St. Louis Fed 2006 Annual Report - Check Point

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CheckpointThe Federal Reserves Role in Ensuring

Safety, Soundness and Competitiveness

in a Consolidating Banking Industry

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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

Annual Report2 0 0 6


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Banking mergers and acquisitions have occurred throughout our nations

history. Over the past two decades, they have led to an unprecedented

reduction in the number o banking institutions. Despite ears to the con-

trary, institutions remain sae and sound, and the industry is as competitive

as ever in local markets. The Federal Reserve works to ensure and enorce

such outcomes in order to keep stability and condence high within the

banking industry.

P r e s i d e n t s M e s s a g e

William Poole

P CeO

Fl rv Bk of s. Lo

Not What You Might Expect

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mericas banking landscape has changeddramatically over the past 20 years. The

change started with banks being allowed to

branch unettered within state borders. The process

expanded to banks being allowed, or the rst time

in our nations history, to branch unrestricted across

state borders. Permitting intrastate and interstate

banking and branching led to thousands o mergers

and acquisitions in the industry. Today, the number

o banking organizations is about hal o what it was

in the 1980s. Still, thousands o 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 act, one o the

Federal Reserves jobs is to make sure that banking

competition stays vigorous in local markets, even asthe industry consolidates.

You might also believe that the consolidation trend

has caused some banks to jeopardize their saety

and soundness. This, too, is certainly not the case.

Another o the Feds jobs is to make certain that

banks remain sae and sound, and that they are

complying with all laws and regulations, even

as the industry consolidates.

This years 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 o an evolving banking

landscape.

There was a time when American banking was quite

dierent than it is today. In the 19th and early

20th centuries, our banking system was a

model o active competition among tens o

thousands o small banks. Unortunately,

our environment o many small, indepen-

dent banks prevented these institutions rom achiev-ing maximum eciency, and the system turned out

to be ragile. Some banks ailed, even in relatively

good economic times. Many ailed when economic

conditions deteriorated. The Great Depression

resulted in almost hal o all U.S. banks ailing,

which devastated the economy. This period in U.S.

history illustrates vividly that the number o banking

institutions reveals little about the eectiveness or

eciency o the banking industry.

Although the total number o institutions has re-

cently been dropping, these declines, ueled chiefy

by intrastate and interstate banking and branching,

have enabled banks to structure themselves more e-

ciently than ever beore. No merger or acquisition,

however, can proceed without the Federal Reserve

or another regulator rst reviewing, adjusting and,

ultimately, approving or denying it.

Our annual report examines this less well-known,

but very important, role that the Federal Reserveplays in making sure that such mergers and ac-

quisitions do not endanger a banks saety and

soundness, compliance with laws and regulations,

or the level o banking competition that is vital to

economic welare. Our goal is to make certain that

the banking industry evolves in a way that preserves

the benets o competition and ensures a sae and

sound banking system. So, even i your bank has

changed owners three times in the past two years,

rest assured that the Fed (or another regulator) hasscrutinized each transaction to make sure that the

best interests o the industry, the local market, the

bank and you are upheld.

A

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I. Introduction

Whats Happening to All the Banks around Here?

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It seems to be happening all the time, and everywhere.

You cant 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 buyera bank in town thatyouve heard o or an out-o-town bank that, well, everyone

has heard o. Other times, though, the buyer is unamiliar.

All you know is that yet another bank is going to have a

new owner.

You read urther into the article. It says that the same buyer bought another bank

in town a little more than a year ago. You ask yoursel, Whats happening to all

the banks around here?

You recall a litany o other recent headlinesother transactions. You remember

that Magna Bank became Union Planters, which then became Regions. Boatmens

became NationsBank, which became Bank o America. Mark Twain became Mer-

cantile, which became Firstar, which then became U.S. Bank. Allegiant became

National City; National Bank o Commerce and NBC Bank both became SunTrust

You begin to wonder i competition among banks is disappearing. And, by the way,

isnt the government supposed to do something about this?

Government, in this case, actually reers to the Federal Reserve System, which has

jurisdiction over many o the banking industrys merger and acquisition proposals. The

St. Louis Fed is one o the 12 banks in the Federal Reserve, which is one o our prima-

ry ederal regulators o depository institutions. The other regulators are the Oce o

the Comptroller o the Currency, the Federal Deposit Insurance Corp. and the Oce

o Thrit Supervision. Another ederal agency, the National Credit Union Administra-

tion, regulates credit unions, which are very similar to depository institutions in some

ways. Beyond the our primary regulators, the Department o Justice and the Federal

Trade Commission are also responsible or enorcing the nations 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 com-binations, whether or not they make ront-page news, to ensure that they satisy

all o the requirements set out in the antitrust and banking laws. The provisions

cover nancial condition, managerial resources, anti-money laundering saeguards,

community convenience and needs, and competition, and they are spelled out in

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detailed regulations so that everyone knows what they are up-ront. Only ater all

o these requirements have been met to our satisaction can we approve any deal.

Why do we go through such a thorough process or 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 undamental nancial reason that explains why we should be, and

are, involved. As the nations central bank, the Federal Reserve is responsible or

maintaining nancial stabilitythat is, ensuring both the ongoing and smooth unc-

tioning o the nations payments systems and nancial markets, and a steady supply

o credit to qualied borrowersand the banking system plays a vital role in such

stability. We pay attention to any shock that potentially aects the banking indus-

trys normal operations in the nancial and payments markets. It should, thereore,

not be surprising that the Fed is heavily responsible and accountable or monitoring,

evaluating and overseeing the banking industrys 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 FederalReserve operates as a checkpoint on the road o consolidation. But rst, lets take

a closer look at exactly what banking consolidation is and how it has changed the

nations banking landscape.

Federal Banking regulators

A G E N C Y R E G U L A T E S

F rv sym Fed Bank holding companies and state-charteredcommercial banks that are Fed members

ofc h Cmp h Ccy OCC Commercial banks with national charters

F dp ic Cp. FDIC State-chartered commercial banksthat are not Fed members

ofc th spv OTS Thritsn C u am NCUA Credit unions

dpm Jc DOJ Enorces all o the nations antitrust laws

F t Cmm FTC Enorces all o the nations antitrust laws

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II. The Consolidation

ConundrumCan Fewer Banks Actually Lead to More Banking Competition?



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lthough banking mergers and acquisitions have occurred

throughout U.S. history, the wholesale decline in the num-

ber o banking institutionsor consolidation in the U.S.banking industryis a more recent phenomenon. As illus-

trated in Figure 1, the total number o commercial banks in

the United States, which had been relatively steady through

the 1970s and mid-1980s, has now shrunk to about hal

o what it was just 20 years agorom more than 14,000

banks in 1986 to ewer than 8,000 in 2006. The total

number o savings institutions (also known as thrits, sav-

ings banks, or savings and loan associations), though notdisplayed in the gure, has ollowed an even more dramatic

pathshrinking rom almost 3,700 thrits in 1986 to ewer

than 1,300 in 2006, or about a third o the 1986 level.

All told, these gures mean that more than 6,000 banks (and about 2,400 thrits)

have disappeared over the 20-year period. Indeed, Whats happening to all the

banks around here? is an appropriate question. Its not a huge leap to conclude

that this trend must have led to more concentrationthat is, less competitionin

banking. The reality, however, is quite dierent.

As shown in Figure 2, at the same time the total number o U.S. commercial banks

was declining, a common measure o banking market concentration shows that

the average levels o deposit-market concentration in U.S. metropolitan areas and

nonmetropolitan areas (that is, counties not in metro areas) were also declining

Source: Federal Deposit Insurance Corporation, Quarterly Banking Prole

A

0

4,000

8,000

12,000

16,000

1975 1980 1985 1990 1995 2000 2005

Numberofcommercialbanks

Appearances Can Be Deceiving

Figure 1

The Declining Number of Commercial Banks in the United States

Figures 1 and 2 reveal that

even though the number o

banks has declined over the

past two decades, bankingcompetition in local mar-

kets has actually increased.

Remember, lower market

concentration means higher

competition.



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Sources: Number o commercial banks: Federal Deposit Insurance Corporation, Quarterly Banking Prole;

Indexes o concentration: FDIC Summary o Deposits and Board o Governors

moderately. In other words, as the total number o 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 undamental industry tenet: Banks

compete or customers in local markets. Although some people or small businesses

look beyond their local areas or certain nancial servicesor example, large-

denomination time deposits or investment productssurveys and research continue

to show that customers predominantly choose banks near where they live or work.

Households and small businesses almost exclusively get nancial services like checking

or other transaction accounts (their primary account) and small-business loans rom

local nancial rms, most oten rom banks, though sometimes rom a thrit or credit

union. Regardless o the type o institution, however, the underlying act still holds:

The institution o choice is in the customers neighborhood. Thus, when we talkabout banking competition and the eect o 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.

