, Philadelphia Museum of Art, Franklin Institute, Foreign Policy Research Institute, Rock School of the Pennsylvania Ballet, and Greater Philadelphia First. Walter E. Daller, Jr. (9) Federal Reserve Bank of Philadelphia Board of Directors member since January 2002. Member Budget and Operations and Personnel committees. Chairman, President & CEO of Harleysville National Corporation. Chairman of Harleysville National Bank and Trust Company. Member of Board of Directors of Independent Community Bankers of America and TCM Bank of Tampa, Florida. Serves on boards of North Penn United Way, Lower Salford Historical Society, Muhlenberg House, Montgomery County Lands Trust, and Perkiomen Valley Watershed. Previously served as Federal Reserve Bank of Philadelphia’s representative to Federal Advisory Council. Glenn A. Schaeffer (7) Deputy Chairman, Federal Reserve Bank of Philadelphia Board of Directors. Board member since 1998. Member Budget and Operations and Research and External Affairs committees. President Emeritus Pennsylvania Building and Construction Trades Council, Harrisburg. Co-founder Capital Area Labor Management Committee. Coordinator, Capital Area Labor Management Construction Partnership Coordination Project. Member of Executive Committee of Pennsylvania AFL-CIO, Governor’s Committee on Economic Development through Labor Management, Pennsylvania Prevailing Wage Advisory Board, and Keystone Commission on Education and Employment in the 21st Century. Serves on Capital Blue Cross board. Doris M. Damm (3) Federal Reserve Bank of Philadelphia Board of Directors member since January 2001. Member Audit and Personnel committees. President and Chief Executive Officer of ACCU Staffing Services. Other affiliations include Cerebral Palsy of New Jersey, Cherry Hill Economic Development Council, Our Lady of Lourdes Medical Center, Our Lady of Lourdes Foundation, and Cherry Hill Regional Chamber of Commerce. P. Coleman Townsend, Jr. (8) Federal Reserve Bank of Philadelphia Board of Directors member since January 2002. Member Budget and Operations and Personnel committees. Chairman and CEO of Townsends, Inc. Member of Board of Trustees of University of Delaware and Winterthur Museum. Serves on Council of Advisors for Delaware Center for Horticulture, Lehman Art Center Advisory Committee, Liberty Mutual Advisory Committee, and Board of Overseers for Delaware College of Art and Design. Frank Kaminski, Jr. (1) Federal Reserve Bank of Philadelphia Board of Directors member since 2000. Member Audit and Research and External Affairs committees. Chairman of Atlantic Central Bankers Bank. Professional affiliations include Pennsylvania Bankers Association, Independent Bankers Association of America, Pennsylvania Association of Community Bankers, and Bankers Bank Council. Robert J. Vanderslice (5) Federal Reserve Bank of Philadelphia Board of Directors member since January 2001. Member Audit and Research and External Affairs committees. President and Chief Operating Officer of Pennsville National Bank. Vice President of Penn Bancshares, Inc. Professional affiliations include Federal Reserve Relations Committee of New Jersey Bankers Association, Pennsville Economic Development Coalition, Penns Grove Rotary Club, and Salem County Chamber of Commerce. Charisse R. Lillie (6) Chairman, Federal Reserve Bank of Philadelphia Board of Directors. Board member since 1996. Chairman of litigation department of law firm of Ballard Spahr Andrews & Ingersoll, LLP. Member of Labor and Employment Law Group of firm’s litigation department. Chair of American Bar Association Commission on Racial and Ethnic Diversity. Serves 21 ADVISORY COUNCILS 2002 BUSINESS COUNCIL CHAIRMAN John K. Ball (11), Chairman, President & CEO R.M. Shoemaker Co., West Conshohocken, PA Sandra F. Holsonback,* Director Small Business Development Center Lehigh University, Bethlehem, PA Lynn Banta (12), Owner Twin Stacks Development Co. Inc., Dallas, PA Dennis E. Klima (2), President & CEO Bayhealth Inc., Dover, DE Michael F. Camardo (6), Executive Vice President Lockheed Martin Technology, Cherry Hill, NJ Warren B. Matthews (3), M.D., President Wyncote Family Medicine, Wyncote, PA Chloe R. Eichelberger (9), Owner, President & CEO Chloe Eichelberger Textiles, Inc., York, PA John Milligan (10), President Milligan & Company LLC, Philadelphia, PA Mitchell L. Morgan (7), President Morgan Properties, King of Prussia, PA David J. Freschman (8), President Delaware Innovation Fund, Wilmington, DE 1 2 3 4 9 5 6 7 10 11 Audrey S. Oswell (4), President & COO Resorts Atlantic City, Atlantic City, NJ 8 Jeffrey J. Trester (5), Director and Co-CEO PriceSCAN.com, Inc., Malvern, PA 12 William L. Wilson (1), Principal-in-Charge Synterra, Philadelphia, PA * Not pictured 22 2002 COMMUNITY BANK COUNCIL Thomas J. Bisko,* President The Quakertown National Bank, Quakertown, PA George W. Nise (7), President & CEO Beneficial Savings Bank, Philadelphia, PA Joseph E. Chippie,* President & CEO First National Bank of Wyoming, Wyoming, DE John W. Ord (5), President & CEO Peoples National Bank, Hallstead, PA Thomas W. Cook,* Executive Vice President & CEO The Bank of Landisburg, Landisburg, PA Frederick C. (Ted) Peters II (2), President & CEO The Bryn Mawr Trust Company, Bryn Mawr, PA Patrick M. Ryan (3), President and CEO The Yardville National Bank, Hamilton, NJ John G. Gerlach (1), President & CEO & Director Pocono Community Bank, Stroudsburg, PA Wayne R. Weidner,* Chairman, President & CEO National Penn Bancshares, Inc., Boyertown, PA CHAIRMAN Robert H. King (6), President, Sterling Bank, Mount Laurel, NJ 2 3 5 7 William Leandri (4), President & CEO Luzerne National Bank, Luzerne, PA 6 * Not pictured 23 1 4 ADVISORY COUNCILS 2002 CREDIT UNION COUNCIL Paula M. Albanese (5), President Diamond State FCU, New Castle, DE Thomas A. Phillips (3), General Manager Lakehurst Naval FCU, Lakehurst, NJ Barbara Arrowsmith (1), Manager New Castle County Delaware Employees FCU New Castle, DE Diana L. Roberts,* President & CEO Hershey FCU, Hershey, PA C. Kipp Stecher,* President & CEO AmeriChoice FCU, Mechanicsburg, PA CHAIRMAN Jo Ann Broderick,* President First Commonwealth FCU, Lehigh Valley, PA Judith M. Supplee (6), President & CEO Keystone FCU, West Chester, PA L. Edward Brzozowski (2), President MON-OC FCU, Toms River, NJ Virginia F. Williams (7), CEO FAA Technical Center FCU, Northfield, NJ Dennis Flickinger (4), President & CEO First Capital FCU, York, PA 1 John LaRosa (8), COO & Treasurer Police and Fire FCU, Philadelphia, PA * Not pictured 24 4 7 6 5 James F. McCaw,* President & CEO