101050 International Bank for Reconstruction and Development Management’s Discussion & Analysis and Condensed Quarterly Financial Statements September 30, 2012 (Unaudited)   INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT (IBRD) CONTENTS September 30, 2012 MANAGEMENT’S DISCUSSION AND ANALYSIS I INTRODUCTION 3 II FINANCIAL RISK MANAGEMENT 3 III BALANCE SHEET ANALYSIS 5 IV SUMMARY OF OPERATING INCOME AND INCOME ALLOCATION 7 V SUMMARY OF FAIR VALUE RESULTS 8 VI SENIOR MANAGEMENT CHANGES 9 LIST OF BOXES AND TABLES Box 1. Selected Financial Data 2 Tables 1. Equity-to-Loans Ratio 4 2. Commercial Credit Exposure, Net of Collateral Held, by Counterparty Rating 5 3. Condensed Balance Sheet 5 4. Condensed Statement of Operating and Allocable Income 7 5. Condensed Statement of Net Income on a Comprehensive Basis 8 6. Summary of Fair Value Adjustment on Non-Trading Portfolios, net 8 7. Condensed Balance Sheet 9 8. Condensed Statement of Income 9 CONDENSED QUARTERLY FINANCIAL STATEMENTS CONDENSED BALANCE SHEET 10 CONDENSED STATEMENT OF INCOME 11 CONDENSED STATEMENT OF COMPREHENSIVE INCOME 12 CONDENSED STATEMENT OF CHANGES IN RETAINED EARNINGS 12 CONDENSED STATEMENT OF CASH FLOWS 13 NOTES TO CONDENSED QUARTERLY FINANCIAL STATEMENTS 14 INDEPENDENT ACCOUNTANTS’ REPORT 34 Box 1: Selected Financial Data In millions of U.S. dollars, except ratios and return data in percentages As of and for the three months ended Full Year September 30, September 30, 2012 2011 June 30, 2012 Lending Activates (Discussed in Section III) a Commitments $ 2,580 $ 2,519 $ 20,582 b Gross disbursements 3,483 4,881 19,777 b Net disbursements 1,283 2,551 7,798 Reported Basis Income Statement (Discussed in Section IV) c Operating income $ 283 $ 168 $ 783 Board of Governors-approved transfers – (595) (650) Net income (loss) 892 (1,081) (676) Balance Sheet (Discussed in Section III) Total assets $345,231 $321,982 $338,178 Net investment portfolio 33,970 30,482 35,119 Net loans outstanding 136,346 130,956 134,209 d Borrowing portfolio 133,394 126,849 133,075 Allocable Income (Discussed in Section IV) $ 313 $ 293 $ 998 Usable equity (Discussed in Section II) $ 38,197 $ 38,278 $ 37,636 Performance Ratios (Discussed in Section II) Return on average usable equity Based on operating income 2.97% 1.73% 2.04% e Equity-to-loans ratio 27.09 27.99 26.98 a. Commitments include guarantee commitments. b. Amounts include transactions with the International Finance Corporation (IFC) and capitalized front-end fees and interest. c. Operating income is defined as income before fair value adjustment on non-trading portfolios, net and Board of Governors- approved transfers. d. Net of derivatives. e. Ratio is computed using usable equity and exclude the respective periods’ operating income. (Full year June 30, 2012 amount includes proposed transfer to the General Reserve from FY 2012 net income and proposed reduction of Long-Term Income Portfolio (LTIP) reserve to nil.) 2 IBRD MANAGEMENT’S DISCUSSION AND ANALYSIS: SEPTEMBER 30, 2012 I. Introduction This document should be read in conjunction with the International Bank for Reconstruction and Development’s (IBRD) financial statements and Management’s Discussion and Analysis (MD&A) issued for the fiscal year ended June 30, 2012 (FY 2012). IBRD undertakes no obligation to update any forward-looking statements. Basis of Reporting IBRD prepares its financial statements in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP) referred to in this document as the “reported basis”. Under the reported basis, all instruments in the investment, borrowing and asset-liability management portfolios are carried at fair value with changes in fair value reported in the income statement. However, the loan portfolio is reported at amortized cost (with the exception of loans with embedded derivatives, which are reported at fair value). This asymmetry results in volatility in reported net income and equity, which does not fully reflect the financial results of IBRD. II. Financial Risk Management Under IBRD’s financial risk management framework, it is Management’s intention to hold the instruments in the loan, borrowing, and asset-liability management portfolios to maturity. These instruments include derivatives, which are used to manage the interest rate basis and currency composition of IBRD’s loan and borrowing related cash flows. Accordingly, allocable income, which excludes unrealized mark-to-market gains and losses associated with instruments that are not held for trading purposes, as well as other adjustments for items such as Board of Governors’ approved transfers and pension, provides the best representation of IBRD’s financial results. See Table 4 and the June 30, 2012 MD&A for further details. It is Management’s practice to recommend at the end of each fiscal year, distributions out of allocable income to augment reserves and support development activities. In an effort to maximize its capacity to support its mandate of providing lending to its member countries, IBRD limits its exposure to market and commercial counterparty credit risks. In addition, to ensure that the credit risks associated with its loans and other exposures1 do not exceed its risk bearing capacity, IBRD uses a strategic capital adequacy framework as a key medium-term capital planning tool. The following sections provide details on capital adequacy and the management of market and commercial counterparty credit risks. Capital Adequacy The equity-to-loans ratio is a key measure of IBRD’s capital adequacy and its ability to Equity-to-Loans Ratio respond to client needs, and is guided by the strategic capital adequacy framework, with a 39 target risk coverage range of 23 to 27 percent. This framework seeks to ensure IBRD’s usable 34 equity is sufficient to withstand credit shocks to its loan portfolio over the medium-term 29 capital planning horizon. 24 Target Risk Coverage Range 19 IBRD’s equity-to-loans ratio increased from 26.98% at June 30, 2012 to 27.09% at September Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 30, 2012 (see Table 1), and is slightly above the target risk coverage range. The increase in the ratio was primarily as a result of the increase in usable equity, due to the receipt of additional paid-in capital and additional national currency paid-in capital becoming usable during the period. As a result of the 2008 global financial crisis, IBRD experienced a surge in its lending activity. In order to strengthen IBRD’s capital adequacy and to ensure it remains sufficiently robust to support shareholder goals with regard to its medium-term lending plans, IBRD’s shareholders agreed in 2010 to a package of financial measures with the objective of keeping the equity-to-loans ratio aligned with the strategic capital adequacy framework. The package of financial measures includes a capital increase that is effective over a five year period starting in the fiscal year ended June 30, 2011 (FY 2011), as well as efforts by Management to work with shareholders to increase the usability of their national currency paid-in capital, which is subject to certain restrictions. Under the terms of the capital increase resolutions, subscribed capital is expected to increase by $86.2 billion over the five year period, of which $5.1 billion will be paid- in. As of September 30, 2012, $16,607 million had been subscribed, resulting in additional paid-in capital of $978 million, of which $61 million was paid in during the first three months of the fiscal year ended June 30, 2013 (FY 2013). In addition, as of September 30, 2012, IBRD has entered into agreements to release $1,591 million of national currency paid-in capital for use in IBRD’s operations; of which $1,106 million has been used as of September 30, 2012 ($227 million became usable during the first three months of FY2013). 1 Other exposures include: deferred drawdown option, irrevocable commitments, exposures to member countries’ derivatives and guarantees. IBRD MANAGEMENT’S DISCUSSION AND ANALYSIS: SEPTEMBER 30, 2012 3 Table 1: Equity-to-Loans Ratio In millions of U.S. dollars, except ratio data in percentages September 30, September 30, June 30, As of 2012 2011 2012 Reported Basis Equity-to-loans ratio 27.09% 27.99% 26.98% Usable equity $ 38,197 $ 38,278 $ 37,636 Loans outstanding, LTIP assets and other exposures $140,989 $ 136,708 $ 139,488 Management of Market and Commercial Counterparty Credit Risks As previously discussed, in an effort to maximize its capacity to support its mandate of providing lending to its eligible member countries, IBRD limits its exposure to market and commercial counterparty credit risks. Of the various types of market risk, the most significant market risk faced by IBRD is interest rate risk. IBRD’s exposure to currency and liquidity risks is minimal as a result of its risk management policies. For more details on how IBRD manages these risks, as well as on the overall framework of IBRD’s financial risk management, refer to the June 30, 2012 MD&A. The following sections provide additional details on how IBRD manages interest rate and commercial counterparty credit risks. Interest Rate Risk: To manage its interest rate risk exposure, IBRD seeks to match the interest-rate sensitivity of its assets (loan and investment portfolios) and its liabilities (borrowing portfolio) through the use of derivatives such as interest rate swaps. These derivatives effectively convert IBRD’s financial assets and liabilities into variable rate instruments. While this strategy helps to manage IBRD’s interest margin on debt funded loans from interest rate volatility, the interest income on loans funded by equity, if left unmanaged, would be highly sensitive to fluctuations in short-term interest rates. To