In addition, at the same time the banking industry has been losing institutions, it has

been making huge advancements in technology, dramatically changing how cus-

tomers access their bank accounts. Moreover, changes to interstate branching laws

have allowed banks to open branches where they couldnt beore. Lets examine

these eects a bit more closely.

Improved Accessibility Due to Technology

During the period over which the total number o banking institutions was declining,

tremendous technological advances were taking place in the industry that, today, we

Figure 2

Declining Average Level of Local Market Concentrationin U.S. Metropolitan and Nonmetropolitan Areas

0

4,000

8,000

12,000

16,000

1975 1980 1985 1990 1995 2000 2005

Numberofcommercialbanks

Number of U.S.commercial banks(left axis)

U.S. nonmetroareas concentration(right axis)

U.S. metro areas concentration (right axis)

1,500

2,000

2,500

3,000

3,500

4,000

4,500

Averageleveloflocal-marketconcentratio

n

(S

caleindicatesHerfindahl-HirschmanIndex.Seepag

e26.)

Banks compete orcustomers in local

markets. Although

some people or smallbusinesses look beyond

their local areas orcertain fnancial servic-

esor example, large-

denomination timedeposits or investment

productssurveys andresearch continue to

show that customers

predominantly choosebanks near where they

live or work.

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sometimes take or granted. ATMs give customers access to their accounts and to

cash 24 hours a day, and ATM networks have made it possible or banks to locate

machines away rom branches, all vastly improving customer convenience and ac-

cessibility. 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. Fur-

thermore, ATM availability has increased dramatically since 1986, when there were

about 64,000 machines nationwide. By 2004, that number had climbed to upwards

o 383,000 units.

Today, many ATM eatures are ound on bank web sites. Online, a customer is able

to access his or her accounts, perorm a multitude o 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 o oering Internet-onlyaccounts, which are paying higher interest rates to depositors. Its not a big step

rom here to Internet-only banksthat is, banks without any brick-and-mortar o-

ces or customers to visit. A ew Internet-only banks exist already.

A Historic First: Interstate Branching

While the total number o independent banking institutions has declined, the

number o branches has skyrocketedrom about 66,000 in 1986 to almost 86,000

in 2006. Part o this increase comes rom the introduction o unrestricted nation-

wide interstate branching, which was permitted or the rst time in the mid-1990s.

Interstate branching has allowed banks to streamline their organizations like never

beore, opening the door to a new type o bankone that can operate oces in

many dierent states simultaneously, all as branches o one bank under one bank

charter. Previously, the same institution would have had to manage oces in dier-

ent states as separate banks, each with its own bank charter. In addition, interstate

branching, by allowing numerous banking organizations to eliminate many manage-

rial and other back-oce redundancies, has improved organizations overall oper-

ating eciency. And although these mergers have reduced the overall number o

institutions, they have had no eect on the number o branches.

Combine interstate branching with the technological advances mentioned above,and you end up with a very dierent banking landscape than 20 years ago, one in

which hundreds o multistate banks span regions o the country or even the entire

nation. The modern environment gives customers more access points to banking

products and services than ever beore.

At the same time, the law that permitted interstate branching also restricted any

bank rom purchasing another i, in the end, it would control more than 10 percent

o total U.S. deposits. This prohibition, however, does not prevent a bank rom hav-

ing more than 10 percent o national deposits i the increase occurs through its own

growth. So ar, only Bank o America has come close to that 10-percent markatthe end o the rst quarter o 2007, it controlled about 9 percent o U.S. deposits.

JPMorgan Chase, the second largest institution, trailed Bank o America with 7.1

percent o U.S. deposits, ollowed by Wachovia with 5.8 percent. State laws also

cap the share o total deposits any institution can control in a state, though the

thresholds are oten between 25 percent and 30 percent.



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How Does the Fed Defne Local Banking Markets?

Each o the 12 Federal Reserve banks, in consultation with the Board o Governors o the Federal Reserve Sys-

tem, is responsible or dening the boundaries o local banking markets within its district. The other ederal

banking regulators usually use these denitions 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. Oten, banking markets are based on metropolitan or similar areas in urban regions, and on counties

in rural regions. Local economic and demographic datasuch as commuting patterns, locations o large em-

ployers and retailers, and other inormation that could demonstrate an economic tie or separation between

two areasare then used to enlarge or shrink the size o the market rom the base.

To date, more than 1,500 banking markets have been dened in the United States, covering almost allparts o the country. These denitions are always subject to change as local areas grow or shrink, however.

For help in nding a banking market denition, you can visit CASSIDITM, an application on the St. Louis

Feds web site that includes all market denitions in the country and interactive maps or many o them.

Visit http://cassidi.stlouisfed.org. (See sidebar on page 29.)

Thinking Nationally, Competing Locally

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Inside the Numbers: Fewer Banks, Not Necessarily Fewer Ofces

Weve already seen that one o the eects o interstate branching is ewer banking institutions overall; this

reduction, however, does not translate into ewer oces in local markets. Suppose, or example, Chm

B has oces in s. l, Cb, i., and l rc, a. Although the name above the door

is the same, beore interstate branching was allowed, these were three separate banks because o branchingrestrictions. That is, there were three institutions and three oces. Ater interstate branching, though, the

three banks could be combined into one. Now, there is one institution, but still three oces. These types o

mergers have no eect on local banking competition even though the total number o institutions goes down.


M I S S O U R I

I L L I N O I S

A R K A N S A S

T E N N E S S E E

K E N T U C K Y

M

ISSISSIPPI

I N D I A N A

M I S S O U R I

I L L I N O I S

A R K A N S A S

T E N N E S S E E

K E N T U C K Y

M

ISSISSIPPI

I N D I A N A

Before Interstate Branching After Interstate Branching

Chm B

Chm B

Chm B

Chm B



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Another type o transaction could have Chm B buying tw B, which has one oce located in

Mmph, t. Beore the transaction, there were two institutions and our oces. Ater the transaction,

there will be one institution, but still our oces. Again, we see that although the overall number o institu-

tions has declined, there has been no eect on local competition. All that has happened in Memphis is that

Town Bank has become Chrome Bank. Many o these types o 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 urther illustrates these principles

in a simple way.

M I S S O U R I

I L L I N O I S

A R K A N S A S

T E N N E S S E E

K E N T U C K Y

M

ISSISSIPPI

I N D I A N A

Before Transaction

Chm B

tw B

M I S S O U R I

I L L I N O I S

A R K A N S A S

T E N N E S S E E

K E N T U C K Y

M

ISSISSIPPI

I N D I A N A

After Transaction

Chm B

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A Crazy-Quilt Banking System Consolidates

To illustrate how the number o independent banks nationwide can decrease, while the average number

o 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 o squares

within the quilts below corresponds to a local banking market. These are separated rom each other

by black lines, representing the distinctness o local markets. Each individual colored square stands

or a bank or one o its branches. The identities o banks are dierentiated by their colors. Changes

in the colors o the quilt represent the changing structure o the U.S. banking market.

Beore interstate branching was allowed, U.S. banking was composed largely o single-market banks. The

quilt representing this situation consists o colored squares, each o which appears only once. There are 36

dierent banks and 36 dierent colors. That is, each unique bank in a local market also is unique in the

larger, national market. Each local market has our competing banks; this simple statistic can be used as a

measure o local banking competition.

Since interstate branching has been allowed and thousands o bank mergers have taken place, the U.S. bank-

ing market today is composed o both multimarket and single-market banks. Multimarket banks appear inmany local markets. Single-market banks appear in only one local market.


Before Interstate Branching Allowed



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The quilt representing this situation consists o some colored squares that appear many timesor example,

red appears nine times, yellow appears seven times, dark green appears ve times, etc.while other colors

appear only once (or example, sky blue). There now are 14 dierent banks, down rom 36. So, the bank-

ing system as a whole has undergone a signicant consolidation. But each local market still consists o our

competing banks; so, local market competition remains unchanged.

The key point o this illustration is that even though many mergers have occurred and there now are ar

ewer independent banksrepresented by ewer unique colors in the quilteach local banking market has

our competing banks (our dierent colors), just as beore. Thus, bank mergers need not decrease competi-

tion in local markets as long as the specic 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 o 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 rom 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 Feds attempt to balance competing goals in our bank-merger policynamely, to al-low eciency-enhancing bank mergers to occur across local banking markets without sacricing the benets

o competition within each local banking market.

After Interstate Branching Allowed

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How the Feds Regulation Ensures the Saety and Soundness

o Newly Combined Banking Organizations

III. Eagle Eye



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Not all banking deals are the same. Transactions take two

basic orms. In the more direct combination, at least two

banks merge to orm one institution. The primary ederal

banking regulatory agency with responsibility or the sur-

viving bank must approve these transactions. (See box onpage 7.) I the surviving bank has a state charter, then the

state regulatory agency must also approve the transaction.

