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Checkpoint
The Federal Reserve’s Role in Ensuring
Safety, Soundness and Competitiveness
in a Consolidating Banking Industry

Federal Reserve Bank o f St. Lo u i s

|

2 0 0 6 An n ua l R e p o rt

F e d e ra l R e s e rve Bank o f St. Louis

Annual Report
2006

Pre sident’ s Message

Not What You Might Expect
Banking mergers and acquisitions have occurred throughout our nation’s
history. Over the past two decades, they have led to an unprecedented
reduction in the number of banking institutions. Despite fears to the contrary, institutions remain safe and sound, and the industry is as competitive
as ever in local markets. The Federal Reserve works to ensure and enforce
such outcomes in order to keep stability and confidence high within the
banking industry.

William Poole
President and CEO
Federal Reserve Bank of St. Louis

 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

A

merica’s banking landscape has changed
dramatically over the past 20 years. The
change started with banks being allowed to
branch unfettered within state borders. The process
expanded to banks being allowed, for the first time
in our nation’s history, to branch unrestricted across
state borders. Permitting intrastate and interstate
banking and branching led to thousands of mergers
and acquisitions in the industry. Today, the number
of banking organizations is about half of what it was
in the 1980s. Still, thousands of banks remain, some
as very large, multistate organizations and many
others as small or moderate-sized institutions. All
the while, new banks are created each year.
With so many banks disappearing, you might believe
that banking competition must also be disappearing.
But this is actually not the case. Fewer banks overall
does not have to mean less banking competition
in your neighborhood or mine. In fact, one of the
Federal Reserve’s jobs is to make sure that banking
competition stays vigorous in local markets, even as
the industry consolidates.
You might also believe that the consolidation trend
has caused some banks to jeopardize their safety
and soundness. This, too, is certainly not the case.
Another of the Fed’s jobs is to make certain that
banks remain safe and sound, and that they are
complying with all laws and regulations, even
as the industry consolidates.
This year’s annual report describes the role we play
in monitoring, evaluating and overseeing mergers
and acquisitions in the banking industry to ensure
that consolidation occurs in an orderly and regulated
manner. That is, we will describe how we act as a
“checkpoint” on the road of an evolving banking
landscape.

dent banks prevented these institutions from achieving maximum efficiency, and the system turned out
to be fragile. Some banks failed, even in relatively
good economic times. Many failed when economic
conditions deteriorated. The Great Depression
resulted in almost half of all U.S. banks failing,
which devastated the economy. This period in U.S.
history illustrates vividly that the number of banking
institutions reveals little about the effectiveness or
efficiency of the banking industry.
Although the total number of institutions has recently been dropping, these declines, fueled chiefly
by intrastate and interstate banking and branching,
have enabled banks to structure themselves more efficiently than ever before. No merger or acquisition,
however, can proceed without the Federal Reserve
or another regulator first reviewing, adjusting and,
ultimately, approving or denying it.
Our annual report examines this less well-known,
but very important, role that the Federal Reserve
plays in making sure that such mergers and acquisitions do not endanger a bank’s safety and
soundness, compliance with laws and regulations,
or the level of banking competition that is vital to
economic welfare. Our goal is to make certain that
the banking industry evolves in a way that preserves
the benefits of competition and ensures a safe and
sound banking system. So, even if your bank has
changed owners three times in the past two years,
rest assured that the Fed (or another regulator) has
scrutinized each transaction to make sure that the
best interests of the industry, the local market, the
bank and you are upheld.

There was a time when American banking was quite
different than it is today. In the 19th and early
20th centuries, our banking system was a
model of active competition among tens of
thousands of small banks. Unfortunately,
our environment of many small, indepen-

2006 Annual Report | 

I. Introduction
“What’s Happening to All the Banks around Here?”

 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

2006 Annual Report | 

I

t seems to be happening all the time, and everywhere.
You can’t help but notice. It has probably already occurred
in your town. You open the newspaper one morning, and
the headline glares at you: “Another Local Bank Is Sold!”
Sometimes you recognize the buyer—a bank in town that
you’ve heard of or an out-of-town bank that, well, everyone
has heard of. Other times, though, the buyer is unfamiliar.
All you know is that yet another bank is going to have a
new owner.
You read further into the article. It says that the same buyer bought another bank
in town a little more than a year ago. You ask yourself, “What’s happening to all
the banks around here?”
You recall a litany of other recent headlines—other transactions. You remember
that Magna Bank became Union Planters, which then became Regions. Boatmen’s
became NationsBank, which became Bank of America. Mark Twain became Mercantile, which became Firstar, which then became U.S. Bank. Allegiant became
National City; National Bank of Commerce and NBC Bank both became SunTrust …
You begin to wonder if competition among banks is disappearing. And, by the way,
isn’t the government supposed to do something about this?
“Government,” in this case, actually refers to the Federal Reserve System, which has
jurisdiction over many of the banking industry’s merger and acquisition proposals. The
St. Louis Fed is one of the 12 banks in the Federal Reserve, which is one of four primary federal regulators of depository institutions. The other regulators are the Office of
the Comptroller of the Currency, the Federal Deposit Insurance Corp. and the Office
of Thrift Supervision. Another federal agency, the National Credit Union Administration, regulates credit unions, which are very similar to depository institutions in some
ways. Beyond the four primary regulators, the Department of Justice and the Federal
Trade Commission are also responsible for enforcing the nation’s antitrust laws.
So, is the Fed doing anything about all the banking mergers and acquisitions that
are taking place? Yes. We thoroughly review and analyze proposed banking combinations, whether or not they make front-page news, to ensure that they satisfy
all of the requirements set out in the antitrust and banking laws. The provisions
cover financial condition, managerial resources, anti-money laundering safeguards,
community convenience and needs, and competition, and they are spelled out in

 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

detailed regulations so that everyone knows what they are up-front. Only after all
of these requirements have been met to our satisfaction can we approve any deal.
Why do we go through such a thorough process for each transaction? Why do we
care? On one level, we do it because the law requires us to. But there is a deeper
reason, a more fundamental financial reason that explains why we should be, and
are, involved. As the nation’s central bank, the Federal Reserve is responsible for
maintaining financial stability—that is, ensuring both the ongoing and smooth functioning of the nation’s payments systems and financial markets, and a steady supply
of credit to qualified borrowers—and the banking system plays a vital role in such
stability. We pay attention to any shock that potentially affects the banking industry’s normal operations in the financial and payments markets. It should, therefore,
not be surprising that the Fed is heavily responsible and accountable for monitoring,
evaluating and overseeing the banking industry’s consolidation process.
This essay will examine the methods we employ to ensure that this process takes
place in a regulated and orderly manner. We will demonstrate that the Federal
Reserve operates as a checkpoint on the road of consolidation. But first, let’s take
a closer look at exactly what banking consolidation is and how it has changed the
nation’s banking landscape.

Fe d e r a l B a n k i n g R e g u l at o r s
A gency		

R egulates

Federal Reserve System	
Fed	
		

Bank holding companies and state-chartered
commercial banks that are Fed members

Office of the Comptroller of the Currency	

Commercial banks with national charters

OCC	

Federal Deposit Insurance Corp.	
FDIC	
		

State-chartered commercial banks
that are not Fed members

Office of Thrift Supervision	

OTS	

Thrifts

National Credit Union Administration 	

NCUA	

Credit unions

Department of Justice	

DOJ	

Enforces all of the nation’s antitrust laws

Federal Trade Commission	

FTC	

Enforces all of the nation’s antitrust laws

2006 Annual Report | 

II. The Consolidation
Conundrum
Can Fewer Banks Actually Lead to More Banking Competition?

 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

2006 Annual Report | 

Appearances Can Be Deceiving

Number of commercial banks
Number of commercial banks

Figures 1 and 2 reveal that
even though the number of
banks has declined over the
past two decades, banking
competition in local markets has actually increased.
Remember, lower market
concentration means higher
competition.

Figure 1
Figure 1
The Declining Number of Commercial Banks in the United States
The Declining Number of Commercial Banks in the United States
16,000
16,000

12,000
12,000

8,000
8,000

4,000
4,000

0
0
1975
1975

1980
1980

1985
1985

1990
1990

1995
1995

2000
2000

2005
2005

Source: Federal Deposit Insurance Corporation, Quarterly Banking Profile

A

lthough banking mergers and acquisitions have occurred
throughout U.S. history, the wholesale decline in the number of banking institutions—or consolidation in the U.S.
banking industry—is a more recent phenomenon. As illustrated in Figure 1, the total number of commercial banks in
the United States, which had been relatively steady through
the 1970s and mid-1980s, has now shrunk to about half
of what it was just 20 years ago—from more than 14,000
banks in 1986 to fewer than 8,000 in 2006. The total
number of savings institutions (also known as thrifts, savings banks, or savings and loan associations), though not
displayed in the figure, has followed an even more dramatic
path—shrinking from almost 3,700 thrifts in 1986 to fewer
than 1,300 in 2006, or about a third of the 1986 level.
All told, these figures mean that more than 6,000 banks (and about 2,400 thrifts)
have disappeared over the 20-year period. Indeed, “What’s happening to all the
banks around here?” is an appropriate question. It’s not a huge leap to conclude
that this trend must have led to more concentration—that is, less competition—in
banking. The reality, however, is quite different.
As shown in Figure 2, at the same time the total number of U.S. commercial banks
was declining, a common measure of banking market concentration shows that
the average levels of deposit-market concentration in U.S. metropolitan areas and
nonmetropolitan areas (that is, counties not in metro areas) were also declining

10 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

Figure 2
Declining Average Level of Local Market Concentration
in U.S. Metropolitan and Nonmetropolitan Areas
16,000

12,000
Number of U.S.
commercial banks
(left axis)

8,000

3,500

3,000
2,500

4,000
2,000

U.S. metro areas concentration (right axis)
0
1975

Average level of local-market concentration

Number of commercial banks

4,000

U.S. nonmetro
areas concentration
(right axis)

(Scale indicates Herfindahl-Hirschman Index. See page 26.)

4,500

1,500

1980

1985

1990

1995

2000

2005

Sources: Number of commercial banks: Federal Deposit Insurance Corporation, Quarterly Banking Profile;
Indexes of concentration: FDIC Summary of Deposits and Board of Governors

moderately. In other words, as the total number of institutions was declining,
banking competition in both metropolitan and rural areas was actually starting to
increase. How can this be?
We can answer this question by pointing to a fundamental industry tenet: Banks
compete for customers in local markets. Although some people or small businesses
look beyond their local areas for certain financial services—for example, largedenomination time deposits or investment products—surveys and research continue
to show that customers predominantly choose banks near where they live or work.
Households and small businesses almost exclusively get financial services like checking
or other transaction accounts (their primary account) and small-business loans from
local financial firms, most often from banks, though sometimes from a thrift or credit
union. Regardless of the type of institution, however, the underlying fact still holds:
The institution of choice is in the customer’s neighborhood. Thus, when we talk
about banking competition and the effect of consolidation on it, we need to examine
what is happening in local banking markets, not national or statewide markets. To
better understand how local banking markets explain the consolidation conundrum,
see “Thinking Nationally, Competing Locally,” a sidebar series that begins on page 13.

Banks compete for
customers in local
markets. Although
some people or small
businesses look beyond
their local areas for
certain financial services—for example, largedenomination time
deposits or investment
products—surveys and
research continue to
show that customers
predominantly choose
banks near where they
live or work.

