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2017 Annual Report The Federal Reserve Bank of Philadelphia is one of the 12 regional Reserve Banks in the United States that, together with the Board of Governors in Washington, D.C., make up the Federal Reserve System – the nation’s central bank. The System’s primary role is to ensure a sound financial system and a healthy economy. The Philadelphia Fed serves the Third District, which is composed of Delaware, southern New Jersey, and central and eastern Pennsylvania. Table of Contents Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 President’s Letter. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 First Vice President’s Letter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 The Consumer Finance Institute Studies How People Spend, Save, and Earn. . . . . . . . . . . . . . . . . . . . . . 8 New Initiative Promotes More Inclusive Economic Growth. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 How the Bank Protects the Nation’s Financial System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 The Bank Works to Engage Communities and Strengthen Partnerships. . . . . . . . . . . . . . . . . . . . . . . . . . 20 How the Bank Encourages Leadership from Every Chair . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Board of Directors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Community Depository Institutions Advisory Council . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Economic and Community Advisory Council . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Management Committee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 Additional Bank Officers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 1 Introduction In 2017, the Philadelphia Fed expanded its work to enhance the Through the robust work done by the Bank’s economists, researchers, economic vitality and possibilities for all communities in the Third and outreach specialists, the Philadelphia Fed creates information and District, which encompasses Delaware, southern New Jersey, and data that enable policymakers to make monetary and regulatory policy central and eastern Pennsylvania. The Philadelphia Fed has long been decisions. Bank examiners harness data and weigh intangibles to be known as a source of in-depth, unbiased research around such topics sure area financial institutions meet the needs of the communities as economic mobility and consumer finance. Less is known about they serve by managing risks, offering the right products, and using how Bank employees engage with partners in the region to enable cybersecurity tools to protect consumer data. residents and communities to gain access to economic opportunity and prosperity. The Philadelphia Fed’s 2017 Annual Report highlights The Philadelphia Fed places high value on the region it serves. That’s key events and initiatives that translate numbers-related research to why employees aim to be the best at what they do, leading both as an neighborhood-based action. The details in this report show how we are organization and as individuals. Philadelphia Fed President Patrick achieving that goal. T. Harker delivered 20 public speeches this year. More than 100 employees volunteered in 2017 through PhillyFedCARES in multiple In northeast Pennsylvania, members of the Bank’s Community community outreach events that made visible the Bank’s commitment Development and Regional Outreach Department became involved in to our communities. Over $200,000 was donated by Bank staff, and efforts to create a transit system that meets the needs of all residents. more than 1,100 pounds of food were distributed in the Third District The Northeast Pennsylvania Equitable Transit Planning Council more in 2017 through employee fundraising and participation in the United than tripled in size from 20 to 70 participants, a measurable sign that Way. engagement across various specialties expanded the conversation and underscored the need for local experience to solve local problems. On The Philadelphia Fed is committed to strengthening its engagement in a broader scale, the Consumer Finance Institute (CFI) shed light on the Third District and to translating this leadership to outcomes that issues related to how households earn, spend, save, and borrow. The support stronger communities. This commitment is done by taking our CFI produced important research on critical privacy issues, financial work from numbers to neighborhoods. health among cognitively impaired elderly people, and the economic impact of student loans. 2 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 3 President’s Letter In 2016, our annual report opened with an overview of our newly principles are steeped in that philosophy, and work is carried out with established and forthcoming initiatives. There is always some respect for the individual characteristics and needs of the regions trepidation when embarking on a major new initiative, let alone we’re serving. Our interest is not in imposing our own model or ideas, several, and while the Philadelphia Fed has some of the most but to get results and improve people’s lives. We do that better when exceptional staff I’ve had the pleasure to work with, we faced a big we bring together multiple stakeholders, understand the specifics of commitment. Even the best planning and a world-class staff are no the problem, and work as a team to find the best solution. match for life’s vicissitudes and the hurdles they can erect. This emphasis on local understanding permeates every floor of Ten Not this time. Independence Mall, as you’ll see within the following pages, from keeping policymakers informed of the Fed’s work and research to We hit the ground running and have not looked back. the appreciation for how banks throughout the District serve their communities and the economic forces that drive them. The Consumer Finance Institute launched in 2017, and by the end of the year, it had already garnered widespread attention for its work in The qualities that our team in the Third District exemplify — world- the important, but underresearched, area of elder financial abuse. Its class research, a focus on results, and local understanding, to name research on subjects ranging from student loans to fintech stands out a few — are the foundation on which we’ve built our strategic vision, in a rich and full field, and it is already a go-to source for consumer- which lets us carry out the vital mission of the Federal Reserve System. related data. With a big thanks to all our colleagues, I welcome you to the 2017 The Economic Growth & Mobility Project continues its work apace Annual Report, and say, once again, that I look forward to an even more and launched the first Research in Action (RIA) lab in northeast stellar report next year. Pennsylvania, working with partners across sectors to find ways to improve transportation to get residents to work, school, health care, and other amenities. The community development work at the Philadelphia Fed has always been grounded in the principle that Philadelphia Fed President Patrick T. Harker on a we’re most effective when we work together with a range of partners, community tour of Johnstown, PA, with Frank J. bringing a chorus of diverse voices and ideas to the table. The RIA Janakovic, Johnstown’s mayor 4 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 5 First Vice President’s Letter This year, we launched the Bank’s strategic values: Collaboration means that when we work together, the sum of our Innovate, Collaborate, and Be Open. combined efforts is greater than our individual parts. That means working within and across teams, across the Federal Reserve System, The values an organization selects say a lot about its culture. So and with our external partners, whether we’re cooperating on does the spirit in which they are developed and implemented. At the next-generation research or helping communities throughout the Philadelphia Fed, we choose to see our values as a living, breathing set Third District find ways to become more economically mobile and of ideals, open to both interpretation and evolution. sustainable. The core of this organizational mindset is that each value individually, And being open means knowing that great ideas come from all corners. and the set as a whole, will mean something slightly different to each One of the first things I noticed about the Philadelphia Fed was the employee at the Bank. They won’t be wildly different, of course, but way the executive leadership listened to colleagues at all levels, not the minor variations reflect the underpinning philosophy that our standing on ceremony or hierarchy, but trusting in others’ abilities. diversity of views is one of our great strengths. Every time a colleague There are many ways for an organization to nurture and foster talent, looks at innovation from a different angle, it makes the rest of us but one of the most effective is to empower everyone to speak up and see things in a new light. That ability to view things from a fresh share ideas. perspective is the foundation of all great organizations. The Philadelphia Fed’s strategic values will mean something a For me, innovation doesn’t just mean cutting-edge technology or little different to everyone here. But at their core, they represent abandoning what works for the simple sake of change. It means taking something universal: The way we make our Bank the strongest, most a calculated risk when the situation calls for it. It means keeping effective organization it can be to best meet the needs of our District some things, improving others, and, yes, sometimes replacing whole and the nation. systems. It means rising to meet the challenges of a rapidly changing world with creativity and new ways of thinking. It means being willing to risk failure. 6 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 7 The Consumer Finance Institute Studies How People Spend, Save, and Earn s tudent loans have been the fastest growing segment of consumer debt in the past 10 years, but we know less about them than we do about other types of consumer debt such as mortgages. Hundreds of data breaches are reported in the U.S. each year, with millions of Americans affected, yet there is little research on how these incidents influence consumers. As the baby boomer generation retires, adults aged 65 and older will make up an increasingly larger share of the U.S. population. Yet no comprehensive systems are in place to help protect the elderly from financial fraud and exploitation. These are just a few examples of issues that the Federal Reserve Bank of Philadelphia’s Consumer Finance Institute (CFI) examines. The CFI launched in 2017 at the Bank’s biennial conference organized jointly by the Payment Cards Center, an applied research group focusing on credit and payments, and the Economic Research Department. The CFI’s mission is to increase our understanding of the way credit markets and payment systems function and how they affect the economy. These connections are critical to the Fed’s mission to formulate effective monetary and regulatory policy and foster healthy household finances, a stable financial system, and a resilient economy. The Bank is a significant source of information on the student loan market. During the year, a series of internal workshops allowed staff to learn from representatives of enterprises engaged in the private student loan markets about these firms’ business models and the areas in which they operate. The sessions touched on a variety of topics, Meet part of the Consumer Finance Institute’s (CFI) leadership team (from left to right): Satyajit Chatterjee, Vice President, including the rise in private student lending during the Great Recession, how the increase in for-profit colleges and universities affects levels Research; Julia Cheney, Assistant Vice President and Assistant Director, CFI; and Mike Dotsey, Executive Vice President, Research, and Director, CFI. www.philadelphiafed.org www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 9 that the incident did not appear to have undermined consumer In his remarks announcing the launch of the CFI, Philadelphia Fed confidence in the credit card system, the findings raise questions President Patrick T. Harker made the case for increasing the Bank’s about the efficacy of breach notifications, something that may be of focus on issues around consumer finance, a vital sector that “touches interest to policymakers designing future consumer privacy protection every aspect of the economy.” He noted that the Great Recession had regulations. perhaps brought the significance of this area of the economy into much starker relief. During the year, the CFI analyzed the challenges presented by an aging population facing increased ’’ risk for financial fraud and exploitation. Together with There has never been a the Penn Memory Center and University of Pennsylvania’s Bob Hunt, Senior Vice President and Associate Director, Consumer Finance Institute more important time for Healthy Brain Research Center, the CFI cohosted a conference researchers, financial institution executives, and advocates for funded refinancing and other forms of alternative student lending. the elderly to discuss the latest Fact-finding events such as these inform the focus of future research research on cognitive impairment and help the institution better serve as a resource to industry, the and the best ways to safeguard regulatory community, and the general public. elder financial health. A CFI study consumer debt in the past 10 years, is a major focus of the Consumer Finance Institute. research on the complex that brought together brain of student debt and rates of default, and the growth of privately Research into student loan debt, the fastest growing segment of ways Americans spend, ’’ save, and owe. - Philadelphia Fed President Patrick T. Harker explored how data sharing among As data breaches become an increasingly common occurrence for financial institutions could help to American consumers, the CFI continues to explore this issue. One detect early signs of impairment, CFI study examined how people responded to a data breach at the fraud, and abuse. Because South Carolina Department of Revenue. The paper found that many balancing suspicions of fraud against privacy rights is a chief concern “There has never been a more important time for research on the Philanthropist Brooke Astor with her grandson, Philip Marshall, now individuals directly exposed to the breach took steps to protect in this area, the paper noted the need for a regulatory environment complex ways Americans spend, save, and owe,” Harker said. “These a renowned elder justice advocate. Marshall, who turned in his father themselves from fraud. On the other hand, most consumers who were that enables institutions to more easily share information with family, affect both the overall U.S. and local economies — and, of course, when he suspected financial abuse of his grandmother, shared his not directly exposed but who had learned of the breach through news caregivers, or other institutions while maintaining the privacy of individuals, families, and communities.” reports did little to protect themselves. While this research suggests consumers. 10 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org www.philadelphiafed.org personal story at a November conference focusing on the financial health of older Americans. Federal Reserve Bank of Philadelphia | 11 New Initiative Promotes More Inclusive Economic Growth W ith the launch of the Economic Growth & Mobility Project (EGMP) in early 2017 within the Community Development and Regional Outreach Department, the Philadelphia Fed moved beyond its strengths of convening power and research, exploring a new partnership model with leaders in the private, nonprofit, and philanthropic sectors to promote more inclusive economic growth in the region and to create pathways out of poverty in communities across the Third District. Rather than the Bank driving that effort, the model under EGMP is intended to bring about local solutions to complex local problems, said Ashley Putnam, director of the EGMP, who embraced a similar ethos in her previous role in the New York Mayor’s Office of Workforce Development. “It has to be community driven,” Putnam said. “We’re hearing from communities — things they need, economic issues they’re facing — and then we’re bringing data to bear on those problems.” The Bank selected the Scranton–Wilkes-Barre–Hazleton area in northeast Pennsylvania as the first community of focus. The EGMP’s inaugural Research in Action lab zeroed in on transportation. The Bank through its ongoing outreach had been hearing about transportation being a critical barrier to job access, quality health care, and getting children to school — holding back growth in that part of the Third District. That effort led to the creation of the Northeast Pennsylvania Equitable Transit Planning Council, which quickly grew from 20 members at its Ashley Putnam, Director of the Economic Growth & Mobility start to more than 70 by the end of the year, with a wide cross-section Project, is leading the Bank’s efforts to foster community-driven solutions to complex local problems. www.philadelphiafed.org www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 13 at Wilkes University, focusing on the qualitative aspects, including Beyond the Research in Action model, the EGMP’s work extended to Wilmington, DE, what locals feel about transit access and the hurdles they see — and communities and economic sectors across the District throughout they learned about culminated in a regional summit that drew more than 100 stakeholders the year. the city’s efforts and national attention. to revive the central business That summit was only the midpoint of ’’ the process, though, Putnam said. Now we can say to business “It’s great to get everyone together leaders: ‘Here’s what our and talk about the problems, and we Philadelphia Fed President Patrick T. Harker and other Bank officials embarked on a series of city tours to get a firsthand look at economic conditions in the Third District, including this tour in Johnstown, PA. want those to lead to action,” she said. its Downtown Development District; and in Atlantic City, NJ, they recognized data are saying about the the importance institutions develop strategies from those data.” region,’ and they’re starting one of five companies spotlighted in the Bank’s As work continues in 2018 on that to develop strategies from University, which is partnering with Apprenticeship Guide. those data. South Jersey Gas “Now we can say to business leaders: ‘Here’s what our data are saying about the region,’ and they’re starting to of fields represented — transit agencies, health care, education, local and regional businesses, and nonprofits. district through initial lab, the EGMP focus will “A pioneering aspect is the community partnership model we turn to Philadelphia and workforce developed, really bringing a diverse group of stakeholders to the development for its next lab, while table to come together and say, ‘We know this is a challenge; how also finding ways to help others Scranton, PA, and neighboring communities do we solve it together?’” said Erin Mierzwa, strategic outreach and replicate the EGMP’s process and were the focus of the first EGMP Research in engagement officer, who emphasized the ability to build deeper initial successes to tackle similar Action lab, which dealt with transit access. relationships under the EGMP model. “Everyone had their own focus problems across the region — areas, but everyone wanted to be part of the conversation.” potentially through a workshop event ’’ - Ashley Putnam, Director of Economic Growth & Mobility Project of anchor like Stockton Philadelphia Fed President Patrick T. Harker tours the operation at Philly Shipyard, Inc., to build the $220 million Gateway Project, consisting of a new campus for the university and a new headquarters for the utility. Additionally, the Bank produced several special reports through the course of the year, including a comprehensive apprenticeship guide aimed at employers and workforce intermediaries or other means. The council’s 2017 efforts were aided by a pair of studies — one by A trio of city tours gave Bank officials the chance to meet with local throughout the region, which outlines the current state of leaders and get a firsthand look at what cities and towns across the apprenticeships, considers case studies from organizations the Bank’s Kyle DeMaria, focusing on the quantitative aspects of “There are a lot of other people in the Third District who are very District are facing. In Johnstown, PA, which was hit as hard as many like Philly Shipyard, Inc. and the Northeast Regional Council of the issues, mapping transit barriers throughout the region, and the interested in the process,” Putnam said. “The hope is not that the Bank other single-industry economies, they talked with locals about smart Carpenters and offers paths to explore apprenticeship as a talent other from The Institute for Public Policy and Economic Development will lead seven different labs, but create a toolkit instead.” planning and cross-sector approaches to encouraging growth; in development strategy. 