The other common orm o combination involves an existing bank holding company

acquiring a bank. The Federal Reserve, as sole ederal regulator o bank holding

companies, must approve all o these transactions. Some states also require state

approval o these acquisitions. In addition, some states require banks to have been

operating or a minimum number o years beore another bank or bank holding

company can buy itknown as a minimum-age requirementurther

restricting some transactions.

Regardless o the type o combination and which banking regulatory agency

has primary responsibility or the transaction, all proposals must meet the

ollowing standards:

Fc c: An applicant must be in at least satisactory nancial

condition, both beore and ater the transaction;

M c: An applicant must have adequate managerial resources

to operate the new, larger institution in a sae and sound manner;

a-my : An applicant must have in placeadequate systems or preventing money laundering and must be capable o

extending these saeguards to the new, larger banking organization;

Cvc h cmm v by h ppc

: A proposed transaction must be likely to make banking services more

convenient and to meet the nancial needs o the communities served; and

Cmp: A proposed transaction must not reduce competition in any

local banking market by an unacceptable degree.

Each application, thereore, goes through a multistep process that covers each o

the above areas. The rst our criteria ensure the saety, soundness and serviceorientation o banks and the banking system. The last requirementcompetition

ensures that banks operate in locally competitive markets. We will cover competi-

tion in detail in Part IV o this essay.

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Although it is true that the Fed approves nearly all proposals it evaluatesgiving

rise to the impression that we merely rubber-stamp banking merger and acquisition

applicationsapproval comes only ater an exhaustive process during which we

keep a keen eye out or apparent and, sometimes, hidden weaknesses that could

lead the proposal to ail one o the criteria. To avoid any unoreseen obstacles in

the process, applicants oten contact us beore ling an application. Doing so en-

ables us to point out areas that could be troublesome during the actual application

process. Lesser problems most oten can be addressed through committed actions

documented in the process. I problems are severe or not correctable in a reason-

ably short time rame, 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 fawed proposals, which

benets us and applicants because it enables all parties to address weaknesses

beore the process ocially begins.

So, what exactly is the Fed looking or when examining applications or each

o the rst our criteria? And how are we ullling our role?

Financial Factors

The applicant and the resulting combined institution o a proposed transaction must

be judged as satisactory with respect to relevant nancial actors. These actors

are the same as those reviewed during a bank examinationcapital adequacy, asset

quality, protability, liquidity and sensitivity to market risk. Equally important or

a transaction involving a holding company acquisition o a bank is cash fow. The

company must demonstrate its ability to generate sucient cash rom operations

to cover principal and interest payments on debt incurred rom the acquisition,

as well as its other operating expenses.

We develop an overall picture o the strengths and weaknesses o the combining

banking organizations by reviewing examination reports, periodic nancial reports,

inormation provided in the application, and other available data. We project this

inormation to portray the nancial prole o the consolidated organization. Finan-

cial weaknesses or deciencies that are determined in the analysis o the proposal

must be addressed beore the Federal Reserve approves the application. Some

nancial issues, such as a capital deciency, might be addressed by raising more

equity capital. Other weaknesses, such as poor loan quality or an imbalanced as-

set/liability mix, are not easy to x in a short period o time. Banks can sometimesaddress deciencies o this type with commitments to policy changes or specic

actions ocused on the weakness.

Although it is true

that the Fed approvesnearly all proposals

it evaluatesgiving

rise to the impression

that we merely rub-ber-stamp banking

merger and acquisitionapplicationsapproval

comes only ater an ex-haustive process during

which we keep a keen

eye out or apparentand, sometimes, hidden

weaknesses that couldlead the proposal to ail

one o the criteria.

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Notwithstanding a solid commitment that would be expected to improve a problem

area, the Federal Reserve normally will require some evidence that the proposedaction has had the intended eect. Improvement usually must be demonstrated

beore we approve a transaction.

Thats not to say that any weakness must be corrected or requires improvement be-

ore the Fed approves the proposed transaction. For example, when the acquiring

institution is in satisactory nancial condition, but the target institution is nancially

weak, the size and nancial strength o the acquiring entity is a avorable consider-

ation that can oset weaknesses in the target institution.

Managerial Factors

As with the analysis o nancial actors, each transaction involving the combination

o banking organizations must undergo a management assessment, which consid-

ers the competence, experience and integrity o the ocers, directors and principal

shareholders o the acquiring organization. However, the process o judging

ocers and directors and their ability to operate the consolidated institution lacks

the objectivity that comes with the review o nancial data, including trend analysis

and peer comparison.

We oten can learn something about a banks management by reading previous

examination reports. Feedback rom other regulators, who may have knowledge orelevant actors not covered in reports, also helps to clariy the management picture.

This inormation might come through a letter responding to a request or comments

on a pending application, or inormally through a telephone call. For some banking

combinations, we may require certain ocers, directors and principal shareholders

to undergo a background check. In this process, we ask law enorcement agencies

to provide any unavorable inormation that they may have on an individual.

As with nancial weaknesses, managerial deciencies must be addressed or cor-

rected beore an application is approved. Again, this can occur through inormal

discussions and actions taken beore the submission o the application or through

an action plan as part o the ormal proposal.

Occasionally, even though each institution involved in a proposed banking combina-

tion has eective management, the larger and more complex resulting institution



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could end up being beyond the managerial capacity o the existing ocers and

directors. In such a case, the Fed might require additional management stangas a condition o approval.

Combating Money Laundering

The USA PATRIOT Act o 2001 introduced additional strong measures to prevent,

detect and prosecute international money laundering. Among other things, the

PATRIOT Act requires ederal banking regulatory agencies to take into consideration

a banking organizations eectiveness in combating money laundering activities

when that banking organization les a merger or acquisition application.

This assessment involves a review o the banking organizations policies and

procedures to detect and prevent money laundering.

Minor weaknesses in an anti-money laundering program oten can be addressed

during the application process. However, i signicant program weaknesses

exist, then the acquiring banking organization may be required to demonstrate

veriable improvement over a period o time beore being allowed to expand

through combination.

Convenience and Needs

The Federal Reserve is required to assess whether a proposed banking combinationwould likely have any adverse eect on the convenience and needs o the communi-

ties served by the banking organizations. This assessment ocuses on the availability

and manner in which banks provide products and services to customers. Closing

cost-inecient branches o the resulting organization is one possible way in which

customers convenience and banking needs could be negatively aected.

Assessing convenience and needs also involves taking into account the acquiring

organizations and the target institutions records o meeting the credit needs o

their communities, including low- and moderate-income neighborhoods, as required

under the Community Reinvestment Act (CRA). The Federal Reserve expects an ac-

quiring organization to have an established record o satisactory CRA perormance

beore it les an application. A satisactory CRA record or the target institution is

also important. A less-than-satisactory CRA examination rating on the part o the

acquiring institution or the target can present an obstacle to approval.

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How the Feds Analysis Keeps Markets rom Becoming

Too Concentrated

IV. Competition Is Critical



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0 0 6 a n n u a l r e p o r t |


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hen evaluating a proposed banking merger or acquisition

or its potential eects on competition, we need to know

how it will aect competition in every banking market in

which both the applicant and target have branches. Each

market is evaluated individually. Thus, or example, in any

one o the more prominent mergers highlighted in Part I,

literally dozens o banking markets were analyzed to ensure

that the antitrust competition requirements were met in

each o them.

The Before and After of Competition

Ater we determine which banking markets are involved in a proposal, we have

to examine how each market will change i the proposal is allowed to proceed.

To make this determination, we need to know what each market looks like beore

and ater the combination. We start by building a picture o 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 inormation, we can inerthat deposit inormation is a reasonable measure o a banks presence in a market.

Using branch-level deposit data, we can calculate a banks total deposits and share

o deposits in a market. For thrits, we normally include only hal o their deposits

because thrits do not oer all o the same products and services that banks do,

particularly to businesses. In other words, thrits are not perect substitutes or

banks. I a bank holding company owns several banks in the same market, then the

deposits o the sister institutions are pooled together to determine the bank holding

companys market share. Finally, credit union deposits are not normally included in

a markets deposit calculation. Being membership organizations, credit unions oer

their products and services only to certain groups o people, and these products andservices are oten quite limited when compared with those oered by banks and

thrits. That said, we may include a particular credit unions deposits in the calcula-

tion i substantial evidence supports their inclusion. One piece o such evidence

would be that the credit union oers a wide range o consumer banking products.

In addition, the credit union should have liberal membership rules (typically, at least

70 percent o market residents must be eligible or membership), and it should have

easily accessible street-level branches.