manage this exposure, IBRD implemented in FY 2008, an equity duration extension strategy with the objective of reducing the sensitivity of income to fluctuations in short-term interest rates. Under this strategy, the need to reduce the sensitivity of income was balanced against the availability of instruments with sufficient liquidity to execute the strategy effectively. This balance was achieved by entering into interest rate swaps with a 10-year ladder re-pricing profile, resulting in the duration of equity increasing from three months to approximately five years. The income from this strategy has contributed $262 million to operating income for the first three months of FY 2013, compared with $286 million for the same period in FY 2012. Since inception, this strategy has generated $3,810 million of income for IBRD. Commercial Counterparty Credit Risk: The effective management of commercial counterparty credit risk is vital to the success of IBRD’s funding, investment and asset/liability management activities. The monitoring and managing of this risk is a continuous process due to the changing market environment. Commercial counterparty credit risk is managed through the application of eligibility criteria, volume limits for transactions with individual counterparties, and through the use of mark-to-market collateral arrangements for swap transactions. Table 2 summarizes IBRD’s commercial counterparty credit risk exposure. The overall decrease in this exposure from June 30, 2012 reflects the decline in the liquidity balance as discussed further in Section III. In addition, during the first three months of FY 2013, IBRD’s exposure to counterparties rated A increased by approximately $2 billion, in line with efforts to reduce IBRD’s concentration risk by allowing a wider universe of banking counterparties. Despite this increase in exposure, IBRD’s overall commercial counterparty credit risk profile has remained largely unchanged due to the shorter maturities of instruments rated A+ and below. 4 IBRD MANAGEMENT’S DISCUSSION AND ANALYSIS: SEPTEMBER 30, 2012 As shown below, the credit quality of IBRD’s portfolio still remains concentrated in the upper end of the credit spectrum with 84% of the portfolio rated AA or above, reflecting IBRD’s continued preference for highly rated securities and counterparties across all categories of financial instruments. Total commercial counterparty credit exposure, net of collateral held was $34.2 billion, as of September 30, 2012. Of this amount $8.7 billion (25%) related to countries in the Euro Zone; of which $6.7 billion (77%) is rated AA or above and none were rated below A. Table 2: Commercial Credit Exposure, Net of Collateral Held, by Counterparty Ratinga In millions of U.S. dollars As of September 30, 2012 Investments Agencies, Asset-Backed Securities, Corporates Counterparty Rating Sovereigns and Time Deposits Net Swap Exposure Total Exposure % of Total AAA $ 8,397 $ 8,564 $ – $16,961 50% AA 4,452 6,374 731 11,557 34 A – 5,512 141 5,653 16 BBB – 2 – 2 * BB or lower – 10 – 10 * Total $12,849 $20,462 $872 $34,183 100% As of June 30, 2012 Investments Agencies, Asset-Backed Securities, Corporates Counterparty Rating Sovereigns and Time Deposits Net Swap Exposure Total Exposure % of Total AAA $ 8,842 $ 8,054 $ – $16,896 48% AA 6,086 8,030 550 14,666 42 A – 3,457 177 3,634 10 BBB – 4 – 4 * BB or lower – 8 – 8 * Total $14,928 $19,553 $727 $35,208 100% a. Excludes (a) externally managed portfolios including Post-Employment Benefits Plan and (b) swap exposures executed with borrowing member countries, International Finance Facility for Immunisation and International Development Association (IDA). * Indicates amounts less than 0.5%. III. Balance Sheet Analysis The condensed IBRD’s balance sheet is presented in Table 3. Table 3: Condensed Balance Sheet In millions of U.S. dollars September 30, June 30, As of 2012 2012 Variance Investments and due from banks $ 42,180 $ 39,481 $2,699 Net loans outstanding 136,346 134,209 2,137 Receivable from derivatives 162,459 160,814 1,645 Other assets 4,246 3,674 572 Total Assets $345,231 $338,178 $7,053 Borrowings 147,020 $145,339 $1,681 Payable for derivatives 145,419 144,837 582 Other liabilities 14,537 11,317 3,220 Equity 38,255 36,685 1,570 Total Liabilities and Equity $345,231 $338,178 $7,053 IBRD MANAGEMENT’S DISCUSSION AND ANALYSIS: SEPTEMBER 30, 2012 5 During the first three months of FY 2013, IBRD experienced an increase in the loan and borrowing portfolios and a decrease in the investment portfolio, as discussed below. Lending Activities Highlights IBRD’s principal assets are its loans to member countries. USD Commitment and Bns Disbursement Trend For the first three months of FY 2013, loan commitments were $2,580 million, an increase of 50 $61 million compared to the same period in FY 2012. Following the peak in FY 2010 of 25 $44,197 million in new loan commitments in response to the global financial crisis, the 0 declining commitment levels reflect the expected reversion to pre-crisis levels of approximately $15 billion annually. Commitments As of September 30, 2012, on a reported basis, IBRD’s net loan portfolio increased by $2,137 Gross Disbursements million from June 30, 2012, primarily due to $1,283 million in net loan disbursements made in Net Loans Oustanding the first three months of FY 2013 and currency translation gains of $850 million, consistent USD Bns with the appreciation of the euro against the U.S. dollar during the same period. 138 136 On July 5, 2012, the Executive Directors approved a proposal for IBRD to lend up to $197 134 million to IFC in connection with the release of a member's national currency paid-in capital 132 130 to IBRD. 128 126 Jun-11 Jun-12 Sep-12 Investment Activities Highlights IBRD’s investments include a liquid assets portfolio and holdings related to the Advance Market Commitment for Pneumococcal Vaccines Initiative (AMC) and Post-Employment Benefits Plan (PEBP). In FY 2012, investments included the LTIP, which was fully liquidated during the fourth quarter of FY 2012 in order to maximize the capital available to support lending. As of September 30, 2012, the carrying value of the net investment portfolio was $33,970 million of which $33,069 million related to the liquid asset portfolio (see Note C—Investments Investments in the Notes to the Condensed Quarterly Financial Statements). USD Bns 40 The liquid asset portfolio is comprised of three sub portfolios: stable, operational and discretionary. Its objective is to ensure the availability of sufficient cash flows to meet all of 20 IBRD’s financial commitments, as reflected in the prudential minimum liquidity level. 0 The prudential minimum liquidity level has been set at $22 billion for FY 2013, reflecting an Jun-11 Jun-12 Sep-12 increase of $1 billion from FY 2012. As of September 30, 2012, the liquid asset portfolio was Liquidity LTIP approximately $33 billion or 150% of the prudential minimum liquidity level in effect for FY 2013, compared with 163% of the prudential minimum liquidity level as of June 30, 2012. The decrease is consistent with Management’s decision to revert to normal liquidity levels during FY 2013. During FY 2012, high levels of liquidity were maintained in response to the uncertainty associated with the financial crisis. Management will continue to monitor the liquidity levels to allow for coverage of approximately 12 months of continued operations. Funding Activities Highlights To raise funds, IBRD issues debt securities in a variety of currencies to both institutional and Borrowing Portfolio USD retail investors. During the first three months of FY 2013, IBRD raised medium- and long- Bns term debt of $4,284 million in 14 currencies. 135 130 At September 30, 2012, the borrowing portfolio totaled $133,394 million, an increase of $319 125 million, as compared with June 30, 2012 (see Note E—Borrowings in the Notes to the 120 Condensed Quarterly Financial Statements). This was primarily due to $640 million of 115 currency translation losses consistent with the appreciation of the euro against the U.S. dollar, Jun-11 Jun-12 Sep-12 partially offset by net unrealized mark-to-market gains of $399 million. 6 IBRD MANAGEMENT’S DISCUSSION AND ANALYSIS: SEPTEMBER 30, 2012 IV. Summary of Operating Income and Income Allocation Operating Income The primary drivers of IBRD’s operating income Table 4: Condensed Statement of Operating and Allocable Income are interest earned (net of funding cost) on the loan In millions of U.S. dollars and investment portfolios, income from the equity For the three months ended September duration extension strategy, net non-interest 30, 2012 2011 Variance expense, and the provision for losses on loans and Interest income, net of funding costs Interest margin $ 200 $ 178 $ 22 other exposures. Equity-funded loans 50 43 7 Table 4 summarizes IBRD’s operating income and Equity duration extension strategy 262 286 (24) Investments 58 6 52 provides a reconciliation to allocable income. Net Interest Income $ 570 $ 513 $ 57 Operating income was higher for the first three Provision for losses on loans and other months of FY 2013 by $115 million as compared to exposures –(charge) (2) (3) 1 the same period in FY 2012, primarily as a result of LTIP loss - (103) 103 the following: Other income, net 14 14 – Net non-interest expense (299) (253) (46) LTIP: Operating Income a $ 283 $ 168 $ 115 Adjustments: LTIP was fully liquidated during the fourth quarter Pension and other adjustments 30 6 24 in FY 2012. LTIP – 119 (119) Allocable Income $ 313 $ 293 $ 20 Investment income, net of funding costs: a. Reported net income after adjustments to exclude Board of Governors-approved For the first three months of FY 2013, investment