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Contents 2 President’s Message 7 Introduction 9 Promoting Economics and Personal Finance 11 Fostering Community Development Initiatives 14 Educating Bankers in the Third District 17 Teaching Others about the Economy: Research’s Role 20 Making Check Processing More Efficient: Check 21 23 Training Employees for the 21st Century 27 Board of Directors 28 Councils 31 Operating Statistics 32 Current Officers 33 Statement of Auditor Independence 34 Financial Reports 55 Key Bank Contact Information www.philadelphiafed.org | 1 President’s Message T he theme for our 2004 annual report is “Shar- When people know how to assess economic costs and ing Our Knowledge.” Knowledge is integral benefits, they make better decisions about how much to everything we do as individuals and as a to spend, where to invest, and what career to pursue. society. Each of us accumulates knowledge, and we When voters understand the fundamental workings of use and share it as part of every purposeful activity in the economy, they support better public policy choic- which we engage. Our organizations and institutions es, both in their local community and for the nation. In do likewise. short, well-informed economic decisions and well-un- As the nation’s central bank, the Federal Re- derstood economic policies are the building blocks for success in a market economy and serve provides a financial environment that fosters sustained economic growth and a financial system that is reliable and accessible to all. In pursuit of these objectives, we often share our knowledge, and we do so enthusiastically, because the more knowledgeable we make our constituencies – be they consumers, bankers, educators, the public at large, or our own employees – the closer we can come All across the country, the Federal Reserve System is playing a valuable role in educating young people about the financial system and its role in a market economy. to achieving our goals. In this opening letter, I a democratic society. As president of this Bank, I see every day how sharing knowledge helps the Federal Reserve achieve its mandated mission – as monetary authority, as bank regulator, and as payments system provider. For instance, by helping people understand the cross-currents affecting the economy and articulating the value of a stable price environment, we at the Fed will give you a quick overview of the ways in which strengthen the public mandate for a monetary policy the Federal Reserve Bank of Philadelphia endeavors that promotes full employment and sustainable eco- to share its knowledge and the rationale behind those nomic growth. Moreover, by maintaining an open dia- efforts. The essays that follow will convey to you the logue with academia, civic leaders, and the business texture and substance of our programs. Along the way community, we advance our collective knowledge you will meet some of the many people at the Bank about the economy, and hopefully, we make better involved in their development and delivery. I hope you policy decisions ourselves. will find these efforts and the impact they are having as exciting as I do. As a regulator, the Federal Reserve is responsible for promoting safe and sound practices in the bank- As an economist and a former professor, I am ing industry. Over time, industry conditions change, doubly aware of the value of economic education. new laws are enacted, and new regulations are written. 2 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA By keeping the bankers in our District up-to-date on forms of payment offer. Again, sharing our knowledge these developments, we help them adapt more read- is an important part of meeting the challenge. The Fed ily to changing standards. The Fed also oversees the aims to keep both financial institutions and their cus- industry’s compliance with many consumer protection tomers up-to-date on developments in electronic pay- laws. Here we aim to educate not only the financial ments, including current standards for processing trans- institutions but the consumers themselves about their actions, disclosure of fees, protection from fraud, and protections under the law. Sharing our knowledge with recourse in the event of an error. The Fed also keeps both sides and building a common understanding are legislators up-to-date on payments technology, so that surely the best ways to ensure that the law achieves its they can establish standards that provide both reason- intended purpose. able safeguards and ample opportunity to innovate. The Federal Reserve is also responsible for So sharing our knowledge helps us achieve maintaining a reliable and efficient payments system. our mission in all its dimensions. But how do we actu- This is an area where new information technology is ally go about sharing this knowledge? driving tremendous change. Consumers and businesses are rapidly relinquishing paper transactions – handling Reaching Our Constituencies cash or writing checks – in favor of electronic ones, When it comes to providing economic educa- swiping a card or logging on to a computer. The chal- tion to the individual, we have developed a three-part lenge for the Fed is to preserve the reliability we have approach. First, we support programs that help young all come to expect from paper-based payments without people learn more about economics at school. Second, diminishing the convenience that the new electronic we support programs that help adults get the back- The wisdom and leadership of our Board of Directors are of inestimable value in guiding the Bank through changing times. Federal Reserve Bank of Philadelphia President Anthony M. Santomero (center right) with (left to right) Doris Damm, Deputy Chairman, Board of Directors; Ron Naples, Chairman, Board of Directors; and Federal Reserve Bank of Philadelphia First Vice President William H. Stone, Jr. www.philadelphiafed.org | 3 ground they need to handle their immediate economic nomic education and financial literacy to adults across and financial decisions. Third, we offer programs that the District. Financial literacy is a person’s best defense help the public at large understand the ever-changing against financial fraud and abuse, and so we seek to structure of the U.S. economy. offer people financial education before they fall vic- Supporting economic education for school- tim to unscrupulous business practices. Like any good age children is at the core of our efforts because we inoculation program, financial education is most ef- recognize that broad-based economic education now fective if it is targeted at the most vulnerable among will translate into a society of more financially literate us. In this case, the most vulnerable are older people, adults in the future. Unfortunately, the basic concepts people in low- and moderate-income communities, of economics and finance often receive only cursory treatment in many schools. Sometimes, they are excluded altogether. As a consequence, graduates enter adulthood ill-equipped to make good life choices about their careers or their personal finances. This situation has led the Bank to focus on and those with a poor credit history. Financial education is most effective if it is targeted at the most vulnerable among us. programs that integrate economics and We provide both literature to consumers themselves and curricula to those who counsel and instruct them. As a regulator, the Fed specifies the information that financial institutions must provide in the disclosure forms they give their customers. But these disclosures are useful only if consum- finance more fully into school curricula at all levels. We ers can read and understand them. So we think sup- also provide teachers with presentations and seminars porting financial literacy is an essential element of our to enhance their own background in these subjects and approach to effective regulation. with classroom materials and training on their use. By But our posture is not a purely defensive one, working with schools and teachers, the Philadelphia geared to protect the consumer from harm. Over the Fed can leverage its knowledge resources and have a long term, we hope to help all consumers master the substantial impact. basics of money management, empowering them to We are not alone in this effort. All across the take control of their financial futures. An example of country, the Federal Reserve System is playing a valu- our success in this endeavor is our faith-based financial able role in educating young people about the financial education initiatives, which have been quite effective system and its role in a market economy. Each Federal in making inroads in communities around our District. Reserve Bank has its own economic education special- Yet our young and at-risk populations are not ists and tailors its programs to the needs and resources the only ones that need education. In today’s rapidly of the District it serves. With our Bank situated on Inde- changing world, education is becoming a life-long pro- pendence Mall in the heart of historic Philadelphia, we cess for virtually everyone. Recognizing that the Bank offer the visiting public “Money in Motion,” a history- has a part to play in that process, we have expanded based look at central banking in the U.S. By partnering our efforts to keep the public up-to-date on changes in with area educators, we are now leveraging the exhibit the financial landscape. We are continually enhancing as an educational resource for area students. our “Money in Motion” exhibit. For instance, in 2004 The Bank also has been active in bringing eco- 4 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA the new $50 bill made its debut. We held several events to educate the public about currency authen- of programs to brief Third District bankers on recent ticity and to point out the security features of the new changes in the law and to discuss emerging trends in bill. In addition, we produced brochures on consumer the financial services industry. credit topics such as identity theft and credit card Building Our Knowledge fraud. We are pleased to share our knowledge and Networking with the Research Community contribute to the continual learning process of our con- Our research economists maintain close ties stituencies. But we too must be continual learners if we with a number of the major colleges and universities in are to pursue our mission effectively. Recognizing this, our area. Many of our economists are engaged in the national and international academic scene, as well. And we often host prominent scholars for a semester or more of research and interaction here in the Bank. This rich network of knowledge-sharing helps advance the frontiers of economic science. Engaging the Banking Community The Philadelphia Fed also our Bank has been quite active in de- The Philadelphia Bank has been quite active in developing educational programs, not just for its own employees but for the entire Federal Reserve System. veloping educational programs, not only for our own staff members but for our colleagues across the entire Federal Reserve System. Our Professional Education Program (PEP) and its partner, ePEP, combine traditional classroom and technology-based instruction to provide a high quality “blended learning” experience for all business lines throughout the System. Through this program, we help the made a significant investment in edu- Federal Reserve build the knowledge cating the banking community during it needs to meet the challenges of a 2004. In October, the payment system took an im- changing world. portant step forward with the enactment of the Check I am proud of all of the contributions to educa- Clearing for the 21st Century Act. Check 21, as it is tion and knowledge sharing that the Philadelphia Fed known, establishes the legal structure necessary to en- makes. I believe they make a difference in our District’s able the transition from paper to electronic check pro- communities, in the financial services industry, and cessing. To take full advantage of this new opportunity, across the Fed System. As I said at the outset, I believe the Federal Reserve launched an aggressive program they serve us well in the pursuit of our mandated mis- to move all retail payments to electronics. To engage sion. As you read this report, I hope you come to share the banking community in this effort, the Bank ac- my perspective. tively shared its knowledge about the implications of Check 21 with District banking leaders and kept them informed about the evolution of Federal Reserve payments processing throughout 2004. Board of Directors In the context of this year’s report, it is particularly fitting that we recognize the contribution of our Aside from developments in payments, our Board of Directors, who share their knowledge with bank supervision and regulation staff offered a number us so generously. Their wisdom and leadership are of www.philadelphiafed.org | 5 inestimable value in guiding the Bank through these changing times. A Closing Thought Before closing, I will mention that Philadel- I am pleased to report that Ronald J. Naples, phia’s role in the monetary policy decision-making chairman and CEO of Quaker Chemical Corpora- process is now somewhat more pronounced because tion, has been reappointed chairman of the Board of 2005 is a voting year for Philadelphia on the Federal Directors, and Doris M. Damm, president and CEO of Open Market Committee (FOMC). As many of you ACCU Staffing Services, has been reappointed deputy know, the FOMC consists of 12 Federal Reserve Bank chairman of the Board of Directors for 2005. In ad- presidents and the seven members of the Board of Gov- dition, P. Coleman Townsend, chairman and CEO ernors and sets the course for monetary policy. While of Townsends, Inc., has been re-elected to a second all Fed presidents attend and contribute to the discus- three-year term. sions, only five vote on the final decision. The voting We greatly look forward to the counsel and schedule is dictated by the Federal Reserve Act and guidance of our newest Board member, Wayne R. is done on a rotating schedule of one-year terms. So Weidner, chairman of National Penn Bank. At the expect the Philadelphia Reserve Bank to be even more same time, we offer our sincere thanks to Walter E. closely watched in the year ahead. Daller, Jr., chairman, president, and CEO of Har- At times like this, I especially appreciate the leysville National Corporation, who completed his strong support I receive from the Third District busi- term of service on our Board of Directors. His insights ness community, our Board of Directors, our Research will be missed. Department, and the Bank’s advisory councils, as well I would also like to acknowledge the contribution of Rufus A. Fulton, Jr., chairman and CEO of as from all of the employees who keep us in touch with the Third District. Fulton Financial Corporation. We had the pleasure of his service for three years on our Board (1997-2000), and he represented the District admirably on the Federal Advisory Council (FAC) from 2001 to 2004. In his stead, we are also pleased to announce that Bruce L. Hammonds, president and CEO of MBNA Corporation, has been appointed to represent the Third District on the FAC. On behalf of all of us here at the Philadelphia Anthony M. Santomero Fed, I thank our Board members for their thoughtful President insights and commitment to public service. April 2005 6 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA Introduction Sharing knowledge with its many constituencies allows the Federal Reserve Bank of Philadelphia to contribute to the economic vitality of the Third District and the nation. www.philadelphiafed.org | 7 Members of the Pennsylvania Governor’s Institute for the Social Studies came to the Bank to learn about resources for teaching economics in the primary grades. 