K of C FCU, Philadelphia, PA 3 2 8 CURRENT OFFICERS Anthony M. Santomero President William H. Stone, Jr. First Vice President Donald F. Doros Executive Vice President Richard W. Lang Executive Vice President Michael E. Collins Senior Vice President and Lending Officer Loretta J. Mester Senior Vice President and Director of Research John B. Shaffer Senior Vice President and General Auditor Milissa M. Tadeo Senior Vice President Human Resources and Treasury Services John G. Bell Vice President Financial Statistics Robert J. Bucco Vice President Wholesale Product Office Peter P. Burns Vice President and Director Payment Cards Center Theodore M. Crone Vice President and Economist Dean Croushore Vice President and Economist John J. Deibel Vice President and Chief Administrative Officer Supervision, Regulation and Credit Patrick L. Donahue Vice President Customer Relations Michael Dotsey Vice President and Senior Economic Policy Advisor Herbert E. Taylor Vice President and Corporate Secretary William Evans, Jr. Vice President Information Technology Services Vish P. Viswanathan Vice President and Discount Officer Supervision, Regulation and Credit Donna L. Franco Vice President and Chief Financial Officer Joanna H. Frodin Vice President Supervision, Regulation and Credit Faith P. Goldstein Vice President Public Affairs Arun K. Jain Vice President Retail Payment Services Henry T. Kern Vice President Cash Services Thomas P. Lambinus Vice President Facilities, Records, Purchasing, Transportation, and Document Services Bernard M. Wennemer Assistant Vice President Supervision, Regulation and Credit Shirley L. Coker Assistant Vice President and Counsel Anthony J. White Assistant Vice President Customer Relations William L. Gaunt Assistant Vice President Supervision, Regulation and Credit Michael P. Zamulinsky Assistant Vice President Supervision, Regulation and Credit Stephen G. Hart Assistant Vice President Human Resources Mitchell S. Berlin Research Officer and Economist Mary Ann Hood Assistant Vice President Human Resources Aileen C. Boer Research Support Officer John P. Kelly Assistant Vice President Retail Payment Services Edward M. Mahon Vice President and General Counsel Elisabeth V. Levins Assistant Vice President Supervision, Regulation and Credit Stephen A. Meyer Vice President and Senior Economic Policy Advisor Alice Kelley Menzano Assistant Vice President Information Technology Services Mary DeHaven Myers Vice President and Community Affairs Officer Patrick M. Regan Assistant Vice President and Information Security Officer A. Reed Raymond, III Vice President Supervision, Regulation and Credit Anthony T. Scafide, Jr. Assistant Vice President Customer Relations Richard A. Sheaffer Vice President Treasury Services Ronald R. Sheldon Assistant Vice President Retail Payment Services Includes promotions through March 2003 25 Richard A. Valente Assistant Vice President and Assistant General Auditor Eileen P. Adezio Assistant Vice President Supervision, Regulation and Credit Howard M. James, Jr. Assistant Vice President Supervision, Regulation and Credit William W. Lang Vice President Supervision, Regulation and Credit Marie Tkaczyk Assistant Vice President Information Technology Services Donna L. Brenner Budget Officer and Assistant Secretary Accounting Services Michael T. Doyle Business Planning and Analysis Officer Linda K. Kirson Office Automation Support Officer Information Technology Services Joseph L. McCann Administrative Services and Security Officer Edward C. Morrison Operations Officer Information Technology Services Michelle M. Scipione Cash Services Officer Stephen J. Smith Assistant Counsel S TAT E M E N T O F A U D I T O R I N D E P E N D E N C E The firm engaged by the Board of Governors for the audits of the individual and combined financial statements of the Reserve Banks for 2002 was PricewaterhouseCoopers LLP (PwC). Fees for these services totaled $1.0 million. In order to ensure auditor independence, the Board of Governors requires that PwC be independent in all matters relating to the audit. Specifically, PwC may not perform services for the Reserve Banks or others that would place it in a position of auditing its own work, making management decisions on behalf of the Reserve Banks, or in any other way impairing its audit independence. In 2002, the Bank did not engage PwC for advisory services. 26 28 Letter to Directors 29 Report of Independent Accountants 30 Report of Independent Accountants 31 Statements of Condition 32 Statements of Income 33 Statements of Changes in Capital 34 Notes to Financial Statements 27 FINANCIAL REPORTS CONTENTS FEDERAL RESERVE BANK OF PHILADELPHIA LETTER TO DIRECTORS 28 29 FEDERAL RESERVE BANK OF PHILADELPHIA REPORT OF INDEPENDENT ACCOUNTANTS FEDERAL RESERVE BANK OF PHILADELPHIA REPORT OF INDEPENDENT ACCOUNTANTS 30 As of December 31, 2002 and December 31, 2001 (in millions) 2002 2001 ASSETS Gold certificates Special drawing rights certificates Coin Items in process of collection U.S. government and federal agency securities, net Investments denominated in foreign currencies Accrued interest receivable Bank premises and equipment, net Other assets $ Total assets 430 83 61 494 24,576 510 210 73 96 $ 454 83 44 526 23,071 481 234 70 91 $ 26,533 $ 25,054 $ 18,624 811 $ 21,773 – 577 3 556 413 2 100 47 5,391 51 7 29 2,239 51 5 Total liabilities 26,067 24,612 Capital: Capital paid-in Surplus 233 233 221 221 466 442 $ 26,533 $ 25,054 LIABILITIES AND CAPITAL Liabilities: Federal Reserve notes outstanding, net Securities sold under agreements to repurchase Deposits: Depository institutions Other deposits Deferred credit items Interest on Federal Reserve notes due U.S. Treasury Interdistrict settlement account Accrued benefit costs Other liabilities Total capital Total liabilities and capital The accompanying notes are an integral part of these financial statements. 31 FEDERAL RESERVE BANK OF PHILADELPHIA STATEMENTS OF CONDITION FEDERAL RESERVE BANK OF PHILADELPHIA STATEMENTS OF INCOME For the years ended December 31, 2002 and December 31, 2001 (in millions) Interest income: Interest on U.S. government and federal agency securities Interest on investments denominated in foreign currencies 2002 2001 984 8 $ 1,219 11 992 1,230 1 – 991 1,230 46 20 62 3 3 47 20 (47) 13 4 134 37 81 9 13 21 29 79 9 13 24 32 153 157 $ 972 $ 1,110 $ 14 12 $ Total interest income Interest expense: Interest expense on securities sold under agreements to repurchase Net interest income Other operating income: Income from services Reimbursable services to government agencies Foreign currency gains (losses), net U.S. government securities gains, net Other income Total other operating income Operating expenses: Salaries and other benefits Occupancy expense Equipment expense Assessments by Board of Governors Other expenses Total operating expenses Net income prior to distribution Distribution of net income: Dividends paid to member banks Transferred to (from) surplus Payments to U.S. Treasury as interest on Federal Reserve notes Total distribution $ 14 (7) 946 1,103 972 $ 1,110 The accompanying notes are an integral part of these financial statements. 