In addition, at the same time the banking industry has been losing institutions, it has
been making huge advancements in technology, dramatically changing how customers access their bank accounts. Moreover, changes to interstate branching laws
have allowed banks to open branches where they couldn’t before. Let’s examine
these effects a bit more closely.
Improved Accessibility Due to Technology
During the period over which the total number of banking institutions was declining,
tremendous technological advances were taking place in the industry that, today, we
2 0 0 6 A n n u a l R e p o r t | 11

sometimes take for granted. ATMs give customers access to their accounts and to
cash 24 hours a day, and ATM networks have made it possible for banks to locate
machines away from branches, all vastly improving customer convenience and accessibility. ATM networks have also enabled smaller banks to give their customers
access to any machine on the network, whether owned by the bank or not. Furthermore, ATM availability has increased dramatically since 1986, when there were
about 64,000 machines nationwide. By 2004, that number had climbed to upwards
of 383,000 units.
Today, many ATM features are found on bank web sites. Online, a customer is able
to access his or her accounts, perform a multitude of transactions and, in many
cases, pay bills. In such an environment, even a small institution can compete with
a much larger one. Some banks have even taken the step of offering Internet-only
accounts, which are paying higher interest rates to depositors. It’s not a big step
from here to Internet-only banks—that is, banks without any brick-and-mortar offices for customers to visit. A few Internet-only banks exist already.
A Historic First: Interstate Branching
While the total number of independent banking institutions has declined, the
number of branches has skyrocketed—from about 66,000 in 1986 to almost 86,000
in 2006. Part of this increase comes from the introduction of unrestricted nationwide interstate branching, which was permitted for the first time in the mid-1990s.
Interstate branching has allowed banks to streamline their organizations like never
before, opening the door to a new type of bank—one that can operate offices in
many different states simultaneously, all as branches of one bank under one bank
charter. Previously, the same institution would have had to manage offices in different states as separate banks, each with its own bank charter. In addition, interstate
branching, by allowing numerous banking organizations to eliminate many managerial and other back-office redundancies, has improved organizations’ overall operating efficiency. And although these mergers have reduced the overall number of
institutions, they have had no effect on the number of branches.
Combine interstate branching with the technological advances mentioned above,
and you end up with a very different banking landscape than 20 years ago, one in
which hundreds of multistate banks span regions of the country or even the entire
nation. The modern environment gives customers more access points to banking
products and services than ever before.
At the same time, the law that permitted interstate branching also restricted any
bank from purchasing another if, in the end, it would control more than 10 percent
of total U.S. deposits. This prohibition, however, does not prevent a bank from having more than 10 percent of national deposits if the increase occurs through its own
growth. So far, only Bank of America has come close to that 10-percent mark—at
the end of the first quarter of 2007, it controlled about 9 percent of U.S. deposits.
JPMorgan Chase, the second largest institution, trailed Bank of America with 7.1
percent of U.S. deposits, followed by Wachovia with 5.8 percent. State laws also
cap the share of total deposits any institution can control in a state, though the
thresholds are often between 25 percent and 30 percent.
12 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

Thinking Nationally, Competing Locally
How Does the Fed Define Local Banking Markets?
Each of the 12 Federal Reserve banks, in consultation with the Board of Governors of the Federal Reserve System, is responsible for defining the boundaries of local banking markets within its district. The other federal
banking regulators usually use these definitions when analyzing a merger or acquisition application.
A local banking market is an economically integrated area that includes and surrounds a central city or large
town. Often, banking markets are based on metropolitan or similar areas in urban regions, and on counties
in rural regions. Local economic and demographic data—such as commuting patterns, locations of large employers and retailers, and other information that could demonstrate an economic tie or separation between
two areas—are then used to enlarge or shrink the size of the market from the base.
To date, more than 1,500 banking markets have been defined in the United States, covering almost all
parts of the country. These definitions are always subject to change as local areas grow or shrink, however.
For help in finding a banking market definition, you can visit CASSIDITM, an application on the St. Louis
Fed’s web site that includes all market definitions in the country and interactive maps for many of them.
Visit http://cassidi.stlouisfed.org. (See sidebar on page 29.)

2 0 0 6 A n n u a l R e p o r t | 13

Thinking Nationally, Competing Locally

Inside the Numbers: Fewer Banks, Not Necessarily Fewer Offices
We’ve already seen that one of the effects of interstate branching is fewer banking institutions overall; this
reduction, however, does not translate into fewer offices in local markets. Suppose, for example, Chrome
Bank has offices in St. Louis, Carbondale, Ill., and Little Rock, Ark. Although the name above the door
is the same, before interstate branching was allowed, these were three separate banks because of branching
restrictions. That is, there were three institutions and three offices. After interstate branching, though, the
three banks could be combined into one. Now, there is one institution, but still three offices. These types of
mergers have no effect on local banking competition even though the total number of institutions goes down.

After Interstate Branching

Before Interstate Branching

Chrome Bank

Chrome Bank
ILLINOIS

INDIANA

ILLINOIS

INDIANA

Chrome Bank
MISSOURI

MISSOURI
KENTUCKY

KENTUCKY

TENNESSEE

14 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

MISSISSIPPI

Chrome Bank

TENNESSEE
ARKANSAS

MISSISSIPPI

ARKANSAS

Another type of transaction could have Chrome Bank buying Town Bank, which has one office located in
Memphis, Tenn. Before the transaction, there were two institutions and four offices. After the transaction,
there will be one institution, but still four offices. Again, we see that although the overall number of institutions has declined, there has been no effect on local competition. All that has happened in Memphis is that
Town Bank has become Chrome Bank. Many of these types of transactions have occurred over the past
20 years too. All the while, many small banks have started up in numerous communities, adding to local
competition. The “crazy-quilt banking system” example on pages 16-17 further illustrates these principles
in a simple way.

Before Transaction

After Transaction

Chrome Bank

Chrome Bank
ILLINOIS

INDIANA

MISSOURI

ILLINOIS

INDIANA

MISSOURI
KENTUCKY

KENTUCKY

TENNESSEE

TENNESSEE

Town Bank

MISSISSIPPI

ARKANSAS

MISSISSIPPI

ARKANSAS

2 0 0 6 A n n u a l R e p o r t | 15

Thinking Nationally, Competing Locally

A Crazy-Quilt Banking System Consolidates
To illustrate how the number of independent banks nationwide can decrease, while the average number
of banks in each local market stays the same or increases, think about the patterns and colors in a quilt.
Suppose we represent the U.S. national banking market as a huge quilt. Each two-by-two group of squares
within the quilts below corresponds to a local banking market. These are separated from each other
by black lines, representing the distinctness of local markets. Each individual colored square stands
for a bank or one of its branches. The identities of banks are differentiated by their colors. Changes
in the colors of the quilt represent the changing structure of the U.S. banking market.
Before interstate branching was allowed, U.S. banking was composed largely of single-market banks. The
quilt representing this situation consists of colored squares, each of which appears only once. There are 36
different banks and 36 different colors. That is, each unique bank in a local market also is unique in the
larger, national market. Each local market has four competing banks; this simple statistic can be used as a
measure of local banking competition.
Since interstate branching has been allowed and thousands of bank mergers have taken place, the U.S. banking market today is composed of both multimarket and single-market banks. Multimarket banks appear in
many local markets. Single-market banks appear in only one local market.

Before Interstate Branching Allowed

16 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

The quilt representing this situation consists of some colored squares that appear many times—for example,
red appears nine times, yellow appears seven times, dark green appears five times, etc.—while other colors
appear only once (for example, sky blue). There now are 14 different banks, down from 36. So, the banking system as a whole has undergone a significant consolidation. But each local market still consists of four
competing banks; so, local market competition remains unchanged.
The key point of this illustration is that even though many mergers have occurred and there now are far
fewer independent banks—represented by fewer unique colors in the quilt—each local banking market has
four competing banks (four different colors), just as before. Thus, bank mergers need not decrease competition in local markets as long as the specific mergers that take place are controlled.
For example, the bank represented by a red square probably would not be allowed to acquire another bank in
any local market, while the bank represented by yellow probably would be allowed to acquire another bank
only in one of the local markets in which it does not already appear, and so on. Even a single-market bank
(represented by sky blue) probably would be prohibited from acquiring another bank in its own local market,
though it likely would be allowed to buy another bank in any other market.
The quilts illustrate the Fed’s attempt to balance competing goals in our bank-merger policy—namely, to allow efficiency-enhancing bank mergers to occur across local banking markets without sacrificing the benefits
of competition within each local banking market.

After Interstate Branching Allowed

2 0 0 6 A n n u a l R e p o r t | 17

III. Eagle Eye
How the Fed’s Regulation Ensures the Safety and Soundness
of Newly Combined Banking Organizations

18 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

2 0 0 6 A n n u a l R e p o r t | 19

N

ot all banking deals are the same. Transactions take two
basic forms. In the more direct combination, at least two
banks merge to form one institution. The primary federal
banking regulatory agency with responsibility for the “surviving” bank must approve these transactions. (See box on
page 7.) If the surviving bank has a state charter, then the
state regulatory agency must also approve the transaction.
The other common form of combination involves an existing bank holding company
acquiring a bank. The Federal Reserve, as sole federal regulator of bank holding
companies, must approve all of these transactions. Some states also require state
approval of these acquisitions. In addition, some states require banks to have been
operating for a minimum number of years before another bank or bank holding
company can buy it—known as a “minimum-age requirement”—further
restricting some transactions.
Regardless of the type of combination and which banking regulatory agency
has primary responsibility for the transaction, all proposals must meet the
following standards:
•	 Financial condition: An applicant must be in at least satisfactory financial
condition, both before and after the transaction;
•	 Managerial resources: An applicant must have adequate managerial resources
to operate the new, larger institution in a safe and sound manner;
•	 Anti-money laundering safeguards: An applicant must have in place
adequate systems for preventing money laundering and must be capable of
extending these safeguards to the new, larger banking organization;
•	 Convenience and needs of the communities served by the applicant and
target: A proposed transaction must be likely to make banking services more
convenient and to meet the financial needs of the communities served; and
•	 Competition: A proposed transaction must not reduce competition in any
local banking market by an unacceptable degree.
Each application, therefore, goes through a multistep process that covers each of
the above areas. The first four criteria ensure the safety, soundness and service
orientation of banks and the banking system. The last requirement—competition—
ensures that banks operate in locally competitive markets. We will cover competition in detail in Part IV of this essay.

20 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

Although it is true that the Fed approves nearly all proposals it evaluates—giving
rise to the impression that we merely rubber-stamp banking merger and acquisition
applications­—approval comes only after an exhaustive process during which we
keep a keen eye out for apparent and, sometimes, hidden weaknesses that could
lead the proposal to fail one of the criteria. To avoid any unforeseen obstacles in
the process, applicants often contact us before filing an application. Doing so enables us to point out areas that could be troublesome during the actual application
process. Lesser problems most often can be addressed through committed actions
documented in the process. If problems are severe or not correctable in a reasonably short time frame, then the applicant typically is asked to delay the proposed
transaction until it has corrected the problem and demonstrated improvement.
In this way, the Fed uses its “moral suasion” to discourage flawed proposals, which
benefits us and applicants because it enables all parties to address weaknesses
before the process officially begins.
So, what exactly is the Fed looking for when examining applications for each
of the first four criteria? And how are we fulfilling our role?

Although it is true
that the Fed approves
nearly all proposals
it evaluates—giving
rise to the impression
that we merely rubber-stamp banking
merger and acquisition
applications­—approval
comes only after an exhaustive process during
which we keep a keen
eye out for apparent
and, sometimes, hidden
weaknesses that could
lead the proposal to fail
one of the criteria.

Financial Factors
The applicant and the resulting combined institution of a proposed transaction must
be judged as satisfactory with respect to relevant financial factors. These factors
are the same as those reviewed during a bank examination—capital adequacy, asset
quality, profitability, liquidity and sensitivity to market risk. Equally important for
a transaction involving a holding company acquisition of a bank is cash flow. The
company must demonstrate its ability to generate sufficient cash from operations
to cover principal and interest payments on debt incurred from the acquisition,
as well as its other operating expenses.
We develop an overall picture of the strengths and weaknesses of the combining
banking organizations by reviewing examination reports, periodic financial reports,
information provided in the application, and other available data. We project this
information to portray the financial profile of the consolidated organization. Financial weaknesses or deficiencies that are determined in the analysis of the proposal
must be addressed before the Federal Reserve approves the application. Some
financial issues, such as a capital deficiency, might be addressed by raising more
equity capital. Other weaknesses, such as poor loan quality or an imbalanced asset/liability mix, are not easy to fix in a short period of time. Banks can sometimes
address deficiencies of this type with commitments to policy changes or specific
actions focused on the weakness.