transfers and fair value adjustment on non-trading portfolios, net, see Table 5. income, net of funding costs was $58 million, primarily due to the unrealized mark-to-market gains resulting from the tightening of credit spreads. In contrast, during the same period in FY 2012, investment income, net of funding costs was $6 million, primarily due to a decline in yields and unrealized mark-to-market losses as a result of the widening of the credit spreads. These factors were partially offset by: Net non-interest expense: The $46 million increase in net non-interest expense was primarily due to higher pension expense. Income Allocation On August 9, 2012, IBRD’s Executive Directors approved the allocation of $390 million out of the net income earned in the fiscal year ended June 30, 2012, to the General Reserve. In addition, the Executive Directors also approved a reduction in the Pension Reserve by $3 million, an increase in Restricted Retained Earnings by $13 million and a reduction in the LTIP Reserve by $225 million, reflecting the liquidation of LTIP. Subsequent to the reporting date, on October 12, 2012, IBRD’s Board of Governors approved an immediate transfer to IDA of $608 million, out of the FY 2012 net income. IBRD MANAGEMENT’S DISCUSSION AND ANALYSIS: SEPTEMBER 30, 2012 7 V. Summary of Fair Value Results Movements in fair value measures reflect short-term volatility based on the market environment. Given that IBRD intends to hold its instruments to maturity (with the exception of the investment portfolio), fair value results are not used for income allocation purposes by Management. Rather, they are used for specific purposes, for example, to assess the performance of the investments portfolio, which is a trading portfolio, and to manage counterparty credit risk, including collateral management. See Section II for further details on commercial counterparty credit risk management. Tables 5, 6, 7 and 8 provide information on a full fair value basis for IBRD. Under the fair value basis, in addition to the instruments in the investment, borrowing and Table 5: Condensed Statement of Net Income on a Comprehensive Basis asset-liability management portfolios, all loans are (Fair Value Net Income) reported at fair value. In millions of U.S. dollars The primary drivers of the fair value adjustments For the three months ended September 30, 2012 2011 Variance Reported Basis Operating Income $ 283 $ 168 $ 115 are the movements of the yield curves, the impact Board of Governors-approved transfers – (595) 595 of IBRD’s own credit, and the credit quality of the Fair value adjustments on non-trading loan portfolio as measured by Credit Default Swap portfolios, net 609 (654) 1,263 (CDS) spreads after adjustments to reflect IBRD’s Reported Basis Net Income (Loss) $ 892 $(1,081) $1,973 recovery experience. Fair value adjustment on loans, net 1,814 (2,526) 4,340 Changes in accumulated other The fair value net income was $2,924 million for comprehensive income (loss) 218 (266) 484 the first three months of FY 2013, compared to a Fair Value Net Income (Loss) $2,924 $(3,873) $6,797 net loss of $3,873 million for the same period in FY 2012 (See Table 5). The increase of $6,797 million in fair value net income is explained by the following factors: Board of Governors-Approved Transfers: There were no Board of Governors-approved transfers during the first three months of FY 2013. Subsequent to the reporting date, IBRD transferred $608 million to IDA, out of the FY 2012 net income on October 16, 2012. During the first three months of FY 2012, the Board of Governors approved a transfer of $520 million from IBRD’s FY 2011 net income to IDA. In addition, the Board of Governors also approved a transfer of $75 million from Surplus to the South Sudan Transition Trust Fund. Fair Value Adjustment on Non-Trading Portfolios, net: For the first three months of FY 2013, IBRD experienced net unrealized gains of $609 million, compared with net unrealized losses of $654 million in the same period in FY 2012 (see Table 6). The key factors contributing to these unrealized gains/losses are as follows: During the first three months of FY 2013, IBRD Table 6: Summary of Fair Value Adjustment on Non-Trading Portfolios, net experienced net unrealized gains on the borrowing In millions of U.S. dollars portfolio of $399 million. For the three months ended September 30, 2012 2011 Variance IBRD also experienced net unrealized gains of Borrowing Portfolio (including loan-related $204 million on the derivatives held in the asset- derivatives) $399 $(1,908) $ 2,307 liability management portfolio, where IBRD is a Derivatives held in the asset-liability fixed interest rate receiver. The net unrealized management portfolio 204 1,264 (1,060) gains were primarily due to the decline in the yield Derivatives held in the client operations portfolio (1) 1 (2) A loan with an embedded derivative 7 (11) 18 curves of major currencies for maturities less than Net unrealized gains/(losses) $609 $ (654) $ 1,263 10 years. During the first three months of FY 2012, IBRD experienced net unrealized losses of $654 million, primarily due to the significant decline in the interest rates across all major yield curves during the period. Fair Value Adjustment on Loans: For the first three months of FY 2013, the fair value adjustment on loans was positive $1,814 million compared to negative $2,526 million in the same period in FY 2012 (see Table 5). This adjustment reflects changes in both interest rates and credit risk. The positive fair value adjustment for the first three months of FY 2013 was primarily driven by unrealized credit gains due to the tightening of sovereign CDS spreads. In contrast, during the same period in FY 2012, the negative fair value adjustment was primarily driven by unrealized credit losses due to the widening of CDS spreads, partially offset by the decline in interest rates. Changes to Accumulated Other Comprehensive Income: The changes to AOCI for the first three months of FY 2013 resulted in an increase of $218 million, which primarily relates to the net positive currency translation adjustments resulting from the appreciation of the euro against the U.S. dollar (see Table 5). In contrast, during the same period in FY 2012, the change to AOCI resulted in a charge of $266 million, primarily related to the net negative currency translation adjustments resulting from the depreciation of the euro against the U.S. dollar. 8 IBRD MANAGEMENT’S DISCUSSION AND ANALYSIS: SEPTEMBER 30, 2012 Tables 7 and 8 provide a reconciliation from the reported basis to the fair value basis for both the balance sheet and income statement. Table 7: Condensed Balance Sheet In millions of U.S. dollars As of September 30, 2012 June 30, 2012 Reported Basis Adjustments Fair Value Basis Reported Basis Adjustments Fair Value Basis Due from banks $ 8,877 – $ 8,877 $ 5,806 – $ 5,806 Investments 33,303 – 33,303 33,675 – 33,675 Receivable from derivatives 162,459 – 162,459 160,814 160,814 Net loans outstanding 136,346 $(208) 136,138 134,209 $(2,011) 132,198 Other assets 4,246 – 4,246 3,674 3,674 Total assets $345,231 $(208) $ 345,023 $338,178 $(2,011) $336,167 Borrowings $147,020 $ (1)a $147,019 $145,339 $ (2)a $145,337 Payable for derivatives 145,419 – 145,419 144,837 – 144,837 Other liabilities 14,537 – 14,537 11,317 – 11,317 Total liabilities 306,976 $ (1) 306,975 301,493 (2) 301,491 Paid in capital 12,479 – 12,479 12,418 – 12,418 Retained earnings and other equity 25,776 (207) 25,569 24,267 (2,009) 22,258 Total equity 38,255 (207) 38,048 36,685 (2,009) 34,676 Total liabilities and equity $345,231 $(208) $345,023 $338,178 $(2,011) $336,167 a. Amount represents amortization of transition adjustment relating to the adoption of FASB’s guidance on derivatives and hedging on July 1, 2000. Table 8: Condensed Statement of Income In millions of U.S. dollars For the three months ended September 30, 2012 2011 Fair Value Net Fair Value Net Income on a Income on a Reported Comprehensive Reported Comprehensive Basis Adjustments Basisa Basis Adjustments Basisa Income from loans $ 636 – $636 $ 629 – $ 629 Income from investments, netb 106 – 106 (83) – (83) Equity duration extension swaps, net 262 – 262 286 – 286 Other income 85 – 85 82 – 82 Total income $1,089 – $1,089 $ 914 – $ 914 Borrowing expenses $ 405 – $ 405 $ 391 – $ 391 Administrative expenses including contributions to special programs 399 – 399 352 – 352 Provision for losses on loans and other exposures – increase (decrease) 2 $ (2) – 3 $ (3) – Total expenses $ 806 $ (2) $804 $ 746 $ (3) $ 743 Operating income $ 283 $ 2 $ 285 $ 168 $ 3 $ 171 Board of Governors-approved transfers – – – (595) – (595) Fair value adjustment on non-trading portfolios, netc 609 – 609 (654) – (654) Fair value adjustment on loansd – 1,812 1,812 – (2,529) (2,529) Changes to accumulated other comprehensive income – 218 218 – (266) (266) Net Income (Loss) $ 892 $ 2,032 $ 2,924 $ (1,081) $(2,792) $(3,873) a. Net income on a fair value comprehensive basis comprises net income on a reported basis, the additional fair value adjustment on the loan portfolio and changes to AOCI. b. Unrealized gains (losses) on derivatives in the investments trading portfolio are included in income from investments, net. c. Excludes the fair value adjustment on loans which are not carried at fair value under the reported basis. d. Excludes the reversal of the provision for losses on loans and other exposures. VI. Senior Management Changes Effective July 1, 2012, Jim Yong Kim became the President of IBRD. Following the decision by Vincenzo La Via to retire as CFO of IBRD, Charles McDonough was appointed as acting CFO effective March 28, 2012. A global search for a new CFO is in progress. IBRD MANAGEMENT’S