14 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 15 W How the Bank Protects the Nation’s Financial System hen Philadelphia Fed community bank examiners head into the field, they’re not just considering hard numbers on a balance sheet, financial statements, or loan figures; they’re also weighing the intangibles — key additions like pieces of local context and regional characteristics. For instance, around Souderton, PA, the home territory of one of our supervised institutions, examiners drive by farm trucks loaded with pigs destined for the local meat plant, a clear reminder of what drives the local economy. “Not driving through the marketplace of the bank to me is a huge loss,” said Mark Hall, supervising examiner. “Having that perspective really helps you understand what management’s feeling is.” Examiners like Hall in the Philadelphia Fed’s Supervision, Regulation, and Credit (SRC) Department supervise 21 state member banks to ensure those banks comply with governmental regulations and meet the needs of the communities in which they operate, helping maintain a robust, safe, and sound financial system. Philadelphia Fed supervision teams, like others across the other 11 Federal Reserve Districts, determine whether banks are offering consumers safe financial products and managing risks effectively. Philadelphia Fed examiners use both onsite and offsite reviews to ensure those state member banks are in compliance; while the newer offsite review process offers flexibility and reduces the burden on both Jonathan Brown, Supervising Examiner, part of the team banks and examiners, the onsite process can feature more face-to-face that supervises TD Bank, works every day to monitor safety and soundness for the largest bank holding company in the Third District. www.philadelphiafed.org www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 17 environment. Using quantitative and qualitative assessments, teams The Philadelphia Fed continues its leadership role in the System on a determine what those banks can withstand before cracks start to pair of publications — Community Banking Connections and Consumer emerge, and what levels of capital a bank would need to absorb Compliance Outlook, focusing on safety and soundness and consumer losses, meet obligations to creditors, and continue to issue credit — compliance issues, respectively — that reach more than 30,000 essentially to avoid a repeat of the financial crisis. community bankers, helping them understand and comply with applicable laws and regulations. Those publications are, in turn, part Meet the onsite team that supervises Synchrony Financial, located in Stamford, CT. Left to right, standing: Atul Dholakia, Examinations Specialist; Audra Grasetti, Senior Examinations Specialist; and Christie Vazquez, Senior Examinations Specialist. Left to right, seated: Melonie Sterling, Examiner, and Chung Cho, Supervising Examiner. “CCAR is a direct result of that — an initiative to prevent something of the department’s larger outreach effort, which focuses on sharing like that happening independently before it really happens,” said information, knowledge, and experience outside the examination Andrea Anastasio, supervising examiner. environment in workshops, forums, and online training. Supervision teams also collaborate with regulatory Philadelphia Fed agencies like the Office of the Comptroller of the Currency supervision teams, like and others, which helps ensure banks’ management time with local bank officers. Regardless of the location, examiners are offering a consistent view emphasize open lines of communication to make sure they can assess a on their operations, reduces bank’s strategy and ensure it is serving its community’s best interests the overall regulatory while remaining healthy, safe, and sound. burden, and allows the agencies and the Bank to At the largest bank holding companies in the District, supervision have a unified, consistent teams maintain an onsite presence, focusing on those institutions’ message. risk and control functions, and conduct evaluations under the others across the other 11 Federal Reserve Districts, Cathy Lovell, Examiner, is part of the team that supervises community banks and holding companies in the Third District. are offering consumers safe financial products and Comprehensive Capital Analysis and Review (CCAR) program, a Also, following a number of Federal Reserve System initiative that went into force in 2011 following high-profile data breaches the financial crisis. around the nation in the past several years, the Philadelphia Fed’s teams have stepped up efforts to protect consumers, focusing on For supervisory teams, CCAR reviews are a kind of stress test cybersecurity to ensure banks are protecting consumer data and to measure what a large bank can endure in a severely adverse working to ensure similar breaches won’t occur in the future. 18 | Federal Reserve Bank of Philadelphia determine whether banks www.philadelphiafed.org managing risks effectively. Mark Hall, Supervising Examiner, highlights the value of having an onsite presence at the institution during community bank supervision. www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 19 The Bank Works to Engage Communities and Strengthen Partnerships T he Philadelphia Fed has long been a source of in-depth research, an advocate of community development work, and a supplier of regulations and policy for financial institutions. But a deep well of compelling knowledge matters little if the general public does not know about it. Advocacy and partnerships work best when the parties share mutual respect and commitment. Reaching out to key stakeholders was another high-priority objective in 2017. The following stories detail how the Bank worked to build relationships with public policy stakeholders, financial institutions, and colleagues within the Federal Reserve System to safeguard the System’s digital infrastructure and the nation’s financial system. External Affairs The Federal Reserve System does not make or advocate for specific legislation or government policy. But given the Fed’s goal to safeguard the economy and financial system, officials at the Philadelphia Fed and System-wide are interested in ensuring policymakers have all the information and data needed to arrive at sound policy that supports the Fed’s dual mandate of promoting full employment and price stability. The Bank’s External Affairs unit of the Corporate Affairs Department was created to develop and maintain relationships with Third District policymakers and their staffs and to keep abreast of all policy developments. “Every day we’re focused on legislative activities that may affect the Fed, and we monitor what’s going on with the elected officials who represent the Third District on the federal, state, and local The External Affairs team of Jonathan Lewis (left) and Matthew level,” said Matthew O’Keefe, external affairs strategist. O’Keefe look over a map of the Third District, where they work to develop relationships with local policymakers. www.philadelphiafed.org www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 21 O’Keefe and Lewis also work with the Bank’s Financial Outreach team According to Bill Guinan, outreach specialist, going out and meeting leaders to discuss specific questions that are posed by the Board,” said for information on state banking committees and concerns among executives is paramount. “To develop a solid relationship built on Kraemer. “These questions cover regulations, economic indicators, regional financial institutions. “Cybersecurity is always an issue for mutual respect, face-to-face meetings are critical,” he said. and the payments system.” many of our elected officials,” said O’Keefe. The face-to-face connections enable Guinan and his colleague Bond In November 2017, Larry Santucci of the Bank’s Consumer Finance The External Affairs team also sends data and other reports to area Kraemer, another Bank outreach specialist, to maintain relationships legislative offices. The Tri-State Trends newsletter, distributed to Third that create a two-way street of information sharing. “We design our District legislative staff eight times per year, details Bank research meetings to gather information on the banking environment, on the and events as well as economic data on the Third District states of regulatory environment, on a local economy, but also we’re there Pennsylvania, New Jersey, and Delaware. Additionally, legislators are to share some information on the strategic initiatives of the Federal informed about the Bank’s high-priority objectives. Lewis noted that Reserve Bank of Philadelphia,” said Guinan. when the Economic Growth & Mobility Project (EGMP) was rolled out in 2016, “We made sure to talk to our Congressional members who Before each meeting, Guinan and Kraemer do their homework. “It’s were on the Education and Workforce Committee about the research important to do research, to be current on publications and regulations products that were coming out of EGMP.” so that we can answer any questions that come up,” said Kraemer. One of the Bank’s objectives is to produce compelling knowledge. One unique facet of the Philadelphia Fed’s outreach to financial O’Keefe and his colleague Jonathan Lewis, outreach analyst, learn as O’Keefe and Lewis’s task is to ensure this in-depth research is part institutions is the annual field meetings. These meetings are scheduled much as they can about each policymaker and staff before meeting of any discussion among policymakers. “Our goal,” said O’Keefe, across eight cities in the Third District and bring together chief them. “We know what our specific members are focused on, what their “is to ensure the Philadelphia Fed is viewed as the go-to source for executives of local community banks with Fed senior leadership. “We hot topics are,” said Lewis. “We can then find Fed research related to information when our elected officials and various other stakeholders also attend industry events and meetings,” said Kraemer, in order to those topics so that the policymakers have solid information when want to learn about important issues.” keep the conversation going throughout the year. Institute led a conference on aging and financial health, a topic that was highlighted to local officials by the External Affairs unit of Corporate Affairs. Maintaining relationships with local financial institutions is the goal of the Financial Institution Relations group of (left to right) Outreach Specialists Bond Kraemer and Bill Guinan as well as Tony White, who retired in 2017. The Philadelphia Fed has worked for decades to build these discussing legislation or regulations.” Financial Institution Relations One example is the work done by Philadelphia Fed economists on Another area of collaboration between the Bank and the financial partnerships with community bankers and other financial sector sector is the Community Depository Institutions Advisory Council. This executives. The relationships allow for the exchange of thoughtful cognitive impairment and financial health. When the Bank hosted a Overseeing the financial system is one of the Federal Reserve System’s advisory council, established by the Board of Governors of the Federal questions, a store of mutual respect, and sharing of industry conference on aging and finances, O’Keefe made sure the staff of a main missions. The geography of the Third District enables the Bank’s Reserve System in Washington, D.C., allows financial executives to knowledge that help the Federal Reserve System keep the U.S. financial local member of Congress who was interested in aging-related issues Financial Institution Outreach group to travel across Pennsylvania, weigh in on issues related to banking and regulations. “We have 12 system robust and secure. was aware of the conference and relayed to them various findings that New Jersey, and Delaware to visit local banks, credit unions, and other bankers who meet twice a year with President Harker and other senior came out of the conference. institutions. 22 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 23 Information Technology and Collaboration Services successful delivery of collaboration services, we were designated the policy deliberations,” said Harris. “We also manage very important The Bank doesn’t just protect information for the Federal Reserve. It provider for services concerning security and service delivery for the transactional capabilities in the economy like the ACH system, Fedwire also shares its knowledge of the latest in cybersecurity best practices Relationship building is not solely an external-facing process. The entire Fed System,” said Terry Harris, senior vice president and chief Funds Transfers. These are some of the crown jewels of the payments with financial institutions in the Third District, which covers Information Technology Services (ITS) department at the Philadelphia information officer. systems that run our economy.” Delaware, southern New Jersey, and central and eastern Pennsylvania. These relationships help institutions better protect data and Fed maintains relationships within the Federal Reserve System to ensure effective internal collaboration and to ensure the Fed’s The goal in building these System-wide relationships is not just to information technology infrastructure and the U.S. payments system avoid duplicative work but to identify and exploit best practices. remain secure from outside threats. “Previously, IT personnel in 10 different locations were doing their own planning, building, and running in their own particular collaboration service space,” explained Joseph Dietzmann, vice president and End User Services collaborative services executive. Philadelphia Fed management either led or participated in the streamlining of those efforts so that the planning, building, and operations teams work together. The new arrangement allows for more efficient service delivery and greater system security. “Because the Philadelphia Fed is the lead collaboration services provider, we are responsible at the end of the provide safe financial products to businesses and people. ’’ “We engage very actively with the financial institutions in our We’re protecting sensitive, District to give them our perspective on information security,” personally identifiable security and data privacy officer, attended field meetings information, and we’re also holds a conference for financial institution information protecting monetary which Fed experts discuss new trends in cybersecurity. policy deliberations. The Bank’s experts are well placed to know the latest risks day for the most effective delivery and utilization of the different IT products,” said Dietzmann. ’’ - Terry Harris, Senior Vice President and In 2017, the Philadelphia Fed took the lead on a wide array of efforts Chief Information Officer said Harris. Keith Morales, vice president of information with member community bankers in the District. The Bank security officers from member and nonmember banks during and how best to protect information because Harris and his team keep in constant contact with the nation’s security agencies, including Homeland Security and the CIA, NSA, and FBI, to develop approaches to reducing insider risk and better understand and react to intelligence information in advance. (Left to right) Joseph Dietzmann, Nancy Hunter, and Terry Harris are that included safeguarding the Fed System’s e-mail by instituting part of the Information Technology Services department that keeps a new classification protocol. The Bank also developed partnerships “We’re able to bring in those agencies to discuss the threats on the Fed’s IT infrastructure secure. across the System to keep sensitive data safe from hacking. That is the financial industry, and we’re able to share best practices important because the Fed handles millions of pieces of data from “We are always a target,” said Nancy Hunter, special information security and share incident information so that everyone can benefit in learning about what went wrong and what went right,” said Hunter. employees, other regulators, and financial institutions that use the advisor. Indeed, cyberattacks on the Federal Reserve System number in The bank’s Collaboration Services group has taken the lead in Fed’s many payment systems. “Here at the Fed we’re protecting the hundreds of thousands a day. The ITS department fights a constant “And that has been very favorably received, both at the field meetings collaboration technology efforts with the other Reserve Banks and the confidential supervisory information, we’re protecting sensitive, battle to keep the Fed and the financial system safe and working. and in the conference we host each year.” Board of Governors. “Because of our decade-plus of experience and personally identifiable information, and we’re protecting monetary 24 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 25 How the Bank Encourages Leadership from Every Chair N o matter where you are sitting — whether in the executive suite or in a cubicle — making a sound business decision is a critical function in every business line. It is also a philosophy that resonates at the Philadelphia Fed. The Bank extols the importance of inclusive leadership from every seat in the organization, which helps employees bridge all the solid and dotted lines on the organizational chart. “The Bank’s leadership development programs are inclusive,” said Mary Ann Hood, senior vice president, Human Resources. “Whether you’re an officer or someone who is just starting out in an entry-level job, this comprehensive plan creates opportunities for everyone in the Bank to achieve their best.” We strive to be a strong, performing organization known for developing its leaders, said Hood. “Our employees are our greatest assets, making significant contributions to this Bank and to the Federal Reserve System. We want to be sure we continue to give our employees development opportunities to help them succeed.” To adapt the organization into an evolving 21st century business framework, the Bank customized this leadership philosophy to its mission and adopted it as a strategic initiative, said Steve Hart, vice president, Human Resources. “For us, seeing the value in leadership at all levels of the organization is the key,” said Hart. Support of this initiative came from members of the Philadelphia Fed’s Management Committee. The Philadelphia Fed’s leadership philosophy may start in the office, but the impact of our work extends far and wide into the community. Members of PhillyFedCARES frequently volunteer at Philadelphia’s McCall School. www.philadelphiafed.org www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 27 positive way and contribute to economic policy and supervision at the In years past, Bank employees Jessica Zhou, Timothy McCollum, and technology System level,” she said. “In doing so, we need to put even more focus Ron Lavish have extended their expertise to the System via a variety of governance for on developing leaders and being a contributor not only in Philadelphia special projects. Zhou and McCollum, accounting analysts in Financial most of his 34 but in the community and the System as a whole.” The keys are being Management Services, were part of a seven-member team that years at the Bank. leaders in our space and being the best at what we do, she said. provided onsite reviews for the Reserve Bank Operations and Payment His System work Systems at the Federal Reserve Bank of Minneapolis. Following was recognized This cultural shift in the workplace recognizes the speed at which the Board of Governors of the Federal Reserve System’s lead, they in 2017 when change is happening not only in the Bank but in the System, in reviewed discretionary expenditures, operational perspectives, and he won the technology, and in the world in Conference general, said Hood. She points of General ’’ to new opportunities at the Ron Lavish, Audit Manager, has been honored for his work on many System initiatives, especially winning the Conference of General Auditors Award for Excellence in 2017. Bank for employee growth and development. For starters, the Leaders Academy (in-house management training for the next generation of leaders) is “By providing strong leadership in the Federal Reserve System’s core being revamped, there is a new functions and in all areas that support those functions, we aspire as an college recruiting program, and organization to share our subject matter expertise, thought leadership, more rotational opportunities and ability to collaborate within the Bank and in the System,” said are being offered across the Hood. She acknowledges that the Bank has a strong foundation of Bank to promote collaboration. System leadership in several key areas of central bank expertise: These new opportunities join economic research, community development, and supervision and the Bank’s staples of Grow regulation. “We want to communicate the value and the impact our the Home Team assignments work has on our community and the System,” she said. and management training