2 0 0 6 A n n u a l R e p o r t | 21

Notwithstanding a solid commitment that would be expected to improve a problem
area, the Federal Reserve normally will require some evidence that the proposed
action has had the intended effect. Improvement usually must be demonstrated
before we approve a transaction.
That’s not to say that any weakness must be corrected or requires improvement before the Fed approves the proposed transaction. For example, when the acquiring
institution is in satisfactory financial condition, but the target institution is financially
weak, the size and financial strength of the acquiring entity is a favorable consideration that can offset weaknesses in the target institution.
Managerial Factors
As with the analysis of financial factors, each transaction involving the combination
of banking organizations must undergo a management assessment, which considers the competence, experience and integrity of the officers, directors and principal
shareholders of the acquiring organization. However, the process of judging
officers and directors and their ability to operate the consolidated institution lacks
the objectivity that comes with the review of financial data, including trend analysis
and peer comparison.
We often can learn something about a bank’s management by reading previous
examination reports. Feedback from other regulators, who may have knowledge of
relevant factors not covered in reports, also helps to clarify the management picture.
This information might come through a letter responding to a request for comments
on a pending application, or informally through a telephone call. For some banking
combinations, we may require certain officers, directors and principal shareholders
to undergo a background check. In this process, we ask law enforcement agencies
to provide any unfavorable information that they may have on an individual.
As with financial weaknesses, managerial deficiencies must be addressed or corrected before an application is approved. Again, this can occur through informal
discussions and actions taken before the submission of the application or through
an action plan as part of the formal proposal.
Occasionally, even though each institution involved in a proposed banking combination has effective management, the larger and more complex resulting institution

22 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

could end up being beyond the managerial capacity of the existing officers and
directors. In such a case, the Fed might require additional management staffing
as a condition of approval.
Combating Money Laundering
The USA PATRIOT Act of 2001 introduced additional strong measures to prevent,
detect and prosecute international money laundering. Among other things, the
PATRIOT Act requires federal banking regulatory agencies to take into consideration
a banking organization’s effectiveness in combating money laundering activities
when that banking organization files a merger or acquisition application.
This assessment involves a review of the banking organization’s policies and
procedures to detect and prevent money laundering.
Minor weaknesses in an anti-money laundering program often can be addressed
during the application process. However, if significant program weaknesses
exist, then the acquiring banking organization may be required to demonstrate
verifiable improvement over a period of time before being allowed to expand
through combination.
Convenience and Needs
The Federal Reserve is required to assess whether a proposed banking combination
would likely have any adverse effect on the convenience and needs of the communities served by the banking organizations. This assessment focuses on the availability
and manner in which banks provide products and services to customers. Closing
cost-inefficient branches of the resulting organization is one possible way in which
customers’ convenience and banking needs could be negatively affected.
Assessing convenience and needs also involves taking into account the acquiring
organization’s and the target institution’s records of meeting the credit needs of
their communities, including low- and moderate-income neighborhoods, as required
under the Community Reinvestment Act (CRA). The Federal Reserve expects an acquiring organization to have an established record of satisfactory CRA performance
before it files an application. A satisfactory CRA record for the target institution is
also important. A less-than-satisfactory CRA examination rating on the part of the
acquiring institution or the target can present an obstacle to approval.

2 0 0 6 A n n u a l R e p o r t | 23

IV. Competition Is Critical
How the Fed’s Analysis Keeps Markets from Becoming
Too Concentrated

24 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

2 0 0 6 A n n u a l R e p o r t | 25

W

hen evaluating a proposed banking merger or acquisition
for its potential effects on competition, we need to know
how it will affect competition in every banking market in
which both the applicant and target have branches. Each
market is evaluated individually. Thus, for example, in any
one of the more prominent mergers highlighted in Part I,
literally dozens of banking markets were analyzed to ensure
that the antitrust competition requirements were met in
each of them.

The Before and After of Competition
After we determine which banking markets are involved in a proposal, we have
to examine how each market will change if the proposal is allowed to proceed.
To make this determination, we need to know what each market looks like before
and after the combination. We start by building a picture of each market using
bank deposit data.
We mentioned earlier that checking or other transaction accounts are the primary
accounts customers have with their banks. From this information, we can infer
that deposit information is a reasonable measure of a bank’s presence in a market.
Using branch-level deposit data, we can calculate a bank’s total deposits and share
of deposits in a market. For thrifts, we normally include only half of their deposits
because thrifts do not offer all of the same products and services that banks do,
particularly to businesses. In other words, thrifts are not “perfect substitutes” for
banks. If a bank holding company owns several banks in the same market, then the
deposits of the sister institutions are pooled together to determine the bank holding
company’s market share. Finally, credit union deposits are not normally included in
a market’s deposit calculation. Being membership organizations, credit unions offer
their products and services only to certain groups of people, and these products and
services are often quite limited when compared with those offered by banks and
thrifts. That said, we may include a particular credit union’s deposits in the calculation if substantial evidence supports their inclusion. One piece of such evidence
would be that the credit union offers a wide range of consumer banking products.
In addition, the credit union should have liberal membership rules (typically, at least
70 percent of market residents must be eligible for membership), and it should have
easily accessible street-level branches.
Once we have market shares for all institutions in the market, we can take the next
step and determine the market’s concentration. To do this, we use a tool called the
Herfindahl-Hirschman Index (more commonly referred to as HHI).
To calculate HHI, we simply square all the market shares (expressed as percentages)
and add up the squared numbers. This sum is a number between zero and 10,000:

26 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

The smaller the HHI number is, the less concentrated the market is (the more competition there is among banks in the market), and the less likely any one bank is able
to exert much control in the market. For example, if a market has only one bank,
it would have a 100 percent market share, and HHI would equal 10,000, or 1002 x 1.
If, instead, there are 100 banks in a market with 1 percent market share each, HHI
would then equal 100, or 12 x 100. To make this calculation even easier, CASSIDI
performs it for you for any banking market in the nation. (See sidebar on page 29.)
To determine if a deal will satisfy the antitrust requirements, we need to look at the
buyer’s market share after the transaction and the market’s HHI before and after the
combination. If the “after”-market HHI is not above a certain level and the increase
in the market HHI caused by the deal is not above a certain level, then the deal satisfies the Justice Department’s merger guidelines. (See box at right.) Specifically, the
department generally will not challenge a banking proposal unless the after-market
HHI exceeds 1,800 points AND the increase in HHI resulting from the deal exceeds
200 points. This is often called the “1,800/200” rule and is unique to banking.
Other industries are allowed only a 50-point increase in HHI when it is above
1,800 points. The difference is that the Justice Department recognizes that banks
face competition from a variety of other financial providers, such as thrifts, credit
unions and other types of financial firms. Allowing banking markets the leeway of
a 200-point change in HHI accounts for the “expanded” competition banks face.
In addition to the Justice Department’s rules, the Federal Reserve also will typically
not allow a bank to buy its way to more than 35 percent of any banking market’s
total deposits. Although similar in structure to the national- and state-level deposit
share caps mentioned earlier, this market-level threshold is a Federal Reserve policy,
not a law, and exceeding it triggers a closer examination of the market’s economic
circumstances, not rejection of the proposal. As with the national- and state-level
caps, banks can grow their way to controlling more than 35 percent of a market’s
total deposits.
What if the Picture Is Not Clear?
If one or more of the banking markets in a transaction do not satisfy the 1,800/200
rule, does that then mean the transaction cannot go through? No, not automatically. What it does mean, though, is that we will need to investigate those markets
further to find out if perhaps other important factors aren’t being picked up by the
HHI calculation. One of the first items we’ll look at is the number of other banks
remaining in the market and each one’s market share after the deal. We’ll also
want to know if any new banks have opened in the market recently and if deposit,
income and population growth in the area have been relatively strong when compared with similar areas in the rest of the state. We’ll look to see if a thrift in this
market has been aggressively pursuing business customers, making its share of
loans to businesses look more similar to other banks than to other thrifts. If so, we
may end up including all of that savings institution’s deposits rather than just half in
the market’s deposit calculation. Or, there may be a credit union in the market that
has a storefront like a bank or thrift and opens its doors to most people in the area.
If so, we may end up including a portion of its deposits in the market’s deposit

Merger Guidelines

The Justice Department
divides the spectrum of
market concentration
as measured by the HHI
into three regions that
can be broadly characterized as unconcentrated (HHI below 1,000),
moderately concentrated
(HHI between 1,000
and 1,800), and highly
concentrated (HHI above
1,800). For a banking transaction not to
require stricter economic
scrutiny in a particular
market, the transaction
cannot both increase
HHI by more than 200
points AND result in a
highly concentrated market (a final HHI greater
than 1,800 points).

2 0 0 6 A n n u a l R e p o r t | 27

calculation. We would also need to know if the bank being bought is in trouble,
perhaps even on the verge of shutting down. We can then use some or all of this
information to demonstrate that factors are at play in the market that are not being
captured by the HHI, and, when these factors are considered, the deal will not end
up substantially lessening competition in the banking market.
At times, though, a market’s current concentration and the potential increase from
a deal are just too large for some of these other economic factors to overcome.
In such cases, the buyer may offer (or we may require the buyer) to sell branches
to other banks in an attempt to keep a local market’s HHI increase to below 200
points. This process, known as “divestiture,” has become increasingly common over
the past decade or so, and many institutions, particularly those engaging in large
transactions, now come to the table with divestiture plans already laid out.
Competitive Analysis In Action—The Real World
To get a feel for how a competitive analysis might actually play out, let’s look at a
recent real-world acquisition—Regions Bank’s purchase of AmSouth Bank. Before
the deal, Regions was the 21st largest bank in the nation (based on total assets)
and controlled less than 1 percent of national deposits. It operated branches in 16
states. AmSouth was the 27th largest bank in the country and also controlled less
than 1 percent of national deposits. It operated branches in seven states. After the
deal, Regions became the 13th largest bank in the country and controlled less than
2 percent of national deposits.
Regions and AmSouth had branches in 67 common banking markets across seven
states: Alabama, Florida, Georgia, Kentucky, Louisiana, Mississippi and Tennessee.
A competitive analysis like that described above was conducted for each of these
67 local banking markets. In 42 of them, the 1,800/200 rule was satisfied without
divestitures or any further market examinations. That left 25 markets in which the
1,800/200 rule was violated and/or Regions’ after-market share exceeded 35 percent. Each would require divestiture, further examination or both. In 12 of these
25 banking markets, divestitures of AmSouth branches were enough to satisfy the
1,800/200 rule.
The remaining 13 markets required further examinations because, even after accounting for any proposed divestitures, they fell outside the 1,800/200 guidelines
and/or Regions’ after-market share exceeded 35 percent. Credit-union deposits
played a role in countering the initial HHI analysis in 11 of these markets, and thrifts
in three markets were considered full competitors with commercial banks. In addition, new bank openings in the recent past, strong income, population and deposit
growth relative to surrounding areas, and the number and strength of the remaining competitors in all 13 markets contributed to the final decision to approve the
application. Thus, the initial HHI analysis did not fully explain the actual competitive
picture in these markets. When all was said and done, the information gathered
and actions taken were sufficient to conclude that the deal would not have a significantly adverse effect on competition in any of the banking markets. The acquisition was approved in October 2006. Read more about the outcome of this case at
www.federalreserve.gov/boarddocs/press/orders/2006/20061020/attachment.pdf.

28 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

CASSIDI

TM

St. Louis Fed Offers Online Way To Get Banking
Competition Information
The Federal Reserve Bank of St. Louis launched a web site in 2006 intended
to give bankers, consultants and the public a convenient way to view banking competition information. The application is called CASSIDITM—Competitive Analysis and Structure Source Instrument for Depository Institutions—
and is accessible at http://cassidi.stlouisfed.org.
A free application, CASSIDI allows users to:
•	 view banking market definitions for any part of the country,
•	 search for information in a user-friendly format,
•	 benefit from regular updates as market structures change,
•	 explore “what if” (pro forma) scenarios by seeing how a potential
transaction might change a banking market’s concentration or affect HHI,
•	 select whole institutions or individual branches as potential targets,
•	 look up geographic and depository information for all institutions and
their branches, and
•	 view maps of many banking markets throughout the United States.

2 0 0 6 A n n u a l R e p o r t | 29

V. Conclusion

B

efore reading this essay, the average person most likely assumed that consolidation
in the U.S. banking industry, which has been the norm for the past two decades,
has reduced banking competition. This view is understandable because, over the
past 20 years, mergers and acquisitions have cut the number of banking organizations to about half of its previous level. But a look at local banking markets—where
banking competition actually takes place—tells a different story: Users of banking
services still have many choices among competing providers. Today’s institutions
have about 20,000 more branches than all of the banking organizations in the
1980s. And because of interstate branching, customers are likely to find banks with
branches in many states across a region or even across the country. Technologies
that either did not exist or were in their infancy two decades ago—for example,
online banking and ATMs—now offer customers access to their accounts every
moment of the day.
Such dramatic changes in so relatively short a period naturally raise concerns about
the safety and soundness of banking organizations and about the state of banking competition. The Federal Reserve, however, is responsible for ensuring—even
as the banking industry consolidates—that institutions remain safe and sound, that
they comply with all applicable laws and regulations, and that local banking markets
remain vigorously competitive. To accomplish these goals, we (or one of the other
primary federal regulators) review, adjust and, ultimately, approve or deny every
application for a banking merger or acquisition to make certain that it satisfies all of
the requirements set out in the antitrust laws. The requirements include financial
condition, managerial resources, anti-money laundering safeguards, community
convenience and needs, and local banking market competition. Only after we are
satisfied that all of the requirements have been met can we approve a transaction.
By engaging in such a thorough evaluation, we are indeed fulfilling our role of operating as a checkpoint in the banking consolidation process.

30 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

2 0 0 6 A n n u a l R e p o r t | 31

32 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

B o a r d s of D i r e c t o r s

Thank You
(retiring board members)
We bid farewell and express our gratitude to those members of
the Eighth District boards of directors who retired in 2006.
Our appreciation and best wishes go out to the following:
Little Rock
Stephen M. Erixon
Raymond E. Skelton
Louisville
Norman E. Pfau Jr.
Memphis
J.W. Gibson II
Russell Gwatney
St. Louis
Walter L. Metcalfe Jr.
We also extend our deepest sympathies to the family and
friends of Cornelius A. Martin, Louisville chairman,
who passed away in 2006.