DISCUSSION AND ANALYSIS: SEPTEMBER 30, 2012 9 CONDENSED BALANCE SHEET Expressed in millions of U.S. dollars September 30, 2012 June 30, 2012 (Unaudited) (Unaudited) Assets Due from banks—Note C Unrestricted currencies $ 8,717 $ 5,682 Currencies subject to restrictions 160 124 8,877 5,806 Investments-Trading (including securities transferred under repurchase agreements or securities lending agreements of $2 million—September 30, 2012; $7 million—June 30, 2012)—Note C 32,291 33,466 Securities purchased under resale agreements—Note C 1,012 209 Derivative assets—Notes C, F and I Investments 17,013 18,554 Client operations 27,668 27,560 Borrowings 112,926 110,103 Other assets/liabilities 4,852 4,597 162,459 160,814 Loans outstanding—Notes D and I Total loans 200,612 199,241 Less undisbursed balance 62,145 62,916 Loans outstanding (including a loan at fair value of $138 million— September 30, 2012; $125 million—June 30, 2012) 138,467 136,325 Less: Accumulated provision for losses on loans 1,698 1,690 Deferred loan income 423 426 Net loans outstanding 136,346 134,209 Other assets—Notes C and I 4,246 3,674 Total assets $345,231 $338,178 Liabilities Borrowings—Note E $147,020 $145,339 Securities sold under repurchase agreements, securities lent under securities lending agreements, and payable for cash collateral received—Note C 6,867 3,700 Derivative liabilities—Notes C, F and I Investments 17,630 18,631 Client operations 27,659 27,551 Borrowings 99,300 97,839 Other assets/liabilities 830 816 145,419 144,837 Other liabilities—Notes C, D and I 7,670 7,617 Total liabilities 306,976 301,493 Equity Capital stock—Note B Authorized (2,307,600 shares—September 30, 2012 and June 30, 2012) Subscribed (1,713,624 shares—September 30, 2012; 1,702,605 shares—June 30, 2012) 206,723 205,394 Less uncalled portion of subscriptions 194,244 192,976 Paid-in capital 12,479 12,418 Nonnegotiable, noninterest-bearing demand obligations on account of subscribed capital (584) (845) Receivable amounts to maintain value of currency holdings (79) (79) Deferred amounts to maintain value of currency holdings 686 561 Retained earnings (see Condensed Statement of Changes in Retained Earnings; Note G) 29,939 29,047 Accumulated other comprehensive loss—Note J (4,186) (4,417) Total equity 38,255 36,685 Total liabilities and equity $345,231 $338,178 The Notes to Condensed Quarterly Financial Statements are an integral part of these Statements. 10 IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 CONDENSED STATEMENT OF INCOME Expressed in millions of U.S. dollars Three Months Ended September 30, (Unaudited) 2012 2011 Income Loans—Note D $ 636 $ 629 Investments-Trading, net—Note C 106 (83) Interest on equity duration extension swaps, net—Note F 262 286 Other—Note I 85 82 Total income 1,089 914 Expenses Borrowings, net 405 391 Administrative—Notes H and I 384 337 Contributions to special programs 15 15 Provision for losses on loans and other exposures—Note D 2 3 Total expenses 806 746 Income before fair value adjustment on non-trading portfolios, net and Board of Governors-approved transfers 283 168 Fair value adjustment on non-trading portfolios, net—Notes D, E, F and K 609 (654) Board of Governors-approved transfers—Note G — (595) Net income (loss) $ 892 $(1,081) The Notes to Condensed Quarterly Financial Statements are an integral part of these Statements. IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 11 CONDENSED STATEMENT OF COMPREHENSIVE INCOME Expressed in millions of U.S. dollars Three Months Ended September 30, (Unaudited) 2012 2011 Net income (loss) $ 892 $(1,081) Other comprehensive income (loss)—Note J Reclassification to net income: Derivatives and hedging transition adjustment 1 1 Amortization of unrecognized net actuarial losses 67 19 Amortization of unrecognized prior service costs 5 2 Currency translation adjustment 158 (339) Total other comprehensive income (loss) 231 (317) Comprehensive income (loss) $1,123 $(1,398) CONDENSED STATEMENT OF CHANGES IN RETAINED EARNINGS Expressed in millions of U.S. dollars Three Months Ended September 30, (Unaudited) 2012 2011 Retained earnings at beginning of the fiscal year $29,047 $29,723 Net income (loss) for the period 892 (1,081) Retained earnings at end of the period $29,939 $28,642 The Notes to Condensed Quarterly Financial Statements are an integral part of these Statements. 12 IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 CONDENSED STATEMENT OF CASH FLOWS Expressed in millions of U.S. dollars Three Months Ended September 30, (Unaudited) 2012 2011 Cash flows from investing activities Loans Disbursements $(3,477) $(4,868) Principal repayments 2,200 2,322 Principal prepayments — 8 Loan origination fees received 8 8 Other investing activities, net (17) (20) Net cash used in investing activities (1,286) (2,550) Cash flows from financing activities Medium- and long-term borrowings New issues 4,047 10,864 Retirements (6,334) (5,999) Net short-term borrowings 1,184 (2,239) Net derivatives—borrowings 628 303 Capital subscriptions 61 13 Other capital transactions, net 243 32 Net cash (used in) provided by financing activities (171) 2,974 Cash flows from operating activities Net income (loss) 892 (1,081) Adjustments to reconcile net income (loss) to net cash provided by operating activities Fair value adjustment on non-trading portfolios, net (609) 654 Depreciation and amortization 214 213 Provision for losses on loans and other exposures 2 3 Changes in: Investments—Trading, net 4,277 1,276 Other assets and liabilities (286) (85) Net cash provided by operating activities 4,490 980 Effect of exchange rate changes on unrestricted cash 2 (7) Net increase in unrestricted cash 3,035 1,397 Unrestricted cash at beginning of the fiscal year 5,682 2,312 Unrestricted cash at end of the period $ 8,717 $ 3,709 Supplemental disclosure Increase (decrease) in ending balances resulting from exchange rate fluctuations Loans outstanding $850 $(2,080) Investment portfolio 43 13 Borrowing portfolio 640 (1,611) Capitalized loan origination fees included in total loans 6 13 Interest paid on Borrowing portfolio 203 77 The Notes to Condensed Quarterly Financial Statements are an integral part of these Statements. IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 13 NOTES TO CONDENSED QUARTERLY FINANCIAL STATEMENTS NOTE A—SUMMARY OF SIGNIFICANT The implementation of the Act is dependent on the ACCOUNTING AND RELATED POLICIES development of various rules to clarify and interpret its requirements. Pending the development of these Basis of Preparation rules, no impact on IBRD has been determined as of These unaudited condensed quarterly financial September 30, 2012. IBRD continues to evaluate the statements should be read in conjunction with the potential future implications of the Act. June 30, 2012 audited financial statements and notes included therein. The condensed comparative In June 2011, the FASB issued ASU 2011-05, information that has been derived from the June 30, Comprehensive Income (Topic 220): Presentation of 2012 audited financial statements has not been Comprehensive Income. The ASU requires audited. In the opinion of management, the comprehensive income to be reported in either a condensed quarterly financial statements reflect all single statement or in two consecutive statements. adjustments necessary for a fair presentation of The ASU does not change which items are reported IBRD’s financial position and results of operations in in other comprehensive income or existing accordance with accounting principles generally requirements to reclassify items out of accumulated accepted in the United States of America (U.S. other comprehensive income to net income. GAAP). Subsequently, in December 2011, the FASB issued ASU 2011-12, Deferral of the Effective Date for Management makes estimates and assumptions that Amendments to the Presentation of Reclassifications affect the reported amounts of assets and liabilities of Items Out of Accumulated Other Comprehensive and disclosure of contingent assets and liabilities at Income in Accounting Standards Update No. the date of the condensed quarterly financial 2011-05, which deferred certain reclassification statements and the reported amounts of income and provisions in ASU 2011-05. For IBRD, the ASUs expenses during the reporting periods. Due to the were effective from the quarter ended September 30, inherent uncertainty involved in making those 2012, but did not have an effect on IBRD’s financial estimates, actual results could differ from those statements as these are already in compliance with estimates. Areas in which significant estimates have one of the options allowed under ASU 2011-05. been made include, but are not limited to, the provision for losses on loans and other exposures, In August 2012, the FASB issued a proposed ASU, valuation of certain instruments carried at fair value, Comprehensive Income (Topic 220): Presentation of and valuation of pension and other postretirement Items Reclassified Out of Accumulated Other plan-related liabilities. The results of operations for Comprehensive Income, which would require entities the first three months of the current fiscal year are not to present separately in the notes to the financial necessarily indicative of results that may be expected statements, tabular information about items that are for the full year. reclassified out of each component of accumulated other comprehensive income. IBRD is currently Certain reclassifications of the prior year’s evaluating the impact of this proposed ASU on its information have been made to conform with the financial statements. current year’s presentation. NOTE B—CAPITAL STOCK Accounting and Reporting Developments The following table provides a summary of changes In March 2010, the Patient Protection and Affordable in IBRD’s authorized and subscribed shares during Care Act and the Health Care and Education the three months ended September 30, 2012 and the Reconciliation Act of 2010 became law. These Acts fiscal year ended June 30, 2012: seek to reform the U.S. health care system and their Authorized Subscribed various provisions will become effective over the shares shares next several years. While the Acts have no impact on As of June 30, 2011 2,307,600 1,605,930 IBRD as of September 30, 2012, IBRD continues to General and Selective Capital evaluate the potential future implications of these Increase (GCI/SCI) — 95,238 New membership — 1,437 Acts. As of June 30, 2012 2,307,600 1,702,605 In July 2010, the Dodd-Frank Wall Street Reform GCI/SCI — 11,019 and Consumer Protection Act (the Act) became law. As of September 30, 2012 2,307,600 1,713,624 The Act seeks to reform the U.S. financial regulatory system by introducing new regulators and extending regulation over new markets, entities, and activities. 