32 $ For the years ended December 31, 2002 and December 31, 2001 (in millions) Capital Paid-in Balance at January 1, 2001 (4.6 million shares) $ 228 Net income transferred from surplus Net change in capital stock redeemed (0.2 million shares) Balance at December 31, 2001 (4.4 million shares) $ Surplus $ 228 Total Capital $ 456 – (7) (7) (7) – (7) 221 $ 221 $ 442 Net income transferred to surplus – 12 12 Net change in capital stock issued (0.2 million shares) 12 – 12 Balance at December 31, 2002 (4.6 million shares) $ 233 $ The accompanying notes are an integral part of these financial statements. 33 233 $ 466 FEDERAL RESERVE BANK OF PHILADELPHIA STATEMENTS OF CHANGES IN CAPITAL FEDERAL RESERVE BANK OF PHILADELPHIA NOTES TO FINANCIAL STATEMENTS 1. STRUCTURE by member banks, three represent the public and three represent member banks. Member banks The Federal Reserve Bank of Philadelphia are divided into three classes according to size. (“Bank”) is part of the Federal Reserve System Member banks in each class elect one director (“System”) created by Congress under the Federal representing member banks and one represent- Reserve Act of 1913 (“Federal Reserve Act”) ing the public. In any election of directors, each which established the central bank of the United member bank receives one vote, regardless of the States. The System consists of the Board of number of shares of Reserve Bank stock it holds. Governors of the Federal Reserve System (“Board 2. OPERATIONS AND SERVICES of Governors”) and twelve Federal Reserve Banks (“Reserve Banks”). The Reserve Banks are chartered by the federal government and possess a The System performs a variety of services and unique set of governmental, corporate, and central bank characteristics. The Bank in Philadelphia operations. Functions include: formulating and serves the Third Federal Reserve District, which conducting monetary policy; participating actively includes Delaware and portions of New Jersey in the payments mechanism, including large-dol- and Pennsylvania. Other major elements of the lar transfers of funds, automated clearinghouse System are the Federal Open Market Committee (“ACH”) operations and check processing; distrib- (“FOMC”) and the Federal Advisory Council. uting coin and currency; performing fiscal agency The FOMC is composed of members of the functions for the U.S. Treasury and certain federal Board of Governors, the president of the Federal agencies; serving as the federal government’s Reserve Bank of New York (“FRBNY”) and, on a bank; providing short-term loans to depository rotating basis, four other Reserve Bank presidents. institutions; serving the consumer and the com- Banks that are members of the System include all munity by providing educational materials and national banks and any state chartered bank that information regarding consumer laws; supervising applies and is approved for membership in the bank holding companies and state member banks; System. and administering other regulations of the Board of Governors. The Board of Governors’ operating costs are funded through assessments on the Board of Directors Reserve Banks. In accordance with the Federal Reserve Act, supervision and control of the Bank are exercised The FOMC establishes policy regarding open by a Board of Directors. The Federal Reserve Act market operations, oversees these operations, and specifies the composition of the Board of Direc- issues authorizations and directives to the FRBNY tors for each of the Reserve Banks. Each board for its execution of transactions. Authorized is composed of nine members serving three-year transaction types include direct purchase and sale terms: three directors, including those designated of securities, matched sale-purchase transactions, as Chairman and Deputy Chairman, are appoint- the purchase of securities under agreements to ed by the Board of Governors, and six directors resell, the sale of securities under agreements to are elected by member banks. Of the six elected repurchase, and the lending of U.S. government 34 securities. The FRBNY is also authorized by tions as separate sales and purchases, rather than the FOMC to hold balances of, and to execute secured borrowings with pledged collateral, as spot and forward foreign exchange (“F/X”) and is generally required by GAAP. In addition, the securities contracts in, nine foreign currencies, Bank has elected not to present a Statement of maintain reciprocal currency arrangements Cash Flows. The Statement of Cash Flows has (“F/X swaps”) with various central banks, and not been included as the liquidity and cash posi- “warehouse” foreign currencies for the U.S. tion of the Bank are not of primary concern to Treasury and Exchange Stabilization Fund the users of these financial statements. Other (“ESF”) through the Reserve Banks. information regarding the Bank’s activities is provided in, or may be derived from, the Statements 3. SIGNIFICANT ACCOUNTING POLICIES of Condition, Income, and Changes in Capital. Therefore, a Statement of Cash Flows would not provide any additional useful information. There Accounting principles for entities with the are no other significant differences between the unique powers and responsibilities of the nation’s policies outlined in the Financial Accounting central bank have not been formulated by the Manual and GAAP. Financial Accounting Standards Board. The Effective January 2001, the System Board of Governors has developed specialized implemented procedures to eliminate the sharing accounting principles and practices that it of costs by Reserve Banks for certain services believes are appropriate for the significantly a Reserve Bank may provide on behalf of the different nature and function of a central bank as System. Major services provided for the System compared to the private sector. These accounting by the Bank, for which the costs will not be principles and practices are documented in the redistributed to the other Reserve Banks, include: Financial