2 0 0 6 A n n u a l R e p o r t | 33

B o a r d s of D i r e c t o r s

Little Rock

C. Sam Walls

Phillip N. Baldwin

Chairman

President and CEO
Southern Bancorp
Arkadelphia, Ark.

CEO
Arkansas Capital Corp.
Little Rock, Ark.

Sonja Yates Hubbard

Cal McCastlain

CEO
E-Z Mart Stores Inc.
Texarkana, Texas

Partner
Pender & McCastlain P.A.
Little Rock, Ark.

34 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

Sharon Priest

William C. Scholl

Executive Director
Downtown Little Rock Partnership
Little Rock, Ark.

President
First Security Bancorp
Searcy, Ark.

Robert A. Young III
Chairman
Arkansas Best Corp.
Fort Smith, Ark.

2 0 0 6 A n n u a l R e p o r t | 35

B o a r d s of D i r e c t o r s

Louisville

John L. Huber

Gordon B. Guess

Chairman

Chairman, President and CEO
The Peoples Bank
Marion, Ky.

President and CEO
Louisville Water Co.
Louisville, Ky.

Barbara Ann Popp

Gary A. Ransdell

CEO
Schuler Bauer Real Estate Services
New Albany, Ind.

President
Western Kentucky University
Bowling Green, Ky.

36 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

John C. Schroeder

L. Clark Taylor Jr.

President
Wabash Plastics Inc.
Evansville, Ind.

CEO
Ephraim McDowell Health
Danville, Ky.

Steven E. Trager
Chairman and CEO
Republic Bank & Trust Co.
Louisville, Ky.

2 0 0 6 A n n u a l R e p o r t | 37

B o a r d s of D i r e c t o r s

Memphis

Meredith B. Allen

Charles S. Blatteis

Chairman

Member (Partner)
The Bogatin Law Firm PLC
Memphis, Tenn.

Vice President, Marketing
Staple Cotton Cooperative Association
Greenwood, Miss.

Nick Clark

Levon Mathews

Partner
Clark & Clark
Memphis, Tenn.

Director of Sales
Regions Morgan Keegan Private Banking
Memphis, Tenn.

38 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

Thomas G. Miller

David P. Rumbarger Jr.

President
Southern Hardware Co. Inc.
West Helena, Ark.

President and CEO
Community Development Foundation
Tupelo, Miss.

Hunter Simmons
President and CEO
First South Bank
Jackson, Tenn.

2 0 0 6 A n n u a l R e p o r t | 39

B o a r d s of D i r e c t o r s

St. Louis

Irl F. Engelhardt

Cynthia J. Brinkley

Chairman

Deputy Chairman

Chairman
Peabody Energy
St. Louis

President
AT&T Missouri
St. Louis

Paul T. Combs

Steven H. Lipstein

President
Baker Implement Co.
Kennett, Mo.

President and CEO
BJC HealthCare
St. Louis

40 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

Lewis F. Mallory Jr.

J. Thomas May

Chairman and CEO
Cadence Financial Corp.
Starkville, Miss.

Chairman and CEO
Simmons First National Corp.
Pine Bluff, Ark.

David R. Pirsein

A. Rogers Yarnell II

President and CEO
First National Bank in Pinckneyville
Pinckneyville, Ill.

President
Yarnell Ice Cream Co. Inc.
Searcy, Ark.

2 0 0 6 A n n u a l R e p o r t | 41

I n d u s t r y C o u n ci l s

Little Rock | Agribusiness

At top,
from left:

Bert Greenwalt, Ph.D.

Ted Huber

Cal McCastlain

John King III

Arkansas State University
State University, Ark.

Huber’s Orchard & Winery
Starlight, Ind.

Pender & McCastlain P.A.
Little Rock, Ark.

King Farms
Helena, Ark.

(Mr. McCastlain is now a member of
Little Rock’s Board of Directors; he has
been replaced by Keith Glover.)

Dr. Leonard Guarraia

Richard Jameson

World Agricultural Forum
St. Louis

Jameson Farms
Brownsville, Tenn.

(not pictured)

(not pictured)

(not pictured)

Keith Glover

Tim Gallagher

Dr. David Williams

Producers Rice Mill
Stuttgart, Ark.

At bottom,
from left:

Bunge North America Inc.
St. Louis

Burkmann Feeds
Danville, Ky.

42 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

Louisville | Health Care

At top,
from left:

Stephen A. Williams

Calvin Anderson

Norton Healthcare
Louisville, Ky.

Blue Cross Blue Shield of Tennessee
Memphis, Tenn.

At bottom,
from left:

Russell D. Harrington Jr.

Sister Mary Jean Ryan

Jeffrey B. Bringardner

Baptist Health
Little Rock, Ark.

SSM Health Care System
St. Louis

Humana Inc.
Louisville, Ky.

(not pictured)

(not pictured)

(not pictured)

Bob Gordon

Dean Kappel

Dick Pierson

Baptist Memorial
Health Care
Memphis, Tenn.

Mid-America
Transplant Services
St. Louis

University of Arkansas
for Medical Sciences
Little Rock, Ark.

2 0 0 6 A n n u a l R e p o r t | 43

Industry Councils

Memphis | Transportation

At top,
from left:

Kirk Thompson

T. Michael Glenn

Dennis Oakley

Joseph Tracy

J.B. Hunt Transport
Services Inc.
Lowell, Ark.

FedEx Corp.
Memphis, Tenn.

Bruce Oakley Inc.
North Little Rock, Ark.

Dot Transportation Inc.
Mt. Sterling, Ill.

At bottom,
from left:

Mark Knoy

Phil Trenary

MEMCO Barge Line
Chesterfield, Mo.

Pinnacle Airlines Inc.
Memphis, Tenn.

(not pictured)

(not pictured)

Charlie W. Johnson

Robert L. Lekites

C.W. Johnson Xpress
Louisville, Ky.

UPS
Louisville, Ky.

44 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

St. Louis | Real Estate

At top,
from left:

Kevin Huchingson

William Mitchell

David Price

Greg Kozicz

Colliers Dickson Flake
Little Rock, Ark.

Memphis Area
Associations of Realtors
Memphis, Tenn.

Whittaker Builders Inc.
St. Louis

Alberici Constructors
St. Louis

At bottom,
from left:

John J. Miranda

Mary Singer

E. Phillip Scherer III

Pinnacle Properties of
Louisville LLC.
Louisville, Ky.

CRESA Partners Memphis
Memphis, Tenn.

Commercial Kentucky Inc.
Louisville, Ky.

(not pictured)
Jack R. McCray
Bank of the Ozarks
Little Rock, Ark.

2 0 0 6 A n n u a l R e p o r t | 45

M a n a g e m e n t C omm i t t e e

William Poole

Dave Sapenaro

President and CEO

First Vice President and COO

Mary Karr

Robert Rasche

Senior Vice President

Senior Vice President

46 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

Judie Courtney

Karl Ashman

Senior Vice President

Senior Vice President

Julie Stackhouse
Senior Vice President

2 0 0 6 A n n u a l R e p o r t | 47

A M e s s a g e F r om M a n a g e m e n t

T

he Federal Reserve Bank of St. Louis ended 2006 and entered 2007 with a full
charge of momentum. However one chooses to define it, 2006 was a successful
year for us—whether it was our economists expanding their published research and
number of presentations, the continued management of the Fed’s Treasury services
by our Treasury Relations and Support Office (TRSO), or our check operations
exceeding revenue projections at lower-than-expected costs.
The St. Louis Fed in 2006 met all 25 key objectives in its strategic plan, all three
Bank-wide financial objectives and one of two organizational climate objectives.
We also met 34 of 45 key operating measures, many of which continue to have
stretch targets. The Bank’s total expenses came in under budget by 4.2 percent
or $9.2 million. Our employees actively contributed to more than 100 System
and District initiatives.
What follows are highlights of the District’s 2006 accomplishments:
Research/Monetary Policy
•	 Continued strong economic research program and high publication and citation
rate. The number of peer-reviewed journal articles published or accepted for
publication was 62, up from 58 in 2005.
•	 Provided excellent support for the Bank’s public programs through research on
topics of interest to community leaders and through research presentations.
•	 Enhanced online economic information and implemented an online bank structural data information system (CASSIDI). Overall, Research’s web pages were
visited more than 60 million times during 2006, up more than 40 percent from
the preceding year.

Supervision, Credit and Center for Online Learning
•	 Completed all mandated bank examinations in a timely manner and received
excellent Board of Governors operations examination.
•	 Raised the Bank’s visibility to bankers and increased the supervisory portfolio of
state member banks from 85 to 94 banks.
•	 Continued to increase the volume of work for the Center for Online Learning, a
recognized Fed System leader in the area of online training.

48 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

U.S. Treasury Support
•	 Received high marks from the U.S. Treasury for services and support provided
on numerous Treasury revenue collection and cash management programs. The
Treasury rated the Bank a 4.8 on a 1 to 5 satisfaction scale.
•	 Met 19 of 22 local Treasury objectives and stayed within the budget caps for 14
of 18 business lines. Budget overruns were all approved ahead of time by the
Treasury. Local Treasury services were rated a 4.5 by the Treasury.
•	 Assisted the Federal Reserve System in completing 82 of 88 key Treasury business
objectives, while underrunning the budget by $7.6 million, or 2.3 percent.

Financial Services
•	 Met seven of eight Retail Payments Office check performance targets, a large improvement from 2005, and significantly improved the Memphis check operation.
•	 Met seven of 10 cash performance targets and provided significant System leadership in cash services.

Administration
•	 Made substantial progress on facilities projects, including beginning construction
of a new tower and renovations of cafeteria and conference facilities.
•	 Completed numerous human resources initiatives related to key areas of focus for
the Bank—leadership and staff development, diversity, and compensation.
•	 Provided significant System leadership in the financial management, information
technology (problem management), support services (physical security) and human resources (employee benefits, HR automation) functions.

2 0 0 6 A n n u a l R e p o r t | 49

A M e s s a g e F r om M a n a g e m e n t

Legal, Public and Community Affairs
•	 Continued to expand the District’s outreach through additional economic education and community development programs, as well as local boards of directors
engagement.
•	 Enhanced the Bank’s monetary policy input programs in support of the Bank’s
president. Industry Councils, a new vehicle for gathering and sharing economic
data with key business and community leaders, were established in all four zones.
•	 Continued to provide editorial and graphic design services to other Reserve banks
for publications and web sites.

Organizational Initiatives
•	 Customer Service: The District continued its efforts to sustain a service-oriented
culture. As a result, all divisions exceeded customer service targets.
•	 Innovation: To support the Bank’s organizational value of innovation, the Bank
implemented an online idea repository yielding 64 new ideas; seven were implemented, and 37 are in process.
•	 Staff Development: Human Resources completed several initiatives to further
leadership and staff development. In addition, a new behavioral competency
model was introduced to employees in 2006.
•	 Employee Communications: Several communications channels were reassessed
or refined in 2006, and new electronic channels of communication were further
explored.
•	 Enterprise Risk Management (ERM): The Bank enhanced the SOX (now AS2) and
ERM programs in 2006 by working more closely with business areas to streamline
data collection and assessment. Most business areas now discuss risks during
regular management meetings throughout the year, and the type of risk information collected has been streamlined, resulting in more timely risk profile updates.

50 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

Financial Statements
For the years ended December 31, 2006 and 2005

The firm engaged by the Board of Governors for the audits of the individual and combined financial statements of the
Reserve Banks for 2006 was PricewaterhouseCoopers LLP (PwC). Fees for these services totaled $4.2 million. To ensure
auditor independence, the Board of Governors requires that PwC be independent in all matters relating to the audit.
Specifically, PwC may not perform services for the Reserve Banks or others that would place it in a position of auditing
its own work, making management decisions on behalf of the Reserve Banks, or in any other way impairing its audit
independence. In 2006, the Bank did not engage PwC for any material advisory services.