14 IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) The following table provides a summary of the changes in subscribed capital, uncalled portion of subscriptions and paid-in capital during the three months ended September 30, 2012 and the fiscal year ended June 30, 2012: In millions of U.S. dollars Uncalled portion of Subscribed capital subscriptions Paid-in capital As of June 30, 2011 $193,732 $(182,012) $11,720 GCI/SCI 11,489 (10,800) 689 New membership 173 (164) 9 As of June 30, 2012 $205,394 $(192,976) $12,418 GCI/SCI 1,329 (1,268) 61 As of September 30, 2012 $206,723 $(194,244) $12,479 NOTE C—INVESTMENTS approximates fair value. As of September 30, 2012, IBRD’s investments include a liquid assets portfolio, the majority of Investments-Trading is comprised of and holdings relating to the Advance Market government and agency obligations, and time Commitment for Pneumococcal Vaccines Initiative deposits (56% and 35%, respectively), with almost all (AMC) and Post Employment Benefit Plan (PEBP). the instruments classified as Level 1 or Level 2 within the fair value hierarchy. The composition of IBRD’s net investment portfolio as of September 30, 2012 and June 30, 2012 was as A summary of IBRD’s Investments-Trading at follows: September 30, 2012 and June 30, 2012, is as follows: In millions of U.S. dollars In millions of U.S. dollars September 30, June 30, Carrying Value 2012 2012 September June 30, Net investments portfolio 30, 2012 2012 Liquid assets portfolio $33,069 $34,189 Investments—Trading AMC holdings 269 326 Equity securities $ 195 $ 165 PEBP holdings 632 604 Government and agency Total $33,970 $35,119 obligations 18,125 19,742 Time deposits 11,243 10,811 Asset-backed securities (ABS) 2,728 2,748 The investment securities held by IBRD are carried Total $32,291 $33,466 and reported at fair value, or at face value which IBRD manages its investments on a net portfolio basis. The following table summarizes IBRD’s net portfolio position as of September 30, 2012 and June 30, 2012: In millions of U.S. dollars Carrying Value September 30, 2012 June 30, 2012 Investments—Trading $ 32,291 $ 33,466 Securities purchased under resale agreements 1,012 209 Securities sold under repurchase agreements, securities lent under securities lending agreements, and payable for cash collateral received (6,867) (3,700) Derivative assets Currency forward contracts 7,217 6,542 Currency swaps 9,653 11,876 Interest rate swaps 142 135 a Other 1 * Total 17,013 18,554 Derivative liabilities Currency forward contracts (7,369) (6,448) Currency swaps (9,948) (11,876) Interest rate swaps (313) (307) Total (17,630) (18,631) b Cash held in investment portfolio 8,425 5,340 c Receivable from investment securities traded 22 18 d Payable for investment securities purchased (296) (137) Net Investment Portfolio $ 33,970 $ 35,119 a. These relate to Mortgage-Backed Securities To-Be-Announced (TBA securities). b. This amount is included in Unrestricted Currencies under Due from Banks on the Condensed Balance Sheet. c. This amount is included in Other assets on the Condensed Balance Sheet. d. This amount is included in Other liabilities on the Condensed Balance Sheet. * Indicates amount less than $0.5 million. IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) 15 IBRD uses derivative instruments to manage currency and interest rate risk in the investment portfolio. For details regarding these instruments, see note F—Derivative Instruments. As of September 30, 2012, there were no short sales included in Other liabilities on the Condensed Balance Sheet (Nil—June 30, 2012). For the three months ended September 30, 2012, IBRD’s income included $27 million of unrealized gains, (unrealized losses of $145 million—three months ended September 30, 2011). Fair Value Disclosures The following tables present IBRD’s fair value hierarchy for investment assets and liabilities measured at fair value on a recurring basis as of September 30, 2012 and June 30, 2012: In millions of U.S. dollars Fair Value Measurements on a Recurring Basis As of September 30, 2012 Level 1 Level 2 Level 3 Total Assets: Investments – Trading Equity securities $ 178 $ 17 $— $ 195 Government and agency obligations 2,684 15,391 50 18,125 Time deposits 793 10,450 — 11,243 ABS — 2,719 9 2,728 Total Investments – Trading 3,655 28,577 59 32,291 Securities purchased under resale agreements 1,012 — — 1,012 Derivative assets-Investments Currency forward contracts — 7,217 — 7,217 Currency swaps — 9,653 — 9,653 Interest rate swaps — 142 — 142 a Other — 1 — 1 Total Derivative assets-Investments — 17,013 — 17,013 Total $4,667 $45,590 $59 $50,316 Liabilities: Securities sold under repurchase agreements and b securities lent under securities lending agreements $— $ 2 $— $ 2 Derivative liabilities-Investments Currency forward contracts — 7,369 — 7,369 Currency swaps — 9,948 — 9,948 Interest rate swaps — 313 — 313 Total Derivative liabilities-Investments — 17,630 — 17,630 Total $— $17,632 $— $17,632 a. These relate to TBA securities. b. Excludes $6,865 million relating to payable for cash collateral received. 16 IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) In millions of U.S. dollars Fair Value Measurements on a Recurring Basis As of June 30, 2012 Level 1 Level 2 Level 3 Total Assets: Investments – Trading Equity securities $ 150 $ 15 $— $ 165 Government and agency obligations 2,559 17,133 50 19,742 Time deposits 1,073 9,738 — 10,811 ABS — 2,739 9 2,748 Total Investments – Trading $3,782 $29,625 $59 $33,466 Securities purchased under resale agreements 9 200 — 209 Derivative assets-Investments Currency forward contracts — 6,542 — 6,542 Currency swaps — 11,876 — 11,876 Interest rate swaps — 135 — 135 a Other — * — * Total Derivative assets-Investments — 18,554 — 18,554 Total Assets $3,791 $48,379 $59 $52,229 Liabilities: Securities sold under repurchase agreements and b securities lent under security lending agreements $— $ 7 $— $ 7 Derivative liabilities-Investments Currency forward contracts — 6,448 — 6,448 Currency swaps — 11,876 — 11,876 Interest rate swaps — 307 — 307 Total Derivative liabilities-Investments — 18,631 — 18,631 Total Liabilities $— $18,638 $— $18,638 a. These relate to TBA securities. b. Excludes $3,693 million relating to payable for cash collateral received. * Indicates amount less than $0.5 million The following table provides a summary of changes in the fair value of IBRD’s Level 3 Investments – Trading assets during the three months ended September 30, 2012 and September 30, 2011: Level 3 Financial Instruments In millions of U.S. dollars Investments–Trading Three Months Ended Three Months Ended September 30, 2012 September 30, 2011 Government and Agency ABS Obligations Total ABS Beginning of the fiscal year $9 $50 $59 $13 Total realized/unrealized gains (losses) in: Net income * * * (*) Purchases * — * * Sales/Settlements (1) — (1) (*) Transfers into (out of), net 1 — 1 (4) End of the period $9 $50 $59 $9 * Indicates amount less than $0.5 million. The following table provides information on the In millions of U.S. dollars unrealized gains or losses included in income for the Three Months Ended September 30, three months ended September 30, 2012 and Unrealized Gains (Losses) 2012 2011 September 30, 2011, relating to IBRD’s Level 3 Condensed Statement of Investments – Trading assets still held at the Income location reporting dates, as well as where those amounts are Investments – Trading, net $1 $(1) included in the Condensed Statement of Income: * Indicates amount less than $0.5 million. IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) 17 The fair value of Level 3 instruments in the losses (both interest and principal) as a percentage of investment portfolio is estimated using valuation the principal balance. models that incorporate observable market inputs and Significant increases (decreases) in the assumptions unobservable inputs. The significant unobservable used for these inputs in isolation would result in a inputs include constant prepayment rates, probability significantly lower (higher) fair value measurement. of default, and loss severity. The constant Generally, a change in the assumption used for the prepayment rate is an annualized expected rate of probability of default is accompanied by a principal prepayment for a pool of ABS. The directionally similar change in the assumption used probability of default is an estimate of the expected for the loss severity and a directionally opposite likelihood of not collecting contractual amounts change in the assumption used for constant owed. Loss severity is the present value of lifetime prepayment rates. The following table provides a summary of