8 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA Promoting Economics and Personal Finance The Federal Reserve’s primary role is to ensure a sound financial system and a healthy economy. However, keeping the financial system and economy sound is easier when consumers are financially literate. Andrew T. Hill, Ph.D. Economic Education Specialist Community Affairs Department T o help consumers become more aware of Fed’s permanent exhibit, “Money in Motion.” The money matters, the Federal Reserve System and curriculum comprises six lessons aimed at different the Federal Reserve Bank of Philadelphia have levels: grades three through five, grades six through renewed their commitment to teaching the public about eight, and high school. The lessons provide classroom economics and personal finance. The Philadelphia Fed activities that prepare students to visit the exhibit, to get plays a strong role in carrying out this commitment the most out of the exhibit while they’re here, and to in the Third District through the work of economic follow up once they’re back in the classroom. education specialists such as Andrew Hill in the Bank’s Also in 2004, the Bank began a series of Community Affairs Department. Over the past several evening courses that helped teachers learn how to years, Hill has helped to develop several new programs integrate economics and personal finance into their and expand existing ones. teaching of reading, writing, and math. This program, “Economics in Children’s Literature,” showed a group What’s New One big undertaking in 2004 involved developing a curriculum to go with the Philadelphia of mostly primary-school educators how to incorporate such lessons using many of the children’s books already in their curriculums. www.philadelphiafed.org | 9 In addition, for five days in July, 37 teachers For the past two years the Bank has been a came to the Philadelphia Fed to attend a course called partner in “Money Talks,” a five-day summer course “Making Sense of Money and Banking.” Modeled after for Delaware teachers who want to learn how to teach a similar program at the St. Louis Fed, “Making Sense” personal finance in kindergarten through grade 12. shows teachers how to incorporate lessons about eco- Partners in this endeavor are the Delaware Bankers As- nomics and the Federal Reserve System into their social sociation and Citigroup. studies, consumer science, and business curriculums. One very successful program over the past The teachers received professional development credit few years has been “Keys to Financial Success,” which and a binder of curriculum materials. was developed in partnership with In the past year, the Federal Reserve System has renewed Existing Programs The Bank also continued to offer long-standing programs in 2004. The “Hot Topics in Economics” seminar, which is in its seventh year, invites teachers to come to the Bank one evening for three short presentations on topics related to economic and personal finance issues. For example, the 2004 program included talks by its commitment to teaching the public about economics and personal finance. the University of Delaware’s Center for Economic Education and Entrepreneurship, the Delaware Bankers Association, and Community Credit Counseling Services of Maryland and Delaware. Originally done as a pilot in a Newark, Delaware, high school in the 2001-02 school year, “Keys” has now grown to 24 high schools in the First State. Recently, a high school in Bristol, Pennsylvania, adopted the pro- various Bank staff on exchange rates, gram, and the Bank’s economic educa- health-care costs, and the outlook for tion specialists are working to expand the economy. A program of even longer standing is the Topi- “Keys” in the Commonwealth. They’re also hoping to start a “Keys” program in New Jersey. cal Seminar Series, which has been held for 21 years At the state level, the Philadelphia Fed’s eco- in Delaware. This five-night series is sponsored by the nomic education specialists attend the annual meetings University of Delaware’s Center for Economic Educa- of the New Jersey Education Association. At the nation- tion and Entrepreneurship. The concluding night of the al level, they participate in a number of conferences, series is devoted to a speaker from the Philadelphia Fed, including those of the National Council on Economic who, last year, made a presentation on the history of Education and the National Council on Social Stud- central banking. ies. Events such as these offer an opportunity to talk to Of course, throughout the year, Hill and other teachers around the Third District and the nation and staff members in Community Affairs are kept busy let them know about free resources available from the with many other presentations and conferences. For Fed. example, in 2004, the Bank hosted the Pennsylvania As we move further into 2005 and beyond, the Governor’s School for Global Entrepreneurship for the Philadelphia Fed will continue to find innovative ways third year, welcomed teachers from the Pennsylvania to fulfill its mission in the economic education and fi- Governor’s Institute for the Social Studies, and partici- nancial literacy arena. pated in the Chamber of Commerce of Southern New Jersey’s annual Summer Institute for Teachers. 10 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA Fostering Community Development Initiatives The Bank’s Community Affairs Department has primarily an informational and educational function. As part of this function, the department develops a number of programs and initiatives that identify issues in low- and moderate-income communities. Marvin M. Smith, Ph.D. Economic Education Specialist Community Affairs Department A s part of its mission, the department expands mixed-income projects, and promoting the importance opportunities for low- and moderate-income of good schools. The Bank also co-sponsored another communities and people by working with conference for practitioners interested in reclaiming lenders, government representatives, and community vacant properties in their Pennsylvania communities, developers through workshops, seminars, and publi- an important issue for older towns and cities. cations. In this way, Community Affairs helps bankers In addition, Community Affairs conducts or understand and respond to the credit and deposit needs commissions research on critical community develop- of underserved communities. ment issues. The Bank co-sponsored a seminar with A major issue being addressed is reinventing the New York Fed and Rutgers University at which America’s older communities. In 2004, Community 60 nationally known academic researchers discussed Affairs held a national conference with speakers and community development finance strategies. Further- attendees from across the United States who discussed more, the department has conducted research on rotat- ways to make existing communities vibrant and com- ing credit and savings associations, informal lending petitive again. Some of the topics covered included arrangements often used by immigrant populations to creating 24/7 downtowns, financing mixed-use and finance small businesses or consumer purchases. www.philadelphiafed.org | 11 Volunteers learn how to educate others on the importance of financial education. Pictured with Marvin Smith (center) are some of the volunteers (clockwise from top): Michael Cunningham, New Covenant Church of Philadelphia; Alberta Wilson, Beulah Baptist Church; Diana Lynch, Eastwick United Methodist Church; and Patsy Harris, Enon Tabernacle Baptist Church. 12 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA While recognizing the need to highlight community development issues, the Bank also understands to take a leadership role in providing ongoing financial education within their houses of worship. the importance of personal financial education for low- Patsy Harris of Enon Tabernacle Baptist Church and moderate-income and minority people. Financially observed that the Philadelphia Fed “provided an exten- literate consumers foster a healthy economy. Financial sive training package we could take back to our church- education helps people develop the skills to meet their es and share with our membership. We were able to objectives, including financial stability, homeowner- incorporate these training materials into our sessions to ship, higher education, or retirement. Consequently, help our members be more informed consumers.” the Philadelphia Fed and the Federal Reserve System Michael Cunningham, director of the New have been actively involved for some time in a num- Covenant Church of Philadelphia’s Institute for Finan- ber of key initiatives to educate the public, particularly cial Success, also attended a train-the-trainer workshop those who are low and moderate income, on matters of at the Philadelphia Fed. Cunningham noted, “The ses- personal finance. sion stimulated participation and gave attendees the confidence to facilitate various financial education Working with Churches workshops within their own congregations.” In fact, the Philadelphia meets this challenge by con- New Covenant Church recently launched a homeown- tinuing to promote financial education. In particular, ership program, which will include credit counseling the Bank launched a faith-based financial education and loan processing classes taught by graduates of the initiative in 2004. Leading this initiative is Economic train-the-trainer workshops. Education Specialist Marvin Smith. By forging strong partnerships with faith-based organizations, particular- Continuing Support and Other Programs ly in minority neighborhoods, the Bank reaches out to But the Philadelphia Fed’s efforts do not end communities and provides people with the tools, train- with the training workshop. The Bank provides continu- ing, and information to build a better financial future. ing support, communication, and encouragement to its Smith’s programs successfully combine counseling and program participants. Once the new instructors have education to trainers, who can then empower congre- conducted their congregations’ financial education gants to secure their own financial success. classes, they have the opportunity to reconvene with Smith asks religious leaders to identify volun- their original training group to share experiences and teers from their congregations to participate in training offer feedback. At that time, the Fed assists them with workshops conducted by Community Affairs. During addressing challenges they have faced and provides these “train-the-trainer” workshops, volunteers learn any necessary additional information. how to teach others about financial matters. These The Bank will also hold presentations at an workshops are held at no cost to the house of worship organization’s request. For example, Smith coached or the participants. members of New Covenant Church on how budgeting The program curriculum includes subjects works and encouraged participants to develop their such as credit, checking, budgeting, savings, consumer own budgets. He also addressed about 1,000 clergy rights, loans, and homeownership. They are also given and lay representatives from the northeastern United valuable teaching tips on different learning styles. Con- States at a fall 2004 convocation of the African Method- gregants who have completed the workshop are able ist Episcopal Church. www.philadelphiafed.org | 13 Educating Bankers In the Third District Supervising banks is obviously a big part of what the Bank’s Supervision, Regulation and Credit (SRC) Department does, but it also conducts several highly successful outreach programs. Michael E. Collins Senior Vice President & Lending Officer Supervision, Regulation & Credit Department T he outreach programs supported by SRC are Bankers’ Forums. To make attendance as convenient as aimed at maintaining communication channels possible, SRC splits the locations: two in Philadelphia between the Philadelphia Fed and its depository and three elsewhere in