Accounting Manual for Federal Reserve Collateral Management System, Electronic Cash Banks (“Financial Accounting Manual”), which Letter System, Groupware Leadership Center, is issued by the Board of Governors. All Reserve Subcommittee on Credit Reserves and Risk Banks are required to adopt and apply accounting Management Administrative Office, Treasury policies and practices that are consistent with the Direct Central Business Administration Function. Financial Accounting Manual. The preparation of the financial statements The financial statements have been prepared in conformity with the Financial Accounting in accordance with the Financial Accounting Manual requires management to make certain Manual. Differences exist between the account- estimates and assumptions that affect the reported ing principles and practices of the System and amounts of assets and liabilities, disclosure of accounting principles generally accepted in the contingent assets and liabilities at the date of the United States of America (“GAAP”). The prima- financial statements, and the reported amounts of ry differences are the presentation of all security income and expenses during the reporting period. holdings at amortized cost, rather than at the fair Actual results could differ from those estimates. value presentation requirements of GAAP, and Unique accounts and significant accounting the accounting for matched sale-purchase transac- policies are explained below. 35 FEDERAL RESERVE BANK OF PHILADELPHIA NOTES TO FINANCIAL STATEMENTS FEDERAL RESERVE BANK OF PHILADELPHIA NOTES TO FINANCIAL STATEMENTS a. Gold Certificates SDR certificate acquisitions or for financing The Secretary of the Treasury is authorized exchange stabilization operations. At the time to issue gold certificates to the Reserve Banks to SDR transactions occur, the Board of Governors monetize gold held by the U.S. Treasury. Payment allocates SDR certificate transactions among for the gold certificates by the Reserve Banks is Reserve Banks based upon Federal Reserve notes made by crediting equivalent amounts in dollars outstanding in each District at the end of the into the account established for the U.S. Treasury. preceding year. There were no SDR transactions These gold certificates held by the Reserve Banks in 2002. are required to be backed by the gold of the U.S. Treasury. The U.S. Treasury may reacquire c. the gold certificates at any time and the Reserve Loans to Depository Institutions The Depository Institutions Deregulation Banks must deliver them to the U.S. Treasury. At and Monetary Control Act of 1980 provides such time, the U.S. Treasury’s account is charged that all depository institutions that maintain and the Reserve Banks’ gold certificate accounts reservable transaction accounts or nonpersonal are lowered. The value of gold for purposes of time deposits, as defined in Regulation D issued backing the gold certificates is set by law at $42 by the Board of Governors, have borrowing 2/9 a fine troy ounce. The Board of Governors privileges at the discretion of the Reserve Banks. allocates the gold certificates among Reserve Borrowers execute certain lending agreements Banks once a year based upon average Federal and deposit sufficient collateral before credit is Reserve notes outstanding in each District. extended. Loans are evaluated for collectibility, and currently all are considered collectible and b. Special Drawing Rights Certificates fully collateralized. If loans were ever deemed to Special drawing rights (“SDRs”) are issued be uncollectible, an appropriate reserve would by the International Monetary Fund (“Fund”) be established. Interest is accrued using the to its members in proportion to each member’s applicable discount rate established at least every quota in the Fund at the time of issuance. SDRs fourteen days by the Boards of Directors of the serve as a supplement to international monetary Reserve Banks, subject to review by the Board of reserves and may be transferred from one national Governors. Reserve Banks retain the option to monetary authority to another. Under the law impose a surcharge above the basic rate in certain providing for United States participation in the circumstances. There were no outstanding loans SDR system, the Secretary of the U.S. Treasury to depository institutions at December 31, 2002 is authorized to issue SDR certificates, somewhat and 2001, respectively. like gold certificates, to the Reserve Banks. At such time, equivalent amounts in dollars are d. credited to the account established for the U.S. and Investments Denominated in Foreign Currencies Treasury, and the Reserve Banks’ SDR certificate U.S. Government and Federal Agency Securities The FOMC has designated the FRBNY to accounts are increased. The Reserve Banks are execute open market transactions on its behalf required to purchase SDRs, at the direction of and to hold the resulting securities in the portfolio the U.S. Treasury, for the purpose of financing known as the System Open Market Account 36 (“SOMA”). In addition to authorizing and between two parties to exchange specified directing operations in the domestic securities currencies, at a specified price, on a specified market, the FOMC authorizes and directs the date. Spot foreign contracts normally settle two FRBNY to execute operations in foreign markets days after the trade date, whereas the settlement for major currencies in order to counter disorderly date on forward contracts is negotiated between conditions in exchange markets or to meet the contracting parties, but will extend beyond other needs specified by the FOMC in carrying two days from the trade date. The FRBNY out the System’s central bank responsibilities. generally enters into spot contracts, with any Such authorizations are reviewed and approved forward contracts generally limited to the second annually by the FOMC. leg of a swap/warehousing transaction. In December 2002, the FRBNY replaced The FRBNY, on behalf of the Reserve matched sale-purchase (“MSP”) transactions with Banks, maintains renewable, short-term F/X securities sold under agreements to repurchase. swap arrangements with two authorized foreign MSP transactions, accounted for as separate sale central banks. The parties agree to exchange and purchase transactions, are transactions in their currencies up to a pre-arranged maximum which the FRBNY sells a security and buys it back amount and for an agreed upon period of time at the rate specified at the commencement of the (up to twelve months), at an agreed upon interest transaction. Securities