52 | F e d e r a l R e s e r v e B a n k o f S t. L o u i s

Management’s Report on Internal Control Over Financial Reporting

To the Board of Directors:

March 5, 2007
	
The management of the Federal Reserve Bank of St. Louis (“the Bank”) is responsible for the preparation and fair presentation
of the Statement of Financial Condition, Statement of Income, and Statement of Changes in Capital as of December 31, 2006
(the “Financial Statements”). The Financial Statements have been prepared in conformity with the accounting principles,
policies, and practices established by the Board of Governors of the Federal Reserve System and as set forth in the Financial
Accounting Manual for the Federal Reserve Banks (“Manual”), and as such, include amounts, some of which 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 Manual 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. Such internal control is designed to provide reasonable assurance to management
and to the Board of Directors regarding the preparation of the Financial Statements in accordance with the Manual. Internal
control contains self-monitoring mechanisms, including, but not limited to, divisions of responsibility and a code of conduct.
Once identified, any material deficiencies in internal control are reported to management and appropriate corrective measures
are implemented.
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 reflected in the Financial Statements,
based upon the criteria established in the “Internal Control -- Integrated Framework” issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this assessment, we believe that the Bank maintained effective internal
control over financial reporting as it relates to the Financial Statements.
Management’s assessment of the effectiveness of the Bank’s internal control over financial reporting as of December 31, 2006,
is being audited by PricewaterhouseCoopers LLP, the independent registered public accounting firm which also is auditing the
Bank’s Financial Statements.
Federal Reserve Bank of St. Louis

William Poole, President and Chief Executive Officer

David A. Sapenaro, First Vice President and Chief Operating Officer

Marilyn K. Corona, Vice President, Chief Financial Officer

2 0 0 6 A n n u a l R e p o r t | 53

Report of Independent Auditors

To the Board of Governors of the Federal Reserve System
and the Board of Directors of the Federal Reserve Bank of St. Louis

We have completed an integrated audit of the Federal Reserve Bank of St. Louis’ 2006 financial statements, and of its internal
control over financial reporting as of December 31, 2006 and an audit of its 2005 financial statements in accordance with the
generally accepted auditing standards as established by the Auditing Standards Board (United States) and in accordance with
the auditing standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits,
are presented below.

Financial statements
We have audited the accompanying statements of condition of the Federal Reserve Bank of St. Louis (the “Bank”) as of
December 31, 2006 and 2005, and the related statements of income and changes in capital for the years then ended, which
have been prepared in conformity with the accounting principles, policies, and practices established by the Board of Governors
of the Federal Reserve System. These financial statements are the responsibility of the Bank’s management. Our responsibility is
to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards as established by the Auditing Standards
Board (United States) and in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made
by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable
basis for our opinion.
As described in Note 3, these financial statements were prepared in conformity with the accounting principles, policies, and
practices established by the Board of Governors of the Federal Reserve System. These principles, policies, and practices, which
were designed to meet the specialized accounting and reporting needs of the Federal Reserve System, are set forth in the
Financial Accounting Manual for Federal Reserve Banks which is a comprehensive basis of accounting other than accounting
principles generally accepted in the United States of America.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the
Bank as of December 31, 2006 and 2005, and results of its operations for the years then ended, on the basis of accounting
described in Note 3.

54 | F e d e ra l R e s e r v e B a n k o f S t. L o u i s

Internal control over financial reporting
Also, in our opinion, management’s assessment, included in the accompanying Management’s report on Internal Control Over
Financial Reporting, that the Bank maintained effective internal control over financial reporting as of December 31, 2006
based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our
opinion, the Bank maintained, in all material respects, effective internal control over financial reporting as of December 31,
2006, based on criteria established in Internal Control - Integrated Framework issued by the COSO. The Bank’s management
is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the
effectiveness of the Bank’s internal control over financial reporting based on our audit. We conducted our audit of internal
control over financial reporting in accordance with generally accepted auditing standards as established by the Auditing Standards Board (United States) and in accordance with the auditing standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all material respects. An audit of internal control over
financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s
assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’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 generally
accepted accounting principles. A company’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 assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company;
and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition
of the company’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.

March 12, 2007

2 0 0 6 A n n u a l R e p o r t | 55

FEDERAL RESERVE BANK OF ST. LOUIS

statements of Condition
(in millions)

As of December 31,
	

2006	

2005

ASSETS			
Gold certificates	

$	

328	

$	

327

Special drawing rights certificates		

71		

71

Coin			

40		

43

Items in process of collection		

196		

216

U.S. government securities, net		

24,897		

23,279

Investments denominated in foreign currencies		

223		

379

Accrued interest receivable		

214		

181

Interdistrict settlement account		

1,807		

2,010

Bank premises and equipment, net		

96		

87

45		

54

Other assets		
	 Total assets	

$	

27,917	

$	 26,647

LIABILITIES AND CAPITAL			
Liabilities:			
	 Federal Reserve notes outstanding, net	

$	

	Securities sold under agreements to repurchase		

25,994	

$	 24,602

941		

947

	 Deposits:			
		 Depository institutions		

434		

482

		Other deposits		

7		

3

	 Deferred credit items		

103		

151

	 Interest on Federal Reserve notes due to U.S. Treasury		

16		

106

	Accrued benefit costs		

80		

57

	Other liabilities		

10		

11

		 Total liabilities	

$	

27,585	

$	 26,359

Capital:			
	 Capital paid-in		

166		

144

166		

144

332		

288

	Surplus (including accumulated other comprehensive
		 loss of $21 million at December 31, 2006)		
		 Total capital		
	 Total liabilities and capital	
The accompanying notes are an integral part of these financial statements.

56 | F e d e ra l R e s e r v e B a n k o f S t. L o u i s

$	

27,917	

$	 26,647

FEDERAL RESERVE BANK OF ST. LOUIS

statements of Income
(in millions)

For the year ended December 31,
	

2006	

2005

Interest income:			
	 Interest on U.S. government securities	

$	 ,112	
1

$	 861

	 Interest on investments denominated in foreign currencies		

4		

6

	 Interest on loans to depository institutions		

1		

1

		 Total interest income		 1,117		

868

Interest expense:
	 Interest expense on securities sold under agreements to repurchase		

42		

25

		Net interest income		 1,075		

843

Other operating income:			
	 Compensation received for services provided		

22		

22

	 Reimbursable services to government agencies		

116		

112

	 Foreign currency gains (losses), net		

13		

(57)

	Other income		

2		

3

		 Total other operating income		

153		

80

Operating expenses:			
	Salaries and other benefits		

94		

89

	Occupancy expense		

10		

10

	Equipment expense		

8		

7

	Assessments by the Board of Governors		

20		

22

	Other expenses 		

107		

103

		 Total operating expenses		

239		

231

Net income prior to distribution	

$	 989	

$	 692

Distribution of net income:			
	 Dividends paid to member banks	

$	

10	

$	

16

	Transferred to/(from) surplus 		

43		

(92)

	Payments to U.S. Treasury as interest on Federal Reserve notes		

936		

768

		 Total distribution	

$	 989	

$	 692

The accompanying notes are an integral part of these financial statements.

FEDERAL RESERVE BANK OF ST. LOUIS

STATEMENTS OF CHANGES IN CAPITAL
for the years ended December 31, 2006, and December 31, 2005
(in millions)

					Surplus
				Net Income	Accumulated Other
			Capital Paid-In	Retained	Comprehensive Loss	
Balance at January 1, 2005
	 (4.7 million shares)	

$	 236 	

$	 236 	

$	

Total Surplus	

–	

Total Capital

$	 236 	

$	 472

	Net change in capital stock
	 redeemed (1.8 million shares)		

(92)		

–		

–		

–		

(92)

	Transferred from surplus		

–		

(92)		

–		

(92)		

(92)

Balance at December 31, 2005
	 (2.9 million shares)	

$	 144 	

$	 144 	

$	

–	

$	 144 	

$	 288

	Net change in capital stock issued
	 (0.4 million shares)		

22 		

–		

–		

–		

22

	Transferred to surplus		

–		

43 		

–		

43 		

43

	Adjustment to initially apply
	 FASB Statement No. 158		

–		

–		

(21)		

(21)		

(21)

Balance at December 31, 2006
	 (3.3 million shares)	

$	 166 	

$	 187 	

$	

(21)	

$	 166 	

$	 332

The accompanying notes are an integral part of these financial statements.
2 0 0 6 A n n u a l R e p o r t | 57

FEDERAL RESERVE BANK OF ST. LOUIS

notes to Financial statements

Note 1

Structure

The Federal Reserve Bank of St. Louis (“Bank”) is part of the
Federal Reserve System (“System”) and one of the twelve
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 and its branches in
Little Rock, Louisville and Memphis serve the Eighth Federal
Reserve District, which includes Arkansas, and portions of Illinois, Indiana, Kentucky, Mississippi, Missouri and Tennessee.
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 national banks and any state-chartered banks
that apply and are approved for membership in the System.
Member banks are divided into three classes according to
size. Member banks in each class elect one director representing member banks and one representing the public. In
any election of directors, each member bank receives one
vote, regardless of the number of shares of Reserve Bank
stock it holds.
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.

Note 2

Operations and Services

The Reserve Banks perform a variety of services and operations.
Functions include participation in formulating and conducting
monetary policy; participation in the payments system, including large-dollar transfers of funds, automated clearinghouse
(“ACH”) operations, and check collection; distribution of coin
and currency; performance of fiscal agency functions for the
U.S. Treasury, certain federal agencies, and other entities; serving as the federal government’s bank; provision of short-term
loans to depository institutions; service to the consumer and the
community by providing educational materials and information regarding consumer laws; and supervision of bank holding
companies, state member banks, and U.S. offices of foreign
banking organizations. The Reserve Banks also provide certain
services to foreign central banks, governments, and international official institutions.

58 | F e d e ra l R e s e r v e B a n k o f S t. L o u i s

The FOMC, in the conduct of monetary policy, establishes
policy regarding domestic open market operations, oversees
these operations, and annually issues authorizations and
directives to the FRBNY for its execution of transactions. The
FRBNY is authorized and directed by the FOMC to conduct
operations in domestic markets, including the direct purchase and sale of U.S. government securities, the purchase
of securities under agreements to resell, the sale of securities
under agreements to repurchase, and the lending of U.S.
government securities. The FRBNY executes these open
market transactions at the direction of the FOMC and holds
the resulting securities, with the exception of securities purchased under agreements to resell, in the portfolio known as
the System Open Market Account (“SOMA”).
In addition to authorizing and directing operations in the
domestic securities market, the FOMC authorizes and directs
the FRBNY to execute operations in foreign markets for major
currencies in order to counter disorderly conditions in exchange
markets or to meet other needs specified by the FOMC in carrying out the System’s central bank responsibilities. The FRBNY
is authorized by the FOMC to hold balances of, and to execute
spot and forward foreign exchange (“FX”) and securities contracts for, nine foreign currencies and to invest such foreign currency holdings ensuring adequate liquidity is maintained. The
FRBNY is authorized and directed by the FOMC to maintain reciprocal currency arrangements (“FX swaps”) with two central
banks and “warehouse” foreign currencies for the U.S. Treasury
and Exchange Stabilization Fund (“ESF”) through the Reserve
Banks. In connection with its foreign currency activities, the
FRBNY may enter into transactions that contain varying degrees
of off-balance-sheet market risk that results from their future
settlement and counter-party credit risk. The FRBNY controls
credit risk by obtaining credit approvals, establishing transaction
limits, and performing daily monitoring procedures.
Although the Reserve Banks are separate legal entities,
in the interests of greater efficiency and effectiveness they
collaborate in the delivery of certain operations and services.
The collaboration takes the form of centralized operations
and product or service 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 between the Reserve
Bank providing the service and the other eleven Reserve
Banks. In some cases, costs incurred by a Reserve Bank for
services provided to other Reserve Banks are not shared; in
other cases, the Reserve Banks are billed for services provided to them by another Reserve Bank.
Major services provided on behalf of the System by the
Bank, for which the costs were not redistributed to the other
Reserve Banks, include operation of the Treasury Relations
and Support Office and the Treasury Relations and Systems
Support Department, which provide services to the U.S.
Treasury. These services include: relationship management,
strategic consulting, and oversight for fiscal and payments
related projects for the Federal Reserve System; and operational support for the Treasury’s tax collection, cash management and collateral monitoring.
During 2005, the Federal Reserve Bank of Atlanta
(“FRBA”) was assigned the overall responsibility for managing the Reserve Banks’ provision of check services to
depository institutions, and, as a result, recognizes total
System check revenue on its Statements of Income. Because
the other eleven Reserve Banks incur costs to provide check

FEDERAL RESERVE BANK OF ST. LOUIS

notes to Financial statements

services, a policy was adopted by the Reserve Banks in 2005
that required that the FRBA compensate the other Reserve
Banks for costs incurred to provide check services. In 2006
this policy was extended to the ACH services, which are
managed by the FRBA, as well as to Fedwire funds transfer
and securities transfer services, which are managed by the
FRBNY. The FRBA and the FRBNY compensate the other Reserve Banks for the costs incurred to provide these services.
This compensation is reported as a component of “Compensation received for services provided”, and the Bank would
have reported $22 million as compensation received for services provided had this policy been in place in 2005 for ACH,
Fedwire funds transfer, and securities transfer services.