Once we have market shares or all institutions in the market, we can take the next

step and determine the markets concentration. To do this, we use a tool called the

Herndahl-Hirschman Index (more commonly reerred 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:

W



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The smaller the HHI number is, the less concentrated the market is (the more com-

petition 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, i a market has only one bank,it would have a 100 percent market share, and HHI would equal 10,000, or 100 2 x 1.

I, 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

perorms it or you or any banking market in the nation. (See sidebar on page 29.)

To determine i a deal will satisy the antitrust requirements, we need to look at the

buyers market share ater the transaction and the markets HHI beore and ater the

combination. I the ater-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 satis-

es the Justice Departments merger guidelines. (See box at right.) Specically, the

department generally will not challenge a banking proposal unless the ater-market

HHI exceeds 1,800 points AND the increase in HHI resulting rom the deal exceeds

200 points. This is oten 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 dierence is that the Justice Department recognizes that banks

ace competition rom a variety o other nancial providers, such as thrits, credit

unions and other types o nancial rms. Allowing banking markets the leeway o

a 200-point change in HHI accounts or the expanded competition banks ace.

In addition to the Justice Departments rules, the Federal Reserve also will typically

not allow a bank to buy its way to more than 35 percent o any banking marketstotal 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 o the markets economic

circumstances, not rejection o the proposal. As with the national- and state-level

caps, banks can grow their way to controlling more than 35 percent o a markets

total deposits.

What if the Picture Is Not Clear?

I one or more o the banking markets in a transaction do not satisy the 1,800/200

rule, does that then mean the transaction cannot go through? No, not automati-

cally. What it does mean, though, is that we will need to investigate those markets

urther to nd out i perhaps other important actors arent being picked up by the

HHI calculation. One o the rst items well look at is the number o other banks

remaining in the market and each ones market share ater the deal. Well also

want to know i any new banks have opened in the market recently and i deposit,

income and population growth in the area have been relatively strong when com-

pared with similar areas in the rest o the state. Well look to see i a thrit in this

market has been aggressively pursuing business customers, making its share o

loans to businesses look more similar to other banks than to other thrits. I so, we

may end up including all o that savings institutions deposits rather than just hal in

the markets deposit calculation. Or, there may be a credit union in the market that

has a storeront like a bank or thrit and opens its doors to most people in the area.

I so, we may end up including a portion o its deposits in the markets deposit

Merger Guidelines

The Justice Departmentdivides the spectrum o

market concentration

as measured by the HHI

into three regions that

can be broadly charac-

terized as unconcentrat-

ed (HHI below 1,000),

moderately concentrated

(HHI between 1,000

and 1,800), and highlyconcentrated (HHI above

1,800). For a bank-

ing 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 mar-ket (a nal HHI greater

than 1,800 points).

0 0 6 a n n u a l r e p o r t |


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calculation. We would also need to know i the bank being bought is in trouble,

perhaps even on the verge o shutting down. We can then use some or all o this

inormation to demonstrate that actors are at play in the market that are not being

captured by the HHI, and, when these actors are considered, the deal will not end

up substantially lessening competition in the banking market.

At times, though, a markets current concentration and the potential increase rom

a deal are just too large or some o these other economic actors to overcome.

In such cases, the buyer may oer (or we may require the buyer) to sell branches

to other banks in an attempt to keep a local markets 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 ActionThe Real World

To get a eel or how a competitive analysis might actually play out, lets look at a

recent real-world acquisitionRegions Banks purchase o AmSouth Bank. Beore

the deal, Regions was the 21st largest bank in the nation (based on total assets)

and controlled less than 1 percent o national deposits. It operated branches in 16

states. AmSouth was the 27th largest bank in the country and also controlled less

than 1 percent o national deposits. It operated branches in seven states. Ater the

deal, Regions became the 13th largest bank in the country and controlled less than

2 percent o 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 or each o these

67 local banking markets. In 42 o them, the 1,800/200 rule was satised without

divestitures or any urther market examinations. That let 25 markets in which the

1,800/200 rule was violated and/or Regions ater-market share exceeded 35 per-

cent. Each would require divestiture, urther examination or both. In 12 o these

25 banking markets, divestitures o AmSouth branches were enough to satisy the

1,800/200 rule.

The remaining 13 markets required urther examinations because, even ater ac-

counting or any proposed divestitures, they ell outside the 1,800/200 guidelinesand/or Regions ater-market share exceeded 35 percent. Credit-union deposits

played a role in countering the initial HHI analysis in 11 o these markets, and thrits

in three markets were considered ull competitors with commercial banks. In addi-

tion, new bank openings in the recent past, strong income, population and deposit

growth relative to surrounding areas, and the number and strength o the remain-

ing competitors in all 13 markets contributed to the nal decision to approve the

application. Thus, the initial HHI analysis did not ully explain the actual competitive

picture in these markets. When all was said and done, the inormation gathered

and actions taken were sucient to conclude that the deal would not have a sig-

nicantly adverse eect on competition in any o the banking markets. The acquisi-

tion was approved in October 2006. Read more about the outcome o this case at

www.ederalreserve.gov/boarddocs/press/orders/2006/20061020/attachment.pd.

| 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


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St. Louis Fed Offers Online Way To Get BankingCompetition Information

The Federal Reserve Bank o St. Louis launched a web site in 2006 intended

to give bankers, consultants and the public a convenient way to view bank-ing competition inormation. The application is called CASSIDITMCompeti-

tive Analysis and Structure Source Instrument or Depository Institutions

and is accessible at http://cassidi.stlouisfed.org.

A ree application, CASSIDI allows users to:

view banking market denitions or any part o the country,

search or inormation in a user-riendly ormat,

benet rom regular updates as market structures change,

explore what i (pro orma) scenarios by seeing how a potential

transaction might change a banking markets concentration or aect HHI,

select whole institutions or individual branches as potential targets,

look up geographic and depository inormation or all institutions and

their branches, and

view maps o many banking markets throughout the United States.

CASSIDITM

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eore reading this essay, the average person most likely assumed that consolidation

in the U.S. banking industry, which has been the norm or 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 o banking organiza-

tions to about hal o its previous level. But a look at local banking marketswhere

banking competition actually takes placetells a dierent story: Users o banking

services still have many choices among competing providers. Todays institutions

have about 20,000 more branches than all o the banking organizations in the

1980s. And because o interstate branching, customers are likely to nd banks with

branches in many states across a region or even across the country. Technologies

that either did not exist or were in their inancy two decades agoor example,

online banking and ATMsnow oer customers access to their accounts every

moment o the day.

Such dramatic changes in so relatively short a period naturally raise concerns about

the saety and soundness o banking organizations and about the state o bank-

ing competition. The Federal Reserve, however, is responsible or ensuringeven

as the banking industry consolidatesthat institutions remain sae 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 o the other

primary ederal regulators) review, adjust and, ultimately, approve or deny every

application or a banking merger or acquisition to make certain that it satises all o

the requirements set out in the antitrust laws. The requirements include nancial

condition, managerial resources, anti-money laundering saeguards, communityconvenience and needs, and local banking market competition. Only ater we are

satised that all o the requirements have been met can we approve a transaction.

By engaging in such a thorough evaluation, we are indeed ullling our role o oper-

ating as a checkpoint in the banking consolidation process.

BV. Conclusion



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0 0 6 a n n u a l r e p o r t | 1


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Thank You(retiring board members)

We bid arewell and express our gratitude to those members o

the Eighth District boards o directors who retired in 2006.

Our appreciation and best wishes go out to the ollowing:

LITTLE ROCK

Stephen M. Erixon

Raymond E. Skelton

LOUISVILLE

Norman E. Pau Jr.

MEMPHIS

J.W. Gibson II

Russell Gwatney

ST. LOUIS

Walter L. Metcale Jr.

We also extend our deepest sympathies to the amily and

riends o Cornelius A. Martin, Louisville chairman,

who passed away in 2006.

B O a r d s O F d i r e C t O r s

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sh P

Executive DirectorDowntown Little Rock PartnershipLittle Rock, Ark.

rb a. Y iii

ChairmanArkansas Best Corp.Fort Smith, Ark.

Wm C. sch

PresidentFirst Security BancorpSearcy, Ark.

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Louisville

Jh l. HbChm

President and CEOLouisville Water Co.Louisville, Ky.

g B. g

Chairman, President and CEOThe Peoples BankMarion, Ky.

gy a. r

PresidentWestern Kentucky UniversityBowling Green, Ky.

Bb a Ppp

CEOSchuler Bauer Real Estate ServicesNew Albany, Ind.




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Jh C. sch

PresidentWabash Plastics Inc.Evansville, Ind.

sv e. t

Chairman and CEORepublic Bank & Trust Co.Louisville, Ky.

l. C ty J.

CEOEphraim McDowell HealthDanville, Ky.

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Memphis

Mh B. aChm

Vice President, MarketingStaple Cotton Cooperative AssociationGreenwood, Miss.