During one of their Federal Reserve System projects, Jessica Zhou and Timothy McCollum, Accounting Analysts in Financial Auditors Award Making good for Excellence. decisions is a crucial only two Fed skill at every level. selected from He was one of ’’ – Peter Drucker, management consultant, corporate philosopher, and author Management Services, provided onsite a team of more than 300 auditors. Lavish For Mary Ann Hood, Senior Vice President of Human Resources, and Karen Vaughn, Associate Director in the Office of Diversity & Inclusion in Human Resources, inclusive development gives everyone an opportunity to achieve their best. has “gone above and beyond the call of duty while continuing to be viewed as a valued advisor reviews for the Reserve Bank Operations throughout the Bank and the System,” according to Michelle Scipione, and Payment Systems at the Federal Reserve Bank of Minneapolis. employees vice president and general auditor. She sees the award as not only financial accounting operations. In the process, the collaboration acknowledging Lavish’s many contributions, but as a tribute to the programs for employees, such was invaluable, they said, in networking with System colleagues and Audit Department and the Bank as well. Although professional development for employees has always been as the System Leadership Initiative, the Urban League, and Leadership comparing procedures at other Reserve Banks. part of the Bank’s DNA, what is driving this initiative today? Hood Philadelphia. Human Resources will lead the charge, but it won’t be sees it as a combination of factors. “Our strategic priorities include the only channel for employee growth and development. Opportunities Likewise, Ron Lavish, Audit manager, has been assisting in System come from all corners of the organization. He looks to employees who an external view of how the Bank should serve the community in a are available at every Bank level and in every department. audits and participating in data management reviews and information “can take a leadership role from any chair in the Bank.” 28 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org For First Vice President James Narron, good ideas and good decisions www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 29 Board of Directors As provided by the Federal Reserve Act, each of the 12 Reserve Banks is supervised by a nine-member board of directors. The directors oversee the Bank’s direction and performance, and they participate in the formulation of the Fed’s monetary policy through their reports on economic and financial conditions and their decisions on the Bank’s discount rate. CHAIRMAN BOARD MEMBERS Michael J. Angelakis (a, d) William S. Aichele (a, c) Patricia A. Hasson (a, c) Chairman and CEO Chairman President and Executive Director Atairos Management, L.P. Univest Corporation of Pennsylvania Clarifi Bryn Mawr, PA Souderton, PA Philadelphia, PA Jon Evans (a, b) David R. Hunsicker (a, b, d) President and CEO Chairman, President, and CEO Atlantic Community Bankers Bank New Tripoli Bank Camp Hill, PA New Tripoli, PA Senior Advisor to the Executive Management Committee Comcast Corporation, Philadelphia, PA DEPUTY CHAIRMAN Edward J. Graham (a, b, d) Carol J. Johnson (a, c) Brian M. McNeill (a, c, d) Former Chairman and CEO Former President and COO President and CEO South Jersey Industries AlliedBarton Security Services TouchPoint, Inc. Folsom, NJ Conshohocken, PA Concordville, PA Phoebe A. Haddon (a, b) Chancellor Rutgers University–Camden Camden, NJ (a) Member of the Bank’s Executive Committee; (b) Member of the Bank’s Audit Committee; (c) Member of the Bank’s Management and Sitting, from left: Phoebe A. Haddon, Edward J. Graham, Michael J. Angelakis, Jon Evans; standing, from left: Brian M. McNeill, William S. Aichele, Budget Committee; (d) Member of the Bank’s Nominating and Governance Committee David R. Hunsicker, Patricia A. Hasson. Not pictured: Carol J. Johnson. 30 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 31 Community Depository Institutions Advisory Council The Community Depository Institutions Advisory Council, created in 2011, includes representatives from commercial banks, thrift institutions, and credit unions. The council provides information, advice, and recommendations to the Federal Reserve Bank of Philadelphia from the perspective of community depository institutions. David J. Hanrahan Rory Ritrievi Richard Stipa President and CEO Capital Bank of New Jersey Vineland, NJ President and CEO Mid Penn Bancorp, Inc. and Mid Penn Bank Millersburg, PA CEO TruMark Financial Credit Union Fort Washington, PA Mark E. Huntley Patrick L. Ryan Jeane M. Vidoni President and CEO Artisans’ Bank Wilmington, DE President and CEO First Bank Hamilton, NJ President and CEO Penn Community Bank Bristol, PA Christopher D. Maher J. Bradley Scovill James Wang Chairman, President, and CEO OceanFirst Bank Toms River, NJ President and CEO Citizens & Northern Bank Wellsboro, PA President and CEO Asian Bank Philadelphia, PA Matthew P. Prosseda Amey R. Sgrignoli William Wood President and CEO First Keystone Community Bank Berwick, PA President and CEO Belco Community Credit Union Harrisburg, PA Chairman CBT Financial Corporation Chairman CBT Bank Clearfield, PA Sitting, from left: Matthew P. Prosseda, Patrick L. Ryan, Christopher D. Maher, James Wang, David J. Hanrahan; standing, from left: William Wood, Rory Ritrievi, Amey R. Sgrignoli. Not pictured: Mark E. Huntley, J. Bradley Scovill, Jeane M. Vidoni, Richard Stipa. 32 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 33 Economic and Community Advisory Council Management Committee The Economic Advisory Council, created in 2008, was expanded and renamed the Economic and Community Advisory Council in 2016. It is now The Management Committee is composed of the Bank’s President and CEO, the first vice president and COO, the chief of staff, and composed of up to 15 leaders who represent businesses of different sizes and industry sectors as well as nonprofit and philanthropic organizations, senior vice presidents. Members advise the president and first vice president on matters of Bank policy and strategy. academic institutions, the public sector, and organized labor. The council advises Federal Reserve officials on emerging trends, market conditions, and economic growth opportunities in the Third District and the nation. Madeline Bell John A. Fry Devesh Raj President and CEO The Children’s Hospital of Philadelphia Philadelphia, PA President Drexel University Philadelphia, PA Staci Berger Chris Gheysens Senior Vice President of Strategic and Financial Planning Comcast Corporation Philadelphia, PA President and CEO Housing and Community Development Network of New Jersey Trenton, NJ President and CEO Wawa, Inc. Wawa, PA Daniel Betancourt President and CEO W. L. Gore & Associates, Inc. Newark, DE President and CEO Community First Fund Lancaster, PA Edward L. Dandridge Chief Marketing and Communications Officer Marsh & McLennan Companies New York, NY Patrick J. Eiding President Philadelphia Council AFL-CIO Philadelphia, PA 34 | Federal Reserve Bank of Philadelphia Terry Kelly Sharmain Matlock-Turner President and CEO Urban Affairs Coalition Philadelphia, PA Michael A. Nutter Patrick T. Harker Mary Ann Hood President and Chief Executive Officer Senior Vice President and EEO Officer, Human Resources; Director, Office of Diversity and Inclusion James D. Narron First Vice President and Chief Operating Officer Arun K. Jain Senior Vice President, Treasury and Financial Services Michael Dotsey Executive Vice President, Director of Research, and Director of the Consumer Finance Institute Jeanne R. Rentezelas Chairman and CEO Rodale Inc. Emmaus, PA Donna L. Franco William G. Spaniel Senior Vice President and Chief Financial Officer Donald F. Schwarz Senior Vice President and Lending Officer, Supervision, Regulation, and Credit Terry E. Harris Maria Rodale Vice President, Program Robert Wood Johnson Foundation Princeton, NJ Senior Vice President and Chief Information Officer, Information Technology Services Senior Vice President and General Counsel, Legal Patricia Wilson Senior Vice President, Chief of Staff, and Corporate Secretary Deborah L. Hayes Linda Thomson Senior Vice President, Corporate Affairs President and CEO JARI Johnstown, PA David N. Dinkins Professor of Professional Practice of Urban and Public Policy Columbia University Former Mayor of the City of Philadelphia Philadelphia, PA www.philadelphiafed.org www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 35 Additional Bank Officers Keith Morales Stanley J. Sienkiewicz Brian W. Calderwood Vice President and Information Security Officer Information Technology Services Vice President Research Support Research Assistant Vice President Groupware Leadership Center Robert F. Mucerino SENIOR VICE PRESIDENTS Mitchell S. Berlin Joseph O. Dietzmann Robert Hunt Vice President and Economist Research Vice President and Collaborations Services Executive End Users Services Vice President Treasury Services Michael T. Doyle Vice President Supervision, Regulation, and Credit Senior Vice President and Associate Director Consumer Finance Institute Keith Sill Senior Vice President and Director Real-Time Data Research Center Research Theresa Y. Singleton Senior Vice President and Community Affairs Officer Community Development and Regional Outreach Donna L. Brenner Vice President Enterprise Risk Management Vice President Treasury Payments Gregory Fanelli Vice President Information Technology Services Jennifer E. Cardy Vice President Financial Management Services John D. Ackley Sr. Vice President Cash Services Roc Armenter Vice President and Economist Research 36 | Federal Reserve Bank of Philadelphia Vice President and Economist Research Stephen G. Hart Vice President Human Resources Vice President and Economist Research Vice President and Managing Officer End User Services Vice President Financial Statistics Vice President Information Technology Services Deming Love Vice President Digital Strategy Michelle Scipione Larry Cordell Vice President and General Auditor Audit Vice President Supervision, Regulation, and Credit www.philadelphiafed.org www.philadelphiafed.org Assistant Vice President Supervision, Regulation, and Credit Heather C. Derbyshire James K. Welch Vice President Law Enforcement and Facilities Management Assistant Vice President Financial Statistics Suzanne W. Furr William T. Wisser Assistant Vice President and General Auditor Vice President Supervision, Regulation, and Credit Audit Perry Santacecilia Vice President Supervision, Regulation, and Credit Assistant Vice President and Counsel Legal Michael T. Costello Linda Van Valkenburg Gregory A. Ramick Vice President Public Affairs Charles Kirkland Assistant Vice President and Assistant Director Consumer Finance Institute Maryann T. Connelly Patrick F. Turner Michelle S. Reardon Kori Ann Connelly Vice President and Deputy General Counsel Legal Robin P. Myers Vice President Cash Services Satyajit Chatterjee VICE PRESIDENTS Vice President Human Resources Leonard Nakamura Paul S. Calem Vice President Supervision, Regulation, and Credit Julia Cheney Kimberly J. Taylor Christopher C. Henderson ASSISTANT VICE PRESIDENTS Assistant Vice President Supervision, Regulation, and Credit Joanne M. Branigan Assistant Vice President Supervision, Regulation, and Credit Jill Hettinger Assistant Vice President Supervision, Regulation, and Credit Federal Reserve Bank of Philadelphia | 37 Christopher L. Ivanoski Anthony T. Scafide Jr. Daniel W. Crouthamel Assistant Vice President Facilities Assistant Vice President Financial Institutions Relations Research Information Technology Support Officer Research John P. Kelly Stephen J. Smith Assistant Vice President Financial Management Services Assistant Vice President and Counsel Legal Anjanette Kichline H. Robert Tillman Assistant Vice President Supervision, Regulation, and Credit Assistant Vice President Supervision, Regulation, and Credit Andrew A. Kish Gail L. Todd Assistant Vice President Supervision, Regulation, and Credit Assistant Vice President and Credit Officer Supervision, Regulation, and Credit James K. Lofton OFFICERS Assistant Vice President Cash Services Kimberly Caruso John J. Munera III Assistant Vice President Supervision, Regulation, and Credit Wanda Preston Assistant Vice President Supervision, Regulation, and Credit Chellappan Ramasamy Assistant Vice President Supervision, Regulation, and Credit 38 | Federal Reserve Bank of Philadelphia Officer Collateral Data Administration Support Group Kenneth Chin Officer Cash Services Jeff Fries Officer End Users Services Yilin Huang Officer Supervision, Regulation, and Credit Erin Mierzwa Officer Community Development and Regional Outreach Michael O’Brien Officer Law Enforcement Tom Stark Officer Research James W. Corkery Jr. Officer Supervision, Regulation, and Credit Includes promotions through January 2018. www.philadelphiafed.org www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 39 Statement of Auditor Independence The Federal Reserve Board engaged KPMG to audit the 2017 combined and individual financial statements of the Reserve Banks.1 In 2017, KPMG also conducted audits of internal controls over financial reporting for each of the Reserve Banks. Fees for KPMG services totaled $6.8 million. To ensure auditor independence, the Board of Governors requires that KPMG be independent in all matters relating to the audits. Specifically, KPMG 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 2017, the Bank did not engage KPMG for any non-audit services. 1 In addition, KPMG audited the Office of Employee Benefits of the Federal Reserve System (OEB), the Retirement Plan for Employees of the Federal Reserve System (System Plan), and the Thrift Plan for Employees of the Federal Reserve System (Thrift Plan). The System Plan and the Thrift Plan provide retirement benefits to employees of the Board, the Federal Reserve Banks, the OEB, and the Consumer Financial Protection Bureau. 40 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org Federal Reserve Bank of Philadelphia 2017 Financial Statement Contents Management’s Report on Internal Control over Financial Reporting .......................................................................................................................................................................... 42 Independent Auditors’ Report .................................................................................................................................................................................................................................................. 43 Abbreviations ................................................................................................................................................................................................................................................................................. 45 Financial Statements: Statements of Condition as of December 31, 2017 and December 31, 2016 ........................................................................................................................................................ 46 Statements of Operations for the years ended December 31, 2017 and December 31, 2016 ..........................................................................................................................47 Statements of Changes in Capital for the years ended December 31, 2017 and December 31, 2016 ..........................................................................................................48 Notes to Financial Statements.......................................................................................................................................................................................................................................... 49 www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 41 Management’s Report on Internal Control over Financial Reporting FEDERAL RESERVE BANK OF PHILADELPHIA March 8, 2018 To the Board of Directors The management of the Federal Reserve Bank of Philadelphia (Bank) is responsible for the preparation and fair presentation of the Statements of Condition as of December 31, 2017 and 2016, and the Statements of Operations, and Statements of Changes in Capital for the years then ended (the financial statements). The financial statements have been prepared in conformity with the accounting principles, policies, and practices established by the Board of Governors of the Federal Reserve System as set forth in the Financial Accounting Manual for Federal Reserve Banks (FAM), and, as such, include some amounts that are based on management judgments and estimates. To our knowledge, the financial statements are, in all material respects, fairly presented in conformity with the accounting principles, policies and practices documented in the FAM and include all disclosures necessary for such fair presentation. The management of the Bank is responsible for establishing and maintaining effective internal control over financial reporting as it relates to the financial statements. The Bank’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with the FAM. The Bank’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the Bank’s assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with FAM, and that the Bank’s receipts and expenditures are being made only in accordance with authorizations of its management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Bank’s assets that could have a material effect on its financial statements. Even effective internal control, no matter how well designed, has inherent limitations, including the possibility of human error, and therefore can provide only reasonable assurance with respect to the preparation of reliable financial statements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The management of the Bank assessed its internal control over financial reporting based upon the criteria established in the Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, we believe that the Bank maintained effective internal control over financial reporting. Patrick T. Harker President and Chief Executive Officer 42 | Federal Reserve Bank of Philadelphia James D. Narron First Vice President and Chief Operating Officer Donna L. Franco Senior Vice President and Chief Financial Officer www.philadelphiafed.org Independent Auditors’ Report KPMG LLP 1601 Market Street Philadelphia, PA 19103-2499 Independent Auditors’ Report To the Board of Governors of the Federal Reserve System and the Board of Directors of the Federal ReserveIndependent Bank of Philadelphia: Auditors’ Report We To havethe audited theof accompanying of condition of the Federal Reserve Bank of Philadelphia (“FRB Philadelphia”) as of December 31, 2017 and 2016, and the Board Governors statements of the Federal Reserve System related statements of operations and changes in capital for Reserve the years then ended. We also have audited the FRB Philadelphia’s internal control over financial reporting as of and the Board of Directors of the Federal Bank of Philadelphia: December 31, 2017, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway of the Federal Reserve Bank ofeffective Philadelphia We haveThe audited the accompanying statements of condition Commission. FRB Philadelphia’s management is responsible for these financial statements, for maintaining internal (“FRB control over financial reporting, and for its Philadelphia”) as of December 31, 2016 and 2015, and the related statements of operations and changes in assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. capital for the years then ended. We also have audited the FRB Philadelphia’s internal control over financial Ourreporting responsibility is to express an opinion on these financial statements and an opinion on theControl FRB Philadelphia’s internal control over financial reporting based on our audits. as of December 31, 2016, based on criteria established in Internal – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The FRB We Philadelphia’s conducted our audits in accordance with the auditing standards of the Public Company Oversight Board (United States) and in accordance with auditing management is responsible for these financial statements, forAccounting maintaining effective internal controlgenerally over financial and for its assessment the effectiveness financial standards acceptedreporting, in the United States of America. Thoseofstandards require that of weinternal plan and control performover the audits to obtain reasonable assurance about whether reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits Our responsibility is to express an opinion on these financial statements and an opinion on the FRB of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting Philadelphia’s internal control over financial reporting based on our audits. principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal overstandards financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the of the Public Company Accounting We conducted our audits in accordance with thecontrol auditing Oversight Board (United States) and in accordance with auditing standards generally accepted in the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing suchUnited other procedures as we considered necessary in States of America. Those standards require that we plan and perform the audits to obtain reasonable the circumstances. We believe that our audits provide a reasonable basis for our opinions. assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial Thestatements FRB Philadelphia’s internal control over reporting is a process designed to provide reasonable assurance regarding included examining, onfinancial a test basis, evidence supporting the amounts and disclosures in thethe reliability of financial reporting and the preparation financial statements for external purposes in accordance theand accounting principles established by by themanagement, Board of Governors of the Federal Reserve System financialofstatements, assessing the accounting principleswith used significant estimates made and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internalKPMG control over financial reporting, assessing the risk that a LLP is a Delaware limited liability partnership and the U.S. member material weakness exists, and testing and evaluating the design operating effectiveness of internal control firm of the KPMG network and of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swissas entity. based on the assessed risk. Our audits also included performing such other procedures we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. The FRB Philadelphia’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with the accounting principles established by the Board of Governors of the Federal www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 43 Reserve System (the “Board”) as described in Note 3 of the financial statements and as set forth in the Independent Auditors’ Report (the “Board”) as described in Note 3 of the financial statements and as set forth in the Financial Accounting Manual for Federal Reserve Banks (“FAM”). The FRB Philadelphia’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the FRB Philadelphia; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with the FAM, and that receipts and expenditures of the FRB Philadelphia are being made only in accordance with authorizations of management and directors of the FRB Philadelphia; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the FRB Philadelphia’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. As described in Note 3 to the financial statements, the FRB Philadelphia has prepared these financial statements in conformity with the accounting principles established by the Board, as set forth in the FAM, which is a basis of accounting other than U.S. generally accepted accounting principles. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the FRB Philadelphia as of December 31, 2017 and 2016, and the results of its operations for the years then ended, on the basis of accounting described in Note 3. Also, in our opinion, the FRB Philadelphia maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Philadelphia, Pennsylvania March 8, 2018 44 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org Abbreviations ACH Automated clearinghouse GSE Government-sponsored enterprise ASC Accounting Standards Codification IMF International Monetary Fund ASU Accounting Standards Update MAPD Medicare Advantage and Prescription Drug BEP Benefit Equalization Retirement Plan MBS Mortgage-backed securities Budget Act Bipartisan Budget Act of 2018 OEB Bureau Bureau of Consumer Financial Protection Office of Employee Benefits of the Federal Reserve System Financial Accounting Manual for Federal Reserve Banks SDR Special drawing rights FAM FASB Financial Accounting Standards Board SERP Supplemental Retirement Plan for Select Officers of the Federal Reserve Banks FOMC Federal Open Market Committee SOMA System Open Market Account FRBNY Federal Reserve Bank of New York TBA To be announced GAAP Accounting principles generally accepted in the United States of America TDF Term Deposit Facility www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 45 Statements of Condition l As of December 31, 2017 and December 31, 2016 (in millions) 2017 ASSETS Gold certificates $ 348 $ 2016 359 Special drawing rights certificates 210 210 Coin 187 159 65,730 69,711 System Open Market Account: Note 5 Treasury securities, net (of which $724 and $684 is lent as of December 31, 2017 and 2016, respectively) Government-sponsored enterprise debt securities, net (of which $0 and $1 is lent as of December 31, 2017 and 2016, respectively) 123 452 Federal agency and government-sponsored enterprise mortgage-backed securities, net 46,932 48,738 Foreign currency denominated investments, net 1,146 1,070 Central bank liquidity swaps 649 306 Accrued interest receivable 641 697 Note 6 85 85 Interdistrict settlement account 5,003 - Other assets 17 31 Bank premises and equipment, net Total assets $ 121,071 $ 121,818 $ 47,730 $ 45,544 LIABILITIES AND CAPITAL Federal Reserve notes outstanding, net System Open Market Account: Note 5 Securities sold under agreements to repurchase 14,561 19,691 Other liabilities 14 27 Depository institutions 56,228 52,334 Other deposits 2 2 Interest payable to depository institutions and others 25 11 121 Deposits: Accrued benefit costs Notes 8 and 9 123 Accrued remittances to the Treasury 21 75 Interdistrict settlement account - 1,824 Other liabilities 16 14 Total liabilities 118,720 119,643 Capital paid-in 1,783 1,637 Surplus (including accumulated other comprehensive loss of $11 and $14 at December 31, 2017 and 2016, respectively) 568 538 Total capital 2,351 2,175 Total liabilities and capital $ 121,071 $ 121,818 The accompanying notes are an integral part of these financial statements. 46 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org Statements of Operations l For the years ended December 31, 2017 and December 31, 2016 (in millions) INTEREST INCOME System Open Market Account: Note 5 Treasury securities, net Government-sponsored enterprise debt securities, net Federal agency and government-sponsored enterprise mortgage-backed securities, net Foreign currency denominated investments, net Central bank liquidity swaps Total interest income INTEREST EXPENSE System Open Market Account: Note 5 Securities sold under agreements to repurchase Deposits: Depository institutions and others Term Deposit Facility Total interest expense Net interest income NON-INTEREST INCOME (LOSS) System Open Market Account: Note 5 Treasury securities gains, net Federal agency and government-sponsored enterprise mortgage-backed securities gains, net Foreign currency translation gains (losses), net Other Compensation received for service costs provided Reimbursable services to government agencies Other Total non-interest income OPERATING EXPENSES Salaries and benefits Occupancy Equipment Other Assessments: Board of Governors operating expenses and currency costs Bureau of Consumer Financial Protection Total operating expenses Net income before providing for remittances to the Treasury Earnings remittances to the Treasury Note 3m Net income after providing for remittances to the Treasury Change in prior service costs related to benefit plans Note 9 Change in actuarial losses related to benefit plans Note 9 Total other comprehensive income Comprehensive income 2017 $ $ 2016 1,684 11 1,283 (1) 1 2,978 $ 1,694 25 1,223 2,942 88 30 613 3 704 2,274 314 6 350 2,592 1 103 1 16 4 125 1 (5) 1 2 24 3 26 136 16 5 31 127 15 5 46 72 31 291 2,108 2,038 70 4 (1) 3 73 69 33 295 2,323 2,300 23 2 2 25 $ The accompanying notes are an integral part of these financial statements. www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 47 Statements of Changes in Capital l For the years ended December 31, 2017 and December 31, 2016 (in millions, except share data) Surplus Accumulated other Capital Net income Total Total comprehensive paid-in retained surplus capital income (loss) Balance at December 31, 2015 (32,472,211 shares) $ 1,624 $ 566 $ (16) $ 550 $ 2,174 Net change in capital stock issued (263,257 shares) 13 - - - 13 Net income - Other comprehensive income - 23 - 23 23 - 2 2 2 13 (37) - (37) (37) (14) 2 (12) 1 Comprehensive income: Dividends on capital stock Net change in capital Balance at December 31, 2016 (32,735,468 shares) $ Net change in capital stock issued (2,922,570 shares) 1,637 $ 552 146 - Net income - Other comprehensive income 146 $ (14) $ 538 $ 2,175 - - 146 70 - 70 70 - 3 3 3 (43) - (43) (43) 27 3 30 176 Comprehensive income: Dividends on capital stock Net change in capital Balance at December 31, 2017 (35,658,038 shares) $ 1,783 $ 579 $ (11) $ 568 $ 2,351 The accompanying notes are an integral part of these financial statements. 48 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org Notes to Financial Statements (1) STRUCTURE (2) OPERATIONS AND SERVICES The Federal Reserve Bank of Philadelphia (Bank) is part of the Federal Reserve System (System) and is one of the 12 Federal Reserve Banks (Reserve Banks) created by Congress under the Federal Reserve Act of 1913 (Federal Reserve Act), which established the central bank of the United States. The Reserve Banks are chartered by the federal government and possess a unique set of governmental, corporate, and central bank characteristics. The Bank serves the Third Federal Reserve District, which includes Delaware and portions of New Jersey and Pennsylvania. The Reserve Banks perform a variety of services and operations. These functions include participating in formulating and conducting monetary policy; participating in the payment system, including transfers of funds, automated clearinghouse (ACH) operations, and check collection; distributing coin and currency; performing fiscal agency functions for the U.S. Department of the Treasury (Treasury), certain federal agencies, and other entities; serving as the federal government’s bank; providing shortterm loans to depository institutions; providing loans to participants in programs or facilities with broad-based eligibility in unusual and exigent circumstances; serving consumers and communities by providing educational materials and information regarding financial consumer protection rights and laws and information on community development programs and activities; and supervising bank holding companies, state member banks, savings and loan holding companies, U.S. offices of foreign banking organizations, edge and agreement corporations, and certain financial market utilities that have been designated as systemically important. Certain services are provided to foreign official and international account holders, primarily by the FRBNY. In accordance with the Federal Reserve Act, supervision and control of the Bank is exercised by a board of directors. The Federal Reserve Act specifies the composition of the board of directors for each of the Reserve Banks. Each board is composed of nine members serving three-year terms: three directors, including those designated as chairman and deputy chairman, are appointed by the Board of Governors of the Federal Reserve System (Board of Governors) to represent the public, and six directors are elected by member banks. Banks that are members of the System include all nationally-chartered banks and any state-chartered banks that apply and are approved for membership. Member banks are divided into three classes according to size. Member banks in each class elect one director representing member banks and one director representing the public. In any election of directors, each member bank receives one vote, regardless of the number of shares of Reserve Bank stock it holds. In addition to the 12 Reserve Banks, the System also consists, in part, of the Board of Governors and the Federal Open Market Committee (FOMC). The Board of Governors, an independent federal agency, is charged by the Federal Reserve Act with a number of specific duties, including general supervision over the Reserve Banks. The FOMC is composed of members of the Board of Governors, the president of the Federal Reserve Bank of New York (FRBNY), and, on a rotating basis, four other Reserve Bank presidents. www.philadelphiafed.org The FOMC, in conducting monetary policy, establishes policy regarding domestic open market operations and oversees these operations. The FOMC has selected the FRBNY to execute open market transactions for the System Open Market Account (SOMA) as provided in its annual authorization. The FOMC authorizes and directs the FRBNY to conduct operations in domestic markets, including the direct purchase and sale of Treasury securities, government-sponsored enterprise (GSE) debt securities, and federal agency and GSE mortgage-backed securities (MBS); the purchase of these securities under agreements to resell; and the sale of these securities under agreements to repurchase. The FRBNY holds the resulting securities and agreements in a portfolio known as the SOMA. The FRBNY is authorized and directed to lend the Treasury securities and GSE debt securities that are held in the SOMA. Federal Reserve Bank of Philadelphia | 49 Notes to Financial Statements To be prepared to meet the needs specified by the FOMC to carry out the System’s central bank responsibilities, the FOMC authorized and directed the FRBNY to execute standalone spot and forward foreign exchange transactions in the resultant foreign currencies, to hold balances in those currencies, and to invest such foreign currency holdings, while maintaining adequate liquidity. The FRBNY holds these securities and agreements in the SOMA. The FOMC also authorized and directed the FRBNY to maintain reciprocal currency arrangements with the Bank of Canada and the Bank of Mexico in the maximum amounts of $2 billion and $3 billion, respectively, and at the request of the Treasury to conduct swap transactions with the United States Exchange Stabilization Fund in the maximum amount of $5 billion, also known as warehousing. Because of the global character of bank funding markets, the System has, at times, coordinated with other central banks to provide liquidity. The FOMC authorized and directed the FRBNY to maintain standing U.S. dollar liquidity swap arrangements and standing foreign currency liquidity swap arrangements with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank. The FRBNY holds amounts outstanding under these liquidity swap lines in the SOMA. These liquidity swap lines, which were originally established as temporary arrangements, were converted to standing arrangements on October 31, 2013, and are subject to annual review and approval by the FOMC. The FOMC has authorized and directed the FRBNY to conduct small-value exercises periodically for the purpose of testing operational readiness. Although the Reserve Banks are separate legal entities, they collaborate on the delivery of certain services to achieve greater efficiency and effectiveness. This collaboration takes the form of centralized operations and product or function offices that have responsibility for the delivery of certain services on behalf of the Reserve Banks. Various operational and management models are used and are supported by service agreements among the Reserve Banks. In some cases, costs incurred by a Reserve Bank for services provided to other Reserve Banks are not shared; in other cases, 50 | Federal Reserve Bank of Philadelphia the Reserve Banks are reimbursed for costs incurred in providing services to other Reserve Banks. Major services provided by the Bank on behalf of the System for which the costs were not reimbursed by the other Reserve Banks include Collateral Management System; Risk Assessment, Data Analysis, and Research; and Supervision Team Site Support Office. (3) SIGNIFICANT ACCOUNTING POLICIES Accounting principles for entities with the unique powers and responsibilities of the nation’s central bank have not been formulated by accounting standard-setting bodies. The Board of Governors has developed specialized accounting principles and practices that it considers to be appropriate for the nature and function of a central bank. These accounting principles and practices are documented in the Financial Accounting Manual for Federal Reserve Banks (FAM), which is issued by the Board of Governors. The Reserve Banks are required to adopt and apply accounting policies and practices that are consistent with the FAM. The financial statements and associated disclosures have been prepared in accordance with the FAM. Due to the unique nature of the Bank’s powers and responsibilities as part of the nation’s central bank and given the System’s unique responsibility to conduct monetary policy, the Board has adopted accounting principles and practices in the FAM that differ from accounting principles generally accepted in the United States of America (GAAP). The more significant differences are the presentation of all SOMA securities holdings at amortized cost, adjusted for credit impairment, if any, and the recording of all SOMA securities on a settlement-date basis. Amortized cost, rather than the fair value presentation, more appropriately reflects the financial position associated with the Bank’s securities holdings given the System’s unique responsibility to conduct monetary policy. Although the application of fair value measurements to the securities holdings may result in values substantially greater or less than their carrying values, these unrealized changes in value have no direct effect on the quantity of reserves available to the banking system or on the ability of the Reserve Banks, as the central www.philadelphiafed.org Notes to Financial Statements bank, to meet their financial obligations and responsibilities. Both the domestic and foreign components of the SOMA portfolio may involve transactions that result in gains or losses when holdings are sold before maturity. Decisions regarding securities and foreign currency transactions, including their purchase and sale, are primarily motivated by monetary policy and financial stability objectives rather than profit. Accordingly, fair values, earnings, and gains or losses resulting from the sale of such securities and currencies are incidental to open market operations and do not motivate decisions related to policy or open market activities. Accounting for these securities on a settlement-date basis, rather than the trade-date basis required by GAAP, better reflects the timing of the transaction’s effect on the quantity of reserves in the banking system. In addition, the Bank does not present a Statement of Cash Flows as required by GAAP because the liquidity and cash position of the Bank are not a primary concern given the Reserve Bank’s unique powers and responsibilities as a central bank. Other information regarding the Bank’s activities is provided in, or may be derived from, the Statements of Condition, Operations, and Changes in Capital, and the accompanying notes to the financial statements. Other than those described above, the accounting policies described in FAM are generally consistent with those in GAAP and the references to GAAP in the notes to the financial statements highlight those areas where FAM is consistent with GAAP. Preparing the financial statements in conformity with the FAM requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates. Significant accounts and accounting policies are explained below. a. Consolidation The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) established the Bureau of Consumer Financial Protection (Bureau) as an independent bureau within the System that has supervisory authority over some institutions previously supervised by the Reserve Banks in connection with those institutions’ compliance with consumer protection statutes. Section 1017 of the Dodd-Frank Act provides that the financial statements of the Bureau are not to be consolidated with those of the Board of Governors or the System. The Board of Governors funds the Bureau through assessments on the Reserve Banks as required by the Dodd-Frank Act. The Reserve Banks reviewed the law and evaluated the design of and their relationship to the Bureau and determined that it should not be consolidated in the Bank’s financial statements. b. Gold and Special Drawing Rights Certificates The Secretary of the Treasury is authorized to issue gold certificates to the Reserve Banks. Upon authorization, the Reserve Banks acquire gold certificates by crediting equivalent amounts in dollars to the account established for the Treasury. The gold certificates held by the Reserve Banks are required to be backed by the gold owned by the Treasury. The Treasury may reacquire the gold certificates at any time, and the Reserve Banks must deliver them to the Treasury. At such time, the Treasury’s account is charged, and the Reserve Banks’ gold certificate accounts are reduced. The value of gold for purposes of backing the gold certificates is set by law at $42 2/9 per fine troy ounce. Gold certificates are recorded by the Reserve Banks at original cost. The Board of Governors allocates the gold certificates among the Reserve Banks once a year based on each Reserve Bank’s average Federal Reserve notes outstanding during the preceding 12 months. Special drawing rights (SDR) are issued by the International Monetary Fund (IMF) to its members in proportion to each member’s quota in the IMF at the time of issuance. SDRs serve as a supplement to international www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 51 Notes to Financial Statements monetary reserves and may be transferred from one national monetary authority to another. Under the law providing for U.S. participation in the SDR system, the Secretary of the Treasury is authorized to issue SDR certificates to the Reserve Banks. When SDR certificates are issued to the Reserve Banks, equivalent amounts in U.S. dollars are credited to the account established for the Treasury and the Reserve Banks’ SDR certificate accounts are increased. The Reserve Banks are required to purchase SDR certificates, at the direction of the Treasury, for the purpose of financing SDR acquisitions or for financing exchange-stabilization operations. At the time SDR certificate transactions occur, the Board of Governors allocates the SDR certificates among the Reserve Banks based upon each Reserve Bank’s Federal Reserve notes outstanding at the end of the preceding calendar year. SDR certificates are recorded by the Reserve Banks at original cost. c. Coin The amount reported as coin in the Statements of Condition represents the face value of all United States coin held by the Bank. The Bank buys coin at face value from the U.S. Mint in order to fill depository institution orders. d. Loans Loans to depository institutions are reported at their outstanding principal balances and interest income is recognized on an accrual basis. Loans are impaired when current information and events indicate that it is probable that the Bank will not receive the principal and interest that are due in accordance with the contractual terms of the loan agreement. Impaired loans are evaluated to determine whether an allowance for loan loss is required. The Bank has developed procedures for assessing the adequacy of any allowance for loan losses using all available information to identify incurred losses. This assessment includes monitoring information obtained from banking supervisors, borrowers, and other sources to assess the credit condition of the borrowers and, as appropriate, evaluating collateral values. Generally, the Bank would discontinue recognizing interest income on impaired loans until the borrower’s 52 | Federal Reserve Bank of Philadelphia repayment performance demonstrates principal and interest would be received in accordance with the terms of the loan agreement. If the Bank discontinues recording interest on an impaired loan, cash payments are first applied to principal until the loan balance is reduced to zero; subsequent payments are applied as recoveries of amounts previously deemed uncollectible, if any, and then as interest income. e. Securities Purchased Under Agreements to Resell, Securities Sold Under Agreements to Repurchase, and Securities Lending The FRBNY may engage in purchases of securities under agreements to resell (repurchase agreements) with primary dealers. Transactions under these repurchase agreements are typically settled through a tri-party arrangement. In the United States, there are currently two commercial custodial banks that provide these services. In a tri-party arrangement, a commercial custodial bank manages the collateral clearing, settlement, pricing, and pledging, and provides cash and securities custodial services for and on behalf of the FRBNY and counterparty. The collateral pledged must exceed the principal amount of the transaction by a margin determined by the FRBNY for each class and maturity of acceptable collateral. Collateral designated by the FRBNY as acceptable under repurchase agreements primarily includes Treasury securities (including Treasury Inflation-Protected Securities, Separate Trading of Registered Interest and Principal of Securities Treasury securities, and Treasury Floating Rate Notes); direct obligations of several federal and GSE-related agencies, including Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, and Federal Home Loan Banks; and pass-through federal agency and GSE MBS. The repurchase agreements are accounted for as financing transactions with the associated interest income recognized over the life of the transaction. These repurchase agreements are reported at their contractual amounts as “System Open Market Account: Securities purchased under agreements to resell” and the related accrued interest receivable is reported as a component of “System Open Market Account: Accrued interest receivable” in the Statements of Condition. Interest income is reported as a component of “System Open Market Account: Securities purchased under agreements to resell” in the Statements of Operations. www.philadelphiafed.org Notes to Financial Statements The FRBNY may engage in sales of securities under agreements to repurchase (reverse repurchase agreements) with primary dealers and with a set of expanded counterparties that includes banks, savings associations, GSEs, and domestic money market funds. Transactions under these reverse repurchase agreements are designed to have a margin of zero and are settled through a tri-party arrangement, similar to repurchase agreements. Reverse repurchase agreements may also be executed with foreign official and international account holders as part of a service offering. Reverse repurchase agreements are collateralized by a pledge of an amount of Treasury securities, GSE debt securities, or federal agency and GSE MBS that are held in the SOMA. Reverse repurchase agreements are accounted for as financing transactions, and the associated interest expense is recognized over the life of the transaction. These reverse repurchase agreements are reported at their contractual amounts as “System Open Market Account: Securities sold under agreements to repurchase” and the related accrued interest payable is reported as a component of “System Open Market Account: Other liabilities” in the Statements of Condition. Interest expense is reported as a component of “System Open Market Account: Securities sold under agreements to repurchase” in the Statements of Operations. Treasury securities and GSE debt securities held in the SOMA may be lent to primary dealers, typically overnight, to facilitate the effective functioning of the domestic securities markets. The amortized cost basis of securities lent continues to be reported as “System Open Market Account: Treasury securities, net” and “System Open Market Account: Government-sponsored enterprise debt securities, net,” as appropriate, in the Statements of Condition. Securities lending transactions are fully collateralized by Treasury securities based on the fair values of the securities lent increased by a margin determined by the FRBNY. The FRBNY charges the primary dealer a fee for borrowing securities, and these fees are reported as a component of “Non-interest income (loss): System Open Market Account: Other” in the Statements of Operations. Activity related to repurchase agreements, reverse repurchase agreements, and securities lending is allocated to each of the Reserve Banks on a www.philadelphiafed.org percentage basis derived from an annual settlement of the interdistrict settlement account that occurs in the second quarter of each year. f. Treasury Securities, Government-Sponsored Enterprise Debt Securities, Federal Agency and Government-Sponsored Enterprise Mortgage-Backed Securities, and Foreign Currency Denominated Investments Interest income on Treasury securities, GSE debt securities, and foreign currency denominated investments included in the SOMA is recorded when earned and includes amortization of premiums and accretion of discounts. The Board of Governors approved, effective January 1, 2017, accounting for Treasury securities, GSE debt securities, and foreign government debt instruments held in the SOMA using the effective interest method. Previously, the cost bases of these securities were adjusted for amortization of premiums or accretion of discounts on a straight-line basis. This change was applied prospectively and did not have a material effect on the Bank’s financial statements for the year ended December 31, 2017. Interest income on federal agency and GSE MBS is accrued using the effective interest method and includes amortization of premiums, accretion of discounts, and gains or losses associated with principal paydowns. Premiums and discounts related to federal agency and GSE MBS are amortized or accreted over the term of the security to stated maturity, and the amortization of premiums and accretion of discounts are accelerated when principal payments are received. Gains and losses resulting from sales of securities are determined by specific issue based on average cost. Treasury securities, GSE debt securities, and federal agency and GSE MBS are reported net of premiums and discounts in the Statements of Condition and interest income on those securities is reported net of the amortization of premiums and accretion of discounts in the Statements of Operations. In addition to outright purchases of federal agency and GSE MBS that are held in the SOMA, the FRBNY enters into dollar roll transactions (dollar rolls), which primarily involve an initial transaction to purchase or sell Federal Reserve Bank of Philadelphia | 53 Notes to Financial Statements “to be announced” (TBA) MBS for delivery in the current month combined with a simultaneous agreement to sell or purchase TBA MBS on a specified future date. During the years ended December 31, 2017 and 2016, the FRBNY executed dollar rolls to facilitate settlement of outstanding purchases of federal agency and GSE MBS. The FRBNY accounts for dollar rolls as individual purchases and sales, on a settlement-date basis. Accounting for these transactions as purchases and sales, rather than as financing transactions, is appropriate because the purchase or sale component of the MBS TBA dollar roll is paired off or assigned prior to settlement and, as a result, there is no transfer and return of securities. Net gains (losses) resulting from MBS transactions are reported as a component of “Noninterest income (loss): System Open Market Account: Federal agency and government-sponsored enterprise mortgage-backed securities gains, net” in the Statements of Operations. Foreign currency denominated investments, which can include foreign currency deposits, repurchase agreements, and government debt instruments, are revalued daily at current foreign currency market exchange rates in order to report these assets in U.S. dollars. Any negative interest associated with these foreign currency denominated investments is included as a component of “Interest income: System Open Market Account: Foreign currency denominated investments, net” in the Statements of Operations. Foreign currency translation gains and losses that result from the daily revaluation of foreign currency denominated investments are reported as “Non-interest income (loss): System Open Market Account: Foreign currency translation gains (losses), net” in the Statements of Operations. Because the FRBNY enters into commitments to buy Treasury securities, federal agency and GSE MBS, and foreign government debt instruments and records the related securities on a settlement-date basis in accordance with the FAM, the related outstanding commitments are not reflected in the Statements of Condition. 54 | Federal Reserve Bank of Philadelphia Activity related to Treasury securities, GSE debt securities, and federal agency and GSE MBS, including the premiums, discounts, and realized gains and losses, is allocated to each Reserve Bank on a percentage basis derived from an annual settlement of the interdistrict settlement account that occurs in the second quarter of each year. Activity related to foreign currency denominated investments, including the premiums, discounts, and realized and unrealized gains and losses, is allocated to each Reserve Bank on a percentage basis, adjusted annually in the second quarter of each year, calculated as the ratio of each Reserve Bank’s capital and surplus to the Reserve Banks’ aggregate capital and surplus at the preceding December 31. g. Central Bank Liquidity Swaps Central bank liquidity swaps, which are transacted between the FRBNY and a foreign central bank, can be structured as either U.S. dollar or foreign currency liquidity swap arrangements. Central bank liquidity swaps activity, including the related income and expense, is allocated to each Reserve Bank based on a percentage basis, adjusted annually in the second quarter of each year, calculated as the ratio of each Reserve Bank’s capital and surplus to the Reserve Banks’ aggregate capital and surplus at the preceding December 31. U.S. dollar liquidity swaps At the initiation of each U.S. dollar liquidity swap transaction, the foreign central bank transfers a specified amount of its currency to a restricted account for the FRBNY in exchange for U.S. dollars at the prevailing market exchange rate. Concurrent with this transaction, the FRBNY and the foreign central bank agree to a second transaction that obligates the foreign central bank to return the U.S. dollars and the FRBNY to return the foreign currency on a specified future date at the same exchange rate as the initial transaction. The Bank’s allocated portion of the foreign currency amounts that the FRBNY acquires are reported as “System Open Market Account: Central bank liquidity swaps” in the Statements of Condition. Because the swap transaction will be unwound at the www.philadelphiafed.org Notes to Financial Statements same U.S. dollar amount and exchange rate that were used in the initial transaction, the recorded value of the foreign currency amounts is not affected by changes in the market exchange rate. generally range from two to five years. Maintenance costs and minor replacements related to software are charged to operating expense in the year incurred. The foreign central bank compensates the FRBNY based on the amount outstanding and the rate under the swap agreement. The Bank’s allocated portion of the amount of compensation received during the term of the swap transaction is reported as “Interest income: System Open Market Account: Central bank liquidity swaps” in the Statements of Operations. Capitalized assets, including software, buildings, leasehold improvements, furniture, and equipment, are impaired and an adjustment is recorded when events or changes in circumstances indicate that the carrying amount of assets or asset groups is not recoverable and significantly exceeds the assets’ fair value. Foreign currency liquidity swaps i. Interdistrict Settlement Account Foreign currency liquidity swap transactions involve the transfer by the FRBNY, at the prevailing market exchange rate, of a specified amount of U.S. dollars to an account for the foreign central bank in exchange for its currency. The foreign currency amounts that the FRBNY receives are recorded as a liability. h. Bank Premises, Equipment, and Software Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is calculated on a straight-line basis over the estimated useful lives of the assets, which range from 2 to 50 years. Major alterations, renovations, and improvements are capitalized at cost as additions to the asset accounts and are depreciated over the remaining useful life of the asset or, if appropriate, over the unique useful life of the alteration, renovation, or improvement. Maintenance, repairs, and minor replacements are charged to operating expense in the year incurred. Reserve Banks may transfer assets to other Reserve Banks or may lease property of other Reserve Banks. Costs incurred to acquire software are capitalized based on the purchase price. Costs incurred during the application development stage to develop internal-use software are capitalized based on the cost of direct services and materials associated with designing, coding, installing, and testing the software. Capitalized software costs are amortized on a straight-line basis over the estimated useful lives of the software applications, which www.philadelphiafed.org Each Reserve Bank aggregates the payments due to or from other Reserve Banks. These payments result from transactions between the Reserve Banks and transactions that involve depository institution accounts held by other Reserve Banks, such as Fedwire funds and securities transfers and check and ACH transactions. The cumulative net amount due to or from the other Reserve Banks is reflected in the “Interdistrict settlement account” in the Statements of Condition. An annual settlement of the interdistrict settlement account occurs in the second quarter of each year. As a result of the annual settlement, the balance in each Bank’s interdistrict settlement account is adjusted by an amount equal to the average balance in the account during the previous twelve-month period ended March 31. An equal and offsetting adjustment is made to each Bank’s allocated portion of SOMA assets and liabilities. j. Federal Reserve Notes Federal Reserve notes are the circulating currency of the United States. These notes, which are identified as issued to a specific Reserve Bank, must be fully collateralized. All of the Bank’s assets are eligible to be pledged as collateral. The collateral value is equal to the book value of the collateral tendered with the exception of securities, for which the collateral value is equal to the par value of the securities tendered. The par value of reverse repurchase agreements is deducted from the eligible collateral value. Federal Reserve Bank of Philadelphia | 55 Notes to Financial Statements The Board of Governors may, at any time, call upon a Reserve Bank for additional security to adequately collateralize outstanding Federal Reserve notes. To satisfy the obligation to provide sufficient collateral for outstanding Federal Reserve notes, the Reserve Banks have entered into an agreement that provides for certain assets of the Reserve Banks to be jointly pledged as collateral for the Federal Reserve notes issued to all Reserve Banks. In the event that this collateral is insufficient, the Federal Reserve Act provides that Federal Reserve notes become a first and paramount lien on all the assets of the Reserve Banks. Finally, Federal Reserve notes are obligations of the United States government. “Federal Reserve notes outstanding, net” in the Statements of Condition represents the Bank’s Federal Reserve notes outstanding, reduced by the Bank’s currency holdings of $6,451 million and $6,254 million at December 31, 2017 and 2016, respectively. At December 31, 2017 and 2016, all Federal Reserve notes outstanding, net, were fully collateralized. At December 31, 2017, all gold certificates, all SDR certificates, and $1,554 billion of domestic securities held in the SOMA were pledged as collateral. At December 31, 2017, no investments denominated in foreign currencies were pledged as collateral. k. Deposits Depository institutions Depository institutions’ deposits represent the reserve and servicerelated balances in the accounts that depository institutions hold at the Bank. Required reserve balances are those that a depository institution must hold to satisfy its reserve requirement. Reserve requirements are the amount of funds that a depository institution must hold in reserve against specified deposit liabilities. Excess reserves are those held by the depository institutions in excess of their required reserve balances. The interest rates paid on required reserve balances and excess balances are determined by the Board of Governors, based on an FOMC-established target range for the federal funds rate. Interest expense on depository institutions’ deposits is accrued daily at the appropriate rate. Interest 56 | Federal Reserve Bank of Philadelphia payable is reported as a component of “Interest payable to depository institutions and others” in the Statements of Condition. The Term Deposit Facility (TDF) consists of deposits with specific maturities held by eligible institutions at the Reserve Banks. The Reserve Banks pay interest on these deposits at interest rates determined by auction. Interest expense on depository institutions’ deposits is accrued daily at the appropriate rate. Interest payable is reported as a component of “Interest payable to depository institutions and others” in the Statements of Condition. There were no deposits held by the Bank under the TDF at December 31, 2017 and 2016. Other Other deposits include the Bank’s allocated portion of foreign central bank and foreign government deposits held at the FRBNY. l. Capital Paid-in The Federal Reserve Act requires that each member bank subscribe to the capital stock of the Reserve Bank in an amount equal to 6 percent of the capital and surplus of the member bank. These shares are nonvoting, with a par value of $100, and may not be transferred or hypothecated. As a member bank’s capital and surplus changes, its holdings of Reserve Bank stock must be adjusted. Currently, only one-half of the subscription is paid in, and the remainder is subject to call. A member bank is liable for Reserve Bank liabilities up to twice the