Note 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, which
differ significantly from those of the private sector. These
accounting principles and practices are documented in the
Financial Accounting Manual for Federal Reserve Banks
(“Financial Accounting Manual”), which is issued by the
Board of Governors. All of the Reserve Banks are required
to adopt and apply accounting policies and practices that
are consistent with the Financial Accounting Manual and the
financial statements have been prepared in accordance with
the Financial Accounting Manual.
Differences exist between the accounting principles and
practices in the Financial Accounting Manual and generally accepted accounting principles in the United States
(“GAAP”), primarily due to the unique nature of the Bank’s
powers and responsibilities as part of the nation’s central
bank. The primary difference is the presentation of all securities holdings at amortized cost, rather than using the fair
value presentation required by GAAP. Amortized cost more
appropriately reflects the Bank’s securities holdings given its
unique responsibility to conduct monetary policy. While the
application of current market prices to the securities holdings
may result in values substantially above or below their carrying values, these unrealized changes in value would have
no direct effect on the quantity of reserves available to the
banking system or on the prospects for future Bank earnings or capital. Both the domestic and foreign components
of the SOMA portfolio may involve transactions that result
in gains or losses when holdings are sold prior to maturity.
Decisions regarding securities and foreign currency transactions, including their purchase and sale, are motivated by
monetary policy objectives rather than profit. Accordingly,
market values, earnings, and any gains or losses resulting
from the sale of such securities and currencies are incidental
to the open market operations and do not motivate decisions related to policy or open market activities.
In addition, the Bank has elected not to present a Statement of Cash Flows because the liquidity and cash position
of the Bank are not a primary concern given the Bank’s
unique powers and responsibilities. A Statement of Cash

Flows, therefore, would not provide any additional meaningful information. Other information regarding the Bank’s
activities is provided in, or may be derived from, the Statements of Condition, Income, and Changes in Capital. There
are no other significant differences between the policies
outlined in the Financial Accounting Manual and GAAP.
The preparation of the financial statements in conformity
with the Financial Accounting Manual requires management
to make certain estimates and assumptions that affect the
reported amounts of assets and liabilities, 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. Unique accounts and significant
accounting policies are explained below.
a. Gold and Special Drawing Rights Certificates

The Secretary of the U.S. Treasury is authorized to issue gold
and special drawing rights (“SDR”) certificates to the Reserve
Banks.
Payment for the gold certificates by the Reserve Banks is
made by crediting equivalent amounts in dollars into the account established for the U.S. Treasury. The gold certificates
held by the Reserve Banks are required to be backed by the
gold of the U.S. Treasury. The U.S. Treasury may reacquire
the gold certificates at any time and the Reserve Banks
must deliver them to the U.S. Treasury. At such time, the
U.S. Treasury’s account is charged, and the Reserve Banks’
gold certificate accounts are reduced. The value of gold for
purposes of backing the gold certificates is set by law at $42
2/9 a fine troy ounce. The Board of Governors allocates the
gold certificates among Reserve Banks once a year based
on the average Federal Reserve notes outstanding in each
Reserve Bank.
SDR certificates are issued by the International Monetary Fund (“Fund”) to its members in proportion to each
member’s quota in the Fund at the time of issuance. SDR
certificates serve as a supplement to international monetary
reserves and may be transferred from one national monetary
authority to another. Under the law providing for United
States participation in the SDR system, the Secretary of the
U.S. Treasury is authorized to issue SDR certificates somewhat like gold certificates, to the Reserve Banks. When
SDR certificates are issued to the Reserve Banks, equivalent
amounts in dollars are credited to the account established
for the U.S. Treasury, and the Reserve Banks’ SDR certificate
accounts are increased. The Reserve Banks are required
to purchase SDR certificates, at the direction of the U.S.
Treasury, for the purpose of financing SDR acquisitions or
for financing exchange stabilization operations. At the time
SDR transactions occur, the Board of Governors allocates
SDR certificate transactions among Reserve Banks based
upon each Reserve Bank’s Federal Reserve notes outstanding at the end of the preceding year. There were no SDR
transactions in 2006 or 2005.
b. Loans to Depository Institutions

Depository institutions that maintain reservable transaction
accounts or nonpersonal time deposits, as defined in regulations issued by the Board of Governors, have borrowing
privileges at the discretion of the Reserve Bank. Borrowers
execute certain lending agreements and deposit sufficient

2 0 0 6 A n n u a l R e p o r t | 59

FEDERAL RESERVE BANK OF ST. LOUIS

notes to Financial statements

collateral before credit is extended. Outstanding loans are
evaluated for collectibility. If loans were ever deemed to be
uncollectible, an appropriate reserve would be established.
Interest is accrued using the applicable discount rate established at least every fourteen days by the Board of Directors
of the Reserve Bank, subject to review and determination by
the Board of Governors. There were no outstanding loans
to depository institutions at December 31, 2006 and 2005.
c. U.S. Government Securities and Investments Denominated in Foreign Currencies

U.S. government securities and investments denominated
in foreign currencies comprising the SOMA are recorded at
cost, on a settlement-date basis, and adjusted for amortization of premiums or accretion of discounts on a straight-line
basis. Interest income is accrued on a straight-line basis.
Gains and losses resulting from sales of securities are determined by specific issues based on average cost. Foreigncurrency-denominated assets are revalued daily at current
foreign currency market exchange rates in order to report
these assets in U.S. dollars. Realized and unrealized gains
and losses on investments denominated in foreign currencies
are reported as “Foreign currency gains (losses), net” in the
Statements of Income.
Activity related to U.S. government securities, including
the premiums, discounts, and realized and unrealized gains
and losses, is allocated to each Reserve Bank on a percentage basis derived from an annual settlement of interdistrict
clearings that occurs in April of each year. The settlement
also equalizes Reserve Bank gold certificate holdings to
Federal Reserve notes outstanding in each District. Activity
related to investments denominated in foreign currencies is
allocated to each Reserve Bank based on the ratio of each
Reserve Bank’s capital and surplus to aggregate capital and
surplus at the preceding December 31.
d. Securities Sold Under Agreements to Repurchase
and Securities Lending

Securities sold under agreements to repurchase are accounted for as financing transactions and the associated interest
expense is recognized over the life of the transaction. These
transactions are reported in the Statements of Condition at
their contractual amounts and the related accrued interest
payable is reported as a component of “Other liabilities”.
U.S. government securities held in the SOMA are lent
to U.S. government securities dealers in order to facilitate
the effective functioning of the domestic securities market.
Securities-lending transactions are fully collateralized by
other U.S. government securities and the collateral taken is
in excess of the market value of the securities loaned. The
FRBNY charges the dealer a fee for borrowing securities and
the fees are reported as a component of “Other income”.
Activity related to securities sold under agreements to
repurchase and securities lending is allocated to each of the
Reserve Banks on a percentage basis derived from the annual settlement of interdistrict clearings. Securities purchased
under agreements to resell are allocated to FRBNY and not
allocated to the other Reserve Banks.

60 | F e d e ra l R e s e r v e B a n k o f S t. L o u i s

e. FX Swap Arrangements
and Warehousing Agreements

FX swap arrangements are contractual agreements between
two parties, the FRBNY and an authorized foreign central bank,
to exchange specified currencies, at a specified price, on a
specified date. The parties agree to exchange their currencies
up to a prearranged maximum amount and for an agreedupon period of time (up to twelve months), at an agreed-upon
interest rate. These arrangements give the FOMC temporary
access to the foreign currencies it may need to intervene to
support the dollar and give the authorized foreign central bank
temporary access to dollars it may need to support its own currency. Drawings under the FX swap arrangements can be initiated by either party acting as drawer, and must be agreed to by
the drawee party. The FX swap arrangements are structured so
that the party initiating the transaction bears the exchange rate
risk upon maturity. The FRBNY will generally invest the foreign
currency received under an FX swap arrangement in interestbearing instruments.
Warehousing is an arrangement under which the FOMC
agrees to exchange, at the request of the U.S. Treasury, U.S.
dollars for foreign currencies held by the U.S. Treasury or ESF
over a limited period of time. The purpose of the warehousing facility is to supplement the U.S. dollar resources of the
U.S. Treasury and ESF for financing purchases of foreign
currencies and related international operations.
FX swap arrangements and warehousing agreements are
revalued daily at current market exchange rates. Activity
related to these agreements, with the exception of the unrealized gains and losses resulting from the daily revaluation,
is allocated to each Reserve Bank based on the ratio of each
Reserve Bank’s capital and surplus to aggregate capital and
surplus at the preceding December 31. Unrealized gains and
losses resulting from the daily revaluation are allocated to
FRBNY and not allocated to the other Reserve Banks.
f. 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 two to fifty 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.
Costs incurred for software during the application development stage, either developed internally or acquired for internal use, are capitalized based on the cost of direct services
and materials associated with designing, coding, installing,
or testing software. Capitalized software costs are amortized on a straight-line basis over the estimated useful lives
of the software applications, which range from two to five
years. Maintenance costs related to software are charged to
expense in the year incurred.
Capitalized assets including software, buildings, leasehold
improvements, furniture, and equipment are impaired when
events or changes in circumstances indicate that the carrying amount of assets or asset groups is not recoverable and
significantly exceeds their fair value.

FEDERAL RESERVE BANK OF ST. LOUIS

notes to Financial statements

g. Interdistrict Settlement Account

j. Capital Paid-in

At the close of business each day, each Reserve Bank assembles the payments due to or from other Reserve Banks.
These payments result from transactions between Reserve
Banks and transactions that involve depository institution
accounts held by other Reserve Banks, such as Fedwire funds
transfer, check collection, security transfer, and ACH operations. The cumulative net amount due to or from the other
Reserve Banks is reflected in the “Interdistrict settlement
account” in the Statements of Condition.

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. By law, each Reserve Bank is required to pay
each member bank an annual dividend of 6 percent on the
paid-in capital stock. This cumulative dividend is paid semiannually. A member bank is liable for Reserve Bank liabilities
up to twice the par value of stock subscribed by it.

h. Federal Reserve Notes

Federal Reserve notes are the circulating currency of the
United States. These notes are issued through the various Federal Reserve agents (the chairman of the board of
directors of each Reserve Bank and their designees) to the
Reserve Banks upon deposit with such agents of specified classes of collateral security, typically U.S. government
securities. These notes are identified as issued to a specific
Reserve Bank. The Federal Reserve Act provides that the collateral security tendered by the Reserve Bank to the Federal
Reserve agent must be at least equal to the sum of the notes
applied for by such Reserve Bank.
Assets eligible to be pledged as collateral security include
all of the Bank’s assets. 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 securities
pledged for securities sold under agreements to repurchase
is deducted.
The Board of Governors may, at any time, call upon a
Reserve Bank for additional security to adequately collateralize the Federal Reserve notes. To satisfy the obligation to
provide sufficient collateral for outstanding Federal Reserve
notes, the Reserve Banks have entered into an agreement
that provides for certain assets of the Reserve Banks to be
jointly pledged as collateral for the Federal Reserve notes
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 and are backed by the
full faith and credit 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 currency issued to the
Bank but not in circulation, of $3,175 million and $3,494
million at December 31, 2006 and 2005, respectively.
i. Items in Process of Collection
and Deferred Credit Items

“Items in process of collection” in the Statements of Condition primarily represents amounts attributable to checks that
have been deposited for collection and that, as of the balance sheet date, have not yet been presented to the paying
bank. “Deferred credit items” are the counterpart liability
to items in process of collection, and the amounts in this
account arise from deferring credit for deposited items until
the amounts are collected. The balances in both accounts
can vary significantly.

k. Surplus

The Board of Governors requires the Reserve Banks to
maintain a surplus equal to the amount of capital paid-in as
of December 31 of each year. This amount is intended to
provide additional capital and reduce the possibility that the
Reserve Banks would be required to call on member banks
for additional capital.
Accumulated other comprehensive income is reported
as a component of surplus in the Statements of Condition
and the Statements of Changes in Capital. The balance of
accumulated other comprehensive income is comprised
of expenses, gains, and losses related to defined benefit
pension plans and other postretirement benefit plans that,
under accounting principles, are included in comprehensive
income but excluded from net income. Additional information regarding the classifications of accumulated other
comprehensive income is provided in Notes 9 and 10.
l. Interest on Federal Reserve Notes

The Board of Governors requires the Reserve Banks to transfer excess earnings to the U.S. Treasury as interest on Federal
Reserve notes, after providing for the costs of operations,
payment of dividends, and reservation of an amount necessary to equate surplus with capital paid-in. This amount
is reported as a component of “Payments to U.S. Treasury
as interest on Federal Reserve notes” in the Statements of
Income and is reported as a liability in the Statements of
Condition. Weekly payments to the U.S. Treasury may vary
significantly.
In the event of losses or an increase in capital paid-in at a
Reserve Bank, payments to the U.S. Treasury are suspended
and earnings are retained until the surplus is equal to the
capital paid-in.
In the event of a decrease in capital paid-in, the excess surplus, after equating capital paid-in and surplus at December 31,
is distributed to the U.S. Treasury in the following year.
m. Income and Costs Related to
U.S. Treasury Services

The Bank is required by the Federal Reserve Act to serve as
fiscal agent and depository of the United States. By statute,
the Department of the Treasury is permitted, but not required, to pay for these services.