sold under agreements rate. These arrangements give the FOMC to repurchase are treated as secured borrowing temporary access to foreign currencies that it may transactions with the associated interest expense need for intervention operations to support the recognized over the life of the transaction. dollar and give the partner foreign central bank The FRBNY has sole authorization by the temporary access to dollars it may need to support FOMC to lend U.S. government securities held in its own currency. Drawings under the F/X swap the SOMA to U.S. government securities dealers arrangements can be initiated by either the and to banks participating in U.S. government FRBNY or the partner foreign central bank, and securities clearing arrangements on behalf of must be agreed to by the drawee. The F/X swaps the System, in order to facilitate the effective are structured so that the party initiating the functioning of the domestic securities market. transaction (the drawer) bears the exchange rate These securities-lending transactions are fully risk upon maturity. The FRBNY will generally collateralized by other U.S. government securities. invest the foreign currency received under an F/X FOMC policy requires FRBNY to take possession swap in interest-bearing instruments. of collateral in excess of the market values of Warehousing is an arrangement under which the securities loaned. The market values of the the FOMC agrees to exchange, at the request of collateral and the securities loaned are monitored the Treasury, U.S. dollars for foreign currencies by FRBNY on a daily basis, with additional held by the Treasury or ESF over a limited period collateral obtained as necessary. The securities of time. The purpose of the warehousing facility loaned continue to be accounted for in the is to supplement the U.S. dollar resources of the SOMA. Treasury and ESF for financing purchases of foreign F/X contracts are contractual agreements currencies and related international operations. 37 FEDERAL RESERVE BANK OF PHILADELPHIA NOTES TO FINANCIAL STATEMENTS FEDERAL RESERVE BANK OF PHILADELPHIA NOTES TO FINANCIAL STATEMENTS In connection with its foreign currency agency securities” or “Interest on investments activities, the FRBNY, on behalf of the Reserve denominated in foreign currencies,” as Banks, may enter into contracts which contain appropriate. Income earned on securities lending varying degrees of off-balance sheet market risk, transactions is reported as a component of “Other because they represent contractual commitments income.” Gains and losses resulting from sales of involving future settlement and counter-party securities are determined by specific issues based credit risk. The FRBNY controls credit risk on average cost. Gains and losses on the sales of by obtaining credit approvals, establishing U.S. government and federal agency securities transaction limits, and performing daily are reported as “U.S. government securities gains, monitoring procedures. net”. Foreign-currency-denominated assets are While the application of current market revalued daily at current foreign currency market prices to the securities currently held in the exchange rates in order to report these assets in SOMA portfolio and investments denominated U.S. dollars. Realized and unrealized gains and in foreign currencies may result in values losses on investments denominated in foreign substantially above or below their carrying values, currencies are reported as Foreign currency gains these unrealized changes in value would have no (losses), net. Foreign currencies held through F/X direct effect on the quantity of reserves available swaps, when initiated by the counter-party, and to the banking system or on the prospects for warehousing arrangements are revalued daily, future Reserve Bank earnings or capital. Both the with the unrealized gain or loss reported by the domestic and foreign components of the SOMA FRBNY as a component of “Other assets” or portfolio from time to time involve transactions “Other liabilities,” as appropriate. that can result in gains or losses when holdings Balances of U.S. government and federal are sold prior to maturity. Decisions regarding agency securities bought outright, securities the securities and foreign currencies transactions, sold under agreements to repurchase, securities including their purchase and sale, are motivated loaned, investments denominated in foreign by monetary policy objectives rather than profit. currency, interest income and expense, securities Accordingly, market values, earnings, and any lending fee income, amortization of premiums gains or losses resulting from the sale of such and discounts on securities bought outright, gains currencies and securities are incidental to the and losses on sales of securities, and realized open market operations and do not motivate its and unrealized gains and losses on investments activities or policy decisions. denominated in foreign currencies, excluding U.S. government and federal agency those held under an F/X swap arrangement, are securities and investments denominated in foreign allocated to each Reserve Bank. Income from currencies comprising the SOMA are recorded securities lending transactions undertaken by the at cost, on a settlement-date basis, and adjusted FRBNY are also allocated to each Reserve Bank. for amortization of premiums or accretion of Securities purchased under agreements to resell discounts on a straight-line basis. Interest income and unrealized gains and losses on the revaluation is accrued on a straight-line basis and is reported of foreign currency holdings under F/X swaps and as “Interest on U.S. government and federal warehousing arrangements are allocated to the 38 FRBNY and not to other Reserve Banks. of collateral security, typically U.S. government securities. These notes are identified as issued e. Bank Premises, Equipment, and Software to a specific Reserve Bank. The Federal Reserve Bank premises and equipment are stated at Act provides that the collateral security tendered cost less accumulated depreciation. Depreciation by the Reserve Bank to the Federal Reserve agent is calculated on a straight-line basis over must be equal to the sum of the notes applied estimated useful lives of assets ranging from for by such Reserve Bank. In accordance with 2 to 50 years. New assets, major alterations, the Federal Reserve Act, gold certificates, special renovations and improvements are capitalized drawing rights certificates, U.S. government and at cost as additions to the asset