par value of stock subscribed by it. The Federal Reserve Act requires each Reserve Bank to pay each member bank an annual dividend based on the amount of the member bank’s paid-in capital stock and a rate determined by the member bank’s total consolidated assets. Member banks with total consolidated assets in excess of a threshold established in the Federal Reserve Act receive a dividend equal to the smaller of 6 percent or the rate equal to the high yield of the 10-year Treasury note auctioned at the last auction held prior to the payment of the dividend. Member banks with total consolidated assets equal to or less than the threshold receive a dividend of 6 percent. www.philadelphiafed.org Notes to Financial Statements The threshold for total consolidated assets was $10.1 billion and $10.0 billion for the years ended December 31, 2017 and 2016, respectively. This threshold is adjusted annually based on the Gross Domestic Product Price Index, which is published by the Bureau of Economic Analysis. The dividend is paid semiannually and is cumulative. m. Surplus The Federal Reserve Act limits aggregate Reserve Bank surplus to $10 billion, which is allocated among the Reserve Banks based on the ratio of each Bank’s capital paid-in to total Reserve Bank capital paid-in as of December 31 of each year. The amount reported as surplus by the Bank as of December 31, 2017 and 2016 represents the Bank’s allocated portion of surplus. Accumulated other comprehensive loss is reported as a component of “Surplus” in the Statements of Condition and the Statements of Changes in Capital. Additional information regarding the classifications of accumulated other comprehensive loss is provided in Notes 9 and 10. n. Earnings Remittances to the Treasury The Federal Reserve Act requires that any amounts of the surplus funds of the Reserve Banks that exceed, or would exceed, the aggregate surplus limitation of $10 billion shall be transferred to the Board of Governors for transfer to the Treasury. The Bank remits excess earnings to the Treasury after providing for the cost of operations, payment of dividends, and reservation of an amount necessary to maintain surplus at the Bank’s allocated portion of the $10 billion aggregate surplus limitation. Remittances to the Treasury are made on a weekly basis. The amount of the remittances to the Treasury is reported as “Earnings remittances to the Treasury” in the Statements of Operations. The amount due to the Treasury is reported as “Accrued remittances to the Treasury” in the Statements of Condition. See Note 12 for additional information on earnings remittances to the Treasury. www.philadelphiafed.org If earnings during the year are not sufficient to provide for the costs of operations, payment of dividends, and maintaining surplus at an amount equal to the Bank’s allocated portion of the $10 billion aggregate surplus limitation, remittances to the Treasury are suspended. This decrease in earnings remittances to the Treasury results in a deferred asset that represents the amount of net earnings a Reserve Bank will need to realize before remittances to the Treasury resume. o. Income and Costs Related to Treasury Services When directed by the Secretary of the Treasury, the Bank is required by the Federal Reserve Act to serve as fiscal agent and depositary of the United States Government. By statute, the Treasury has appropriations to pay for these services. During the years ended December 31, 2017 and 2016, the Bank was reimbursed for all services provided to the Treasury as its fiscal agent. p. Compensation Received for Service Costs Provided The Federal Reserve Bank of Atlanta has overall responsibility for managing the Reserve Banks’ provision of check and ACH services to depository institutions, the FRBNY has overall responsibility for managing the Reserve Banks’ provision of Fedwire funds and securities services, and the Federal Reserve Bank of Chicago has overall responsibility for managing the Reserve Banks’ provision of electronic access services to depository institutions. The Reserve Bank that has overall responsibility for managing these services recognizes the related total System revenue in its Statements of Operations. The Bank is compensated for costs incurred to provide these services by the Reserve Banks responsible for managing these services and reports this compensation as “Non-interest income (loss): Compensation received for service costs provided” in its Statements of Operations. q. Assessments The Board of Governors assesses the Reserve Banks to fund its operations and the operations of the Bureau. These assessments are allocated to each Reserve Bank based on each Reserve Bank’s capital and surplus balances. The Board of Governors also assesses each Reserve Bank for expenses Federal Reserve Bank of Philadelphia | 57 Notes to Financial Statements related to producing, issuing, and retiring Federal Reserve notes based on each Reserve Bank’s share of the number of notes comprising the System’s net liability for Federal Reserve notes on December 31 of the prior year. The Dodd-Frank Act requires that, after the transfer of its responsibilities to the Bureau on July 21, 2011, the Board of Governors fund the Bureau in an amount not to exceed a fixed percentage of the total operating expenses of the System as reported in the Board of Governor’s 2009 annual report, which totaled $4.98 billion. After 2013, the amount will be adjusted annually in accordance with the provisions of the Dodd-Frank Act. The percentage of total operating expenses of the System for the years ended December 31, 2017 and 2016 was 12.98 percent ($646.2 million) and 12.68 percent ($631.7 million), respectively. The Bank’s assessment for Bureau funding is reported as “Operating expenses: Assessments: Bureau of Consumer Financial Protection” in the Statements of Operations. r. Taxes The Reserve Banks are exempt from federal, state, and local taxes, except for taxes on real property. The Bank’s real property taxes were $1 million for each of the years ended December 31, 2017 and 2016, and are reported as a component of “Operating expenses: Occupancy” in the Statements of Operations. s. Restructuring Charges The Reserve Banks recognize restructuring charges for exit or disposal costs incurred as part of the closure of business activities in a particular location, the relocation of business activities from one location to another, or a fundamental reorganization that affects the nature of operations. Restructuring charges may include costs associated with employee separations, contract terminations, and asset impairments. Expenses are recognized in the period in which the Bank commits to a formalized restructuring plan or executes the specific actions contemplated in the plan and all criteria for financial statement recognition have been met. 58 | Federal Reserve Bank of Philadelphia In 2014, the Treasury announced plans to consolidate the provision of substantially all fiscal agent services for the U.S. Treasury at the Federal Reserve Bank of Cleveland, the Federal Reserve Bank of Kansas City, the FRBNY, and the Federal Reserve Bank of St. Louis. The consolidation is expected to be completed in future years. Note 11 describes the Bank’s restructuring initiatives and provides information about the costs and liabilities associated with employee separations and contract terminations. Costs and liabilities associated with enhanced pension benefits in connection with the restructuring activities for all of the Reserve Banks are recorded on the books of the FRBNY. The Bank had no significant restructuring activities in 2017 and 2016. t. Recently Issued Accounting Standards Other than the significant differences described in Note 3, the accounting policies described in FAM are generally consistent with those in GAAP. The following items represent recent GAAP accounting standards and describe how FAM was or will be revised to be consistent with these standards. In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606). This update was issued to create common revenue recognition guidance for U.S. GAAP and International Financial Reporting Standards. The guidance is applicable to all contracts for the transfer of goods or services regardless of industry or type of transaction. This update requires recognition of revenue in a manner that reflects the consideration that the entity expects to receive in return for the transfer of goods or services to customers. Subsequently, the FASB issued a number of related ASUs including ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date; ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net); ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing; ASU 2016-12, Revenue from Contracts with Customers (Topic 606): www.philadelphiafed.org Notes to Financial Statements Narrow-Scope Improvements and Practical Expedients; and ASU 201620, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. This revenue recognition accounting guidance is effective for the Bank for the year ending December 31, 2019, although the Bank may elect to adopt the guidance earlier. The Bank is continuing to evaluate the effect of this new guidance on its financial statements. In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this update eliminate the requirement to disclose methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost on the balance sheet. This update is effective for the Bank for the year ending December 31, 2019 and is not expected to have a material effect on the Bank’s financial statements. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This update revises the model to assess how a lease should be classified and provides guidance for lessees, requiring lessees to present right-of-use assets and lease liabilities on the balance sheet. The update is effective for the Bank for the year ending December 31, 2020, although earlier adoption is permitted. The Bank is continuing to evaluate the effect of this new guidance on its financial statements. In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This update revises the methodology for assessing expected credit losses and requires consideration of reasonable and supportable information to inform credit loss estimates. The update is effective for the Bank for the year ending December 31, 2021, although earlier adoption is permitted. The Bank is continuing to evaluate the effect of this new guidance on its financial statements. www.philadelphiafed.org In December 2016, the FASB issued ASU 2016-19, Technical Corrections and Improvements. This update covers a wide range of topics in the accounting standard codification and addresses differences between original guidance and the codification. It provides clarification of certain guidance including reference corrections and makes minor improvements to accounting standards. This update was effective for the Bank for the year ended December 31, 2016 and did not have an impact on the Bank’s financial statements. In March 2017, the FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. This update requires an employer to disaggregate the service cost component from the other components of net benefit cost. It also provides explicit guidance on how to present the service cost component and the other components of net benefit cost in the income statement and allows only the service cost component of net benefit cost to be eligible for capitalization. This update is effective for the Bank for the year ending December 31, 2019, and the Bank is continuing to evaluate the effect of this new guidance on its financial statements. (4) LOANS Loans to Depository Institutions The Bank offers primary, secondary, and seasonal loans to eligible borrowers (depository institutions that maintain reservable transaction accounts or nonpersonal time deposits and have established discount window borrowing privileges). Each program has its own interest rate and interest is accrued using the applicable interest rate established at least every 14 days by the Bank’s board of directors, subject to review and determination by the Board of Governors. Primary and secondary loans are extended on a short-term basis, typically overnight, whereas seasonal loans may be extended for a period of up to nine months. Federal Reserve Bank of Philadelphia | 59 Notes to Financial Statements Primary, secondary, and seasonal loans are collateralized to the satisfaction of the Bank to reduce credit risk. Assets eligible to collateralize these loans include consumer, business, and real estate loans; Treasury securities; GSE debt securities; foreign sovereign debt; municipal, corporate, and state and local government obligations; asset-backed securities; corporate bonds; commercial paper; and bank-issued assets, such as certificates of deposit, bank notes, and deposit notes. Collateral is assigned a lending value that is deemed appropriate by the Bank, which is typically fair value reduced by a margin. Loans to depository institutions are monitored daily to ensure that borrowers continue to meet eligibility requirements for these programs. If a borrower no longer qualifies for these programs, the Bank will generally request full repayment of the outstanding loan or, for primary or seasonal loans, may convert the loan to a secondary credit loan. Collateral levels are reviewed daily against outstanding obligations, and borrowers that no longer have sufficient collateral to support outstanding loans are required to provide additional collateral or to make partial or full repayment. The Bank had no loans outstanding as of December 31, 2017 and 2016. At December 31, 2017 and 2016, the Bank did not have any loans that were impaired, restructured, past due, or on non-accrual status, and no allowance for loan losses was required. There were no impaired loans during the years ended December 31, 2017 and 2016. Interest income attributable to loans to depository institutions was immaterial during the years ended December 31, 2017 and 2016. (5) SYSTEM OPEN MARKET ACCOUNT a. Domestic Securities Holdings Pursuant to FOMC directives, during the year ended December 31, 2016 and through September 30, 2017, the FRBNY continued to reinvest all principal payments from the SOMA’s holdings of GSE debt securities and federal agency and GSE MBS in federal agency and GSE MBS and to roll over maturing Treasury securities at auction. In October 2017, the FOMC initiated a balance sheet normalization program intended to reduce gradually the SOMA holdings by decreasing reinvestment of the principal payments received from securities held in the SOMA through the implementation of monthly caps. Effective from October 2017 and through December 2017, the FOMC directed the FRBNY to roll over principal payments from the SOMA holdings of Treasury securities maturing during each calendar month that exceeded a $6 billion cap, and to reinvest in federal agency and GSE MBS the amount of principal payments from the SOMA holdings of GSE debt securities and federal agency and GSE MBS received during each calendar month that exceeded a $4 billion cap. According to the balance sheet normalization plan, the FOMC anticipates that it will increase the monthly cap on Treasury redemptions in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month, and that it will increase the monthly cap on GSE debt securities and federal agency and GSE MBS paydowns in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month. The FOMC also anticipates that the caps will remain in place once they reach their respective maximums so that the SOMA holdings will continue to decline in a gradual and predictable manner until the FOMC judges that the SOMA is holding no more securities than necessary to implement monetary policy efficiently and effectively. The Bank’s allocated share of activity related to domestic open market operations was 2.582 percent and 2.715 percent at December 31, 2017 and 2016, respectively. The FRBNY executes domestic open market operations and, on behalf of the Reserve Banks, holds the resulting securities in the SOMA. 60 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org Notes to Financial Statements The Bank’s allocated share of Treasury securities, GSE debt securities, and federal agency and GSE MBS, net, excluding accrued interest, held in the SOMA at December 31, 2017 and 2016 was as follows (in millions): 2017 Par Unamortized premiums 41,947 $ Unaccreted discounts Total amortized cost Treasury securities Notes $ Bonds Total Treasury securities 21,420 250 $ 2,467 (122) $ (232) 42,075 23,655 $ 63,367 $ 2,717 $ (354) $ 65,730 GSE debt securities $ 113 $ 10 $ - $ 123 Federal agency and GSE MBS $ 45,570 $ 1,372 $ (10) $ 46,932 2016 Par Unamortized premiums 44,480 $ Unaccreted discounts Total amortized cost Treasury securities Notes $ Bonds Total Treasury securities 22,413 401 $ (152) 2,816 $ 44,729 (247) 24,982 $ 66,893 $ 3,217 $ (399) $ 69,711 GSE debt securities $ 439 $ 13 $ - $ 452 Federal agency and GSE MBS $ 47,283 $ 1,466 $ (11) $ 48,738 There were no material transactions related to repurchase agreements during the years ended December 31, 2017 and 2016. www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 61 Notes to Financial Statements During the years ended December 31, 2017 and 2016, the FRBNY entered into reverse repurchase agreements as part of its monetary policy activities. These operations have been undertaken as necessary to maintain the federal funds rate in a target range. In addition, reverse repurchase agreements are entered into as part of a service offering to foreign official and international account holders. Financial information related to reverse repurchase agreements allocated to the Bank and held in the SOMA for the years ended December 31, 2017 and 2016 was as follows (in millions): Allocated to the Bank 2017 Primary dealers and expanded counterparties: Contract amount outstanding, end of year $ Total SOMA 2016 8,252 $ 2017 12,717 $ 2016 319,595 $ 468,355 Average daily amount outstanding, during the year 3,834 2,817 145,959 105,648 Maximum balance outstanding, during the year 12,717 12,717 468,355 474,592 Securities pledged (par value), end of year 7,815 12,050 302,690 443,799 Securities pledged (fair value), end of year 8,263 12,742 320,048 469,282 244,363 $ 256,855 Foreign official and international accounts: Contract amount outstanding, end of year $ 6,309 $ 6,974 $ Average daily amount outstanding, during the year 6,332 6,414 241,581 241,848 Maximum balance outstanding, during the year 7,176 7,196 264,290 265,041 Securities pledged (par value), end of year 6,214 6,772 240,660 249,417 Securities pledged (fair value), end of year 6,311 6,975 244,417 256,897 Total contract amount outstanding, end of year $ 14,561 $ 19,691 $ 563,958 $ 725,210 $ 32 $ 8 $ 1,224 $ 303 819 Supplemental information - interest expense: Primary dealers and expanded counterparties Foreign official and international accounts 56 22 2,141 88 30 3,365 Total interest expense - securities sold under agreements to repurchase $ $ $ $ 1,122 Securities pledged as collateral, at December 31, 2017 and 2016, consisted solely of Treasury securities. The contract amount outstanding as of December 31, 2017 of reverse repurchase agreements that were transacted with primary dealers and expanded counterparties had a term of one business day and matured on January 2, 2018. The contract amount outstanding as of December 31, 2017 of reverse repurchase agreements that were transacted with foreign official and international account holders had a term of one business day and matured on January 2, 2018. 