2 0 0 6 A n n u a l R e p o r t | 61

FEDERAL RESERVE BANK OF ST. LOUIS

notes to Financial statements

n. Assessments by the Board of Governors

Note 4

U.S. Government Securities, Securities Sold Under
Agreements to Repurchase, and Securities Lending

The Board of Governors assesses the Reserve Banks to fund
its operations based on each Reserve Bank’s capital and
surplus balances as of December 31 of the previous year.
The Board of Governors also assesses each Reserve Bank for
the expenses incurred for the U.S. Treasury to issue and retire
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 previous year.

The FRBNY, on behalf of the Reserve Banks, holds securities
bought outright in the SOMA. The Bank’s allocated share of
SOMA balances was approximately 3.177 percent and 3.103
percent at December 31, 2006 and 2005, respectively.
The Bank’s allocated share of U.S. Government securities,
net, held in the SOMA at December 31, was as follows (in
millions):

o. 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, 2006 and 2005, and are reported as a component of “Occupancy expense”.

				

2006		

2005

Par value:
U.S. government:
	 Bills	

$	

	Notes		

p. Restructuring Charges

	 Bonds		

In 2003, the Reserve Banks began the restructuring of
several operations, primarily check, cash, and U.S. Treasury
services. The restructuring included streamlining the management and support structures, reducing staff, decreasing
the number of processing locations, and increasing processing capacity in some locations. These restructuring activities
continued in 2004 through 2006.
Note 11 describes the restructuring and provides information about the Bank’s costs and liabilities associated with employee separations and contract terminations. The costs associated with the impairment of certain of the Bank’s assets
are discussed in Note 6. 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. Costs and liabilities associated with
enhanced post-retirement benefits are discussed in Note 9.

8,801	

$	

12,784		
3,162		

8,418
11,795
2,881

Total par value		

24,747		

23,094

Unamortized premiums		

277		

273

Unaccreted discounts		

(127)		

Total allocated to the Bank	

$	 24,897	

$	

(88)
23,279

At December 31, 2006 and 2005, the fair value of the U.S.
government securities allocated to the Bank, excluding accrued interest, was $25,287 million and $23,815 million,
respectively, as determined by reference to quoted prices for
identical securities.

q. Implementation of FASB Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other
Postretirement Plans

The Bank initially applied the provisions of FASB Statement No. 158, Employers’ Accounting for Defined Benefit Pension and
Other Postretirement Plans, at December 31, 2006. This accounting standard requires recognition of the overfunded or underfunded status of a defined benefit postretirement plan in the Statements of Condition, and recognition of changes in the
funded status in the years in which the changes occur through comprehensive income. The transition rules for implementing the
standard require applying the provisions as of the end of the year of initial implementation with no retrospective application. The
incremental effects on the line items in the Statement of Condition at December 31, 2006, were as follows (in millions):

				
Before		After
				Application of		Application of
				Statement 158	Adjustments	Statement 158
Accrued benefit costs		
	 Total liabilities	

59		

$	 27,564	

21		

$	 21	

80

$	 27,585

Surplus		

187		

(21)		

166

	 Total capital	

353		

(21)	

332

62 | F e d e ra l R e s e r v e B a n k o f S t. L o u i s

$	

$	

FEDERAL RESERVE BANK OF ST. LOUIS

notes to Financial statements

The total of the U.S. government securities, net, held in
the SOMA was $783,619 million and $750,202 million at
December 31, 2006 and 2005, respectively. At December
31, 2006 and 2005, the fair value of the U.S. government
securities held in the SOMA, excluding accrued interest,
was $795,900 million and $767,472 million, respectively,
as determined by reference to quoted prices for identical
securities.
Although the fair value of security holdings can be substantially greater or less than the carrying value at any point
in time, these unrealized gains or losses have no effect on
the ability of a Reserve Bank, as a central bank, to meet its
financial obligations and responsibilities, and should not be
misunderstood as representing a risk to the Reserve Banks,
their shareholders, or the public. The fair value is presented
solely for informational purposes.
At December 31, 2006 and 2005, the total contract
amount of securities sold under agreements to repurchase
was $29,615 million and $30,505 million, respectively, of
which $941 million and $947 million were allocated to the
Bank. The total par value of the SOMA securities that were
pledged for securities sold under agreements to repurchase
at December 31, 2006 and 2005 was $29,676 million
and $30,559 million, respectively, of which $943 million
and $948 million was allocated to the Bank. The contract
amount for securities sold under agreements to repurchase
approximates fair value.
The maturity distribution of U.S. government securities
bought outright and securities sold under agreements to
repurchase, that were allocated to the Bank at December 31, 2006, was as follows (in millions):
				Securities
			U.S.	Sold Under
			
Government	Agreements to
			Securities	Repurchase
			

Within 15 days	

(Par value)	

$	

1,290	

16 days to 90 days		

5,882

Over 1 year to 5 years		

7,122

Over 5 years to 10 years		

2,149

Over 10 years		

$	 941

5,747

91 days to 1 year		

(Contract amount)

2,557

Total allocated to the Bank	

$	 24,747	

$	 941

At December 31, 2006 and 2005, U.S. government securities
with par values of $6,855 million and $3,776 million, respectively, were loaned from the SOMA, of which $218 million and
$117 million, respectively, were allocated to the Bank.

and securities purchased under agreements to resell. These
investments are guaranteed as to principal and interest by
the issuing foreign governments.
The Bank’s allocated share of investments denominated
in foreign currencies was approximately 1.089 percent and
2.002 percent at December 31, 2006 and 2005, respectively.
The Bank’s allocated share of investments denominated in
foreign currencies, including accrued interest, valued at foreign currency market exchange rates at December 31, was
as follows (in millions):
				

2006		

2005

European Union Euro:
	 Foreign currency deposits	

$	

68	

$	 109

	Securities purchased under
		 agreements to resell		

24		

39

	Government debt instruments		

45		

71

	 Foreign currency deposits		

28		

52

	Government debt instruments		

58		

108

Japanese Yen:

Total allocated to the Bank	

$	 223	

$	 379

At December 31, 2006 and 2005, the fair value of investments denominated in foreign currencies, including accrued
interest, allocated to the Bank was $222 million and $380
million, respectively. The fair value of government debt
instruments was determined by reference to quoted prices
for identical securities. The cost basis of foreign currency
deposits and securities purchased under agreements to
resell, adjusted for accrued interest, approximates fair value.
Similar to the U.S. government securities discussed in Note
4, unrealized gains or losses have no effect on the ability
of a Reserve Bank, as a central bank, to meet its financial
obligations and responsibilities.
Total System investments denominated in foreign currencies were $20,482 million and $18,928 million at December
31, 2006 and 2005, respectively. At December 31, 2006
and 2005, the fair value of the total System investments denominated in foreign currencies, including accrued interest,
was $20,434 million and $18,965 million, respectively.
The maturity distribution of investments denominated in
foreign currencies that were allocated to the Bank at December 31, 2006, was as follows (in millions):
			European	Japanese
			Euro	Yen	
Within 15 days	

$	 48	

$	 28	

Total
$	 76

Investments Denominated in Foreign Currencies

The FRBNY, on behalf of the Reserve Banks, holds foreign
currency deposits with foreign central banks and with the
Bank for International Settlements and invests in foreign
government debt instruments. Foreign government debt
instruments held include both securities bought outright

26		 13		

39

91 days to 1 year		
Note 5

16 days to 90 days		

27		 24		

51

Over 1 year to 5 years		

36		 21		

57

Total allocated to the Bank	

$	 137	

$	 86	

$	 223

At December 31, 2006 and 2005, there were no material
open foreign exchange contracts.
At December 31, 2006 and 2005, the warehousing facility
was $5,000 million with no balance outstanding.

2 0 0 6 A n n u a l R e p o r t | 63

FEDERAL RESERVE BANK OF ST. LOUIS

notes to Financial statements

A summary of bank premises and equipment at December
31 is as follows (in millions):

$2 million for each of the years ended December 31, 2006
and 2005, respectively. Certain of the Bank’s leases have
options to renew.
Future minimum rental payments under noncancelable
operating leases with remaining terms of one year or more,
at December 31, 2006 are as follows (in thousands):

				

					Operating

Note 6

Bank Premises, Equipment, and Software

2006		

2005

Bank premises and equipment:
	Land	

2007			
$	 11	

$	 11

	 Buildings		 69		

67

	 Building machinery
		 and equipment		 18		

17

	 Construction in progress		 18		

7

	 Furniture and equipment		 43		

$	

789

2008				

417

2009				

430

2010				

75

46

		Subtotal		 159		 148
Accumulated depreciation		 (63)		 (61)
Bank premises and equipment, net	

$	 96		

Depreciation expense, for the
year ended December 31	

$	 8	

$	

87
8

The Bank leases space to outside tenants with lease terms of
less than one year. Rental income from such leases was immaterial for the years ended December 31, 2006 and 2005.
Future minimum payments under agreements in existence at
December 31, 2006 were immaterial.
The Bank has capitalized software assets, net of amortization, of $8 million and $11 million at December 31, 2006
and 2005, respectively. Amortization expense was $3 million
for each of the years ended December 31, 2006 and 2005.
Capitalized software assets are reported as a component of
“Other assets” and the related amortization is reported as a
component of “Other expenses”. Software assets of $3 million were written off in 2006. The majority of the write-offs
were reimbursed by the Department of the Treasury.
The Bank’s restructuring plan, as discussed in Note 11,
resulted in the impairment of a building asset. An asset impairment loss of $1 million for the period ending December
31, 2006, was determined using fair values based on quoted
market values or other valuation techniques and is reported
as a component of “Other expenses”. This impairment represents a further write down of the Little Rock facility, which
is available for sale and reported as a component of “Other
assets”. The Bank had no impairment losses in 2005.

Note 7

Commitments and Contingencies

At December 31, 2006, the Bank was obligated under noncancelable leases for premises and equipment with remaining terms ranging from one to approximately four years.
These leases provide for increased rental payments based
upon increases in real estate taxes, operating costs,
or selected price indices.
Rental expense under operating leases for certain operating facilities, warehouses, and data processing and office
equipment (including taxes, insurance and maintenance
when included in rent), net of sublease rentals, was

64 | F e d e ra l R e s e r v e B a n k o f S t. L o u i s

Future minimum rental payments		

$	 1,711

At December 31, 2006, there were no other material commitments or long-term obligations in excess of one year.
Under the Insurance Agreement of the Federal Reserve
Banks, each of the Reserve Banks has agreed to bear, on a
per incident basis, a pro rata share of losses in excess of one
percent of the capital paid-in of the claiming Reserve Bank,
up to 50 percent of the total capital paid-in of all Reserve
Banks. Losses are borne in the ratio that a Reserve Bank’s
capital paid-in bears to the total capital paid-in of all Reserve
Banks at the beginning of the calendar year in which the loss
is shared. No claims were outstanding under the agreement
at December 31, 2006 or 2005.
The Bank is involved in certain legal actions and claims
arising in the ordinary course of business. Although it is
difficult to predict the ultimate outcome of these actions, in
management’s opinion, based on discussions with counsel,
the aforementioned litigation and claims will be resolved
without material adverse effect on the financial position or
results of operations of the Bank.

Note 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 Bank’s employees participate
in the Retirement Plan for Employees of the Federal Reserve
System (“System Plan”). Employees at certain compensation
levels participate in the Benefit Equalization Retirement Plan
(“BEP”) and certain Reserve Bank officers participate in the
Supplemental Employee Retirement Plan (“SERP”).
The System Plan is a multi-employer plan with contributions funded by the participating employers. Participating
employers are the Federal Reserve Banks, the Board of Governors, and the Office of Employee Benefits of the Federal
Reserve Employee Benefits System. No separate accounting is maintained of assets contributed by the participating
employers. The FRBNY acts as a sponsor of the System Plan
and the costs associated with the Plan are not redistributed
to other participating employers.
The Bank’s projected benefit obligation, funded status,
and net pension expenses for the BEP and the SERP at

FEDERAL RESERVE BANK OF ST. LOUIS

notes to Financial statements

December 31, 2006 and 2005, and for the years then
ended, were not material.

Following is a reconciliation of the beginning and ending
balance of the plan assets, the unfunded postretirement
benefit obligation, and the accrued postretirement benefit
costs (in millions):

Thrift Plan

Employees of the Bank may also participate in the defined
contribution Thrift Plan for Employees of the Federal Reserve
System (“Thrift Plan”). The Bank’s Thrift Plan contributions
totaled $3 million for each of the years ended December
31, 2006 and 2005, and are reported as a component of
“Salaries and other benefits” in the Statements of Income.
The Bank matches employee contributions based on a specified formula. For the years ended December 31, 2006 and
2005, the Bank matched 80 percent on the first 6 percent
of employee contributions for employees with less than
five years of service and 100 percent on the first 6 percent
of employee contributions for employees with five or more
years of service.