the Third District. The forums institutions, keeping Third District bankers informed, give chief executive officers from area banks an oppor- helping them comprehend banking regulations and tunity to discuss emerging issues and challenges with compliance, and soliciting their input and feedback on SRC staff and their peers. The most important aspect of emerging and existing public policy issues. the Bankers’ Forums is hearing concerns directly from bankers, but it also gives SRC a chance to meet with Meetings financial institutions outside the examination process. To keep the lines of communication open, SRC Although these meetings generally focus on discussions holds meetings throughout the year. These meetings about local financial industry issues, in 2004, the Bank take various forms and are geared to different audi- Secrecy Act (BSA) and the USA Patriot Act were com- ences. mon themes. The BSA requires banks to file suspicious Five times annually, the department holds 14 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA activity reports on money laundering and certain other crimes. The Patriot Act, in part, reinforces anti-money commentary on guidelines issued by other regulators. laundering statutes with an eye to preventing funding In its publications outreach last year, SRC of terrorists and their organizations. In discussions, SRC reached an even broader audience when The RMA cautioned bankers that, when there is a violation of Journal printed an article by Mike Collins on fraud man- these laws, the Fed cannot exercise discretion in en- agement techniques. RMA is a professional association forcement actions, since such proceedings are gener- that advances the use of sound risk principles in the ally mandated by statute. SRC also sponsors two other annual meetings: a roundtable for certified public accountants who audit banks SRC supervises and a roundtable for banks’ chief financial officers and internal auditors. The agenda for these meetings is set by SRC in conjunction with the Federal Reserve’s Board of Governors in Washington, DC. financial services industry. The most important aspect of the Bankers’ Forums is hearing concerns directly from bankers, but it also gives SRC a chance to meet with financial institutions outside the examination process. Other Initiatives Enhancing commu- nication with other regulators was also a priority in 2004. To that end, SRC developed and hosted a program with Pennsylvania’s Department of Banking to establish good communication between new leadership. In addition, SRC developed and hosted a program with the Publications heads of the banking depart- Another way SRC keeps ments in each of the District’s bankers abreast of what’s happening in the financial three states to discuss coordination of crisis manage- services industry is through its quarterly newsletter SRC ment activities. Insights and its companion insert Compliance Corner. Another area in SRC, the Consumer This publication, which is available in both paper and Compliance/Community Reinvestment Act (CC/CRA) electronic form, offers a wealth of information to de- unit, contributes significantly to SRC’s outreach initia- pository institutions. Each issue begins with a commen- tives. Last year, the unit developed a CD-ROM training tary from Senior Vice President Mike Collins on top- module on the Home Mortgage Disclosure Act, entitled ics ranging from trends in enforcement activity, to the “HMDA: Understanding the Changes to Regulation.” changing supervisory landscape, to the impact of the The CC/CRA unit also conducted a training session on Sarbanes-Oxley Act. Newsletter articles cover subjects consumer regulations for the National Credit Union Ad- such as “phishing” (an Internet scam), Basel II’s impact ministration and, with the Bank’s Retail Payments De- on competition in the U.S. financial services industry, partment, participated in several Check 21 initiatives. and training for bank directors. Although SRC Insights This unit also conducts outreach to community groups is targeted to the banks SRC supervises, it also contains and fields consumer complaints. www.philadelphiafed.org | 15 Visiting Scholar Jan Brueckner of the University of California-Irvine meets with members of the Bank’s Research Department to discuss his latest research. 16 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA Teaching Others About the Economy: Research’s Role The Research Department plays many different roles within the Bank and the Federal Reserve System. We talked with Philadelphia Fed Director of Research Loretta J. Mester to find out what Research does to promote the Bank’s education efforts. Loretta J. Mester, Ph.D. Senior Vice President & Director of Research Research Department Q: Tell us about the Research Department’s educa- edge within the economics profession by disseminating tional roles. our research worldwide. LJM: The department does many different things to educate its various constituencies. Our main responsi- Q: What is the department’s role in preparing bility is to brief President Santomero in preparation for President Santomero for the FOMC? Federal Open Market Committee (FOMC) meetings. But LJM: we also try to educate the public on current economic current economic conditions, and we develop forecasts conditions and economic research. of the economy and discuss the risks to those forecasts. Our economists brief President Santomero on Our economists give speeches on the econom- We analyze forecasts from others as well. We point out ic outlook. They also write articles for the department’s different options for monetary policy and the reasoning flagship publication, Business Review. behind those options. Preparation for the briefings is We also talk to reporters to help them better quite lengthy and entails gathering and analyzing data understand various aspects of the economy. In turn, they and applying various economic models to the current can better explain the economy to their readers. economic situation to develop appropriate policy Of course, we also work to advance knowl- recommendations. www.philadelphiafed.org | 17 Q: How does the Business Review fit into Research’s Q: Do your reports literally move markets? educational role? Isn’t the material highly technical? LJM: They can. The BOS has been known to move LJM: The work our economists do is often highly markets. Traders read the survey immediately upon technical. However, in the Business Review, we distill its release, and movement in the markets is sometimes the technical material into a form that is accessible to attributed to survey results that have come out educated lay readers. We want readers to understand differently than market participants expected. economic issues, but not necessarily all of the technical Q: Can you tell us about the department’s conferences details. We should note and forums? that our Review differs from those of many of the other Reserve Banks. Our Business Review articles are aimed at an educated lay audience — people who are interested in economic issues but who are not economists. One way we measure our success in this area is by the The annual Policy Forum brings together policymakers, academics, market economists, and members of the press. LJM: The Research Department sponsors several conferences a year that span the various interests of the Bank’s research efforts. Since 2001, we’ve been hosting the Policy Forum, a large macroeconomic conference that brings together policymakers, academics, market number of requests we get to economists, and members of the include Business Review articles press. The Policy Forum’s partici- in reading materials for college courses and books of pants discuss relevant issues that the Federal Open readings that accompany textbooks. And we’ve been Market Committee will need to deal with in the com- highly successful on that front. ing years. We also co-sponsor a macroeconomics work- Q: What about the department’s other publications? shop each year with the University of Pennsylvania’s How is the information gleaned from your economic Economics Department. surveys used? In 2005, we will have several events. In April, LJM: Our surveys are used in current analysis of the we will hold a conference on immigration. In June, national and regional economy. For example, the we’ll be co-hosting a conference in Berlin, Germany, Survey of Professional Forecasters and the Livingston on “Bank Relationships, Credit Extension, and the Survey report measures of inflation expectations, along Macroeconomy.” Our co-sponsors are the German In- with forecasts of other economic variables. These stitute for Economic Research and the Journal of Finan- measures of expectations are important variables in cial Intermediation. In September, we will co-sponsor a setting monetary policy, and they’re also used as a conference on issues in consumer credit and payments data source in economic research. with the Bank’s Payment Cards Center. The department’s Business Outlook Survey These conferences serve several purposes. (BOS) of regional manufacturers is used for regional They inform us about cutting-edge research on the analysis. Because it comes out earlier than other conference topic and bring together researchers with measures of the national economy, the information in common interests, which can spur collaborations. They the BOS is also used as an early forecast of trends in the also advance the research agenda on these topics by national economy. illuminating which questions remain open. 18 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA Q: How is your department’s research disseminated to Q: Is any of your work international in nature? other institutions? LJM: Economics itself is international in scope. As LJM: The web is the premier medium through which I mentioned earlier, our research is disseminated we disseminate early versions of our research. Since the through the web, both on the Bank’s own web site and web is a global instrument, our economics colleagues on various databases. Some of our economists focus on around the world have access to our papers. But even topics such as international economics and trade. before the final working paper is produced, economists We have set up economist exchange programs have been exchanging ideas by presenting seminars with both the Bank of Sweden and Bank of Canada. Their economists come to the at other institutions and conferring with colleagues. In addition, we sponsor our own seminar series and visiting scholar program, through which we bring in other economists to discuss their research. In effect, economists “vet” their work by presenting it to other economists. We also send our papers to academic and Fed libraries and post them to online databases Over the years, the Research Department has helped various institutions in the area by supplying data, reviewing their analysis, and offering policy advice. Philadelphia Fed for a week or so, and we then send one of our economists to their central bank for a week. This helps create closer ties among central bank staff, who often are researching similar types of economic questions. It also enables our economists to gain a broader perspective of world economic conditions. Q: Do the other 11 Reserve Banks’ such as the Social Sciences Research Network. Ultimately, we revise our work based Research Departments work the same way? on the feedback gleaned from presenting and discuss- LJM: Our general goals are very similar. Certainly, ing our work, and then submit papers to academic jour- briefing a Reserve Bank’s president for the FOMC is nals. This starts another round of revisions as authors a critical function of all Research departments in the respond to referees’ comments before the work is finally System. Of course, regional knowledge is the unique published in the journal. item each Reserve Bank president brings to the FOMC meetings. Q: How does the Bank’s Research Department help Some System departments emphasize different the Philadelphia region? areas of interest, depending on their location. For LJM: Over the years, we’ve helped various institutions example, Reserve Banks in the Midwest may do more in the area by supplying data, reviewing their analysis, research on agriculture-related economic issues. Some and offering policy advice. In 2004, our chief regional departments may emphasize shorter term current economist attended the Mayor’s Economic Summit to analysis, while others emphasize longer term research. discuss the economic future of Philadelphia. Most of the Reserve Banks, including our own, have a We produce articles on the region, either as mix of these activities. stand-alone reports or as part of our Business Review, which contain information about some aspect of the local economy. Various city organizations have used this information in their policy discussions. www.philadelphiafed.org | 19 Making Check Processing More Efficient: Check 21 The Check Clearing for the 21st Century Act, also called Check 21, fosters innovation and efficiency in the payments system. On October 28, 2004, this important new legislation took effect. Anthony Scafide, Assistant Vice President, and Tom Lombardo, Manager, both in Customer Relations T he essence of the law is that it allows a substi- tions to increase their use of image processing in check tute check, created from an electronic image, to collection and improve their business operations. serve as the legal equivalent of the check itself. In doing so, it eliminates a significant legal barrier to Preparation at the System Level check truncation and electronification of check pro- As preparations to implement Check 21 were cessing. A collecting bank can create an electronic im- underway across the financial services industry, the age of a check, transmit the image to the paying bank’s Federal Reserve System embarked on a year of training- location, and then present the paying bank with a paper intensive