Ch s. B

Member (Partner)The Bogatin Law Firm PLCMemphis, Tenn.

lv Mhw

Director o SalesRegions Morgan Keegan Private BankingMemphis, Tenn.

nc C

PartnerClark & ClarkMemphis, Tenn.




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thm g. M

PresidentSouthern Hardware Co. Inc.West Helena, Ark.

H smm

President and CEOFirst South BankJackson, Tenn.

dv P. rmb J.

President and CEOCommunity Development FoundationTupelo, Miss.

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St. Louis

i F. ehChm

ChairmanPeabody EnergySt. Louis

Cyh J. Bydpy Chm

PresidentAT&T MissouriSt. Louis

sv H. lp

President and CEOBJC HealthCareSt. Louis

P t. Cmb

PresidentBaker Implement Co.Kennett, Mo.




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lw F. My J.

Chairman and CEOCadence Financial Corp.Starkville, Miss.

dv r. P

President and CEOFirst National Bank in PinckneyvillePinckneyville, Ill.

J. thm My

Chairman and CEOSimmons First National Corp.Pine Blu, Ark.

a. r Y ii

President

Yarnell Ice Cream Co. Inc.Searcy, Ark.

0 0 6 a n n u a l r e p o r t | 1


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

Little Rock | Agribusiness

Bert Greenwalt, Ph.D.

Arkansas State UniversityState University, Ark.

Ted Huber

Hubers Orchard & WineryStarlight, Ind.

Cal McCastlain

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

(Mr. McCastlain is now a member ofLittle Rocks Board of Directors; he has

been replaced by Keith Glover.)

John King III

King FarmsHelena, Ark.

Dr. Leonard Guarraia

World Agricultural ForumSt. Louis

Richard Jameson

Jameson FarmsBrownsville, Tenn.

(not pictured)

Tim Gallagher

Bunge North America Inc.St. Louis

(not pictured)

Keith Glover

Producers Rice MillStuttgart, Ark.

At top,

from left:

At bottom,

from left:

(not pictured)

Dr. David Williams

Burkmann FeedsDanville, 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


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Louisville | Health Care

sph a. Wm

Norton HealthcareLouisville, Ky.

Cv a

Blue Cross Blue Shield o TennesseeMemphis, Tenn.

r d. H J.

Baptist HealthLittle Rock, Ark.

s My J ry

SSM Health Care SystemSt. Louis

Jy B. B

Humana Inc.Louisville, Ky.

(not pictured)

Bb g

Baptist MemorialHealth CareMemphis, Tenn.

(not pictured)

d kpp

Mid-AmericaTransplant ServicesSt. Louis

(not pictured)

dc P

University o Arkansasor Medical SciencesLittle Rock, Ark.

a p,

m :

a bm,

m :

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M a n a g e M e n t C O M M i t t e e

Wm P

President and CEO

dv sp

First Vice President and COO

rb rch

Senior Vice President

My k




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J Cy


J sch


k ahm


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T

a M e s s a g e F r O M M a n a g e M e n t

he Federal Reserve Bank o St. Louis ended 2006 and entered 2007 with a ull

charge o momentum. However one chooses to dene it, 2006 was a successul

year or uswhether it was our economists expanding their published research andnumber o presentations, the continued management o the Feds Treasury services

by our Treasury Relations and Support Oce (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 nancial objectives and one o two organizational climate objectives.

We also met 34 o 45 key operating measures, many o which continue to have

stretch targets. The Banks 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 ollows are highlights o the Districts 2006 accomplishments:

Research/Monetary Policy

Continued strong economic research program and high publication and citation

rate. The number o peer-reviewed journal articles published or accepted or

publication was 62, up rom 58 in 2005.

Provided excellent support or the Banks public programs through research on

topics o interest to community leaders and through research presentations.

Enhanced online economic inormation and implemented an online bank struc-

tural data inormation system (CASSIDI). Overall, Researchs web pages were

visited more than 60 million times during 2006, up more than 40 percent rom

the preceding year.

Supervision, Credit and Center for Online Learning

Completed all mandated bank examinations in a timely manner and received

excellent Board o Governors operations examination.

Raised the Banks visibility to bankers and increased the supervisory portolio ostate member banks rom 85 to 94 banks.

Continued to increase the volume o work or the Center or Online Learning, a

recognized Fed System leader in the area o online training.



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Legal, Public and Community Affairs

Continued to expand the Districts outreach through additional economic educa-

tion and community development programs, as well as local boards o directors

engagement.

Enhanced the Banks monetary policy input programs in support o the Banks

president. Industry Councils, a new vehicle or gathering and sharing economic

data with key business and community leaders, were established in all our zones.

Continued to provide editorial and graphic design services to other Reserve banks

or publications and web sites.

Organizational Initiatives

Customer Service: The District continued its eorts to sustain a service-oriented

culture. As a result, all divisions exceeded customer service targets.

Innovation: To support the Banks organizational value o innovation, the Bank

implemented an online idea repository yielding 64 new ideas; seven were imple-

mented, and 37 are in process.

Sta Development: Human Resources completed several initiatives to urther

leadership and sta development. In addition, a new behavioral competencymodel was introduced to employees in 2006.

Employee Communications: Several communications channels were reassessed

or rened in 2006, and new electronic channels o communication were urther

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 o risk inorma-

tion collected has been streamlined, resulting in more timely risk prole updates.

a M e s s a g e F r O M M a n a g e M e n t



52/70

FinancialStatementsFor the years ended December 31, 2006 and 2005


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54/70

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

ManageMents RepoRt on InteRnal ContRol oveR FInanCIal RepoRtIng

To The Board o direcTors:

Mrch 5, 2007

th mm h Fdr Rr Bk s. lui (h Bk) i rib r h rri d ir ri

h sm Fici Cdii, sm Icm, d sm Ch i Ci Dcmbr 31, 2006

(h Fici sm). th Fici sm h b rrd i crmiy wih h ccui rici,

ici, d rcic bihd by h Brd grr h Fdr Rr sym d rh i h Fici

accui Mu r h Fdr Rr Bk (Mu), d uch, icud mu, m which r bd

mm judm d im. t ur kwd, h Fici sm r, i mri rc, iry r-

d i crmiy wih h ccui rici, ici d rcic dcumd i h Mu d icud dicur

cry r uch ir ri.

th mm h Bk i rib r bihi d miii ci ir cr r ci rri

i r h Fici sm. such ir cr i did rid rb urc mm

d h Brd Dircr rrdi h rri h Fici sm i ccrdc wih h Mu. Ir

cr ci -miri mchim, icudi, bu imid , diii ribiiy d cd cduc.

oc idid, y mri dcici i ir cr r rrd mm d rri crrci mur

r immd.

e ci ir cr, mr hw w did, h ihr imii, icudi h ibiiy hum rrr,

d hrr c rid y rb urc wih rc h rri rib ci m. a,

rjci y ui ci uur rid r ubjc h rik h cr my bcm idqubcu ch i cdii, r h h dr cmic wih h ici r rcdur my drir.

th mm h Bk d i ir cr r ci rri rfcd i h Fici sm,

bd u h criri bihd i h Ir Cr -- Ird Frmwrk iud by h Cmmi sri

orizi h trdwy Cmmii. Bd hi m, w bi h h Bk miid ci ir

cr r ci rri i r h Fici sm.

Mm m h ci h Bk ir cr r ci rri Dcmbr 31, 2006,

i bi udid by pricwrhuCr llp, h idd rird ubic ccui rm which i udii h

Bk Fici sm.

Fdr Rr Bk s. lui

Wm P, prid d Chi excui ocr

d a. sp, Fir vic prid d Chi ori ocr

M K. c, vic prid, Chi Fici ocr


55/70

54 | 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

W h cmd ird udi h Fdr Rr Bk s. lui 2006 ci m, d i ir

cr r ci rri Dcmbr 31, 2006 d udi i 2005 ci m i ccrdc wih h

ry ccd udii drd bihd by h audii sdrd Brd (Uid s) d i ccrdc wih

h udii drd h pubic Cmy accui orih Brd (Uid s). our ii, bd ur udi,

r rd bw.

ttmt

W h udid h ccmyi m cdii h Fdr Rr Bk s. lui (h Bk) Dcmbr 31, 2006 d 2005, d h rd m icm d ch i ci r h yr h dd, which

h b rrd i crmiy wih h ccui rici, ici, d rcic bihd by h Brd grr

h Fdr Rr sym. th ci m r h ribiiy h Bk mm. our ribiiy i

xr ii h ci m bd ur udi.