accounts. federal agency securities, securities purchased Maintenance, repairs and minor replacements under agreements to resell, loans to depository are charged to operations in the year incurred. institutions, and investments denominated in Costs incurred for software, either developed foreign currencies are pledged as collateral for internally or acquired for internal use, during the net Federal Reserve notes outstanding. The application development stage are capitalized collateral value is equal to the book value of based on the cost of direct services and materials the collateral tendered, with the exception of associated with designing, coding, installing, or securities, whose collateral value is equal to the testing software. par value of the securities tendered, and securities purchased under agreements to resell, which are f. Interdistrict Settlement Account valued at the contract amount. The par value At the close of business each day, all Reserve of securities pledged for securities sold under Banks and branches assemble the payments due agreements to repurchase is similarly deducted. to or from other Reserve Banks and branches as a The Board of Governors may, at any time, call result of transactions involving accounts residing upon a Reserve Bank for additional security to in other Districts that occurred during the day’s adequately collateralize the Federal Reserve operations. Such transactions may include notes. The Reserve Banks have entered into funds settlement, check clearing and ACH an agreement which provides for certain assets operations, and allocations of shared expenses. of the Reserve Banks to be jointly pledged as The cumulative net amount due to or from other collateral for the Federal Reserve notes of all Reserve Banks is reported as the “Interdistrict Reserve Banks in order to satisfy their obligation settlement account.” of providing sufficient collateral for outstanding Federal Reserve notes. In the event that this g. Federal Reserve Notes collateral is insufficient, the Federal Reserve Act Federal Reserve notes are the circulating provides that Federal Reserve notes become a currency of the United States. These notes first and paramount lien on all the assets of the are issued through the various Federal Reserve Reserve Banks. Finally, as obligations of the agents (the Chairman of the Board of Directors United States, Federal Reserve notes are backed of each Reserve Bank) to the Reserve Banks by the full faith and credit of the United States upon deposit with such agents of certain classes government. 39 FEDERAL RESERVE BANK OF PHILADELPHIA NOTES TO FINANCIAL STATEMENTS FEDERAL RESERVE BANK OF PHILADELPHIA NOTES TO FINANCIAL STATEMENTS The “Federal Reserve notes outstanding, net” costs of operations, payment of dividends, and account represents the Bank’s Federal Reserve reservation of an amount necessary to equate notes outstanding, reduced by its currency surplus with capital paid-in. holdings of $6,893 million, and $6,562 million In the event of losses or a substantial increase at December 31, 2002 and December 31, 2001, in capital, payments to the U.S. Treasury are respectively. suspended until such losses are recovered through subsequent earnings. Weekly payments to the h. Capital Paid-in U.S. Treasury may vary significantly. The Federal Reserve Act requires that each member bank subscribe to the capital j. stock of the Reserve Bank in an amount equal Income and Costs related to Treasury Services The Bank is required by the Federal Reserve to 6 percent of the capital and surplus of the Act to serve as fiscal agent and depository of the member bank. As a member bank’s capital United States. By statute, the Department of the and surplus changes, its holdings of the Reserve Treasury is permitted, but not required, to pay for Bank’s stock must be adjusted. Member banks these services. Beginning January 1, 1998, the are those state-chartered banks that apply and reimbursement process for all Reserve Banks was are approved for membership in the System and centralized at the Bank that included the transfer all national banks. Currently, only one-half of of each Reserve Bank’s Treasury reimbursement the subscription is paid-in and the remainder is receivable to the Bank. The centralized portion subject to call. These shares are nonvoting with of the Bank’s reimbursement receivable, reported a par value of $100. They may not be transferred in “Other assets,” totaled $73 million and or hypothecated. By law, each member bank $70 million at December 31, 2002 and 2001, is entitled to receive an annual dividend of respectively. 6 percent on the paid-in capital stock. This cumulative dividend is paid semiannually. A k. member bank is liable for Reserve Bank liabilities Taxes The Reserve Banks are exempt from federal, up to twice the par value of stock subscribed by it. state, and local taxes, except for taxes on real property, which are reported as a component of i. Surplus “Occupancy expense.” The Board of Governors requires Reserve 4. U.S. GOVERNMENT AND FEDERAL AGENCY SECURITIES 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 Securities bought outright are held in the additional capital. Pursuant to Section 16 of the SOMA at the FRBNY. An undivided interest Federal Reserve Act, Reserve Banks are required in SOMA activity and the related premiums, by the Board of Governors to transfer to the U.S. discounts and income, with the exception of Treasury excess earnings, after providing for the securities purchased under agreements to resell, is 40 allocated to each Reserve Bank on a percentage basis derived from an annual settlement of Maturities of Securities Held Par value Total Within 15 days 16 days to 90 days 91 days to 1 year Over 1 year to 5 years Over 5 years to 10 years Over 10 years $ 1,055 5,930 5,455 6,643 2,050 3,070 interdistrict clearings. The settlement, performed in April of each year, equalizes Reserve Bank gold certificate holdings to Federal Reserve notes outstanding. The Bank’s allocated share of SOMA balances was approximately 3.845 percent and 4.107 percent at December 31, 2002 and 2001, respectively. Total The Bank’s allocated share of securities held in the SOMA at December 31, that were bought $ 24,203 As mentioned in footnote 3, in December outright, was as follows (in millions): 2002, the FRBNY replaced MSP transactions with securities sold under agreements to repurchase. 