activities to educate Reserve Bank custom- reproduction or with the electronic image itself. ers on making the most of the opportunities available The Fed proposed Check 21 to enable the through the new legislation. Importantly, the Fed also industry to make check processing more efficient and helped them clarify how best to pass those benefits reliable. Now, banks must consider how to use the along to their own customers. new options offered by Check 21 to create shareholder In early 2004, experts from the Federal Reserve value and improve service quality. The new legislation System made presentations at the Bank Administration provides an excellent opportunity for financial institu- Institute’s Check 21 Implementation Planning Clinics, 20 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA which were held around the nation to review the legal for further outreach to bankers around the region. aspects of Check 21, provide an overview of Federal Following the field meetings, Anthony Scafide, Reserve initiatives, and share perspectives on develop- assistant vice president, and Tom Lombardo, manager, ing and implementing Check 21 plans. both of the Philadelphia Fed’s Customer Relations De- The Federal Reserve also sponsored online partment, presented six open seminars throughout the Check 21 seminars to support financial institutions’ Third District to provide bankers the opportunity to efforts to develop and implement Check 21 strategies. learn more about Check 21. Upon customers’ requests, These online seminar topics included an overview of or when more one-on-one training was needed, Scafide the new Check 21 product suite, information on how to and Lombardo also conducted comprehensive presen- best use the new product suite within financial institu- tations for individual bank customers interested in ob- tions’ business environments, and tools to help assess taining more information on Check 21. readiness for Check 21 implementation. Participants, The seminars emphasized how financial in- numbering in the thousands, agreed that these online stitutions can enhance their efficiencies and improve seminars were very informative and highly practical customer service. Another important component of the and allowed the Reserve Banks’ busy customers to be seminars was the introduction of a variety of new and informed without leaving their offices. improved products, services, and solutions offered by In addition, in Federal Reserve Bank Customer Service locations around the nation, account execu- the Federal Reserve and designed to support banks’ best use of the new options under Check 21. tives continue to talk to customers, answering questions about Check 21 and helping identify opportunities to leverage technology and evaluate banks’ long-term payments processing strategies in light of Check 21. Follow-Up As a follow-up to the six seminars and to address any outstanding issues bankers were facing, Scafide and Lombardo developed “Keeping Our Prom- Preparation in Our District ise,” a Check 21 town hall meeting focusing on issues Education continued at the District level, as dealing with regulation, compliance, operations, and each of the 12 Reserve Banks held seminars around products and pricing. The session allowed an open their respective regions to help bankers learn to maxi- dialogue between the bankers and relevant experts in mize efficiencies under Check 21 and take advantage of each of the topical areas discussed. Check 21-related opportunities. It will take some time for the full effects of In Philadelphia, our District’s training began Check 21 to be realized. The infrastructure of check with the 2004 Field Meetings. Each year, Philadelphia processing will evolve, generating new check products Fed officials travel throughout the Third District edu- and services, and new ways to deliver them. The Fed- cating financial institutions on the economic outlook, eral Reserve is committed to working with the financial banking trends and developments, and financial ser- services industry in this dynamic environment to ensure vices. Last year, the financial services portion of the a smooth transition and to achieve all the efficiencies meeting focused exclusively on the upcoming imple- this new legislation offers. mentation of Check 21. These meetings set the stage More information on Check 21 is available at www.frbservices.org or on the Federal Reserve Board of Governors’ web site at www.federalreserve.gov. Or you may contact the Federal Reserve Bank of Philadelphia’s Customer Service office at (877) 574-1776. www.philadelphiafed.org | 21 Examiners in the Bank’s Supervision, Regulation and Credit Department use a most unusual tool — Philadelphia’s Mural Arts Program. 22 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA Training Employees For the 21st Century Training employees is also an important aspect of sharing our knowledge. A well-trained staff makes the Philadelphia Fed better able to serve both its external and internal customers. The Organizational Learning & Development unit has primary responsibility for this task. Stephen G. Hart Assistant Vice President Organizational Learning & Development Division Human Resources Department T he Federal Reserve Bank of Philadelphia carries Both units share three primary objectives: match em- out its mission to educate the public in many ployees’ skills to the Bank’s or System’s strategic focus, ways. But members of the public are not the be performance driven and results oriented, and have a only ones who benefit from Fed education and training. technological bias. The Bank also trains employees at every level and in a To meet these objectives, OL&D staff, under variety of ways to help them become even more effec- the direction of Assistant Vice President Steve Hart, tive at their jobs. offer a variety of training programs for employees. Organizational Learning and Development A quick look at just a few of the items on OL&D’s (OL&D), which is part of the Bank’s Human Resources training calendar demonstrates this. For example, last Department, has two primary training units. One year, OL&D offered courses on building collaborative group concentrates on training within the Bank, and relationships, learning leadership at work, establishing the other, called the Electronic Professional Education good client/consultant relationships, and preventing Program (ePEP), concentrates on training System-wide. workplace violence. www.philadelphiafed.org | 23 Active Training But it quickly became evident that one week Also this past year, OL&D made a concerted of training, once a year, wasn’t enough. Nor did such a effort to move from passive to active training. Instead of schedule meet the training needs of the various Federal waiting for people to come to them, staff members vis- Reserve Banks. So a blended learning model was devel- ited departments to identify training needs. In this new oped. role, the trainers not only customize training to meet To further facilitate the System’s training needs, departmental needs, but they also expand their roles the Philadelphia Fed proposed the idea of continuous as organizational development consultants. This new learning: No matter what month new employees are model offers opportunities for the trainers to help managers and officers look at skill development as well as ways to improve a process, develop team effectiveness, or explore the use of alternative management styles. In addition, the Bank’s trainers were busy last year in operations areas, helping employees adjust to the new check processing platform and implementing Check 21. OL&D also got involved in cross-training Check employees. Some OL&D staff members ventured into a new area: hired, they do not have to wait to The most exciting training news in 2004 was the announcement that in 2005 the Bank will offer an on-site bachelor’s degree completion program in conjunction with Philadelphia University. learn FRS accounting methods. To implement this idea, online models were created. Furthermore, subject matter experts round out these online sessions by sharing their experience via Sametime, a web-based tool that allows employees to attend live virtual training sessions from their desktops. Another component of blended learning is virtual learning. The Philadelphia Fed and Banks around the System can use video confer- developing training materials for encing to “attend” training sessions. special projects. In particular, they While this technology can be used worked with a vendor on technical support for the Trea- for information sharing, it also allows Fed trainers to sury Check Information System (TCIS) project, a new hold interactive, collaborative sessions. web-based system for reconcilement and claims processing of Treasury Checks. A particularly successful ePEP program in 2004 involved training the examiners in Supervision, Regulation and Credit using a most unusual tool—Philadel- ePEP and Blended Learning phia’s Mural Arts Program. As part of this course, 60 The Bank’s trainers also oversaw several ePEP examiners went through various exercises, all designed programs. Originally, the Professional Education Pro- to stress the importance of good communication, col- gram involved a full week of training in Federal Reserve laboration, and teamwork. One “experiential exercise” System accounting functions. Then the System expand- had participants visit some of Center City Philadelphia’s ed that model to include Fed employees who work in murals and reflect on the facts, emotions, and symbols Cash departments. contained in these works of art. 24 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA Training the Examiners An exercise of this type is particularly useful because examiners are collaborating more in their work. For example, safety and soundness examiners may have to work more closely with community affairs examiners. Thus, it’s crucial for them to be able to communicate more effectively. Bachelor’s Degree Program Perhaps the most exciting training news in 2004 was the announcement that in 2005 the Bank will offer an on-site bachelor’s degree completion program in conjunction with Philadelphia University. This opportunity, S ome Philadelphia Fed employees need highly specialized training. One example is bank examiners. What goes into the making of a commissioned bank examiner? Ian Harvey Manager, Staff and Career Development Supervision, Regulation & Credit Department Training takes approximately three years to complete. A quick listing of what assistant examiners undergo includes: • An orientation program that teaches everything from basics of banking and bank examinations to administrative details. • An introduction to common operational, analytical, and which will allow employees to obtain supervisory techniques for banks, bank and financial holding an undergraduate degree in Finance or companies, and foreign banking organizations, focusing on Management, follows close on the heels credit, market, liquidity, operational, legal, and reputational of the Bank’s very successful and well- risks. received associate’s degree program, • A 115-hour self-study program in three segments. which was offered through the Com- • A report writing course and sessions on conducting meetings munity College of Philadelphia. Early indications are that this program will prove to be popular with employees. As the Bank rises to meet the challenges of the 21st century workplace, OL&D will continue to play a major role in ensuring that Bank employees have the skills they need to carry out the Bank’s and the System’s strategic goals. with management. • A management skills course that teaches critical thinking, teamwork, negotiation, and listening techniques. • Courses on fundamentals of interest rate risk management, bank management, and examination management. Successful completion of training, coupled with demonstrated skills on-the-job, allows an assistant examiner to earn the designation of commissioned examiner. At this stage, in addition to their technical skills, examiners demonstrate analytical rigor, are effective communicators, and possess strong leadership skills. But it doesn’t end there. Federal Reserve examiners’ learning continues throughout their careers, as they hone their technical and supervisory skills through on-the-job training and continuing professional development, ensuring that they possess a deeper understanding of the broader financial system. www.philadelphiafed.org | 25 26 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA Federal Reserve Bank of Philadelphia Board of Directors Robert E. Chappell (7) Board member since January 2000. Chair, Budget and Operations Committee and Member, Personnel Committee. Chairman and CEO of Penn Mutual Life Insurance Company. Chairman of Insurance Federation of Pennsylvania. Member of Taxation and Financial Services Steering Committee for American Council of Life Insurance. Serves on boards of Quaker Chemical Corporation, South Chester Tube Company, LOMA, and Wharton Financial Institutions Center at University of Pennsylvania. Walter E. Daller, Jr. (5) Board member since January 2002. Member, Budget and Operations and Personnel committees. Chairman, President, and CEO of Harleysville National Corporation. Chairman of Harleysville National Bank and Trust Company. Serves on boards of North Penn United Way, Lower Salford Historical Society, Muhlenberg House, Montgomery County Lands Trust, Perkiomen Valley Watershed, and TCM Bank of Tampa, Florida. Doris M. Damm (9) Deputy Chairman, Federal Reserve Bank of Philadelphia Board of Directors. Board member since January 2001. Chair, Personnel Committee and Member, Audit Committee. 