the valuation technique applied in determining fair values of these Level 3 instruments as of September 30, 2012 and June 30, 2012, and quantitative information regarding the significant unobservable inputs used: In millions of U.S. dollars Fair Value at Fair Value at Range (weighted Range (weighted September 30, June 30, Valuation average) average) Portfolio 2012 2012 Technique Unobservable input September 30, 2012 June 30, 2012 0% to 10% 0% to 18% Probability of default (4.91%) (5.77%) Investments Discounted Constant 0% to11% 0.50% to 15% $9 $9 (ABS) Cash Flow prepayment rate (2.41%) (4.80%) 0% to100% 0% to 100% Loss severity (50.99%) (76.19%) Inter-level transfers For instruments for which market quotations are not available, fair values are determined using The table below provides the details of all gross model-based valuation techniques, whether inter-level transfers for the three months ended internally-generated or vendor-supplied, that include September 30, 2012 and September 30, 2011: the standard discounted cash flow method using In millions of U.S. dollars market observable inputs such as yield curves, credit Investments–Trading spreads, and constant prepayment rates. Where ABS Three Months Ended September 30, applicable, unobservable inputs such as constant 2012 2011 prepayment rates, probability of default and loss Level 2 Level 3 Level 2 Level 3 severity are used. Unless quoted prices are available, Transfers into time deposits are reported at face value, which (out of) $7 $(7) $7 $(7) approximates fair value. Transfers (out of) into (8) 8 (3) 3 Securities purchased under resale agreements, $(1) $1 $4 $(4) Securities sold under agreements to repurchase, and Securities lent under securities lending agreements The transfers from Level 2 to Level 3 reflect the unavailability of quoted prices for similar instruments These securities are reported at face value, which resulting from a decreased volume of trading for approximates fair value. these instruments. Conversely, the transfers from Commercial Credit Risk Level 3 to Level 2 reflect the availability of quoted prices for similar instruments resulting from For the purpose of risk management, IBRD is a party increased volume of trading for these instruments. to a variety of financial transactions, certain of which involve elements of credit risk. Credit risk exposure Valuation Methods and Assumptions represents the maximum potential loss due to Summarized below are the techniques applied in possible nonperformance by obligors and determining the fair values of investments. counterparties under the terms of the contracts. For all securities, IBRD limits trading to a list of Investment securities authorized dealers and counterparties. Where available, quoted market prices are used to Swap Agreements: Credit risk is mitigated through determine the fair value of trading securities. the application of eligibility criteria and volume Examples include most government and agency limits for transactions with individual counterparties securities, mutual funds, futures contracts, and through the use of mark-to-market collateral exchange-traded equity securities and ABS. arrangements for swap transactions. IBRD may 18 IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) require collateral in the form of cash or other The following is a summary of the collateral received approved liquid securities from individual by IBRD in relation to swap transactions as of counterparties in order to mitigate its credit exposure. September 30, 2012 and June 30, 2012: IBRD has entered into master derivatives agreements In millions of U.S. dollars which contain legally enforceable close-out netting September June 30, 30, 2012 2012 provisions. These agreements may further reduce the Collateral received gross credit risk exposure related to the swaps. Credit Cash $ 6,865 $ 3,693 risk with financial assets subject to a master Securities 7,642 10,238 derivatives arrangement is further reduced under Total collateral received $14,507 $13,931 these agreements to the extent that payments and Collateral permitted to be repledged $14,507 $13,931 receipts with the counterparty are netted at Amount of collateral repledged — — settlement. The reduction in exposure as a result of Securities Lending: IBRD may engage in securities these netting provisions can vary due to the impact of lending and repurchases, against adequate collateral, changes in market conditions on existing and new as well as securities borrowing and reverse transactions. The extent of the reduction in exposure repurchases (resales) of government and agency may therefore change substantially within a short obligations, and ABS. Transfers of securities by period of time following the balance sheet date. IBRD to counterparties are not accounted for as sales as the accounting criteria for the treatment as a sale have not been met. Counterparties are permitted to repledge these securities until the repurchase date. The following is a summary of the carrying amount of the securities transferred under repurchase or securities lending agreements, and the related liabilities: In millions of U.S. dollars September 30, June 30, 2012 2012 Financial Statement Presentation Securities transferred under Included under Investments-Trading on the Condensed repurchase or securities lending $2 $7 Balance Sheet agreements Included under Securities sold under repurchase Liabilities relating to securities agreements, securities lent under securities lending transferred under repurchase or $2 $7 agreements, and payable for cash collateral received, on the securities lending agreements Condensed Balance Sheet. IBRD receives collateral in connection with resale Other exposures include: Deferred Drawdown agreements as well as swap agreements. This Options (DDOs), Irrevocable Commitments, collateral serves to mitigate IBRD's exposure to Exposures to member Countries’ Derivatives, and credit risk. Guarantees. IBRD’s loans are reported at amortized cost, with the exception of one loan which is carried In the case of resale agreements, IBRD receives and reported at fair value, because it contains an collateral in the form of liquid securities and is embedded derivative. permitted to repledge these securities. While these transactions are legally considered to be true Of the total loans outstanding as of September 30, purchases and sales, the securities received are not 2012, 82% were to the Latin America and the recorded on IBRD’s Balance Sheet as the accounting Caribbean, Europe and Central Asia, and East Asia criteria for treatment as a sale have not been met. and Pacific regions, combined. As of September 30, 2012, IBRD had received Based on IBRD’s internal credit quality indicators, securities with a fair value of $1,022 million ($209 the majority of loans outstanding are in the Medium million—June 30, 2012). None of these securities had risk and High risk classes. been transferred under repurchase or securities lending agreements as of that date (Nil—June 30, As of September 30, 2012, only 0.33% of IBRD’s 2012). loans were in nonaccrual status and were all related to one borrower. The total provision for losses on NOTE D—LOANS AND OTHER EXPOSURES accrual and nonaccrual loans accounted for 1.23% of IBRD’s loans and other exposures (exposures) are the total loans portfolio. generally made to, or guaranteed by member countries of IBRD. In addition, IBRD may also make loans to the International Finance Corporation (IFC), an affiliated organization, without any guarantee. IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) 19 Credit Quality of Sovereign Exposures characteristics of IBRD’s exposures, these exposures Based on an evaluation of IBRD’s exposures, are grouped into three classes in accordance with assigned borrower risk ratings which relate to the management has determined that IBRD has one portfolio segment – Sovereign Exposures. IBRD’s likelihood of loss: Low, Medium and High risk loans constitute the majority of the Sovereign classes, as well as exposures in nonaccrual status. IBRD considers all exposures in nonaccrual status to Exposures portfolio segment. be impaired. IBRD’s country risk ratings are an assessment of its borrowers’ ability and willingness to repay IBRD on IBRD’s borrowers’ country risk ratings are key time and in full. These ratings are internal credit determinants in the provision for losses. Country risk quality indicators. Individual country risk ratings are ratings are determined in review meetings that take derived on the basis of both quantitative and place several times a year. All countries are reviewed qualitative analysis. The components considered in at least once a year, or more frequently, if the analyses can be grouped broadly into eight circumstances warrant, to determine the appropriate categories: political risk, external debt and liquidity, ratings. fiscal policy and public debt burden, balance of IBRD considers loans to be past due when a borrower payments risks, economic structure and growth fails to make payment on any principal, interest or prospects, monetary and exchange rate policy, other charges due to IBRD on the dates provided in financial sector risks, and corporate sector debt and the contractual loan agreement. vulnerabilities. For the purpose of analyzing the risk The following tables provide an aging analysis of IBRD’s loans as of September 30, 2012 and June 30, 2012: In millions of U.S. dollars September 30, 2012 Days past due Up to 45 46-60 61-90 91-180 Over 180 Total Past Due Current Total Risk Class Low $— $— $— $— $ — $ — $ 14,904 $ 14,904 Medium — — — — — — 69,591 69,591 High 1 — — — — 1 53,370 53,371 a Loans in accrual status 1 — — — — 1 137,865 137,866 Loans in nonaccrual a status 5 — — — 441 446 17 463 b Loan at fair value — — — — — — 138 138 Total $6 $— $— $— $441 $447 $138,020 $138,467 In millions of U.S. dollars June 30, 2012 Days past due Up to 45 46-60 61-90 91-180 Over 180 Total Past Due Current Total Risk Class Low $— $— $— $— $ — $ — $ 14,799 $ 14,799 Medium — — — — — — 68,191 68,191 High 10 — — — — 10 52,738 52,748 a Loans in accrual status 10 — — — — 10 135,728 135,738 Loans in nonaccrual a status — — — 13 428 441 21 462 b Loan at fair value — — — — — — 125 125 Total $10 $— $— $13 $428 $451 $135,874 $136,325 a. At amortized cost b. For the loan at fair value, and which is in accrual status, credit risk assessment is incorporated in the determination of fair value. 