				
Fair value of plan assets
	 at January 1	

2006		
$	

–	

–

2.8		

2.8

Contributions by plan participants		

0.5		

0.4

Benefits paid		

(3.3)		

(3.2)

Fair value of plan assets
	 at December 31	

$	

Unfunded postretirement
	 benefit obligation	

$	 73.0	

–	

$	

–

$	 66.2
$	

3.3

Unrecognized net actuarial loss				 (18.7)

Note 9

Accrued postretirement
	 benefit cost			

Postretirement Benefits Other Than Pensions and
Postemployment Benefits

In addition to the Bank’s retirement plans, employees who
have met certain age and length-of-service requirements are
eligible for both medical benefits and life insurance coverage
during retirement.
The Bank funds benefits payable under the medical and life
insurance plans as due and, accordingly, has no plan assets.
Following is a reconciliation of beginning and ending balances of the benefit obligation (in millions):
				

2006		 2005

$	 66.2	

$	 50.8

Amounts included in accumulated
	 other comprehensive loss
	 are show below (in millions):

Postretirement Benefits other than Pensions

Prior service cost	

$	 15.1

Net actuarial loss		 (36.3)
Total accumulated other
	 comprehensive loss	

$	 (21.2)

Accrued postretirement benefit costs are reported as a
component of “Accrued benefit costs” in the Statements of
Condition.
For measurement purposes, the assumed health care cost
trend rates at December 31 are as follows:

$	 55.6

Service cost-benefits earned
	 during the period		

1.7		

1.6

Interest cost on accumulated
	 benefit obligation		

3.3		

3.4

Actuarial loss		

19.9		

8.4

Contributions by plan participants		

0.5		

0.4

Benefits paid		

(3.3)		

(3.2)

Plan amendments		

(15.3)		

Accumulated postretirement
	 benefit obligation at December 31	

$	

Contributions by employer		

Unrecognized prior service cost			

Accumulated postretirement
	 benefit obligation at January 1	

2005

				

$	 73.0	

–

2006		

Health care cost trend
	 rate assumed for next year		

9.00%		

9.00%

Rate to which the cost trend
	 rate is assumed to decline
	 (the ultimate trend rate)		

5.00%		

5.00%

Year that the rate reaches
	 the ultimate trend rate		

2012		

2005

2011

$	 66.2

At December 31, 2006 and 2005, the weighted-average
discount rate assumptions used in developing the postretirement benefit obligation were 5.75 percent and 5.50 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.

2 0 0 6 A n n u a l R e p o r t | 65

FEDERAL RESERVE BANK OF ST. LOUIS

notes to Financial statements

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, 2006 (in millions):
			One Percentage	One Percentage
			
Point Increase	
Point Decrease
Effect on aggregate of
	 service and interest cost
	 components of net periodic
	 postretirement benefit costs	

$	 0.5	

Effect on accumulated
	 postretirement
	 benefit obligation		

$	 (0.5)

to the Medicare Part D prescription drug benefit. The estimated effects of the subsidy, retroactive to January 1, 2004,
are reflected in actuarial loss in the accumulated postretirement benefit obligation.
There were no receipts of federal Medicare subsidies in
the year ended December 31, 2006. Expected receipts in
the year ending December 31, 2007, related to payments
made in the year ended December 31, 2006, are $301
thousand.
Following is a summary of expected postretirement benefit
payments (in millions):
			

Without Subsidy	

2007	

$	

With Subsidy

3.9	

$	 3.5

(5.8)

The following is a summary of the components of net
periodic postretirement benefit expense for the years ended
December 31 (in millions):

2008		

4.2		

3.8

2009		

5.5		

4.5		

4.0

2010		

4.7		

4.3

2011		

5.2		

4.6

2012-2016		
Total	

				
Service cost-benefits earned
	 during the period	

2006		
$	 1.7	

$	 1.6

Amortization of prior service cost		 (3.4)		 (0.5)
Recognized net actuarial loss		 2.3		 0.9
	Total periodic expense		 3.9		 5.4
$	 3.9	

$	 5.4

Estimated amounts that will be
	 amortized from accumulated
	 other comprehensive loss into
	 net periodic postretirement
	 benefit expense in 2007
	 are shown below (in millions):
Prior service cost	

$	 46.9

2005

Interest cost on accumulated
	 benefit obligation		 3.3		 3.4

Net periodic postretirement
	 benefit expense	

30.2		 26.7

$	 52.7	

Postemployment Benefits

The Bank offers benefits to former or inactive employees.
Postemployment benefit costs are actuarially determined
using a December 31 measurement date and include the
cost of medical and dental insurance, survivor income, and
disability benefits. The accrued postemployment benefit
costs recognized by the Bank at December 31, 2006 and
2005 were $5 million for each year. This cost is included as
a component of “Accrued benefit costs” in the Statements
of Condition. Net periodic postemployment benefit expense
included in 2006 and 2005 operating expenses were $213
thousand and $1 million, respectively, and are recorded as a
component of “Salaries and other benefits” in the Statements of Income.

Note 10

$	(3.4)

accumulated other comprehensive income

Actuarial loss		 4.1
Total	

$	 0.7

Net postretirement benefit costs are actuarially determined
using a January 1 measurement date. At January 1, 2006
and 2005, the weighted-average discount rate assumptions
used to determine net periodic postretirement benefit costs
were 5.50 percent and 5.75 percent, respectively.
Net periodic postretirement benefit expense is reported as
a component of “Salaries and other benefits” in the Statements of Income.
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

66 | F e d e ra l R e s e r v e B a n k o f S t. L o u i s

Following is a reconciliation of beginning and ending balances of accumulated other comprehensive loss (in millions):
				
				
				
				
Balance at December 31, 2005	

Amount Related
to Postretirement
Benefits other
than Pensions
$	

	Adjustment to initially apply
	 FASB Statement No. 158		
Balance at December 31, 2006	

–
(21)

$	 (21)

Additional detail regarding the classification of accumulated
other comprehensive loss is included in Note 9.

FEDERAL RESERVE BANK OF ST. LOUIS

notes to Financial statements

Note 11

Business Restructuring Charges

In 2003, the Bank announced plans for restructuring to streamline operations and reduce costs, including consolidation
of check, check adjustment and cash operations and staff reductions in various functions of the Bank. In 2006, additional
consolidation and restructuring initiatives were announced in the check adjustment operations. These actions resulted in
the following business restructuring charges (in millions):
			Year-ended 12/31/2006
			
Total	Accrued			Accrued
			Estimated	Liability	
Total		Liability
			Costs	
12/31/2005	Charges	
Total Paid	
12/31/2006
Employee separation	

$	 4.5	

Other		
Total	

$	

0.4		

$	 4.9	

$	

–	

$	 0.4	

–		
–	

$	

–		

$	 0.4	

–	

$	 0.4

–		

$	

–	

–

$	 0.4

Employee separation costs are primarily severance costs related to identified staff reductions of approximately 186, including
11 staff reductions related to restructuring announced in 2006. Costs related to staff reductions for the years ended
December 31, 2006 and 2005 are reported as a component of “Salaries and other benefits” in the Statements of Income.
Restructuring costs associated with the impairment of certain Bank assets, including software, buildings, leasehold
improvements, furniture, and equipment, are discussed in Note 6.
The Bank anticipates substantially completing its announced plans by May 2007.

2 0 0 6 A n n u a l R e p o r t | 67

Federal Advisory
Council Member

Roy A. Hendin

Visweswara R. Kaza

Michael R. Pakko

Vice President, Deputy General Counsel

Assistant Vice President

Research Officer

Vicki L. Kosydor

Carrie E. Keen

Scott B. Smith

Robert G. Jones

Assistant Vice President

Supervisory Officer

President and CEO

Vice President

William D. Little

Yi Wen

Assistant Vice President

Research Officer

Raymond McIntyre

Christopher H. Wheeler

Assistant Vice President

Research Officer

and Assistant Secretary

Old National Bancorp
Evansville, Ind.

Jean M. Lovati
Vice President

Michael J. Mueller
Vice President

Kim D. Nelson

Bank Officers

John W. Mitchell
Assistant Vice President

Littl e Rock Office

Christopher J. Neely

Robert A. Hopkins

Assistant Vice President

Senior Branch Executive

Vice President

Kathleen O’Neill Paese
S t. L o u is Of f i c e

Vice President

William Poole

Todd J. Purdy

President and CEO

Vice President

David A. Sapenaro

Steven N. Silvey

First Vice President and COO

Vice President

Karl W. Ashman

Randall C. Sumner

Senior Vice President

Vice President

Judith A. Courtney

Daniel L. Thornton

Senior Vice President

Vice President

Mary H. Karr

Jonathan C. Basden

Senior Vice President,

Assistant Vice President

General Counsel and Secretary

Robert H. Rasche

Dennis W. Blase

Assistant Vice President

Louis ville Office

Glen M. Owens

Maria G. Hampton

Assistant Vice President

Senior Branch Executive

Kathy A. Schildknecht
Assistant Vice President

Philip G. Schlueter
Assistant Vice President

Harriet Siering
Assistant Vice President

Diane A. Smith
Assistant Vice President

Assistant Vice President

Senior Vice President
and Director of Research

Edward M. Nelson

Daniel P. Brennan

Leisa J. Spalding
Assistant Vice President

Assistant Vice President

Michael D. Renfro
Senior Vice President

Susan K. Curry

and General Auditor

Assistant Vice President

Julie L. Stackhouse

Hillary B. Debenport

Senior Vice President

Assistant Vice President

Richard G. Anderson

Michael J. Dueker

Vice President

Assistant Vice President

John P. Baumgartner

William M. Francis Jr.

Vice President

Assistant Vice President

Timothy A. Bosch

Kathy A. Freeman

Vice President

Assistant Vice President

Timothy C. Brown

Thomas A. Garrett

Vice President

Assistant Vice President

James B. Bullard

Massimo Guidolin

Vice President

Assistant Vice President

Ronald L. Byrne

Elizabeth A. Hayes

Vice President

Assistant Vice President

Marilyn K. Corona

Paul M. Helmich

Vice President

Assistant Vice President

Cletus C. Coughlin

Edward A. Hopkins

Vice President

Assistant Vice President

William T. Gavin

James L. Huang

Vice President

Assistant Vice President

Susan F. Gerker

Debra E. Johnson

Vice President

Assistant Vice President

James E. Stephens

68 | F e d e ra l R e s e r v e B a n k o f S t. L o u i s

Assistant Vice President

Matthew W. Torbett
Assistant Vice President

Howard J. Wall
Assistant Vice President

David C. Wheelock
Assistant Vice President

Glenda J. Wilson
Assistant Vice President

Jane Anne Batjer
Assistant Counsel

Diane B. Camerlo
Assistant Counsel

Winchell S. Carroll
Supervisory Officer

Joseph C. Elstner
Public Affairs Officer

Joel H. James
Bank Relations Officer

Arthur A. North
Supervisory Officer

Michael T. Owyang
Research Officer

Mem phis Office

Martha L. Perine Beard
Senior Branch Executive

James A. Price
Assistant Vice President

The Federal Reserve Bank of St. Louis is one of 12 regional Reserve banks which,
together with the Board of Governors, make up the nation’s central bank. The Fed
carries out U.S. monetary policy, regulates certain depository institutions, provides
wholesale-priced services to banks and acts as fiscal agent for the U.S. Treasury.
The St. Louis Fed serves the Eighth Federal Reserve District, which includes all of
Arkansas, eastern Missouri, southern Indiana, southern Illinois, western Kentucky,
western Tennessee and northern Mississippi. Branch offices are located in Little
Rock, Louisville and Memphis.

Authors of Essay:
Dennis Blase
William Emmons
Patrick Pahl
Adam Zaretsky

FEDERAL RESERVE BANK OF ST. LOUIS
One Federal Reserve Bank Plaza
Broadway and Locust Street
St. Louis, Missouri 63102
314-444-8444

Editor: Stephen Greene

LITTLE ROCK BRANCH
Stephens Building
111 Center Street, Suite 1000
Little Rock, Arkansas 72201
501-324-8300

Designer: Brian Ebert
Production: Barb Passiglia
Photography for Boards of Directors,
Industry Councils and Management
Committee: Steve Smith Studios

For additional print copies, contact:
Public Affairs Department
Federal Reserve Bank of St. Louis
Post Office Box 442
St. Louis, Missouri 63166
314-444-8809
www.stlouisfed.org

LOUISVILLE BRANCH
National City Tower
101 South Fifth Street, Suite 1920
Louisville, Kentucky 40202
502-568-9200
MEMPHIS BRANCH
200 North Main Street
Memphis, Tennessee 38103
901-523-7171