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. William F. Hecht (6) Board member since January 2004. Member, Research and External Affairs and Budget and Operations committees. Chairman, President, and CEO of PPL Corporation. Member of Executive Committee of Edison Electric Institute. Director of Nuclear Energy Institute, Edison Electric Institute, Lehigh Valley Hospital and Health Network, Dentsply International and RenaissanceRe Holdings, Ltd. Vice Chairman Board of Trustees of Lehigh University. President of Lehigh Valley Partnership. Garry L. Maddox (1) Board member since January 2003. Member, Audit and Personnel committees. President and CEO of A. Pomerantz & Company. Founding President of World Wide Concessions, Inc. Founder and Executive Director of LPGA Urban Youth Golf Program of Greater Atlantic City. Founder and President of Youth Golf and Academics Program. Serves on boards of Boys and Girls Club of Camden County, Corporate Alliance for Drug Education, Greater Philadelphia Chamber of Commerce, Fairmount Park Commission, Neumann College, Philadelphia Sports Congress, Operation Good Neighbor, and St. Christopher’s Hospital for Children. Director Emeritus of Philadelphia Child Guidance Center. Member of Board of Governors of National Adoption Center. Ronald J. Naples (8) Chairman, Federal Reserve Bank of Philadelphia Board of Directors. Board member since January 2001. Chairman and Chief Executive Officer of Quaker Chemical Corporation. Chairman of Board of 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 American Red Cross - Southeastern Pennsylvania Chapter. Eugene W. Rogers (4) Board member since January 2004. Member, Audit and Research and External Affairs committees. CEO of Newfield Bancorp, Inc. and CEO of Newfield National Bank. Director of Atlantic Central Bankers Bank. Member of Kennedy Hospital Advisory Board, and Chairman of South Jersey Community Bankers Association. Kenneth R. Shoemaker (3) Board member since January 2003. Chair, Audit Committee and Member, Research and External Affairs Committee. President and CEO of Orrstown Bank; President and CEO of Orrstown Financial Services. Chairman of Council of Trustees of Shippensburg University. Serves on boards of Cumberland Valley School of Music and Carlisle Regional Medical Center. Founding President of Mainstreet Non-Profit Redevelopment Corporation. P. Coleman Townsend, Jr. (2) Board member since January 2002. Chair, Research and External Affairs Committee and Member, Budget and Operations Committee. Chairman and CEO of Townsends, Inc. Member of Board of Trustees of University of Delaware, Winterthur Museum, Gardens & Library, The Henlopen Fund, and Historical Society of Delaware. Serves on Council of Advisors for Delaware Center for Horticulture. Active participant on Delaware Art Museum-Collections Committee, Delaware Public Policy Institute, and Delaware Business Roundtable. www.philadelphiafed.org | 27 Federal Reserve Bank of Philadelphia 2004 Business Advisory Council Lynn Banta (7) Owner Twin Stacks Development Co. Inc. Dallas, PA Melinda K. Holman (2) President Holman Enterprises Pennsauken, NJ Jeffrey J. Trester (1) Director & Co-CEO PriceSCAN.com, Inc. Malvern, PA Michael F. Camardo* Executive Vice President Lockheed Martin Technology Cherry Hill, NJ Chairman Dennis E. Klima (8) President & CEO Bayhealth Inc. Dover, DE Rodman Ward (4) President Speakman Company Wilmington, DE Robert L. Gronlund (10) Chairman & CEO Wood Mode Inc. Kreamer, PA Douglass C. Henry, Jr. (9) CEO Henry Molded Products, Inc. Lebanon, PA John Milligan (3) President Milligan & Company Philadelphia, PA Albert Morrison, III (5) Chairman, President & CEO Burnham Holdings Lancaster, PA William L. Wilson* Principal-in-Charge Synterra Philadelphia, PA Mark S. Stellini (6) President & CEO InfoSystems Wilmington, DE * Not pictured 28 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA Federal Reserve Bank of Philadelphia 2004 Community Bank Advisory Council John W. Adonizio (6) Chairman & President Landmark Community Bank Pittston, PA Robert E. Forse (3) Chairman, President & CEO Woodlands Bank Williamsport, PA Thomas A. Bracken (1) President & CEO Sun National Bank Vineland, NJ Mark D. Gainer (2) President & CEO Union National Community Bank Mt. Joy, PA Joseph E. Chippie* President & CEO First National Bank of Wyoming Wyoming, DE Chairman Aaron L. Groff (8) Chairman, President & CEO Ephrata National Bank Ephrata, PA William F. Snell* President & CEO Farmers and Merchants Trust Co. Chambersburg, PA George W. Nise (4) President & CEO Beneficial Savings Bank Philadelphia, PA Peter C. Zimmerman (5) President & CEO First National Bank of Newport Newport, PA Donna M. Coughey (9) President & CEO First Financial Bank Downingtown, PA John T. Parry (10) President & CEO First National Bank & Trust Co. of Newtown Newtown, PA Michael M. Quick (7) Chairman Susquehanna Patriot Bank Marlton, NJ * Not pictured 2 6 7 3 4 8 9 5 10 www.philadelphiafed.org | 29 Federal Reserve Bank of Philadelphia 2004 Credit Union Advisory Council David W. Clendaniel* President & CEO Dover FCU Dover, DE Dorothy A. Fox (4) President & CEO NE PA Community FCU Stroudsburg, PA Eileen Crean (5) President & CEO CUMCO FCU Vineland, NJ Louise P. Lingenfelser (2) President & CEO UGI Employees FCU Wyomissing, PA Maurice Dawkins (6) President & CEO American Spirit FCU Newark, DE Robert L. Marquette (1) President & CEO Members 1st FCU Mechanicsburg, PA James E. Everhart, Jr. (7) President & CEO Louviers FCU Newark, DE Larry D. Miller (3) President & CEO Mennonite Financial FCU Lancaster, PA Chairman Diana L. Roberts (8) President & CEO Hershey FCU Hershey, PA Larry L. Stoner (10) President & CEO Susquehanna Valley FCU Camp Hill, PA Edwin L. Williams* President & CEO Discovery FCU Wyomissing, PA Virginia F. Williams (9) CEO FAA Technical Center FCU Northfield, NJ * Not pictured 6 30 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA 3 2 1 7 5 4 8 9 10 Operating Statistics I n 2004, Philadelphia’s total volume of commercial processor of cash in the Federal Reserve System in checks processed decreased 9 percent and the 2004. The volume of currency processed increased dollar value of transactions decreased 19 percent. 7 percent, while the related dollar value increased 3 Philadelphia continues to be responsible for process- percent, both attributable to normal growth. Gaining ing all government checks for the First, Second, Third, a large customer in 2004 led to a 76 percent increase Fourth, and a portion of the Fifth Federal Reserve Dis- in processed coin volume and a 19 percent increase in tricts. While the volume of U.S. government checks processed coin value. remained fairly constant, the dollar volume increased 10 percent in 2004. In 2004, both the number and value of loans to depository institutions were higher than in the previous The Philadelphia Bank continued to be a major year. SERVICES TO DEPOSITORY INSTITUTIONS 2004 2004 2003 2003 Volume Dollar Value Volume Dollar Value 82.0 million checks $109.6 billion 81.9 million checks $100.0 billion 1,129.4 million checks $2,001.8 billion 1,239.6 million checks $2,457.1 billion Currency processed 2,358.1 million notes $44.3 billion 2,212.0 million notes $43.0 billion Coin paid and received 756.3 thousand bags $242.7 million 430.9 thousand bags $204.6 million 120 loans $1,393.6 million 99 loans $308.3 million Check processing: U.S. government Commercial checks Cash operations: Loans to depository institutions during the year www.philadelphiafed.org |31 Federal Reserve Bank of Philadelphia Current Officers Anthony M. Santomero President William H. Stone, Jr. First Vice President Richard W. Lang Executive Vice President D. Blake Prichard Executive Vice President Michael E. Collins Senior Vice President and Lending Officer Supervision, Regulation and Credit Loretta J. Mester Senior Vice President and Director of Research Research Milissa M. Tadeo Senior Vice President Cash Services 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 Research John J. Deibel Vice President and Chief Examination Officer Supervision, Regulation and Credit Michael Dotsey Vice President and Senior Economic Policy Advisor Research Richard A. Elliott Vice President Facilities Management, Records, and Document Services Donna L. Franco Vice President and Chief Financial Officer Faith P. Goldstein Vice President Public Affairs Mary Ann Hood Vice President Human Resources Arun K. Jain Vice President Cash Services William W. Lang Vice President Supervision, Regulation and Credit Edward M. Mahon Vice President and General Counsel Legal Stephen A. Meyer Vice President and Senior Economic Policy Advisor Research Mary DeHaven Myers Vice President and Community Affairs Officer Community Affairs A. Reed Raymond, III Vice President and Chief Administrative Officer Supervision, Regulation and Credit Kei-Mu Yi Vice President and Economist Research Eric A. Sonnheim Assistant Vice President Supervision, Regulation and Credit Mitchell S. Berlin Assistant Vice President and Economist Research C. Danny Spriggs Assistant Vice President Protection Donna Brenner Assistant Vice President Accounting Services Jennifer E. Cardy Assistant Vice President and Assistant General Auditor Shirley L. Coker Assistant Vice President and Counsel, Legal Michael T. Doyle Assistant Vice President and Technical Services Officer Information Technology Services William L. Gaunt Assistant Vice President Supervision, Regulation and Credit Stephen G. Hart Assistant Vice President Human Resources John P. Kelly Assistant Vice President Check Operations Retail Payment Services Patrick M. Regan Vice President Information Technology Services Elisabeth V. Levins Assistant Vice President Supervision, Regulation and Credit Richard A. Sheaffer Vice President and General Auditor Alice Kelley Menzano Assistant Vice President Information Technology Services Herbert E. Taylor Vice President and Corporate Secretary Vish P. Viswanathan Vice President and Discount Officer Supervision, Regulation and Credit Includes promotions through February 2005 32 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA Camille M. Ochman Assistant Vice President Treasury Services Anthony T. Scafide, Jr. Assistant Vice President Customer Relations Marie Tkaczyk Assistant Vice President Information Technology Services Constance H. Wallgren Assistant Vice President Supervision, Regulation and Credit John D. Ackley Treasury Services Officer Treasury Services Aileen C. Boer Research Support Officer Research Maryann T. Connelly Assistant Counsel, Legal Cynthia L. Course Enforcement and Information Services & Support Officer Supervision, Regulation and Credit Frank J. Doto Information Technology Officer Supervision, Regulation and Credit Suzanne W. Furr Wholesale Product Officer Wholesale Product Office Spyro Karetsos Enterprise Risk Management Officer Enterprise Risk Management Wanda Preston Check Adjustments Officer Retail Payment Services Michelle M. Scipione Cash Services Officer Cash Services Stephen J. Smith Assistant Counsel, Legal Statement of Auditor Independence The firm engaged by the Board of Governors for the audits of the individual and combined financial statements of the Reserve Banks for 2004 was PricewaterhouseCoopers LLP (PwC). Fees for these services totaled $2.0 million. 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 2004, the Bank did not engage PwC for any material advisory services. www.philadelphiafed.org | 33 Financial Reports 35 Letter to Directors 36 Report of Independent Accountants 37 Report of Independent Auditors 38 Statements of Condition 39 Statements of Income 40 Statements of Changes in Capital 41 Notes to Financial Statements 34 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA Letter to Directors www.philadelphiafed.org | 35 Report of Independent Accountants 36 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA Report of Independent Auditors www.philadelphiafed.org | 37 Federal Reserve Bank of Philadelphia Statements of Condition As of December 31, 2004 and December 31, 2003 (in millions) 2004 2003 ASSETS Gold certificates Special drawing rights certificates Coin Items in process of collection Loans to depository institutions U.S. government securities, net Investments denominated in foreign currencies Accrued interest receivable Interdistrict settlement account Bank premises and equipment, net Other assets Total assets $ 382 83 56 360 5 21,581 624 151 4,007 76 74 $ 380 83 37 493 21,121 552 158 905 80 97 $ 27,399 $ 23,906 $ 24,725 916 $ 21,347 802 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 Accrued benefit costs Other liabilities Total liabilities Capital: Capital paid-in Surplus Total capital Total liabilities and capital The accompanying notes are an integral part of these financial statements. 38 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA $ 603 1 490 27 42 7 719 2 451 9 52 7 26,811 23,389 294 294 258 259 588 517 27,399 $ 23,906 Federal Reserve Bank of Philadelphia Statements of Income For the years ended December 31, 2004 and December 31, 2003 (in millions) 2004 Interest income: Interest on U.S. government securities Interest on investments denominated in foreign currencies $ 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, 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 surplus Payments to U.S. Treasury as interest on Federal Reserve notes Total distribution 2003 662 8 $ 742 7 670 749 9 7 661 742 38 21 36 3 40 20 75 3 98 138 73 10 13 34 27 84 9 13 36 29 157 171 $ 602 $ 709 $ 17 35 550 $ 15 26 668 $ 602 $ 709 The accompanying notes are an integral part of these financial statements. www.philadelphiafed.org | 39 Federal Reserve Bank of Philadelphia Statements of Changes in Capital For the years ended December 31, 2004 and December 31, 2003 (in millions) Capital Paid-in Balance at January 1, 2003 (4.6 million shares) $ Transferred to surplus Net change in capital stock issued (0.6 million shares) Balance at December 31, 2003 (5.2 million shares) $ Transferred to surplus Net change in capital stock issued (0.7 million shares) Balance at December 31, 2004 (5.9 million shares) The accompanying notes are an integral part of these financial statements. 