20 IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) Accumulated Provision for Losses on Loans and between the present value of payments of interest and Other Exposures charges made according to the related instrument’s contractual terms and the present value of its Management determines the appropriate level of expected future cash flows. It is IBRD’s practice not accumulated provisions for losses, which reflects the to write off its loans. All contractual obligations probable losses inherent in IBRD’s exposures. associated with exposures in nonaccrual status have Probable losses comprise estimates of losses arising eventually been cleared, thereby allowing borrowers from default and nonpayment of principal amounts to eventually emerge from nonaccrual status. To date, due, as well as present value losses. Delays in no loans have been written off. receiving loan payments result in present value losses to IBRD since it does not charge fees or additional Notwithstanding IBRD’s historical experience, the interest on any overdue interest or charges. These risk of losses associated with nonpayment of present value losses are equal to the difference principal amounts due is included in the accumulated provision for losses on loans and other exposures. Changes to the Accumulated provision for losses on loans and other exposures for the three months ended September 30, 2012, and for the fiscal year ended June 30, 2012, are summarized below: In millions of U.S. dollars September 30, 2012 June 30, 2012 Loans Other Total Loans Other Total Accumulated provision, beginning of the fiscal year $1,690 $35 $1,725 $1,549 $29 $1,578 Provision – (release) charge (1) 3 2 181 8 189 Translation adjustment 9 * 9 (40) (2) (42) Accumulated provision, end of the period/fiscal year $1,698 $38 $1,736 $1,690 $35 $1,725 Composed of accumulated provision for losses on: Loans in accrual status $1,466 $1,459 Loans in nonaccrual status 232 231 Total $1,698 $1,690 Loans, end of the period/fiscal year: Loans at amortized cost in accrual status $137,866 $135,738 Loans at amortized cost in nonaccrual status 463 462 Loan at fair value in accrual status 138 125 Total $138,467 $136,325 * Indicates amount less than $0.5 million. Reported as Follows Condensed Balance Sheet Condensed Statement of Income Accumulated Provision for Losses on: Loans Accumulated provision for losses on Provision for losses on loans and other loans exposures Other (excluding exposures to member Other liabilities Provision for losses on loans and other countries’ derivatives) exposures Exposures to member countries’ Derivative assets – Client operations Provision for losses on loans and other derivatives exposures Overdue Amounts status, unpaid interest and other charges accrued on exposures to the member are deducted from the It is the policy of IBRD to place in nonaccrual status income of the current period. Interest and other all loans and other exposures made to or guaranteed charges on nonaccruing exposures are included in by a member of IBRD if principal, interest, or other income only to the extent that payments have been charges with respect to any such exposures are received by IBRD. If collectibility risk is considered overdue by more than six months, unless IBRD’s to be particularly high at the time of arrears management determines that the overdue amount will clearance, the member’s exposures may not be collected in the immediate future. In addition, if automatically emerge from nonaccrual status. In such development credits and other exposures made by instances, a decision on the restoration of accrual International Development Agency (IDA) to a status is made on a case-by-case basis and in certain member government are placed in nonaccrual status, cases that decision may be deferred until a suitable all loans and other exposures made to, or guaranteed period of payment performance has passed. by, that member government, will also be placed in nonaccrual status by IBRD. On the date a member’s loans and other exposures are placed into nonaccrual IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) 21 At September 30, 2012, there were no principal or guarantees, and is not included on the Condensed interest amounts on loans in accrual status, which Balance Sheet. These guarantees have original were overdue by more than three months. The maturities ranging between 4 and 19 years, and following tables provide a summary of selected expire in decreasing amounts through 2029. financial information related to loans in nonaccrual At September 30, 2012, liabilities of $56 million ($50 status as of September 30, 2012 and June 30, 2012, million—June 30, 2012), related to IBRD's and for the three months ended September 30, 2012 obligations under guarantees have been included in and September 30, 2011: Other liabilities on the Condensed Balance Sheet. In millions of U.S. dollars These include the accumulated provision for September June 30, guarantee losses of $22 million ($18 million—June 30, 2012 2012 30, 2012). Recorded investment in a nonaccrual loans $463 $462 During the three months ended September 30, 2012, Accumulated provision for loan losses on nonaccrual loans 232 231 and September 30, 2011, no guarantees provided by Average recorded investment in IBRD were called. nonaccrual loans for the period/fiscal year 462 464 Waivers of Loan Charges Overdue amounts of nonaccrual IBRD provides waivers on eligible loans, which loans 780 761 of which: include a portion of interest on loans, a portion of the Principal 446 441 commitment charge on undisbursed balances and a Interest and charges 334 320 portion of the front-end fee charged on all eligible loans. Waivers are approved annually by the a. A loan loss provision has been recorded against each of the loans in nonaccrual status. Executive Directors of IBRD. The reduction in net income during the three months In millions of U.S. dollars ended September 30, 2012 and September 30, 2011 Three Months Ended resulting from waivers of loan charges is summarized September 30, 2012 2011 below: Interest income not recognized In millions of U.S. dollars as a result of loans being in Three Months Ended nonaccrual status $9 $9 September 30, 2012 2011 During the three months ended September 30, 2012 Interest waivers $33 $37 and September 30, 2011, no interest income was Commitment charge waivers 5 8 recognized on loans in nonaccrual status and there Loan origination fee waivers 5 7 were no loans placed in nonaccrual status or restored Total $43 $52 to accrual status. Information relating to the sole borrowing member Segment Reporting with loans or other exposures in nonaccrual status at Based on an evaluation of IBRD’s operations, September 30, 2012 is as follows: management has determined that IBRD has only one In millions of U.S. dollars reportable segment since IBRD does not manage its Principal, Interest operations by allocating resources based on Principal and Charges Nonaccrual determination of the contribution to net income from Borrower outstanding overdue since individual borrowers. Zimbabwe $463 $780 October 2000 Loan income comprises interest, commitment fees, Guarantees loan origination fees and prepayment premia, net of waivers. For the three months ended September 30, Guarantees of $1,820 million were outstanding at 2012, loans to two countries generated in excess of September 30, 2012 ($1,753 million—June 30, ten percent of total loan income; this amounted to 2012). This amount represents the maximum $68 million, each. potential amount of undiscounted future payments that IBRD could be required to make under these 22 IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) Information about IBRD’s loan outstanding balances and associated loan income by geographic region, as of and for the three months ended September 30, 2012, and September 30, 2011, is presented in the following table: In millions of U.S. dollars September 30, 2012 September 30, 2011 Region Loans Outstanding Loan Income Loans Outstanding Loan Income Africa $ 1,887 $ 4 $ 1,414 $ 2 East Asia and Pacific 27,561 129 26,206 118 Europe and Central Asia 39,374 144 37,359 174 Latin America and the Caribbean 46,324 278 45,141 261 Middle East and North Africa 9,946 45 9,832 47 South Asia 13,137 35 12,919 26 a Other 238 1 50 1 Total $138,467 $636 $132,921 $629 a. Represents loans to IFC, an affiliated organization. Fair Value Disclosures In millions of U.S. dollars September 30, 2012 June 30, 2012 The loan carried at fair value is classified as Level 3. Carrying Fair Carrying Fair This loan has an embedded derivative and its fair Value Value Value Value value is estimated on a matrix basis against the Net Loans Outstanding $136,346 $136,138 $134,209 $132,198 related bond. As IBRD’s loans are not traded, the yield which is used as a key input to determining the fair value of this loan is not observable. The yield Valuation Methods and Assumptions applied in determining the fair value of the loan at All of IBRD’s loans are made to, or guaranteed by, September 30, 