2002 Par value: U.S. government: Bills Notes Bonds Total par value Unamortized premiums Unaccreted discounts Total allocated to Bank At December 31, 2002, securities sold under 2001 agreements to repurchase with a contract amount of $21,091 million and a par value of $21,098 million were outstanding, of which $811 $ 8,717 11,455 4,031 $ 7,479 10,923 4,258 24,203 22,660 414 (41) 464 (53) $ 24,576 $ 23,071 million and $811 million, respectively, were allocated to the Bank. At December 31, 2001, MSP transactions involving U.S. government securities with a par value of $23,188 million were outstanding, of which $952 million was allocated to the Bank. Securities sold under agreements to repurchase and MSP transactions are generally overnight arrangements. At December 31, 2002 and 2001, U.S. government securities with par values of $1,841 million and $7,345 million, respectively, were loaned from the SOMA, of which $71 million and Total SOMA securities bought outright $302 million were allocated to the Bank. were $639,125 million and $561,701 million at December 31, 2002 and 2001, respectively. 5. INVESTMENTS DENOMINATED IN FOREIGN CURRENCIES The maturity distribution of U.S. government and federal agency securities bought outright, which were allocated to the Bank at December 31, 2002, was as follows (in millions): 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 41 FEDERAL RESERVE BANK OF PHILADELPHIA NOTES TO FINANCIAL STATEMENTS FEDERAL RESERVE BANK OF PHILADELPHIA NOTES TO FINANCIAL STATEMENTS debt instruments. Foreign government debt million at December 31, 2002 and 2001, instruments held include both securities respectively. bought outright and securities purchased under The maturity distribution of investments agreements to resell. These investments are denominated in foreign currencies which were guaranteed as to principal and interest by the allocated to the Bank at December 31, 2002, was foreign governments. as follows (in millions): Each Reserve Bank is allocated a share of Maturities of Investments Denominated in Foreign Currencies foreign-currency-denominated assets, the related interest income, and realized and unrealized Within 1 year Over 1 year to 5 years Over 5 years to 10 years foreign currency gains and losses, with the exception of unrealized gains and losses on F/X swaps and warehousing transactions. This Total allocation is based on the ratio of each Reserve Bank’s capital and surplus to aggregate capital were no open foreign exchange contracts or The Bank’s allocated share of investments outstanding F/X swaps. denominated in foreign currencies was At December 31, 2002 and 2001, the approximately 3.015 percent and 3.305 percent at warehousing facility was $5,000 million, with zero December 31, 2002 and 2001, respectively. balance outstanding. The Bank’s allocated share of investments denominated in foreign currencies, valued at 6. BANK PREMISES AND EQUIPMENT current foreign currency market exchange rates at December 31, was as follows (in millions): European Union Euro: Foreign currency deposits Government debt instruments including agreements to resell Japanese Yen: Foreign currency deposits Government debt instruments including agreements to resell Accrued interest Total $ 510 At December 31, 2002 and 2001, there and surplus at the preceding December 31. 2002 $ 471 27 12 A summary of bank premises and equipment 2001 at December 31 is as follows (in millions): $ 168 $ 152 99 89 54 62 186 176 3 2 $ 510 $ 481 2002 Bank premises and equipment: Land $ 2.6 Buildings 66.2 Building machinery and equipment 10.8 Construction in progress 1.3 Furniture and equipment 63.6 Total investments denominated in foreign currencies were $16,913 million and $14,559 42 2001 $ 2.5 65.8 9.6 .5 59.1 144.5 137.5 Accumulated depreciation (72.0) (67.8) Bank premises and equipment, net $ 72.5 $ 69.7 Depreciation expense was $9 million for both Federal Reserve Banks dated as of March 2, 1999, years ended December 31, 2002 and 2001. each of the Reserve Banks has agreed to bear, The Bank leases unused space to an outside on a per incident basis, a pro rata share of losses tenant. This lease has a term of 2 years. Rental in excess of one percent of the capital paid-in income from such lease was $1 million for both of the claiming Reserve Bank, up to 50 percent years ended December 31, 2002 and 2001. Future of the total capital paid-in of all Reserve Banks. minimum lease payments under the noncancel- Losses are borne in the ratio that a Reserve Bank’s able agreement in existence at December 31, capital paid-in bears to the total capital paid-in of 2002 were $3 million for years 2003 through all Reserve Banks at the beginning of the calendar 2004. year in which the loss is shared. No claims were outstanding under such agreement at December 7. COMMITMENTS AND CONTINGENCIES 31, 2002 or 2001. The Bank is involved in certain legal actions and claims arising in the ordinary course At December 31, 2002, the Bank was of business. Although it is difficult to predict obligated under noncancelable leases for premises the ultimate outcome of these actions, in and equipment with terms ranging from 1 to management’s opinion, based on discussions with approximately 3 years. These leases provide for counsel, the aforementioned litigation and claims increased rentals based upon increases in real will be resolved without material adverse effect on estate taxes, operating costs or selected price the financial position or results of operations of indices. the Bank. Rental expense under operating leases for 8. RETIREMENT AND THRIFT PLANS certain operating facilities, warehouses, and data processing and office equipment (including taxes, insurance and maintenance when included in rent), net of sublease rentals, was $1 million and Retirement Plans $658 thousand for the years ended December The Bank currently offers two defined 31, 2002 and 2001, respectively. Certain of the benefit retirement plans to its employees, based Bank’s leases have options to renew. The Bank on length of service and level of compensation. has no capital leases. Substantially all of the Bank’s employees Future minimum rental payments under participate in the Retirement Plan for Employees noncancelable operating leases with terms of one of the Federal Reserve System (“System Plan”) year or more, at December 31, 2002, were $560 and the Benefit Equalization Retirement Plan thousand, $300 thousand, and $50 thousand for (“BEP”) and certain Bank officers participate the years 2003, 2004, and 2005, respectively. in a Supplemental Employee Retirement At December 31, 2002, the Bank has no Plan (“SERP”). The System Plan is a multi- other commitments and long-term obligations in employer plan with contributions fully funded by excess of one year. participating employers. No separate accounting Under the Insurance Agreement of the is maintained of assets contributed by the 43 FEDERAL RESERVE BANK OF PHILADELPHIA NOTES TO FINANCIAL STATEMENTS FEDERAL RESERVE BANK OF PHILADELPHIA NOTES TO FINANCIAL STATEMENTS 9. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS AND POSTEMPLOYMENT BENEFITS participating employers. The Bank’s projected benefit obligation and net pension costs for the BEP at December 31, 2002 and 2001 and for the SERP at December 31, 2002, and for the years then ended, are not material. Postretirement benefits other than pensions In addition to the Bank’s retirement plans, Thrift Plan employees who have met certain age and length of Employees of the Bank may also participate service requirements are eligible for both medical in the defined contribution Thrift Plan for benefits and life insurance coverage during retirement. Employees of the Federal Reserve System (“Thrift The Bank funds benefits payable under the Plan”). The Bank’s Thrift Plan contributions medical and life insurance plans as due and, totaled $3 million for each of the years ended accordingly, has no plan assets. Net postretirement December 31, 2002 and 2001 and are reported as benefit costs are actuarially determined using a a component of “Salaries and other benefits.” January 1 measurement date. Following is a reconciliation of beginning and ending balances of the benefit obligation (in millions): 2002 2001 Accumulated postretirement benefit obligation at January 1 Service cost-benefits earned during the period Interest cost of accumulated benefit obligation Actuarial loss (gain) Contributions by plan participants Benefits paid Plan amendments (curtailments, special termination benefits) $ 37.2 0.7 2.2 (2.6) 0.2 (2.4) (0.2) $ 33.4 0.7 2.4 2.1 0.3 (1.5) (0.2) Accumulated postretirement benefit obligation at December 31 $ 35.1 $ 37.2 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): 2002 2001 Fair value of plan assets at January 1 Actual return on plan assets Contributions by the employer Contributions by plan participants Benefits paid Fair value of plan assets at December 31 Unfunded postretirement benefit obligation Unrecognized initial net transition asset (obligation) Unrecognized prior service cost Unrecognized net actuarial gain (loss) $ – – 2.2 0.2 (2.4) $ – $ 35.1 – 14.3 (6.2) $ – – 1.2 0.3 (1.5) $ – $ 37.2 – 16.0 (8.9) Accrued postretirement benefit costs $ 43.2 $ 44.3 Accrued postretirement benefit costs are reported as a component of “Accrued benefit costs.” 44 At December 31, 2002 and 2001, the expected to decrease gradually to 5.0 percent by weighted average discount rate assumptions used 2008, and remain at that level thereafter. in developing the benefit obligation were 6.75 Assumed health care cost trend rates have percent and 7.00 percent, respectively. a significant effect on the amounts reported for For measurement purposes, a 9.0 percent health care plans. A one percentage point change annual rate of increase in the cost of covered in assumed health care cost trend rates would health care benefits was assumed for 2003. have the following effects for the year ended Ultimately, the health care cost trend rate is December 31, 2002 (in millions): One Percentage Point Increase Effect on aggregate of service and interest cost components of net periodic postretirement benefit costs Effect on accumulated postretirement benefit obligation $ One Percentage Point Decrease 0.3 3.0 $ (0.3) (3.4) The following is a summary of the components of net periodic postretirement benefit costs for the years ended December 31 (in millions): 2002 Service cost-benefits earned during the period Interest cost of accumulated benefit obligation Amortization of prior service cost Recognized net actuarial loss Net periodic postretirement benefit costs $ 0.7 2.2 (1.9) 0.1 $ 1.1 2001 $ 0.7 2.4 (1.8) 0.2 $ 1.5 Net periodic postretirement benefit costs are reported as a component of “Salaries and other benefits.” costs. The accrued postemployment benefit costs Postemployment benefits recognized by the Bank at December 31, 2002 The Bank offers benefits to former or inactive employees. Postemployment benefit costs are and 2001, were $7 million for both years. This actuarially determined and include the cost of cost is included as a component of “Accrued medical and dental insurance, survivor income, benefit costs.” Net periodic postemployment and disability benefits. Costs were projected using benefit costs included in 2002 and 2001 operating the same discount rate and health care trend expenses were $1 million for both years. rates as were used for projecting postretirement 45 FEDERAL RESERVE BANK OF PHILADELPHIA NOTES TO FINANCIAL STATEMENTS FEDERAL RESERVE BANK OF PHILADELPHIA NOTES TO FINANCIAL STATEMENTS 10. SUBSEQUENT EVENT locations. The restructuring, which is expected to begin in 2003 and conclude by the end of 2004, will have no significant effect on the Bank. At In January 2003, the System announced plans to restructure its check collection operations. this time, the Reserve Banks have not developed The restructuring plans include streamlining detailed estimates of the cost of the restructuring the check management structure, reducing staff, plan in the aggregate or for the individual Reserve decreasing the number of check-processing loca- Banks affected. tions, and increasing processing capacity in other 46 T he Federal Reserve Bank of Philadelphia’s web site is our electronic front door. A visit to our site allows you to keep up with the latest information on the re- gional and national economy and consumer issues. You can also find links to employment opportunities, educational and consumer resources, and the latest consumer and research publications from the Federal Reserve Bank of Philadelphia. Our new e-mail service notifies you of web updates for subscription topics you choose, including circular letters, news releases, speeches, Payment Cards Center information, and more. Visit us at www.phil.frb.org to learn more. V I S I T w w w. p h i l . f r b . o rg KEY FEDERAL RESERVE BANK OF PHILADELPHIA PHONE NUMBERS Business Planning and Analysis 215-574-6564 Community Affairs 215-574-6458 Financial Statistics/Regulatory Reporting 215-574-6455 Human Resources 215-574-6150 Library & Research Center 215-574-6540 Payment Cards Center 215-574-7220 Public Affairs 215-574-6113 Research 215-574-6448 Supervision, Regulation and Credit 215-574-6480 Consumer Complaints 1-800-372-1220 Treasury Services 215-574-4332