W cducd ur udi i ccrdc wih ry ccd udii drd bihd by h audii sdrd

Brd (Uid s) d i ccrdc wih h udii drd h pubic Cmy accui orih Brd (Ui-

d s). th drd rquir h w d rrm h udi bi rb urc bu whhr h

ci m r r mri mim. a udi icud xmii, bi, idc uri h

mu d dicur i h ci m, i h ccui rici ud d iic im md

by mm, d ui h r ci m ri. W bi h ur udi rid rb

bi r ur ii.

a dcribd i n 3, h ci m wr rrd i crmiy wih h ccui rici, ici, d

rcic bihd by h Brd grr h Fdr Rr sym. th rici, ici, d rcic, which

wr did m h ciizd ccui d rri d h Fdr Rr sym, r rh i h

Fici accui Mu r Fdr Rr Bk which i cmrhi bi ccui hr h ccui

rici ry ccd i h Uid s amric.

I ur ii, h ci m rrrd b r iry, i mri rc, h ci ii h

Bk Dcmbr 31, 2006 d 2005, d ru i ri r h yr h dd, h bi ccui

dcribd i n 3.

RepoRt oF InDepenDent aUDItoRs

To The Board o Governors o The ederal reserve sysTeMand The Board o direcTors o The ederal reserve BanK o sT. louis


56/70

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

it t f ptg

a, i ur ii, mm m, icudd i h ccmyi Mm rr Ir Cr or

Fici Rri, h h Bk miid ci ir cr r ci rri Dcmbr 31, 2006

bd criri bihd i Ir Cr - Ird Frmwrk iud by h Cmmi sri oriz-

i h trdwy Cmmii (Coso), i iry d, i mri rc, bd h criri. Furhrmr, i ur

ii, h Bk miid, i mri rc, ci ir cr r ci rri Dcmbr 31,

2006, bd criri bihd i Ir Cr - Ird Frmwrk iud by h Coso. th Bk mm

i rib r miii ci ir cr r ci rri d r i m h ci

ir cr r ci rri. our ribiiy i xr ii mm m d h

ci h Bk ir cr r ci rri bd ur udi. W cducd ur udi ir

cr r ci rri i ccrdc wih ry ccd udii drd bihd by h audii s-

drd Brd (Uid s) d i ccrdc wih h udii drd h pubic Cmy accui orih Brd

(Uid s). th drd rquir h w d rrm h udi bi rb urc bu whhr

ci ir cr r ci rri w miid i mri rc. a udi ir cr r

ci rri icud bii udrdi ir cr r ci rri, ui mm

m, i d ui h di d ri ci ir cr, d rrmi uch hr r-

cdur w cidr cry i h circumc. W bi h ur udi rid rb bi r ur ii.

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ribiiy ci rri d h rri ci m r xr ur i ccrdc wih ryccd ccui rici. a cmy ir cr r ci rri icud h ici d rcdur

h (i) ri h mic rcrd h, i rb di, ccury d iry rfc h rci d di-

ii h h cmy; (ii) rid rb urc h rci r rcrdd cry rmi

rri ci m i ccrdc wih ry ccd ccui rici, d h rci d x-

diur h cmy r bi md y i ccrdc wih uhrizi mm d dircr h cmy;

d (iii) rid rb urc rrdi ri r imy dci uuhrizd cquiii, u, r diii

h cmy h cud h mri c h ci m.

Bcu i ihr imii, ir cr r ci rri my r r dc mim. a,

rjci y ui ci uur rid r ubjc h rik h cr my bcm idqu

bcu ch i cdii, r h h dr cmic wih h ici r rcdur my drir.

Mrch 12, 2007


57/70


asseTs

gd cric $ 328 $ 327

sci drwi rih cric 71 71

Ci 40 43

Im i rc cci 196 216

U.s. rm curii, 24,897 23,279

Im dmid i ri currci 223 379

accrud ir rcib 214 181

Irdiric m ccu 1,807 2,010

Bk rmi d quim, 96 87

ohr 45 54

Tt t $ 27,917 $ 26,647

liaBiliTies and caPiTal

libiii:

Fdr Rr udi, $ 25,994 $ 24,602

scurii d udr rm rurch 941 947

Di:

Diry iiui 434 482

ohr di 7 3

Drrd crdi im 103 151

Ir Fdr Rr du U.s. trury 16 106

accrud b c 80 57

ohr ibiii 10 11

Tt bt $ 27,585 $ 26,359

Ci:

Ci id-i 166 144

suru (icudi ccumud hr cmrhi

$21 mii Dcmbr 31, 2006) 166 144

Tt pt 332 288

Tt bt pt $ 27,917 $ 26,647

FeDeRal ReseRve BanK oF st. loUIs

sTaTeMenTs o condiTion

( in millions)

As of December 31,

2006 2005

The accompanying notes are an integral part o these fnancial statements.


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2 0 0 6 A n n u A l R e p o R t | 57

Ir icm:

Ir U.s. rm curii $ 1,112 $ 861

Ir im dmid i ri currci 4 6Ir diry iiui 1 1

Tt tt m 1,117 868

Ir x:

Ir x curii d udr rm rurch 42 25

nt tt m 1,075 843

ohr ri icm:

Cmi rcid r ric ridd 22 22

Rimburb ric rm ci 116 112

Fri currcy i (), 13 (57)

ohr icm 2 3

Tt t ptg m 153 80

ori x:

sri d hr b 94 89

occucy x 10 10

equim x 8 7

am by h Brd grr 20 22

ohr x 107 103

Tt ptg xp 239 231

nt m p t tbt $ 989 $ 692

Diribui icm:

Diidd id mmbr bk $ 10 $ 16

trrrd /(rm) uru 43 (92)

pym U.s. trury ir Fdr Rr 936 768

Tt tbt $ 989 $ 692


sTaTeMenTs o incoMe

( in millions)

For the year ended December 31,

2006 2005


sp

nt im amt ot

cpt P-i rt cmp l Tt sp Tt cpt

Bc Jury 1, 2005

(4.7 mii hr) $ 236 $ 236 $ $ 236 $ 472

n ch i ci ck

rdmd (1.8 mii hr) (92) (92)

trrrd rm uru (92) (92) (92)

Bc Dcmbr 31, 2005

(2.9 mii hr) $ 144 $ 144 $ $ 144 $ 288

n ch i ci ck iud

(0.4 mii hr) 22 22

trrrd uru 43 43 43

adjum iiiy y

FasB sm n. 158 (21) (21) (21)

B t dmb 31, 2006

(3.3 m ) $ 166 $ 187 $ (21) $ 166 $ 332


sTaTeMenTs o chanGes in caPiTal

or the years ended December 31, 2006, and December 31, 2005( in millions)



59/70


noTe 1

sTrucTure

th Fdr Rr Bk s. lui (Bk) i r h

Fdr Rr sym (sym) d h wRr Bk (Rr Bk) crd by Cr udrh Fdr Rr ac 1913 (Fdr Rr ac),which bihd h cr bk h Uid s.th Rr Bk r chrrd by h dr rmd uiqu rm, crr, dcr bk chrcriic. th Bk d i brch ili Rck, luii d Mmhi r h eihh FdrRr Diric, which icud ark, d ri Ii-i, Idi, Kucky, Miiii, Miuri d t.

I ccrdc wih h Fdr Rr ac, uriid cr h Bk i xrcid by brd dirc-r. th Fdr Rr ac ci h cmii

h brd dircr r ch h Rr Bk. echbrd i cmd i mmbr ri hr-yrrm: hr dircr, icudi h did chir-m d duy chirm, r id by h Brd grr h Fdr Rr sym (Brd gr-r) rr h ubic, d ix dircr r cdby mmbr bk. Bk h r mmbr h symicud i bk d y -chrrd bkh y d r rd r mmbrhi i h sym.Mmbr bk r diidd i hr c ccrdi iz. Mmbr bk i ch c c dircr rr-i mmbr bk d rri h ubic. Iy ci dircr, ch mmbr bk rci , rrd h umbr hr Rr Bkck i hd.

th sym ci, i r, h Brd gr-r d h Fdr o Mrk Cmmi (FoMC).th Brd grr, idd dr cy, ichrd by h Fdr Rr ac wih umbr -cic dui, icudi r urii r h RrBk. th FoMC i cmd mmbr h Brd grr, h rid h Fdr Rr Bk nwYrk (FRBnY) d, ri bi, ur hr RrBk rid.

noTe 2

oPeraTions and services

th Rr Bk rrm riy ric d ri.Fuci icud ricii i rmui d cducimry icy; ricii i h ym ym, icud-i r-dr rr ud, umd crihu(aCH) ri, d chck cci; diribui cid currcy; rrmc c cy uci r hU.s. trury, cri dr ci, d hr ii; r-i h dr rm bk; rii hr-rm diry iiui; ric h cumr d hcmmuiy by ridi duci mri d irm-

i rrdi cumr w; d urii bk hdicmi, mmbr bk, d U.s. c ribki rizi. th Rr Bk rid criric ri cr bk, rm, d ir-i ci iiui.

th FoMC, i h cduc mry icy, bihicy rrdi dmic mrk ri, rh ri, d uy iu uhrizi ddirci h FRBnY r i xcui rci. thFRBnY i uhrizd d dircd by h FoMC cduc

ri i dmic mrk, icudi h dirc ur-ch d U.s. rm curii, h urch curii udr rm r, h curiiudr rm rurch, d h di U.s.rm curii. th FRBnY xcu h mrk rci h dirci h FoMC d hdh rui curii, wih h xci curii ur-chd udr rm r, i h ri kw h sym o Mrk accu (soMa).