40 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA $ 233 Surplus $ 233 Total Capital $ 466 - 26 26 25 - 25 258 $ 259 $ 517 - 35 35 36 - 36 294 $ 294 $ 588 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 are divided The Federal Reserve Bank of Philadelphia (“Bank”) into three classes according to size. Member banks is part of the Federal Reserve System (“System”) cre- in each class elect one director representing member ated by Congress under the Federal Reserve Act of banks and one representing the public. In any election 1913 (“Federal Reserve Act”) which established the of directors, each member bank receives one vote, re- central bank of the United States. The System consists gardless of the number of shares of Reserve Bank stock of the Board of Governors of the Federal Reserve Sys- it holds. tem (“Board of Governors”) and twelve Federal Reserve Banks (“Reserve Banks”). The Reserve Banks are char- 2. OPERATIONS AND SERVICES tered by the federal government and possess a unique set of governmental, corporate, and central bank char- The System performs a variety of services and oper- acteristics. The Bank in Philadelphia serves the Third ations. Functions include formulating and conducting Federal Reserve District, which includes Delaware, and monetary policy; participating actively in the payments portions of New Jersey and Pennsylvania. Other major mechanism, including large-dollar transfers of funds, au- elements of the System are the Federal Open Market tomated clearinghouse (“ACH”) operations, and check Committee (“FOMC”) and the Federal Advisory Coun- processing; distributing coin and currency; performing cil. The FOMC is composed of members of the Board fiscal agency functions for the U.S. Treasury and certain of Governors, the president of the Federal Reserve Bank federal agencies; serving as the federal government’s of New York (“FRBNY”), and, on a rotating basis, four bank; providing short-term loans to depository institu- other Reserve Bank presidents. Banks that are members tions; serving the consumer and the community by pro- of the System include all national banks and any state- viding educational materials and information regarding chartered bank that applies and is approved for mem- consumer laws; supervising bank holding companies bership in the System. and state member banks; and administering other regulations of the Board of Governors. The Board of Gov- Board of Directors In accordance with the Federal Reserve Act, supervision and control of the Bank are exercised by a Board ernors’ operating costs are funded through assessments on the Reserve Banks. The FOMC establishes policy regarding open mar- The Federal Reserve Act specifies the ket operations, oversees these operations, and issues composition of the Board of Directors for each of the authorizations and directives to the FRBNY for its ex- Reserve Banks. Each board is composed of nine mem- ecution of transactions. Authorized transaction types bers serving three-year terms: three directors, including include direct purchase and sale of securities, the pur- those designated as Chairman and Deputy Chairman, chase of securities under agreements to resell, the sale are appointed by the Board of Governors, and six direc- of securities under agreements to repurchase, and the tors are elected by member banks. Of the six elected lending of U.S. government securities. of Directors. The FRBNY www.philadelphiafed.org | 41 Federal Reserve Bank of Philadelphia Notes to Financial Statements is also authorized by the FOMC to hold balances of, tion, the Bank has elected not to present a Statement of and to execute spot and forward foreign exchange (“F/ Cash Flows. The Statement of Cash Flows has not been X”) and securities contracts in, nine foreign currencies included because the liquidity and cash position of the and to invest such foreign currency holdings ensuring Bank are not of primary concern to the users of these adequate liquidity is maintained. In addition, FRBNY financial statements. Other information regarding the is authorized to maintain reciprocal currency arrange- Bank’s activities is provided in, or may be derived from, ments (“F/X swaps”) with various central banks, and the Statements of Condition, Income, and Changes in “warehouse” foreign currencies for the U.S. Treasury Capital. A Statement of Cash Flows, therefore, would and Exchange Stabilization Fund (“ESF”) through the not provide any additional useful information. There Reserve Banks. are no other significant differences between the policies outlined in the Financial Accounting Manual and 3. SIGNIFICANT ACCOUNTING POLICIES GAAP. Each Reserve Bank provides services on behalf of Accounting principles for entities with the unique the System for which costs are not shared. Major ser- powers and responsibilities of the nation’s central bank vices provided on behalf of the System by the Bank, for have not been formulated by the Financial Accounting which the costs were not redistributed to the other Re- Standards Board. The Board of Governors has devel- serve Banks, include: Collateral Management System, oped specialized accounting principles and practices Electronic Cash Letter System, Groupware Leadership that it believes are appropriate for the significantly dif- Center, Subcommittee on Credit, Reserves, and Risk ferent nature and function of a central bank as com- Management Administration Office, and Treasury Di- pared with the private sector. These accounting prin- rect Central Business Administration Function. ciples and practices are documented in the Financial The preparation of the financial statements in con- Accounting Manual for Federal Reserve Banks (“Finan- formity with the Financial Accounting Manual requires cial Accounting Manual”), which is issued by the Board management to make certain estimates and assump- of Governors. All Reserve Banks are required to adopt tions that affect the reported amounts of assets and li- and apply accounting policies and practices that are abilities, disclosure of contingent assets and liabilities consistent with the Financial Accounting Manual. at the date of the financial statements, and the reported The financial statements have been prepared in amounts of income and expenses during the reporting accordance with the Financial Accounting Manual. period. Actual results could differ from those estimates. Differences exist between the accounting principles Unique accounts and significant accounting policies and practices of the System and accounting principles are explained below. generally accepted in the United States of America (“GAAP”). The primary difference is the presentation of a. Gold Certificates all security holdings at amortized cost, rather than at the The Secretary of the Treasury is authorized to issue fair value presentation requirements of GAAP. In addi- gold certificates to the Reserve Banks to monetize gold 42 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA Federal Reserve Bank of Philadelphia Notes to Financial Statements held by the U.S. Treasury. Payment for the gold certifi- transactions among Reserve Banks based upon Federal cates by the Reserve Banks is made by crediting equiva- Reserve notes outstanding in each District at the end of lent amounts in dollars into the account established for the preceding year. There were no SDR transactions in the U.S. Treasury. These gold certificates held by the 2004 or 2003. Reserve Banks are required to be backed by the gold of the U.S. Treasury. The U.S. Treasury may reacquire c. Loans to Depository Institutions the gold certificates at any time and the Reserve Banks The Depository Institutions Deregulation and Mon- must deliver them to the U.S. Treasury. At such time, etary Control Act of 1980 provides that all depository in- the U.S. Treasury’s account is charged, and the Reserve stitutions that maintain reservable transaction accounts Banks’ gold certificate accounts are lowered. The value or nonpersonal time deposits, as defined in Regulation of gold for purposes of backing the gold certificates is D issued by the Board of Governors, have borrowing set by law at $42 2/9 a fine troy ounce. The Board of privileges at the discretion of the Reserve Bank. Bor- Governors allocates the gold certificates among Reserve rowers execute certain lending agreements and deposit Banks once a year based on average Federal Reserve sufficient collateral before credit is extended. Loans are notes outstanding in each District. evaluated for collectibility, and currently all are considered collectible and fully collateralized. If loans were b. Special Drawing Rights Certificates ever deemed to be uncollectible, an appropriate reserve Special drawing rights (“SDRs”) are issued by the would be established. Interest is accrued using the ap- International Monetary Fund (“Fund”) to its members plicable discount rate established at least every fourteen in proportion to each member’s quota in the Fund at days by the Board of Directors of the Reserve Bank, sub- the time of issuance. SDRs serve as a supplement to ject to review by the Board of Governors. international monetary reserves and may be transferred from one national monetary authority to another. Un- d. U.S. Government and Federal Agency Securities der the law providing for United States participation and Investments Denominated in Foreign Currencies in the SDR system, the Secretary of the U.S. Treasury The FOMC has designated the FRBNY to execute is authorized to issue SDR certificates, somewhat like open market transactions on its behalf and to hold the gold certificates, to the Reserve Banks. At such time, resulting securities in the portfolio known as the Sys- equivalent amounts in dollars are credited to the ac- tem Open Market Account (“SOMA”). In addition to count established for the U.S. Treasury, and the Reserve authorizing and directing operations in the domestic Banks’ SDR certificate accounts are increased. The Re- securities market, the FOMC authorizes and directs the serve Banks are required to purchase SDR certificates, FRBNY to execute operations in foreign markets for ma- at the direction of the U.S. Treasury, for the purpose of jor currencies in order to counter disorderly conditions financing SDR acquisitions or for financing exchange in exchange markets or to meet other needs specified stabilization operations. At the time SDR transactions by the FOMC in carrying out the System’s central bank occur, the Board of Governors allocates SDR certificate responsibilities. Such authorizations are reviewed and www.philadelphiafed.org | 43 Federal Reserve Bank of Philadelphia Notes to Financial Statements approved annually by the FOMC. support its own currency. Drawings under the F/X swap The FRBNY has sole authorization by the FOMC to arrangements can be initiated by either the FRBNY or lend U.S. government securities held in the SOMA to the partner foreign central bank and must be agreed to U.S. government securities dealers and to banks partici- by the drawee. The F/X swaps are structured so that pating in U.S. government securities clearing arrange- the party initiating the transaction (the drawer) bears the ments on behalf of the System, in order to facilitate the exchange rate risk upon maturity. The FRBNY will gen- effective functioning of the domestic securities market. erally invest the foreign currency received under an F/X These securities-lending transactions are fully collater- swap in interest-bearing instruments. alized by other U.S. government securities. FOMC pol- Warehousing is an arrangement under which the icy requires the FRBNY to take possession of collateral FOMC agrees to exchange, at the request of the Trea- in excess of the market values of the securities loaned. sury, U.S. dollars for foreign currencies held by the The market values of the collateral and the securities Treasury or ESF over a limited period of time. The pur- loaned are monitored by the FRBNY on a daily basis, pose of the warehousing facility is to supplement the with additional collateral obtained as necessary. The U.S. dollar resources of the Treasury and ESF for financ- securities lent are accounted for in the SOMA. ing purchases of foreign currencies and related interna- F/X contracts are contractual agreements between tional operations. two parties to exchange specified currencies, at a speci- In connection with its foreign currency activities, fied price, on a specified date. Spot foreign contracts the FRBNY, on behalf of the Reserve Banks, may enter normally settle two days after the trade date, whereas into contracts that contain varying degrees of off-bal- the settlement date on forward contracts is negotiated ance-sheet market risk, because they represent con- between the contracting parties, but will extend beyond tractual commitments involving future settlement and two days from the trade date. The FRBNY generally counter-party credit risk. The FRBNY controls credit enters into spot contracts, with any forward contracts risk by obtaining credit approvals, establishing trans- generally limited to the second leg of a swap/warehous- action limits, and performing daily monitoring proce- ing transaction. dures. The FRBNY, on behalf of the Reserve Banks, main- While the application of current market prices to tains renewable, short-term F/X swap arrangements with the securities currently held in the SOMA portfolio and two authorized foreign central banks. The parties agree investments denominated in foreign currencies may re- to exchange their currencies up to a pre-arranged maxi- sult in values substantially above or below their carrying mum amount and for an agreed-upon period of time values, these unrealized changes in value would have (up to twelve months), at an agreed-upon interest rate. no direct effect on the quantity of reserves available to These arrangements give the FOMC temporary access the banking system or on the prospects for future Re- to foreign currencies it may need for intervention opera- serve