62 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org Notes to Financial Statements The remaining maturity distribution of Treasury securities, GSE debt securities, federal agency and GSE MBS bought outright, and reverse repurchase agreements that were allocated to the Bank at December 31, 2017 and 2016 was as follows (in millions): December 31, 2017: Over 1 year to 5 years Over 5 years to 10 years Over 10 years Total $ 8,144 $ 27,815 $ 8,014 $ 16,082 $ 63,367 - 51 2 - 60 113 - - - 4 517 45,049 45,570 14,561 - - - - - 14,561 402 $ 1,120 $ 4,094 $ 33,244 $ 10,841 $ 17,192 $ 66,893 - 77 243 55 - 64 439 - - - 2 287 46,994 47,283 19,691 - - - - - 19,691 Within 15 days 16 days to 90 days $ 532 $ 2,780 - 91 days to 1 year Treasury securities (par value) GSE debt securities (par value) Federal agency and GSE MBS (par value)1 Securities sold under agreements to repurchase (contract amount) December 31, 2016: Treasury securities (par value) $ GSE debt securities (par value) Federal agency and GSE MBS (par value)1 Securities sold under agreements to repurchase (contract amount) 1 The par amount shown for federal agency and GSE MBS is the remaining principal balance of the securities. Federal agency and GSE MBS are reported at stated maturity in the table above. The estimated weighted-average life of these securities, which differs from the stated maturity primarily because it factors in scheduled payments and prepayment assumptions, was approximately 6.9 and 7.2 years as of December 31, 2017 and 2016, respectively. www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 63 Notes to Financial Statements The amortized cost and par value of Treasury securities and GSE debt securities that were loaned from the SOMA under securities lending agreements allocated to the Bank and held in the SOMA at December 31, 2017 and 2016 were as follows (in millions): Allocated to the Bank 2017 Treasury securities (amortized cost) $ 2017 2016 684 $ 28,053 $ 25,195 697 671 26,990 24,698 GSE debt securities (amortized cost) - 1 - 44 GSE debt securities (par value) - 1 - 44 Treasury securities (par value) $ 724 2016 Total SOMA Securities pledged as collateral by the counterparties in the securities lending arrangements at December 31, 2017 and 2016 consisted solely of Treasury securities. The securities lending agreements outstanding as of December 31, 2017 had a term of one business day and matured on January 2, 2018. The FRBNY enters into commitments to buy and sell Treasury securities and records the related securities on a settlement-date basis. As of December 31, 2017, the total purchase price of the Treasury securities under outstanding commitments was $11,447 million of which $296 million was allocated to the Bank. These commitments had contractual settlement dates extending through January 2, 2018. The FRBNY enters into commitments to buy and sell federal agency and GSE MBS and records the related securities on a settlement-date basis. As of December 31, 2017, the total purchase price of the federal agency and GSE MBS under outstanding purchase commitments was $19,257 million, none of which was related to dollar rolls. The total purchase price of outstanding purchase commitments allocated to the Bank was $497 million, none of which was related to dollar rolls. These commitments, which had contractual settlement dates extending through January 2018, are for the purchase of TBA MBS for which the number and identity of the pools that will be delivered to fulfill the commitment are unknown at 64 | Federal Reserve Bank of Philadelphia the time of the trade. As of December 31, 2017, there were no outstanding sales commitments for federal agency and GSE MBS. MBS commitments are subject to varying degrees of off-balance-sheet market risk and counterparty credit risk that result from their future settlement. The FRBNY requires the posting of cash collateral for MBS commitments as part of its risk management practices used to mitigate the counterparty credit risk. Other liabilities, which are primarily related to federal agency and GSE MBS purchases and sales, include the FRBNY’s obligation to return cash margin posted by counterparties as collateral under commitments to purchase and sell federal agency and GSE MBS. In addition, other liabilities include obligations that arise from the failure of a seller to deliver MBS to the FRBNY on the settlement date. Although the FRBNY has ownership of and records its investments in the MBS as of the contractual settlement date, it is not obligated to make payment until the securities are delivered, and the amount included in other liabilities represents the FRBNY’s obligation to pay for the securities when delivered. The amount of other liabilities allocated to the Bank and held in the SOMA at December 31, 2017 and 2016 was as follows (in millions): Allocated to the Bank Total SOMA 2017 2016 2017 2016 Other liabilities: Cash margin $ 12 $ 27 $ 481 $ 983 - - 14 9 2 - 63 20 27 $ 558 $ 1,012 Obligations from MBS transaction fails Other Total other liabilities $ 14 $ Accrued interest receivable on domestic securities holdings held in the SOMA was $24,655 million and $25,517 million as of December 31, 2017 and 2016, respectively, of which $637 million and $693 million, respectively, was allocated to the Bank. These amounts are reported as a component of “System Open Market Account: Accrued interest receivable” in the Statements of Condition. www.philadelphiafed.org Notes to Financial Statements Information about transactions related to Treasury securities, GSE debt securities, and federal agency and GSE MBS allocated to the Bank and held in the SOMA during the years ended December 31, 2017 and 2016, is summarized as follows (in millions): Allocated to the Bank Notes Balance at December 31, 2015 $ 23,167 $ 64,186 5,052 368 (15) (2) (1) GSE debt securities $ 44,780 5,420 - 10,318 (17) - (6) 1 - - 1 (4,964) (445) (5,409) (446) (10,147) (133) (267) (400) (9) (358) 16 40 56 - - 3,755 2,120 5,875 68 4,150 $ 44,729 $ 24,982 $ 69,711 452 $ 48,738 4,237 414 4,651 - 8,532 (3) (8) (11) - (9) - 1 1 - - (4,617) (346) (4,963) (308) (7,608) (100) (207) (307) (3) (276) Sales1 Realized gains (losses), net2 Principal payments and maturities Amortization of premiums and accretion of discounts, net Inflation adjustment on inflation-indexed securities Annual reallocation adjustment3 Purchases1 Sales 1 Realized gains (losses), net2 Principal payments and maturities Amortization of premiums and accretion of discounts, net Inflation adjustment on inflation-indexed securities $ Federal agency and GSE MBS 839 Purchases $ 19 48 67 - - (2,190) (1,229) (3,419) (18) (2,445) $ 42,075 $ 23,655 $ 65,730 $ 123 $ 46,932 $ $ $ $ - Annual reallocation adjustment3 Balance at December 31, 2017 Bonds $ 41,019 1 Balance at December 31, 2016 Total Treasury securities Year-ended December 31, 2016 Supplemental information - par value of transactions: Purchases4 Sales 5,059 (15) 368 (1) 5,427 (16) $ - 9,945 (6) Year-ended December 31, 2017 Supplemental information - par value of transactions: Purchases4 Sales $ 4,248 (3) $ 417 (7) $ 4,665 (10) $ - $ 8,277 (8) Purchases and sales may include payments and receipts related to principal, premiums, discounts, and inflation compensation adjustments to the basis of inflation-indexed securities. The amount reported as sales includes the realized gains and losses on such transactions. Purchases and sales exclude MBS TBA transactions that are settled on a net basis. ² Realized gains (losses), net is the offset of the amount of realized gains and losses included in the reported sales amount. ³ Reflects the annual adjustment to the Bank’s allocated portion of the related SOMA securities that results from the annual settlement of the interdistrict settlement account, as discussed in Note 3i. ⁴ Includes inflation compensation. 1 www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 65 Notes to Financial Statements Total SOMA Notes Balance at December 31, 2015 Federal agency and GSE MBS $ 931,448 $ 2,580,676 $ 33,748 $ 1,800,449 190,992 13,882 204,874 - 387,210 (534) (62) (596) - (213) (22) 7 (15) - 6 (187,843) (16,597) (204,440) (16,764) (379,065) (5,049) (10,033) (15,082) (336) (13,384) Sales 1 Realized gains (losses), net2 Principal payments and maturities Amortization of premiums and accretion of discounts, net Inflation adjustment on inflation-indexed securities 567 1,438 2,005 - - $ 1,647,339 $ 920,083 $ 2,567,422 $ 16,648 $ 1,795,003 161,378 15,849 177,227 - 324,524 (124) (326) (450) - (331) (2) 30 28 - 2 (175,933) (13,402) (189,335) (11,789) (290,939) (3,796) (7,917) (11,713) (107) (10,559) 709 1,845 2,554 - - $ 1,629,571 $ 916,162 $ 2,545,733 $ 4,752 $ 1,817,700 $ $ 13,868 $ 205,099 $ (45) (600) 15,976 $ 177,772 (275) (400) Purchases1 Sales1 Realized gains (losses), net2 Principal payments and maturities Amortization of premiums and accretion of discounts, net Inflation adjustment on inflation-indexed securities Balance at December 31, 2017 Bonds GSE debt securities $ 1,649,228 Purchases1 Balance at December 31, 2016 Total Treasury securities Year-ended December 31, 2016 Supplemental information - par value of transactions: Purchases3 Sales 191,231 (555) - $ - 373,197 (203) Year-ended December 31, 2017 Supplemental information - par value of transactions: Purchases3 Sales $ 161,796 (125) $ $ - $ 314,797 (320) Purchases and sales may include payments and receipts related to principal, premiums, discounts, and inflation compensation adjustments to the basis of inflation-indexed securities. The amount reported as sales includes the realized gains and losses on such transactions. Purchases and sales exclude MBS TBA transactions that are settled on a net basis. 2 Realized gains (losses), net is the offset of the amount of realized gains and losses included in the reported sales amount. 3 Includes inflation compensation. 1 66 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org Notes to Financial Statements b. Foreign Currency Denominated Investments The FRBNY conducts foreign currency operations and, on behalf of the Reserve Banks, holds the resulting foreign currency denominated investments in the SOMA. The FRBNY holds foreign currency deposits with foreign central banks and invests in foreign government debt instruments of France, Germany, the Netherlands, and Japan. These foreign government debt instruments are backed by the full faith and credit of the issuing foreign governments. In addition, the FRBNY may enter into repurchase agreements to purchase government debt securities for which the accepted collateral is the debt instruments issued by a foreign government. At December 31, 2017 and 2016, there were no repurchase agreements outstanding and, consequently, no related foreign securities held as collateral. Information about foreign currency denominated investments recorded at amortized cost and valued at foreign currency market exchange rates allocated to the Bank and held in the SOMA at December 31, 2017 and 2016 was as follows (in millions): Allocated to the Bank 2017 2016 Total SOMA 2017 2016 Euro: Foreign currency deposits $ 326 $ 231 $ 6,070 $ 4,205 French government debt instruments 166 214 3,089 3,892 German government debt instruments 120 104 2,239 1,884 88 81 1,626 1,462 364 257 6,765 4,668 Dutch government debt instruments Japanese yen: Foreign currency deposits The Bank’s allocated share of activity related to foreign currency operations was 5.377 percent and 5.502 percent at December 31, 2017 and 2016, respectively. Japanese government debt instruments Total 82 183 1,527 3,331 $ 1,146 $ 1,070 $ 21,316 $ 19,442 Net interest income earned on foreign currency denominated investments for the years ended December 31, 2017 and 2016 was immaterial for the Bank and held in the SOMA as follows (in millions): Total SOMA 2017 2016 $ (19) $ (11) 2 4 Net interest income:1 Euro Japanese yen Total net interest income $ (17) $ (7) As a result of negative interest rates in certain foreign currency denominated investments held in the SOMA, interest income on foreign currency denominated investments, net contains negative interest of $36 million and $32 million for the years ended December 31, 2017 and 2016, respectively. 1 www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 67 Notes to Financial Statements Accrued interest receivable on foreign currency denominated investments, net was $82 million and $79 million as of December 31, 2017 and 2016, respectively, of which $4 million was allocated to the Bank. These amounts are reported as a component of “System Open Market Account: Accrued interest receivable” in the Statements of Condition. The remaining maturity distribution of foreign currency denominated investments that were allocated to the Bank at December 31, 2017 and 2016 was as follows (in millions): Within 15 days 16 days to 90 days 91 days to 1 year Over 1 year to 5 years Over 5 years to 10 years Total December 31, 2017: Euro Japanese yen Total $ 331 $ 364 5 $ 66 $ 168 $ 130 3 14 65 - $ 700 446 $ 695 $ 8 $ 80 $ 233 $ 130 $ 1,146 $ 234 $ 18 $ 64 $ 175 $ 139 $ December 31, 2016: Euro Japanese yen Total 630 266 19 74 81 - 440 $ 500 $ 37 $ 138 $ 256 $ 139 $ 1,070 There were no foreign exchange contracts related to foreign currency operations outstanding as of December 31, 2017. The FRBNY enters into commitments to buy foreign government debt instruments and records the related securities on a settlement-date basis. As of December 31, 2017, there were no outstanding commitments to purchase foreign government debt instruments. During 2017, there were purchases and maturities of foreign government debt instruments of $576 million and $3,567 million, respectively, of which $31 million and $193 million, respectively, were allocated to the Bank. There were immaterial sales of foreign government debt instruments in 2017. In connection with its foreign currency activities, the FRBNY may enter into transactions that are subject to varying degrees of off-balance-sheet market risk and counterparty credit risk that result from their future settlement. The FRBNY controls these risks by obtaining credit approvals, establishing transaction limits, receiving collateral in some cases, and performing monitoring procedures. Foreign currency working balances held and foreign exchange contracts executed by the Bank to facilitate international payments and currency transactions made on behalf of foreign central banks and U.S. official institution customers were immaterial as of December 31, 2017 and 2016. 68 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org Notes to Financial Statements c. Central Bank Liquidity Swaps U.S. Dollar Liquidity Swaps The Bank’s allocated share of U.S. dollar liquidity swaps was 5.377 percent and 5.502 percent at December 31, 2017 and 2016, respectively. The total foreign currency held in the SOMA under U.S. dollar liquidity swaps at December 31, 2017 and 2016 was $12,067 million and $5,563 million, respectively, of which $649 million and $306 million, respectively, was allocated to the Bank. The remaining maturity distribution of U.S. dollar liquidity swaps that were allocated to the Bank at December 31, 2017 and 2016 was as follows (in millions): 2017 2016 Within 15 days Within 15 days Euro Japanese yen Total $ 640 $ 239 9 67 $ 649 $ 306 holdings can be substantially greater than or less than the recorded value at any point in time, these unrealized gains or losses have no effect on the ability of the Reserve Banks, as the central bank, to meet their financial obligations and responsibilities. Because SOMA securities are recorded at amortized cost, cumulative unrealized gains (losses) are not recognized in the Statements of Condition and the changes in cumulative unrealized gains (losses) are not recognized in the Statements of Operations. The fair value of the Treasury securities, GSE debt securities, federal agency and GSE MBS, and foreign government debt instruments held in the SOMA is subject to market risk, arising from movements in market variables such as interest rates and credit risk. The fair value of federal agency and GSE MBS is also affected by the expected rate of prepayments of mortgage loans underlying the securities. The fair value of foreign government debt instruments is also affected by currency risk. Based on evaluations performed as of December 31, 2017 and 2016, there are no credit impairments of SOMA securities holdings. Foreign Currency Liquidity Swaps At December 31, 2017 and 2016, there was no balance outstanding related to foreign currency liquidity swaps. d. Fair Value of SOMA Assets and Liabilities The fair value amounts below are presented solely for informational purposes and are not intended to comply with the fair value disclosures required by FASB Accounting Standards Codification (ASC) Topic 820 (ASC 820), Fair Value Measurement. Although the fair value of SOMA security www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 69 Notes to Financial Statements The following table presents the amortized cost, fair value, and cumulative unrealized gains (losses) on the Treasury securities, GSE debt securities, and federal agency and GSE MBS allocated to the Bank and held in the SOMA at December 31, 2017 and 2016 (in millions): Allocated to the Bank 2017 Amortized cost Fair value 2016 Cumulative unrealized gains (losses), net Amortized cost Fair value Cumulative unrealized gains (losses), net Treasury securities: Notes $ Bonds Total Treasury securities GSE debt securities $ 41,945 $ (130) $ 44,729 $ 44,992 $ 263 23,655 26,038 2,383 24,982 26,709 1,727 65,730 67,983 2,253 69,711 71,701 1,990 123 139 16 452 474 22 46,932 46,731 (201) 48,738 48,533 (205) $ 112,785 $ 114,853 $ 2,068 $ 118,901 $ 120,708 $ 1,807 $ $ $ - $ $ $ 1 Federal agency and GSE MBS Total domestic SOMA portfolio securities holdings 42,075 Memorandum - Commitments for: Purchases of Treasury securities Purchases of Federal agency and GSE MBS 296 497 296 498 317 1 972 318 977 5 Total SOMA 2016 2017 Cumulative unrealized gains (losses), net Fair value Cumulative unrealized gains (losses), net $ 1,629,571 $ 1,624,540 $ (5,031) 916,162 1,008,468 92,306 920,083 983,680 63,597 2,545,733 2,633,008 87,275 2,567,422 2,640,706 73,284 Amortized cost Amortized cost Fair value Treasury securities: Notes Bonds Total Treasury securities GSE debt securities $ 1,657,026 $ 9,687 4,752 5,383 631 16,648 17,442 794 1,817,700 1,809,918 (7,782) 1,795,003 1,787,484 (7,519) $ 4,368,185 $ 4,448,309 $ 80,124 $ 4,379,073 $ 4,445,632 $ 66,559 $ $ $ $ $ $ Federal agency and GSE MBS Total domestic SOMA portfolio securities holdings $ 1,647,339 Memorandum - Commitments for: Purchases of Treasury securities Purchases of Federal agency and GSE MBS 70 | Federal Reserve Bank of Philadelphia 11,447 19,257 11,467 19,285 20 28 11,679 35,787 11,719 35,974 40 187 www.philadelphiafed.org Notes to Financial Statements The fair value of Treasury securities and GSE debt securities was determined using pricing services that provide market consensus prices based on indicative quotes from various market participants. The fair value of federal agency and GSE MBS was determined using a pricing service that utilizes a model-based approach that considers observable inputs for similar securities. The cost bases of repurchase agreements, reverse repurchase agreements, central bank liquidity swaps, and other investments held in the SOMA portfolio approximate fair value. Due to the short-term nature of these agreements and the defined amount that will be received upon settlement, the cost basis is estimated to approximate fair value. At December 31, 2017 and 2016, the fair value of foreign currency denominated investments held in the SOMA was $21,348 million and $19,510 million, respectively, of which $1,148 million and $1,073 million, respectively, was allocated to the Bank. The fair value of foreign government debt instruments was determined using pricing services that provide market consensus prices based on indicative quotes from various market participants. The fair value of foreign currency deposits was determined by reference to market interest rates. The following table provides additional information on the amortized cost and fair value of the federal agency and GSE MBS portfolio held in the SOMA and allocated to the Bank at December 31, 2017 and 2016 (in millions): Distribution of MBS holdings by coupon rate Amortized cost 2016 Fair value Amortized cost Fair value Allocated to the Bank: 2.0% $ 232 $ 226 $ 287 $ 278 2.5% 2,852 2,798 3,294 3,221 3.0% 17,406 17,065 18,831 18,370 3.5% 16,282 16,273 15,240 15,219 4.0% 7,483 7,536 7,484 7,599 4.5% 1,758 1,856 2,345 2,501 5.0% 732 776 997 1,063 5.5% 163 174 225 243 6.0% 22 24 31 34 6.5% 2 3 4 5 Total $ 46,932 $ 8,968 $ 46,731 $ 8,739 $ 48,738 $ 10,556 $ 48,533 Total SOMA: 2.0% $ 10,243 2.5% 110,452 108,371 121,326 118,641 3.0% 674,138 660,939 693,524 676,572 3.5% 630,590 630,245 561,271 560,510 4.0% 289,819 291,868 275,650 279,877 4.5% 68,069 71,896 86,351 92,111 5.0% 28,352 30,048 36,708 39,159 5.5% 6,318 6,739 8,298 8,939 6.0% 870 939 1,155 1,253 6.5% 124 134 164 179 $ 1,817,700 $ 1,809,918 $ 1,795,003 $ 1,787,484 Total www.philadelphiafed.org 2017 Federal Reserve Bank of Philadelphia | 71 Notes to Financial Statements The following tables present the realized gains (losses) and the change in the cumulative unrealized gains (losses) related to SOMA domestic securities holdings allocated to the Bank and held in the SOMA during the years ended December 31, 2017 and 2016 (in millions): Allocated to Bank 2017 Realized gains, net1 Treasury securities $ 1 2016 Change in cumulative unrealized gains (losses)2, 4 $ Change in cumulative unrealized gains (losses)2, 4 Realized gains, net3 398 $ - $ (797) GSE debt securities - (4) - (17) Federal agency and GSE MBS - 9 1 (540) Total $ 1 $ 403 $ 1 $ (1,354) Total SOMA 2017 Realized gains, net1,3 Treasury securities $ GSE debt securities Federal agency and GSE MBS Total $ 2016 Change in cumulative unrealized gains (losses)2 28 $ 13,991 - (163) 8 (263) 36 $ 13,565 Change in cumulative unrealized gains (losses)2 Realized (losses) gains, net1,3 $ (15) $ - (623) 19 $ 4 (21,949) (17,326) $ (39,898) ¹ Realized gains (losses) for Treasury securities are reported in “Non-interest income (loss): System Open Market Account: Treasury securities gains, net” in the Statements of Operations. ² Because SOMA securities are recorded at amortized cost, the change in the cumulative unrealized gains (losses) is not reported in the Statements of Operations. ³ Realized gains for federal agency and GSE MBS are reported in “Non-interest income (loss): System Open Market Account: Federal agency and government-sponsored enterprise mortgage-backed securities gains, net” in the Statements of Operations. ⁴ The amount reported as change in cumulative unrealized gains (losses) allocated to the Bank is affected by the annual adjustment to the Bank’s allocated portion of the related SOMA securities, as discussed in Note 3f. 72 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org Notes to Financial Statements The amount of change in cumulative unrealized gains (losses) position, net related to foreign currency denominated investments was a loss of $36 million and a gain of $5 million for the years ended December 31, 2017 and 2016, respectively, of which $2 million and $277 thousand, respectively, were allocated to the Bank. Realized gains, net related to foreign currency denominated investments was an immaterial amount for the year ended December 31, 2017 and zero for the year ended December 31, 2016. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 establishes a three-level fair value hierarchy that distinguishes between assumptions developed using market data obtained from independent sources (observable inputs) and the Bank’s assumptions developed using the best information available in the circumstances (unobservable inputs). The three levels established by ASC 820 are described as follows: Treasury securities, GSE debt securities, federal agency and GSE MBS, and foreign government debt instruments are classified as Level 2 within the ASC 820 hierarchy because the fair values are based on indicative quotes and other observable inputs obtained from independent pricing services. The fair value hierarchy level of SOMA financial assets is not necessarily an indication of the risk associated with those assets. (6) BANK PREMISES, EQUIPMENT, AND SOFTWARE Bank premises and equipment at December 31, 2017 and 2016 were as follows (in millions): 2017 Bank premises and equipment: Land and land improvements $ Buildings • • • Level 1 – Valuation is based on quoted prices for identical instruments traded in active markets. Level 2 – Valuation is based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 3 – Valuation is based on model-based techniques that use significant inputs and assumptions not observable in the market. These unobservable inputs and assumptions reflect the Bank’s estimates of inputs and assumptions that market participants would use in pricing the assets and liabilities. Valuation techniques include the use of option pricing models, discounted cash flow models, and similar techniques. www.philadelphiafed.org Building machinery and equipment Construction in progress Furniture and equipment Subtotal Accumulated depreciation Bank premises and equipment, net 8 2016 $ 8 120 116 28 29 3 1 43 47 202 201 (117) (116) $ 85 $ 85 $ 9 $ 9 Depreciation expense, for the years ended December 31 Federal Reserve Bank of Philadelphia | 73 Notes to Financial Statements The Bank leases space to outside tenants with remaining lease terms ranging from five to nine years. Rental income from such leases was $3 million and $2 million for the years ended December 31, 2017 and 2016, respectively, and is reported as a component of “Non-interest income (loss): Other” in the Statements of Operations. Future minimum lease payments that the Bank will receive under non-cancelable lease agreements in existence at December 31, 2017, are as follows (in millions): 2018 $ 3 2019 3 2020 3 2021 3 2022 3 Thereafter 7 Total $ 22 The Bank had capitalized software assets, net of amortization, of $6 million and $15 million at December 31, 2017 and 2016, respectively. Amortization expense was $2 million and $3 million for the years ended December 31, 2017 and 2016, respectively. Capitalized software assets are reported as a component of “Other assets” in the Statements of Condition and the related amortization is reported as a component of “Operating expenses: Other” in the Statements of Operations. (7) COMMITMENTS AND CONTINGENCIES In conducting its operations, the Bank enters into contractual commitments, normally with fixed expiration dates or termination provisions, at specific rates and for specific purposes. At December 31, 2017, the Bank was obligated under non-cancelable leases for premises and equipment with remaining terms ranging from one to approximately two years. These leases provide for increased lease 74 | Federal Reserve Bank of Philadelphia payments based upon increases in real estate taxes, operating costs, or selected price indexes. 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), was $2 million and $1 million for the years ended December 31, 2017 and 2016, respectively. Future minimum lease payments under non-cancelable operating leases with remaining terms of one year or more, at December 31, 2017, are as follows (in thousands): Operating leases 2018 $ 492 2019 41 Future minimum lease payments $ 533 At December 31, 2017, there were no material unrecorded unconditional purchase commitments or obligations in excess of one year. Under the Insurance Agreement of the Reserve Banks, each of the Reserve Banks has agreed to bear, on a per-incident basis, a share of certain losses in excess of 1 percent of the capital paid-in of the claiming Reserve Bank, up to 50 percent of the total capital paid-in of all Reserve Banks. Losses are borne in the ratio of a Reserve Bank’s capital paid-in to the total capital paid-in of all Reserve Banks at the beginning of the calendar year in which the loss is shared. No claims were outstanding under the agreement at December 31, 2017 and 2016. The Bank is involved in certain legal actions and claims arising in the ordinary course of business. Although it is difficult to predict the ultimate outcome of these actions, in management’s opinion, based on discussions with counsel, the legal actions and claims will be resolved without material adverse effect on the financial position or results of operations of the Bank. www.philadelphiafed.org Notes to Financial Statements (8) RETIREMENT AND THRIFT PLANS Retirement Plans The Bank currently offers three defined benefit retirement plans to its employees, based on length of service and level of compensation. Substantially all of the employees of the Reserve Banks, Board of Governors, and Office of Employee Benefits of the Federal Reserve System (OEB) participate in the Retirement Plan for Employees of the Federal Reserve System (System Plan).¹ Under the Dodd-Frank Act, newly hired Bureau employees are eligible to participate in the System Plan and, during the years ended December 31, 2017 and 2016, certain costs associated with the System Plan were reimbursed by the Bureau. In addition, employees at certain compensation levels participate in the Benefit Equalization Retirement Plan (BEP) and certain Reserve Bank officers participate in the Supplemental Retirement Plan for Select Officers of the Federal Reserve Banks (SERP). The FRBNY, on behalf of the System, recognizes the net asset or net liability and costs associated with the System Plan in its consolidated financial statements. The Bank reports the net cost related to the BEP and SERP as a component of “Operating expenses: Salaries and benefits” in its Statements of Operations and reports the net liability as a component of “Accrued benefit costs” in its Statements of Condition. The Bank’s projected benefit obligation, funded status, and net pension expenses for the BEP and the SERP at December 31, 2017 and 2016, and for the years then ended, were immaterial. Thrift Plan Employees of the Bank participate in the defined contribution Thrift Plan for Employees of the Federal Reserve System (Thrift Plan). The Bank matches 100 percent of the first 6 percent of employee contributions from the date of hire and provides an automatic employer contribution of 1 percent of eligible pay. The Bank’s Thrift Plan contributions totaled $6 million and $5 million for the years ended December 31, 2017 and 2016, respectively, and are reported as a component of “Operating expenses: Salaries and benefits” in the Statements of Operations. (9) POSTRETIREMENT BENEFITS OTHER THAN RETIREMENT PLANS AND POSTEMPLOYMENT BENEFITS Postretirement Benefits Other Than Retirement Plans In addition to the Bank’s retirement plans, employees who have met certain age and length-of-service requirements are eligible for both medical and life insurance benefits during retirement. The Bank and plan participants fund benefits payable under the medical and life insurance plans as due and the plans have no assets. Following is a reconciliation of the beginning and ending balances of the benefit obligation for the years ended December 31, 2017 and 2016 (in millions): 2017 Accumulated postretirement benefit obligation at January 1 2016 $ 105.3 $ 103.8 Service cost benefits earned during the period 3.5 3.2 Interest cost on accumulated benefit obligation 4.4 4.3 Net actuarial loss 1.5 0.5 Contributions by plan participants Benefits paid Medicare Part D subsidies Plan amendments Accumulated postretirement benefit obligation at December 31 2.0 2.0 (6.9) (6.5) 0.3 0.4 (4.2) (2.4) $ 105.9 $ 105.3 1 The OEB was established by the System to administer selected System benefit plans. www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 75 Notes to Financial Statements At December 31, 2017 and 2016, the weighted-average discount rate assumptions used in developing the postretirement benefit obligation were 3.59 percent and 4.07 percent, respectively. Discount rates reflect yields available on high-quality corporate bonds that would generate the cash flows necessary to pay the plan’s benefits when due. The System Plan discount rate assumption setting convention uses an unrounded rate. Following is a reconciliation of the beginning and ending balance of the plan assets, and the unfunded postretirement benefit obligation and accrued postretirement benefit costs for the years ended December 31, 2017 and 2016 (in millions): 2017 Fair value of plan assets at January 1 Contributions by the employer Contributions by plan participants Benefits paid Medicare Part D subsidies Fair value of plan assets at December 31 Unfunded obligation and accrued postretirement benefit cost Amounts included in accumulated other comprehensive loss are shown below: Prior service cost Net actuarial loss Total accumulated other comprehensive loss $ $ 2016 4.6 2.0 (6.9) 0.3 - $ $ $ 105.9 $ 105.3 $ $ 5.9 (16.5) $ (10.6) 2.2 (15.8) $ (13.6) Accrued postretirement benefit costs are reported as a component of “Accrued benefit costs” in the Statements of Condition. 76 | Federal Reserve Bank of Philadelphia 4.1 2.0 (6.5) 0.4 - For measurement purposes, the assumed health-care cost trend rates at December 31, 2017 and 2016 are provided in the table below: 2017 Health-care cost trend rate assumed for next year Rate to which the cost trend rate is assumed to decline (the ultimate trend rate) Year that the rate reaches the ultimate trend rate 2016 6.20% 6.60% 4.75% 2022 4.75% 2022 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 effects for the year ended December 31, 2017 (in millions): One percentage point increase One percentage point decrease $ 0.5 $ (1.1) 6.9 (12.0) Effect on aggregate of service and interest cost components of net periodic postretirement benefit costs Effect on accumulated postretirement benefit obligation The following is a summary of the components of net periodic postretirement benefit expense for the years ended December 31, 2017 and 2016 (in millions): 2017 Service cost-benefits earned during the period Interest cost on accumulated benefit obligation Amortization of prior service cost Amortization of net actuarial loss Net periodic postretirement benefit expense $ 3.5 4.4 (0.4) 0.7 $ 8.2 2016 $ $ 3.2 4.4 0.1 0.2 7.9 www.philadelphiafed.org Notes to Financial Statements Estimated amounts that will be amortized from accumulated other comprehensive loss into net periodic postretirement benefit expense in 2018 are shown below: Prior service cost $ (1.3) Net actuarial loss 0.8 Total $ (0.5) Net postretirement benefit costs are actuarially determined using a January 1 measurement date. At January 1, 2017 and 2016, the weighted-average discount rate assumptions used to determine net periodic postretirement benefit costs were 4.07 percent and 4.31 percent, respectively. Net periodic postretirement benefit expense is reported as a component of “Operating expenses: Salaries and benefits” in the Statements of Operations. The Medicare Prescription Drug, Improvement and Modernization Act of 2003 established a prescription drug benefit under Medicare (Medicare Part D) and a federal subsidy to sponsors of retiree health-care benefit plans that provide benefits that are at least actuarially equivalent to Medicare Part D. The benefits provided under the Bank’s plan to certain participants are at least actuarially equivalent to the Medicare Part D prescription drug benefit. The estimated effects of the subsidy are reflected in the actuarial loss in the accumulated postretirement benefit obligation and net periodic postretirement benefit expense. During 2017, the Bank adopted an amendment to the health benefits program that eliminated the Aetna Golden Medicare Plan (Health Maintenance Organization) effective January 1, 2018. The plan amendment resulted in a change in the Bank’s accumulated postretirement benefit obligation in the amount of $4.2 million as of December 31, 2017, with an equivalent change in the prior service component of accumulated other comprehensive income. During 2016, the Reserve Banks adopted an amendment to their health benefits program that added a Medicare Advantage and Prescription Drug www.philadelphiafed.org (MAPD) plan to the program effective January 1, 2017. The MAPD plan is a fully insured product that combines into one integrated benefit Medicare and Medicare Supplement coverages, as well as prescription drug coverage. The plan amendment resulted in a change in the Bank’s accumulated postretirement benefit obligation in the amount of $2.4 million as of December 31, 2016, with an equivalent change in the prior service component of accumulated other comprehensive income. Federal Medicare Part D subsidy receipts were $261 thousand and $351 thousand in the years ended December 31, 2017 and 2016, respectively. Expected receipts in 2018, related to benefits paid in the years ended December 31, 2017 and 2016, are $82 thousand and $32 thousand, respectively. Following is a summary of expected postretirement benefit payments (in millions): Without subsidy 2018 2019 2020 2021 2022 2023 - 2027 Total $ $ 4.9 5.1 5.3 5.5 5.7 32.3 58.8 With subsidy $ $ 4.7 4.8 5.0 5.1 5.4 30.2 55.2 Postemployment Benefits The Bank offers benefits to former qualifying or inactive employees. Postemployment benefit costs are actuarially determined using a December 31 measurement date and include the cost of providing disability; medical, dental, and vision insurance; and survivor income benefits. The accrued postemployment benefit costs recognized by the Bank at December 31, 2017 and 2016 were $5.3 million and $5.5 million, respectively. This cost is included as a component of “Accrued benefit costs” in the Statements of Condition. Net periodic postemployment benefit expense (credit) included Federal Reserve Bank of Philadelphia | 77 Notes to Financial Statements in 2017 and 2016 operating expenses were $432 thousand and ($469) thousand, respectively, and are recorded as a component of “Operating expenses: Salaries and benefits” in the Statements of Operations. Additional detail regarding the classification of accumulated other comprehensive loss is included in Note 9. (11) BUSINESS RESTRUCTURING CHARGES (10) ACCUMULATED OTHER COMPREHENSIVE INCOME AND OTHER COMPREHENSIVE INCOME Following is a reconciliation of beginning and ending balances of accumulated other comprehensive income (loss) as of December 31, 2017 and 2016 (in millions): 2017 2016 Amount related to postretirement benefits other than retirement plans Balance at January 1 Change in funded status of benefit plans: Prior service costs arising during the year Amortization of prior service cost Change in prior service costs related to benefit plans Net actuarial loss arising during the year Amortization of net actuarial loss Change in actuarial loss related to benefit plans Change in funded status of benefit plans - other comprehensive income Balance at December 31 $ $ (13.6) Amount related to postretirement benefits other than retirement plans $ (15.8) 4.2 (0.4) 1 2.4 0.1 1 3.8 (1.5) 0.7 1 2.5 (0.5) 0.2 1 (0.8) (0.3) 3.0 (10.6) 2.2 (13.6) $ Reclassification is reported as a component of “Operating expenses: Salaries and benefits” in the Statements of Operations. 1 78 | Federal Reserve Bank of Philadelphia In 2014, the Treasury announced a plan to consolidate the number of Reserve Banks providing fiscal agent services to the Treasury from 10 to 4. As a result of this initiative, the Government Entity Accounting and Reporting System and Treasury Collection Management and Monitoring operations performed by the Federal Reserve Bank of Philadelphia were transitioned to the Federal Reserve Bank of St. Louis in 2015. The Post Payment System and related Treasury Software Quality Assurance functions were transitioned to the Federal Reserve Bank of Kansas City in 2017. The remaining Treasury function is expected to be decommissioned by the end of 2019. The Bank had no business restructuring charges in 2017 and 2016. Following is a summary of financial information related to the restructuring plans (in millions): 2015 and prior restructuring plans Information related to restructuring plans as of December 31, 2017: Total expected costs related to restructuring activity Expected completion date Reconciliation of liability balances: Balance at December 31, 2015 Adjustments Payments Balance at December 31, 2016 Adjustments Payments Balance at December 31, 2017 $ 2.2 2014 $ 2.4 (0.2) (0.2) 2.0 (0.3) (0.3) 1.4 $ $ www.philadelphiafed.org Notes to Financial Statements Employee separation costs are primarily severance costs for identified staff reductions associated with the announced restructuring plans. Separation costs that are provided under terms of ongoing benefit arrangements are recorded based on the accumulated benefit earned by the employee. Separation costs that are provided under the terms of one-time benefit arrangements are generally measured based on the expected benefit as of the termination date and recorded ratably over the period to termination. Restructuring costs related to employee separations are reported as a component of “Operating expenses: Salaries and benefits” in the Statements of Operations. The following table presents the distribution of the Bank’s and System total comprehensive income for the years ended December 31, 2017 and 2016 (in millions): Bank’s portion System total Adjustments to the accrued liability are primarily due to changes in the estimated restructuring costs and are shown as a component of the appropriate expense category in the Statements of Operations. Distribution of comprehensive income (loss): (12) RECONCILIATION OF TOTAL DISTRIBUTION OF COMPREHENSIVE INCOME In accordance with the Federal Reserve Act, the Bank remits excess earnings to the Treasury after providing for the cost of operations, payment of dividends, and reservation of an amount necessary to maintain surplus at the Bank’s allocated portion of the $10 billion aggregate surplus limitation, which was $568 million and $538 million for the years ending December 31, 2017 and 2016, respectively. 2017 2016 2017 2016 Net income before providing for remittances to Treasury $ 2,108 $ 2,323 $ 80,692 $ 92,361 3 2 651 (183) $ 2,111 $ 2,325 $ 81,343 $ 92,178 $ $ $ $ Other comprehensive income (loss) Comprehensive income - available for distribution Transfer to (from) surplus Dividends 30 (12) - - 43 37 784 711 2,038 2,300 80,559 91,467 $ 2,111 $ 2,325 $ 81,343 $ 92,178 Earnings remittances to the Treasury Total distribution of comprehensive income (13) SUBSEQUENT EVENTS The following subsequent event took place after the balance sheet date but was not present at the balance sheet date. In accordance with FASB ASC Topic 855 Subsequent Events, the Bank’s 2017 financial statements were not updated for the impact of this event. Effective February 9, 2018, the Bipartisan Budget Act of 2018 (Budget Act) reduced the statutory limit on aggregate Reserve Bank surplus from $10 billion to $7.5 billion, which required the Reserve Banks to make a lump-sum payment to the Treasury in the amount of $2.5 billion. The Bank’s share of this remittance was $142 million. The payment was remitted to the Treasury on February 22, 2018. Reserve Bank surplus is allocated among Reserve Banks as described in Note 3(m). After making the transfer required by the Budget Act, the Bank’s allocated portion of the aggregate $7.5 billion surplus is $426 million. www.philadelphiafed.org Federal Reserve Bank of Philadelphia | 79 Notes to Financial Statements There were no other subsequent events that required adjustments to or disclosures in the financial statements as of December 31, 2017. Subsequent events were evaluated through March 8, 2018, which is the date that the financial statements were available to be issued. 80 | Federal Reserve Bank of Philadelphia www.philadelphiafed.org Ten Independence Mall, Philadelphia, PA 19106 www.philadelphiafed.org
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