I ddii uhrizi d dirci ri i hdmic curii mrk, h FoMC uhriz d dirch FRBnY xcu ri i ri mrk r mjrcurrci i rdr cur dirdry cdii i xch

mrk r m hr d cid by h FoMC i cr-ryi u h sym cr bk ribiii. th FRBnYi uhrizd by h FoMC hd bc , d xcu d rwrd ri xch (FX) d curii c-rc r, i ri currci d i uch ri cur-rcy hdi uri dqu iquidiy i miid. thFRBnY i uhrizd d dircd by h FoMC mii r-circ currcy rrm (FX w) wih w crbk d wrhu ri currci r h U.s. truryd exch sbiizi Fud (esF) hruh h RrBk. I cci wih i ri currcy ciii, hFRBnY my r i rci h ci ryi dr -bc-h mrk rik h ru rm hir uur

m d cur-ry crdi rik. th FRBnY crcrdi rik by bii crdi r, bihi rciimi, d rrmi diy miri rcdur.

ahuh h Rr Bk r r ii,i h ir rr cicy d ci hycbr i h diry cri ri d ric.th cbri k h rm crizd rid rduc r ric c h h ribiiy r hdiry cri ric bh h Rr Bk.vriu ri d mm md r ud dr urd by ric rm bw h RrBk ridi h ric d h hr RrBk. I m c, c icurrd by Rr Bk r

ric ridd hr Rr Bk r hrd; ihr c, h Rr Bk r bid r ric r-idd hm by hr Rr Bk.

Mjr ric ridd bh h sym by hBk, r which h c wr rdiribud h hrRr Bk, icud ri h trury Rid sur oc d h trury Ri d symsur Drm, which rid ric h U.s.trury. th ric icud: rihi mm,ric cui, d rih r c d ymrd rjc r h Fdr Rr sym; d r-i ur r h trury x cci, ch m-m d cr miri.

Duri 2005, h Fdr Rr Bk a(FRBa) w id h r ribiiy r m-i h Rr Bk rii chck ric diry iiui, d, ru, rciz sym chck ru i sm Icm. Bcuh hr Rr Bk icur c rid chck


noTes To inancial sTaTeMenTs


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

ric, icy w dd by h Rr Bk i 2005h rquird h h FRBa cm h hr RrBk r c icurrd rid chck ric. I 2006hi icy w xdd h aCH ric, which rmd by h FRBa, w Fdwir ud rr

d curii rr ric, which r md by hFRBnY. th FRBa d h FRBnY cm h hr R-r Bk r h c icurrd rid h ric.thi cmi i rrd cm Cm-i rcid r ric ridd, d h Bk wudh rrd $22 mii cmi rcid r r-ic ridd hd hi icy b i c i 2005 r aCH,Fdwir ud rr, d curii rr ric.

noTe 3

siGniicanT accounTinG Policies

accui rici r ii wih h uiqu wrd ribiii h i cr bk h b rmud by ccui drd-i bdi.th Brd grr h dd ciizd ccu-i rici d rcic h i cidr b rri- r h ur d uci cr bk, whichdir iicy rm h h ri cr. thccui rici d rcic r dcumd i hFici accui Mu r Fdr Rr Bk(Fici accui Mu), which i iud by hBrd grr. a h Rr Bk r rquird d d y ccui ici d rcic h

r ci wih h Fici accui Mu d hci m h b rrd i ccrdc wihh Fici accui Mu.

Dirc xi bw h ccui rici drcic i h Fici accui Mu d r-y ccd ccui rici i h Uid s(gaap), rimriy du h uiqu ur h Bkwr d ribiii r h i crbk. th rimry dirc i h ri cu-rii hdi mrizd c, rhr h ui h iru ri rquird by gaap. amrizd c mrrriy rfc h Bk curii hdi i iuiqu ribiiy cduc mry icy. Whi h

ici curr mrk ric h curii hdimy ru i u ubiy b r bw hir cr-ryi u, h urizd ch i u wud h dirc c h quiy rr ib hbki ym r h rc r uur Bk r-i r ci. Bh h dmic d ri cm h soMa ri my i rci h rui i r wh hdi r d rir muriy.Dcii rrdi curii d ri currcy rc-i, icudi hir urch d , r mid bymry icy bjci rhr h r. accrdiy,mrk u, ri, d y i r ruirm h uch curii d currci r icid

h mrk ri d d mi dci-i rd icy r mrk ciii.I ddii, h Bk h cd r s-

m Ch Fw bcu h iquidiy d ch ii h Bk r rimry ccr i h Bkuiqu wr d ribiii. a sm Ch

Fw, hrr, wud rid y ddii m-iu irmi. ohr irmi rrdi h Bkciii i ridd i, r my b drid rm, h s-m Cdii, Icm, d Ch i Ci. thrr hr iic dirc bw h ici

uid i h Fici accui Mu d gaap.th rri h ci m i crmiy

wih h Fici accui Mu rquir mm mk cri im d umi h c hrrd mu d ibiii, h dicur ci d ibiii h d h -ci m, d h rrd mu icm dx duri h rri rid. acu ru cuddir rm h im. Uiqu ccu d iicccui ici r xid bw.

a. Gold and sPecial draWinG riGhTs cerTiicaTes

th scrry h U.s. trury i uhrizd iu dd ci drwi rih (sDR) cric h RrBk.

pym r h d cric by h Rr Bk imd by crdii qui mu i dr i h c-cu bihd r h U.s. trury. th d crichd by h Rr Bk r rquird b bckd by hd h U.s. trury. th U.s. trury my rcquirh d cric y im d h Rr Bkmu dir hm h U.s. trury. a uch im, hU.s. trury ccu i chrd, d h Rr Bkd cric ccu r rducd. th u d rur bcki h d cric i by w $422/9 ry uc. th Brd grr c hd cric m Rr Bk c yr bd h r Fdr Rr udi i chRr Bk.

sDR cric r iud by h Iri M-ry Fud (Fud) i mmbr i rri chmmbr qu i h Fud h im iuc. sDRcric r um iri mryrr d my b rrrd rm i mryuhriy hr. Udr h w ridi r Uids ricii i h sDR ym, h scrry hU.s. trury i uhrizd iu sDR cric m-wh ik d cric, h Rr Bk. WhsDR cric r iud h Rr Bk, qui

mu i dr r crdid h ccu bihdr h U.s. trury, d h Rr Bk sDR cricccu r icrd. th Rr Bk r rquird urch sDR cric, h dirci h U.s.trury, r h ur ci sDR cquiii rr ci xch biizi ri. a h imsDR rci ccur, h Brd grr csDR cric rci m Rr Bk bdu ch Rr Bk Fdr Rr ud-i h d h rcdi yr. thr wr sDRrci i 2006 r 2005.

B. loans To dePosiTory insTiTuTions

Diry iiui h mii rrb rciccu r r im di, dd i ru-i iud by h Brd grr, h brrwirii h dicri h Rr Bk. Brrwrxcu cri di rm d di uci




61/70

60 | 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

cr br crdi i xdd. oudi r

ud r ccibiiy. I wr r dmd b

uccib, rri rr wud b bihd.

Ir i ccrud ui h icb dicu r b-

ihd ry ur dy by h Brd Dircr

h Rr Bk, ubjc riw d drmii by

h Brd grr. thr wr udi

diry iiui Dcmbr 31, 2006 d 2005.

c. u.s. GovernMenT securiTies and invesTMenTs de-

noMinaTed in oreiGn currencies

U.s. rm curii d im dmid

i ri currci cmrii h soMa r rcrdd

c, m-d bi, d djud r mriz-

i rmium r ccri dicu rih-i

bi. Ir icm i ccrud rih-i bi.

gi d rui rm curii r dr-

mid by cic iu bd r c. Fri-

currcy-dmid r rud diy curr

ri currcy mrk xch r i rdr rr

h i U.s. dr. Rizd d urizd i

d im dmid i ri currci

r rrd Fri currcy i (), i h

sm Icm.

aciiy rd U.s. rm curii, icudi

h rmium, dicu, d rizd d urizd i

d , i cd ch Rr Bk rc-

bi drid rm u m irdiric

cri h ccur i ari ch yr. th m

quiz Rr Bk d cric hdi Fdr Rr udi i ch Diric. aciiy

rd im dmid i ri currci i

cd ch Rr Bk bd h ri ch

Rr Bk ci d uru r ci d

uru h rcdi Dcmbr 31.

d. securiTies sold under aGreeMenTs To rePurchase

and securiTies lendinG

scurii d udr rm rurch r ccu-

d r ci rci d h cid ir

x i rcizd r h i h rci. th

rci r rrd i h sm Cdii hir crcu mu d h rd ccrud ir

yb i rrd cm ohr ibiii.