Bank earnings or capital. Both the domestic and tions to support the dollar and give the partner foreign foreign components of the SOMA portfolio from time central bank temporary access to dollars it may need to to time involve transactions that may result in gains or 44 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA Federal Reserve Bank of Philadelphia Notes to Financial Statements losses when holdings are sold prior to maturity. De- securities purchased under agreements to resell and un- cisions regarding the securities and foreign currencies realized gains and losses on the revaluation of foreign transactions, including their purchase and sale, are mo- currency holdings under F/X swaps and warehousing tivated by monetary policy objectives rather than profit. arrangements are allocated to the FRBNY and not to Accordingly, market values, earnings, and any gains other Reserve Banks. or losses resulting from the sale of such currencies and In 2003, additional interest income of $61 million, securities are incidental to the open market operations representing one day’s interest on the SOMA portfo- and do not motivate its activities or policy decisions. lio, was accrued to reflect a change in interest accrual calculations, of which $2 million was allocated to the U.S. government securities and investments denominated in foreign currencies comprising the SOMA Bank. The effect of this change was not material; therefore, it was included in the 2003 interest income. are recorded at cost, on a settlement-date basis, and adjusted for amortization of premiums or accretion of e. Bank Premises, Equipment, and Software discounts on a straight-line basis. Securities sold under Bank premises and equipment are stated at cost less agreements to repurchase are accounted for as secured accumulated depreciation. Depreciation is calculated borrowing transactions with the associated interest ex- on a straight-line basis over estimated useful lives of as- pense recognized over the life of the transaction. Such sets ranging from two to fifty years. Major alterations, transactions are settled by FRBNY. Interest income is renovations, and improvements are capitalized at cost accrued on a straight-line basis. Income earned on se- as additions to the asset accounts and are amortized curities lending transactions is reported as a component over the remaining useful life of the asset. Maintenance, of “Other income.” Gains and losses resulting from repairs, and minor replacements are charged to opera- sales of securities are determined by specific issues tions in the year incurred. Costs incurred for software, based on average cost. Foreign-currency-denominated either developed internally or acquired for internal use, assets are revalued daily at current foreign currency during the application development stage are capital- market exchange rates in order to report these assets in ized based on the cost of direct services and materials U.S. dollars. Realized and unrealized gains and losses associated with designing, coding, installing, or testing on investments denominated in foreign currencies are software. Capitalized software costs are amortized on reported as Foreign currency gains, net. a straight-line basis over the estimated useful lives of Activity related to U.S. government securities bought outright, securities sold under agreements to re- the software applications, which range from two to five years. purchase, securities loaned, investments denominated in foreign currency, excluding those held under an F/ f. Interdistrict Settlement Account X swap arrangement, and deposit accounts of foreign At the close of business each day, all Reserve Banks central banks and governments above core balances and branches assemble the payments due to or from are allocated to each Reserve Bank. U.S. government other Reserve Banks and branches as a result of transac- www.philadelphiafed.org | 45 Federal Reserve Bank of Philadelphia Notes to Financial Statements tions involving accounts residing in other Districts that provides that Federal Reserve notes become a first and occurred during the day’s operations. Such transactions paramount lien on all the assets of the Reserve Banks. may include funds settlement, check clearing and ACH Finally, as obligations of the United States, Federal Re- operations, and allocations of shared expenses. The cu- serve notes are backed by the full faith and credit of the mulative net amount due to or from other Reserve Banks United States government. is reported as the “Interdistrict settlement account.” The “Federal Reserve notes outstanding, net” account represents the Bank’s Federal Reserve notes out- g. Federal Reserve Notes standing reduced by its currency holdings of $7,973 Federal Reserve notes are the circulating currency million, and $8,228 million at December 31, 2004 and of the United States. These notes are issued through 2003, respectively. the various Federal Reserve agents (the Chairman of the Board of Directors of each Reserve Bank) to the Reserve h. Capital Paid-in Banks upon deposit with such agents of certain classes The Federal Reserve Act requires that each member of collateral security, typically U.S. government securi- bank subscribe to the capital stock of the Reserve Bank ties. These notes are identified as issued to a specific in an amount equal to 6 percent of the capital and sur- Reserve Bank. The Federal Reserve Act provides that the plus of the member bank. As a member bank’s capital collateral security tendered by the Reserve Bank to the and surplus changes, its holdings of Reserve Bank stock Federal Reserve agent must be equal to the sum of the must be adjusted. Member banks are state-chartered notes applied for by such Reserve Bank. banks that apply and are approved for membership in Assets eligible to be pledged as collateral security the System and all national banks. Currently, only one- include all Federal Reserve Bank assets. The collateral half of the subscription is paid-in and the remainder is value is equal to the book value of the collateral ten- subject to call. These shares are nonvoting with a par dered, with the exception of securities, whose collateral value of $100. They may not be transferred or hypoth- value is equal to the par value of the securities tendered. ecated. By law, each member bank is entitled to receive The par value of securities pledged for securities sold an annual dividend of 6 percent on the paid-in capital under agreements to repurchase is similarly deducted. stock. This cumulative dividend is paid semiannually. The Board of Governors may, at any time, call upon a Reserve Bank for additional security to adequately col- A member bank is liable for Reserve Bank liabilities up to twice the par value of stock subscribed by it. lateralize the Federal Reserve notes. To satisfy the ob- The Financial Accounting Standards Board (FASB) ligation to provide sufficient collateral for outstanding has deferred the implementation date for SFAS No. 150, Federal Reserve notes, the Reserve Banks have entered “Accounting for Certain Financial Instruments with Char- into an agreement that provides for certain assets of the acteristics of both Liabilities and Equity” for the Bank. Reserve Banks to be jointly pledged as collateral for the When applicable, the Bank will determine the impact Federal Reserve notes of all Reserve Banks. In the event and provide the appropriate disclosures. that this collateral is insufficient, the Federal Reserve Act 46 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA Federal Reserve Bank of Philadelphia Notes to Financial Statements Surplus tralized portion of the Bank’s reimbursement receivable, The Board of Governors requires Reserve Banks to reported in “Other assets,” totaled $53 million and $74 maintain a surplus equal to the amount of capital paid- million at December 31, 2004 and 2003, respectively. in as of December 31. This amount is intended to pro- The centralized portion of the Bank’s Costs of unreim- vide additional capital and reduce the possibility that bursed Treasury services, reported in “Other expense,” the Reserve Banks would be required to call on member totaled $10 thousand at December 31, 2004. banks for additional capital. k. i. Taxes Pursuant to Section 16 of the Federal Reserve The Reserve Banks are exempt from federal, state, Act, Reserve Banks are required by the Board of and local taxes, except for taxes on real property. The Governors to transfer to the U.S. Treasury as interest on Bank’s real property taxes were $2 million for both years Federal Reserve notes excess earnings, after providing ended December 31, 2004 and 2003 and are reported for the costs of operations, payment of dividends, and as a component of “Occupancy expense.” reservation of an amount necessary to equate surplus with capital paid-in. l. Restructuring Charges In the event of losses or an increase in capital In 2003, the System started the restructuring of sev- paid-in, payments to the U.S. Treasury are suspended eral operations, primarily check, cash, and Treasury and earnings are retained until the surplus is equal to the services. The restructuring included streamlining the capital paid-in. Weekly payments to the U.S. Treasury management and support structures, reducing staff, may vary significantly. decreasing the number of processing locations, and In the event of a decrease in capital paid-in, the increasing processing capacity in the remaining loca- excess surplus, after equating capital paid-in and surplus tions. These restructuring activities continued in 2004. at December 31, is distributed to the U.S. Treasury Footnote 10 describes the restructuring and pro- in the following year. This amount is reported as a vides information about the Bank’s costs and liabilities component of “Payments to U.S. Treasury as interest on associated with employee separations and contract ter- Federal Reserve notes”. minations. The costs associated with the write-down of certain Bank assets are discussed in footnote 6. Costs j. Income and Costs related to Treasury Services and liabilities associated with enhanced pension ben- The Bank is required by the Federal Reserve Act to efits for all Reserve Banks are recorded on the books of serve as fiscal agent and depository of the United States. the FRBNY. By statute, the Department of the Treasury is permitted, but not required, to pay for these services. 4. U.S. GOVERNMENT SECURITIES Beginning January 1, 1998, the reimbursement process for all Reserve Banks was centralized at the Bank Securities bought outright are held in the SOMA that included the transfer of each Reserve Bank’s Trea- at the FRBNY. An undivided interest in SOMA activ- sury reimbursement receivable to the Bank. The cen- ity and the related premiums, discounts, and income, www.philadelphiafed.org | 47 Federal Reserve Bank of Philadelphia Notes to Financial Statements with the exception of securities purchased under agree- The maturity distribution of U.S. government secu- ments to resell, is allocated to each Reserve Bank on a rities bought outright and securities sold under agree- percentage basis derived from an annual settlement of ments to repurchase, that were allocated to the Bank at interdistrict clearings that occurs in April of each year. December 31, 2004, was as follows (in millions): The settlement equalizes Reserve Bank gold certificate holdings to Federal Reserve notes outstanding. The Bank’s allocated share of SOMA balances was approximately 2.974 percent and 3.126 percent at December 31, 2004 and 2003, respectively. The Bank’s allocated share of U.S. Government securities, net held in the SOMA at December 31, was as follows (in millions): Within 15 days 2004 2003 Par value: U.S. government: Bills $ 7,822 $ 7,654 Notes 10,732 10,110 Bonds 2,796 3,079 21,350 20,843 Unamortized premiums 280 306 Unaccreted discounts (49) (28) $ 21,581 $21,121 Total par value Total allocated to Bank Maturities of Securities Held Securities Sold U.S. Under Government Agreements Securities to Repurchase (Par value) (Contract amount) $ 912 $ 916 16 days to 90 days 5,305 - 91 days to 1 year 5,069 - Over 1 year to 5 years 6,194 - Over 5 years to 10 years 1,617 - Over 10 years 2,253 - Total $ 21,350 $ 916 At December 31, 2004 and 2003, U.S. government securities with par values of $6,609 million and $4,426 million, respectively, were loaned from the SOMA, of which $197 million and $138 million were allocated to the Bank. At December 31, 2004 and 2003, securities sold under agreements to repurchase with contract amounts of $30,783 million and $25,652 million, respectively, The total of the U.S. Government securities, net held in the SOMA was $725,584 million and $675,569 million at December 31, 2004 and 2003, respectively. and par values of $30,808 million and $25,658 million, respectively, were outstanding. The Bank’s allocated share at December 31, 2004 and 2003 was $916 million and $802 million, respectively, of the contract amount and $916 million and $802 million, respectively, of the par value. 48 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA Federal Reserve Bank of Philadelphia Notes to Financial Statements 5. INVESTMENTS DENOMINATED IN FOREIGN CURRENCIES The FRBNY, on behalf of the Reserve Banks, holds foreign currency deposits with foreign central banks and the Bank for International Settlements and invests in foreign government debt instruments. Foreign government debt instruments held include both securities bought outright and securities purchased under agreements to resell. These investments are guaranteed as to principal and interest by the foreign governments. Each Reserve Bank is allocated a share of foreigncurrency-denominated assets, the related interest income, and realized and unrealized foreign currency European Union Euro: Foreign currency deposits Securities purchased under agreements to resell Government debt instruments Japanese Yen: Foreign currency deposits Government debt instruments Accrued interest gains and losses, with the exception of unrealized gains Total and losses on F/X swaps and warehousing transactions. 