U.s. rm curii hd i h soMa r

U.s. rm curii dr i rdr cii

h ci ucii h dmic curii mrk.

scurii-di rci r uy crizd by

hr U.s. rm curii d h cr k i

i xc h mrk u h curii d. th

FRBnY chr h dr r brrwi curii d

h r rrd cm ohr icm.

aciiy rd curii d udr rm

rurch d curii di i cd ch h

Rr Bk rc bi drid rm h u-

m irdiric cri. scurii urchd

udr rm r r cd FRBnY d

cd h hr Rr Bk.

e. X sWaP arranGeMenTsand WarehousinG aGreeMenTs

FX w rrm r crcu rm bww ri, h FRBnY d uhrizd ri cr bk,

xch cid currci, cid ric, cid d. th ri r xch hir currciu rrrd mximum mu d r rd-u rid im (u w mh), rd-uir r. th rrm i h FoMC mrrycc h ri currci i my d ir ur h dr d i h uhrizd ri cr bkmrry cc dr i my d ur i w cur-rcy. Drwi udr h FX w rrm c b iii-d by ihr ry ci drwr, d mu b rd byh drw ry. th FX w rrm r rucurd h h ry iiii h rci br h xch rrik u muriy. th FRBnY wi ry i h ri

currcy rcid udr FX w rrm i ir-bri irum.

Wrhui i rrm udr which h FoMCr xch, h rqu h U.s. trury, U.s.dr r ri currci hd by h U.s. trury r esFr imid rid im. th ur h wrhu-i ciiy i um h U.s. dr rurc hU.s. trury d esF r ci urch ricurrci d rd iri ri.

FX w rrm d wrhui rm rrud diy curr mrk xch r. aciiyrd h rm, wih h xci h u-rizd i d rui rm h diy rui,

i cd ch Rr Bk bd h ri chRr Bk ci d uru r ci duru h rcdi Dcmbr 31. Urizd i d rui rm h diy rui r cd FRBnY d cd h hr Rr Bk.

. BanK PreMises, equiPMenT, and soTWare

Bk rmi d quim r d c c-cumud drcii. Drcii i ccud rih-i bi r h imd uu i h -, which r rm w y yr. Mjr ri,ri, d imrm r ciizd c

ddii h ccu d r drcid r hrmii uu i h r, i rri, r huiqu uu i h ri, ri, r imr-m. Mic, rir, d mir rcm rchrd ri x i h yr icurrd.

C icurrd r wr duri h ici d-m , ihr dd iry r cquird r i-r u, r ciizd bd h c dirc ricd mri cid wih dii, cdi, ii,r i wr. Ciizd wr c r mr-izd rih-i bi r h imd uu i h wr ici, which r rm w yr. Mic c rd wr r chrd

x i h yr icurrd.Ciizd icudi wr, buidi, hdimrm, uriur, d quim r imird wh r ch i circumc idic h h crry-i mu r ru i rcrb diicy xcd hir ir u.




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

G. inTerdisTricT seTTleMenT accounT

a h c bui ch dy, ch Rr Bk -mb h ym du r rm hr Rr Bk.th ym ru rm rci bw Rr

Bk d rci h i diry iiuiccu hd by hr Rr Bk, uch Fdwir udrr, chck cci, curiy rr, d aCH r-i. th cumui mu du r rm h hrRr Bk i rfcd i h Irdiric mccu i h sm Cdii.

h. ederal reserve noTes

Fdr Rr r h circui currcy hUid s. th r iud hruh h ri-u Fdr Rr (h chirm h brd dircr ch Rr Bk d hir di) h

Rr Bk u di wih uch ci-d c cr curiy, yicy U.s. rmcurii. th r idid iud cicRr Bk. th Fdr Rr ac rid h h c-r curiy drd by h Rr Bk h FdrRr mu b qu h um h id r by uch Rr Bk.

a iib b dd cr curiy icud h Bk . th cr u i qu hbk u h cr drd, wih h xci curii, r which h cr u i qu h ru h curii drd. th r u curiidd r curii d udr rm rurch

i dducd.th Brd grr my, y im, c u

Rr Bk r ddii curiy dquy cr-iz h Fdr Rr . t iy h bii rid uci cr r udi Fdr Rr, h Rr Bk h rd i rmh rid r cri h Rr Bk b

jiy dd cr r h Fdr Rr iud Rr Bk. I h h hi cri iuci, h Fdr Rr ac rid h FdrRr bcm r d rmu i h h Rr Bk. Fiy, Fdr Rr r bii h Uid s d r bckd by h

u ih d crdi h Uid s rm.Fdr Rr udi, i h s-

m Cdii rr h Bk Fdr Rr udi, rducd by h currcy iud hBk bu i circui, $3,175 mii d $3,494mii Dcmbr 31, 2006 d 2005, rciy.

i. iTeMs in Process o collecTion

and deerred crediT iTeMs

Im i rc cci i h sm Cdi-i rimriy rr mu ribub chck hh b did r cci d h, h b-

c h d, h y b rd h yibk. Drrd crdi im r h curr ibiiy im i rc cci, d h mu i hiccu ri rm drri crdi r did im uih mu r ccd. th bc i bh ccuc ry iicy.

j. caPiTal Paid-in

th Fdr Rr ac rquir h ch mmbr bkubcrib h ci ck h Rr Bk i mu qu 6 rc h ci d uru h

mmbr bk. th hr r i wih r u $100 d my b rrrd r hyhcd. a mmbr bk ci d uru ch, i hdi Rr Bk ck mu b djud. Curry, y-h h ubcrii i id-i d h rmidr iubjc c. By w, ch Rr Bk i rquird ych mmbr bk u diidd 6 rc hid-i ci ck. thi cumui diidd i id mi-uy. a mmbr bk i ib r Rr Bk ibiiiu wic h r u ck ubcribd by i.

K. surPlus

th Brd grr rquir h Rr Bk mii uru qu h mu ci id-i Dcmbr 31 ch yr. thi mu i idd rid ddii ci d rduc h ibiiy h hRr Bk wud b rquird c mmbr bkr ddii ci.

accumud hr cmrhi icm i rrd cm uru i h sm Cdiid h sm Ch i Ci. th bc ccumud hr cmrhi icm i cmrid x, i, d rd dd bi d hr rirm b h,udr ccui rici, r icudd i cmrhi

icm bu xcudd rm icm. addii ir-mi rrdi h cici ccumud hrcmrhi icm i ridd i n 9 d 10.

l. inTeresT on ederal reserve noTes

th Brd grr rquir h Rr Bk r-r xc ri h U.s. trury ir FdrRr , r ridi r h c ri,ym diidd, d rri mu c-ry qu uru wih ci id-i. thi mui rrd cm pym U.s. trury ir Fdr Rr i h sm

Icm d i rrd ibiiy i h sm Cdii. Wky ym h U.s. trury my ryiicy.

I h r icr i ci id-i Rr Bk, ym h U.s. trury r uddd ri r rid ui h uru i qu hci id-i.

I h dcr i ci id-i, h xc ur-u, r qui ci id-i d uru Dcmbr 31,i diribud h U.s. trury i h wi yr.

M. incoMe and cosTs relaTed To

u.s. Treasury services

th Bk i rquird by h Fdr Rr ac r c d diry h Uid s. By u,h Drm h trury i rmid, bu r-quird, y r h ric.




63/70


n. assessMenTs By The Board o Governors

th Brd grr h Rr Bk udi ri bd ch Rr Bk ci d

uru bc Dcmbr 31 h riu yr.th Brd grr ch Rr Bk rh x icurrd r h U.s. trury iu d rirFdr Rr bd ch Rr Bk hr h umbr cmrii h sym ibiiy rFdr Rr Dcmbr 31 h riu yr.

o. TaXes

th Rr Bk r xm rm dr, , d cx, xc r x r rry. th Bk rrry x wr $1 mii r ch h yr ddDcmbr 31, 2006 d 2005, d r rrd cm-

occucy x.

P. resTrucTurinG charGes

I 2003, h Rr Bk b h rrucuri r ri, rimriy chck, ch, d U.s. truryric. th rrucuri icudd rmii h m-m d ur rucur, rduci , dcrih umbr rci ci, d icri rc-i cciy i m ci. th rrucuri ciiiciud i 2004 hruh 2006.

n 11 dcrib h

Documents

St. Louis Fed 2006 Annual Report - Check Point