2004 2003 $ 177 $ 191 63 57 112 57 45 41 224 204 3 2 $ 624 $ 552 This allocation is based on the ratio of each Reserve Bank’s capital and surplus to aggregate capital and surplus at the preceding December 31. The Bank’s allocated share of investments denominated in foreign currencies was approximately 2.923 percent and 2.778 percent at December 31, 2004 and 2003, respectively. The Bank’s allocated share of investments denominated in foreign currencies, valued at current foreign currency market exchange rates at December 31, was as follows (in millions): Total System investments denominated in foreign currencies were $21,368 million and $19,868 million at December 31, 2004 and 2003, respectively. The maturity distribution of investments denominated in foreign currencies which were allocated to the Bank at December 31, 2004, was as follows (in millions): Maturities of Investments Denominated in Foreign Currencies European Euro Within 1 year $ 262 Over 1 year to 5 years 88 Over 5 years to 10 years 5 Total $ 355 Japanese Yen Total $ 269 - $ 531 88 5 $ 269 $ 624 www.philadelphiafed.org | 49 Federal Reserve Bank of Philadelphia Notes to Financial Statements At December 31, 2004 and 2003, there were no material open foreign exchange contracts. such lease was $1 million for both years ended December 31, 2004 and 2003. Future minimum lease pay- At December 31, 2004 and 2003, the warehousing ments under the noncancelable agreement in existence facility was $5,000 million, with no balance outstand- at December 31, 2004, were $1 million for years 2005 ing. through 2006. The Bank has capitalized software assets, net of 6. BANK PREMISES, EQUIPMENT, AND SOFTWARE amortization, of $8 million and $6 million at December 31, 2004 and 2003, respectively. Amortization expense was $1 million for both years ended December A summary of bank premises and equipment at December 31 is as follows (in millions): Maximum Useful Life (in years) 31, 2004 and 2003. A software asset was impaired as a result of the decision to standardize check processing in the System. Asset impairment losses of $1 million were reported as 2004 a component of “Other expenses” for the period ending 2003 December 31, 2003. Bank premises and equipment: Land Buildings Building machinery and equipment Construction in progress Furniture and equipment N/A 50 $ 3 74 $ 3 72 7. COMMITMENTS AND CONTINGENCIES At December 31, 2004, the Bank was obligated under noncancelable leases for premises and equip- 20 12 11 N/A 2 1 10 65 71 Subtotal Accumulated depreciation $ 156 (78) $ 158 (78) Bank premises and equipment, net $ 76 $ 80 Depreciation expense, for the years ended ment with terms ranging from one to approximately 2 years. These leases provide for increased rental payments based upon increases in real estate taxes, operating costs, or selected price indices. Rental expense under operating leases for certain operating facilities, warehouses, and data processing and office equipment (including taxes, insurance and maintenance when included in rent), net of sublease rentals, was $1 million for both years ended December 31, 2004 and 2003. Certain of the Bank’s leases have $ 9 $ 9 options to renew. The Bank has no capital leases. Future minimum rental payments under noncancelable operating leases with terms of one year or more, at The Bank leases unused space to an outside tenant. This lease has a term of 2 years. Rental income from 50 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA December 31, 2004, were not material. At December 31, 2004, the Bank has no other com- Federal Reserve Bank of Philadelphia Notes to Financial Statements mitments and long-term obligations in excess of one tributions fully funded by participating employers. Par- year. ticipating employers are the Federal Reserve Banks, the Under the Insurance Agreement of the Federal Re- Board of Governors of the Federal Reserve System, and serve Banks dated as of March 2, 1999, each of the Re- the Office of Employee Benefits of the Federal Reserve serve Banks has agreed to bear, on a per incident basis, Employee Benefits System. No separate accounting is a pro rata share of losses in excess of one percent of the maintained of assets contributed by the participating capital paid-in of the claiming Reserve Bank, up to 50 employers. The FRBNY acts as a sponsor of the Plan percent of the total capital paid-in of all Reserve Banks. for the System and the costs associated with the Plan Losses are borne in the ratio that a Reserve Bank’s capi- are not redistributed to the Bank. The Bank’s projected tal paid-in bears to the total capital paid-in of all Re- benefit obligation and net pension costs for the BEP and serve Banks at the beginning of the calendar year in the SERP at December 31, 2004 and 2003, and for the which the loss is shared. No claims were outstanding years then ended, are not material. under such agreement at December 31, 2004 or 2003. The Bank is involved in certain legal actions and Thrift Plan claims arising in the ordinary course of business. Al- Employees of the Bank may also participate in the though it is difficult to predict the ultimate outcome defined contribution Thrift Plan for Employees of the of these actions, in management’s opinion, based on Federal Reserve System (“Thrift Plan”). The Bank’s Thrift discussions with counsel, the aforementioned litigation Plan contributions totaled $3 million for both years and claims will be resolved without material adverse ended December 31, 2004 and 2003 and are reported effect on the financial position or results of operations as a component of “Salaries and other benefits.” of the Bank. 8. RETIREMENT AND THRIFT PLANS 9. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS AND POSTEMPLOYMENT BENEFITS Retirement Plans Postretirement Benefits other than Pensions The Bank currently offers two defined benefit re- In addition to the Bank’s retirement plans, employ- tirement plans to its employees, based on length of ser- ees who have met certain age and length of service re- vice and level of compensation. Substantially all of the quirements are eligible for both medical benefits and Bank’s employees participate in the Retirement Plan life insurance coverage during retirement. for Employees of the Federal Reserve System (“System The Bank funds benefits payable under the medical Plan”) and the Benefit Equalization Retirement Plan and life insurance plans as due and, accordingly, has no (“BEP”). In addition, certain Bank officers participate in plan assets. Net postretirement benefit costs are actuari- the Supplemental Employee Retirement Plan (“SERP”). ally determined using a January 1 measurement date. The System Plan is a multi-employer plan with con- www.philadelphiafed.org | 51 Federal Reserve Bank of Philadelphia Notes to Financial Statements Following is a reconciliation of beginning and ending balances of the benefit obligation (in millions): Following is a reconciliation of the beginning and ending balance of the plan assets, the unfunded postretirement benefit obligation, and the accrued postretire- 2004 Accumulated postretirement benefit obligation at January 1 2003 ment benefit costs (in millions): 2004 $ 50.4 $ 35.1 Service cost-benefits earned during the period 1.1 0.9 Interest cost of accumulated benefit obligation 2.4 2.7 (5.5) 13.3 0.8 0.5 Benefits paid (2.8) (2.1) Plan amendments (4.5) - Actuarial (gain)/loss Contributions by plan participants Accumulated postretirement benefit obligation at December 31 $ 41.9 $ 50.4 At December 31, 2004 and 2003, the weighted average discount rate assumptions used in developing the postretirement benefit obligation were 5.75 percent and 6.25 percent, respectively. Fair value of plan assets at January 1 $ Actual return on plan assets 2003 - $ - - - Contributions by the employer 2.0 1.6 Contributions by plan participants 0.8 0.5 (2.8) (2.1) Benefits paid Fair value of plan assets at December 31 $ - $ - Unfunded postretirement benefit obligation $ 41.9 $ 50.4 Unrecognized prior service cost 7.5 12.4 Unrecognized net actuarial gain (loss) (13.1) (19.0) Accrued postretirement benefit costs $ 36.3 $ 43.8 Accrued postretirement benefit costs are reported as a component of “Accrued benefit costs.” 52 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA Federal Reserve Bank of Philadelphia Notes to Financial Statements For measurement purposes, the assumed health care cost trend rates at December 31 are as follows: The following is a summary of the components of net periodic postretirement benefit costs for the years ended December 31 (in millions): 2004 2003 2004 Health care cost trend rate assumed for next year 9.00% 10.00% Rate to which the cost trend rate is assumed to decline (the ultimate trend rate) 4.75% 5.00% 2011 2011 Year that the rate reaches the ultimate rate Service cost-benefits earned during the period Interest cost of accumulated benefit obligation Amortization of prior service cost Recognized net actuarial (gain)/loss Total periodic expense Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans. A one percentage point change in assumed health care cost trend rates would have the following $ 1.1 Net periodic postretirement benefit costs $ 0.9 2.4 2.7 (1.7) (1.9) 0.4 0.5 $ 2.2 Curtailment (gain)/loss 2003 $ (7.7) $ (5.5) 2.2 - $ 2.2 effects for the year ended December 31, 2004 (in millions): At December 31, 2004 and 2003, the weighted avOne 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 erage discount rate assumption used to determine net periodic postretirement benefits costs were 6.25 percent and 6.75 percent, respectively. Net periodic postretirement benefit costs are reported as a component of “Salaries and other benefits.” A plan amendment that modified the credited service period eligibility requirements created curtailment 0.6 $ (0.4) gains. The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) was enacted in December 2003. 4.0 (3.2) The Act establishes a prescription drug benefit under Medicare (“Medicare Part D”) and a federal subsidy to sponsors of retiree health care benefit www.philadelphiafed.org | 53 Federal Reserve Bank of Philadelphia Notes to Financial Statements plans that provide benefits that are at least actuarially Postemployment Benefits equivalent to Medicare Part D. Following the guidance The Bank offers benefits to former or inactive em- of the Financial Accounting Standards Board, the Bank ployees. Postemployment benefit costs are actuarially elected to defer recognition of the financial effects of determined using a December 31, 2004 measurement the Act until further guidance was issued in May 2004. date and include the cost of medical and dental insur- Benefits provided to certain participants are at least ance, survivor income, and disability benefits. For 2004, actuarially equivalent to Medicare Part D. The estimat- the Bank changed its practices for estimating postem- ed effects of the subsidy, retroactive to January 1, 2004, ployment costs and used a 5.25 percent discount rate are reflected in the actuarial gain in the accumulated and the same health care trend rates as were used for postretirement benefit obligation and net periodic post- projecting postretirement costs. Costs for 2003, how- retirement benefit costs. ever, were projected using the same discount rate and Following is a summary of the effects of the expect- health care trend rates as were used for projecting postretirement costs. The accrued postemployment benefit ed subsidy (in millions): costs recognized by the Bank at December 31, 2004 2004 This cost is included as a component of “Accrued ben- Decrease in the accumulated postretirement benefit obligation Decrease in the net periodic postretirement benefit costs $ (6.5) $ (0.9) Expected benefit Without With payments: Subsidy Subsidy 2005 $ 2.4 2006 2.5 2.2 2007 2.6 2.2 2008 2.6 2.3 2009 2.7 2.3 2010-2014 15.1 12.6 $ 27.9 $ 24.0 Total 54 | AR 2004 • FEDERAL RESERVE BANK OF PHILADELPHIA and 2003 were $6 million and $8 million, respectively. $ 2.4 efit costs.” Net periodic postemployment benefit costs included in 2004 and 2003 operating expenses were ($1) million and $1 million, respectively. 10. BUSINESS RESTRUCTURING CHARGES In 2004, the System announced plans for consolidation and restructuring plans restructuring to streamline operations and reduce costs, including consolidation of operations and staff reductions in various functions of several Banks. The Bank’s costs associated with the restructuring were not material. www.philadelphiafed.org Key Federal Reserve Bank of Philadelphia Phone Numbers This address is the Philadelphia Fed’s electronic front door. Walk through, and you’ll be able to: Customer Relations 1-877-574-1776 Keep up with the latest information on the regional and Community Affairs 215-574-6458 • national economy. • Learn about the latest consumer issues. • Find links to employment opportunities, educational and consumer resources, and the latest publications from the Federal Reserve Bank of Philadelphia, and much more. In addition, the Bank’s e-mail service notifies you of web updates on the topics you choose, including circular letters, news releases, speeches, payment cards, and more. Be sure to visit the Philadelphia Fed at: www.philadelphiafed.org. Check out these pages: Community Affairs: www.philadelphiafed.org/cca/index.html Financial Services: www.philadelphiafed.org/fedservices.html Payment Cards Center: www.philadelphiafed.org/pcc/index.html Research: www.philadelphiafed.org/econ/index.html Supervision, Regulation and Credit: www.philadelphiafed.org/src/index.html Financial Statistics/Regulatory Reporting 215-574-6455 Human Resources 215-574-6150 Library & Research Center 215-574-6540 Payment Cards Center 215-574-7110 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 www.philadelphiafed.org | 55