2012 was 2%. An increase (decrease) countries that are members of IBRD, except for those in the yield would result in a decrease (increase) in loans made to IFC. IBRD does not currently sell its the fair value of the loan. loans. The following table provides a summary of changes As of September 30, 2012 and June 30, 2012, except in the fair value of IBRD’s Level 3 loan for the three for the one loan which was reported at fair value, all months ended September 30, 2012 and September 30, other loans were carried at amortized cost. The fair 2011: value of these loans is calculated using a discounted In millions of U.S. dollars cash flow method. This method incorporates Credit Three Months Default Swap spreads for each borrower. Basis Ended September 30, adjustments are applied to market recovery levels to 2012 2011 reflect IBRD’s recovery experience. Beginning of fiscal year $125 $139 Total unrealized gains (losses) in: NOTE E—BORROWINGS Net income 9 (9) Other comprehensive income 4 (10) IBRD issues unsubordinated and unsecured fixed and End of the period $138 $120 variable rate debt in a range of currencies. Some of these debt instruments are callable. Variable rates The following table reflects the fair value adjustment may be based on, for example, exchange rates, on the loan included in income for the three months interest rates or equity indices. ended September 30, 2012 and September 30, 2011, as well as where those amounts are included in the Borrowings issued by IBRD are carried and reported Condensed Statement of Income: at fair value. As of September 30, 2012, 93% of the instruments in the portfolio were classified as Level In millions of U.S. dollars 2, within the fair value hierarchy. Three Months Ended September 30, The following table summarizes IBRD’s borrowings Unrealized Gains (Losses) 2012 2011 portfolio after derivatives as of September 30, 2012 Condensed Statement of Income location and June 30, 2012: Fair value adjustment on In millions of U.S. dollars non-trading portfolios, net $7 $(11) September 30, June 30, 2012 2012 The following table presents the fair value of all Borrowings $147,020 $145,339 Currency swaps, net (10,813) (9,663) IBRD’s loans along with their respective carrying Interest rate swaps, net (2,813) (2,601) values as of September 30, 2012 and June 30, 2012: $133,394 $133,075 IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) 23 IBRD uses derivative contracts to modify the interest The following table provides information on the rate and/or currency characteristics of the instruments unrealized gains or losses included in income for the in the borrowing portfolio. For details regarding three months ended September 30, 2012 and Currency swaps and Interest rate swaps, see Note September 30, 2011, relating to IBRD’s total F—Derivative Instruments. borrowings held at the reporting dates, as well as where those amounts are included in the Condensed Fair Value Disclosures Statement of Income: IBRD’s fair value hierarchy for borrowings measured In millions of U.S. dollars at fair value on a recurring basis as of September 30, Three Months 2012 and June 30, 2012 is as follows: Ended September 30, Unrealized Gains (Losses) 2012 2011 In millions of U.S. dollars Condensed Statement of September 30, 2012 June 30, 2012 Income location Level 1 $ — $ — Fair value adjustment on Level 2 136,092 134,371 non-trading portfolios, net $(187) $(3,626) Level 3 10,928 10,968 $147,020 $145,339 During the three months ended September 30, 2012, and September 30, 2011, IBRD’s credit spreads A summary of changes in the fair value of IBRD’s remained largely unchanged. Level 3 borrowings during the three months ended IBRD’s Level 3 borrowings primarily relate to September 30, 2012 and September 30, 2011 is structured bonds. The fair value of these bonds is presented in the following table: estimated using valuation models that incorporate In millions of U.S. dollars model parameters, observable market inputs, and Three Months Ended unobservable inputs. The significant unobservable September 30, inputs used in the fair value measurement of 2012 2011 structured bonds are correlations and long-dated Beginning of fiscal year $10,968 $12,416 interest rate volatilities. Total realized/ unrealized losses (gains) in: Correlation is the statistical measurement of the Net income 62 304 relationship between two variables. For contracts Other comprehensive income 255 383 where the holder benefits from the convergence of Issuances 40 1 the underlying index prices (e.g. interest rates and Settlements (65) (630) foreign exchange rates), an increase in correlation Transfers into (out of), net (332) (45) generally results in an increase in the fair value of the End of the period $10,928 $12,429 instruments. The magnitude and direction of the fair value adjustment will depend on whether the holder Information on the unrealized gains or losses is short or long the option. included in income for the three months ended Interest rate volatility is the extent to which the level September 30, 2012 and September 30, 2011, relating of interest rates change over time. For purchased to IBRD’s Level 3 borrowings still held at the options, an increase in volatility will generally result reporting dates, as well as where those amounts are in an increase in the fair value. In general, the included in the Condensed Statement of Income, is volatility used to price the option depends on the presented in the following table: maturity of the underlying instrument and the option In millions of U.S. dollars strike price. For IBRD, interest rate volatilities are Three Months considered an unobservable input for maturities Ended September 30, greater than ten years for certain currencies. Unrealized Gains (Losses) 2012 2011 Condensed Statement of Income location Fair value adjustment on non-trading portfolios, net $(58) $(288) 24 IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) The following table provides a summary of the valuation technique applied in determining fair values of these Level 3 instruments and quantitative information regarding the significant unobservable inputs used. In millions of U.S. dollars Fair Value at Fair Value at September 30, June 30, Valuation Range (average) Range (average) Portfolio 2012 2012 Technique Unobservable input September 30, 2012 June 30, 2012 -40% to 84% -44% to 83% Correlations Discounted (13%) (13%) Borrowings $10,928 $10,968 Cash Flow Long-dated interest 18% to 32% 17% to 35% rate volatilities ( 24%) (26%) The table below provides the details of all gross Discount notes and vanilla bonds inter-level transfers for the three months ended Discount notes and vanilla bonds are valued using the September 30, 2012 and September 30, 2011: standard discounted cash flow method which relies In millions of U.S. dollars on market observable inputs such as yield curves, Three Months Ended Three Months Ended foreign exchange rates, basis spreads and funding September 30, 2012 September 30, 2011 Level 2 Level 3 Level 2 Level 3 spreads. Borrowings Structured bonds Transfers into (out of) $332 $(332) $45 $(45) Structured bonds issued by IBRD have coupon or repayment terms linked to the level or the Transfers from Level 3 to Level 2 are due to performance of interest rates, foreign exchange rates, increased price transparency. equity indices or commodities. The fair value of the structured bonds is derived using the discounted cash Presented below is the difference between the flow method based on estimated future pay-offs aggregate fair value and aggregate contractual determined by applicable models and computation of principal balance of borrowings: embedded optionality such as caps, floors and calls. In millions of U.S. dollars A wide range of industry standard models such as Principal one factor Hull-White, LIBOR Market Model and Fair Amount Due Black-Scholes are used depending on the specific Value Upon Maturity Difference structure. These models incorporate market September 30, 2012 $147,020 $150,335 $(3,315) observable inputs, such as yield curves, foreign June 30, 2012 $145,339 $149,655 $(4,316) exchange rates, basis spreads, funding spreads, Valuation Methods and Assumptions interest rates volatilities, equity index volatilities and equity indices. Where applicable, the models also Techniques applied in determining the fair values of incorporate significant unobservable inputs such as debt instruments are summarized as follows: correlations and long-dated interest rate volatilities. NOTE F—DERIVATIVE INSTRUMENTS IBRD uses derivative instruments in its investment and borrowing portfolios, and for asset/liability management purposes. It also offers derivative intermediation services to clients and concurrently enters into offsetting transactions with market counterparties. The following table summarizes IBRD’s use of derivatives in its various financial portfolios: Portfolio Derivative instruments used Purpose / Risk being managed Risk management purposes: Currency swaps, interest rate swaps, currency Manage currency and interest rate risks in the Investments forwards, options and futures contracts portfolio Currency swaps, interest rate swaps, and Manage currency risks as well as repricing risks Borrowings structured swaps between loans and borrowings Other Manage currency risk as well as extend the Currency swaps, and interest rate swaps assets/liabilities duration of IBRD’s equity Other purposes: Assist clients in managing their interest rate and Client operations Currency swaps, and interest rate swaps currency risks IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) 25 IBRD engages in an equity duration extension September 30, 2012 is $428 million. IBRD has not strategy which employs interest rate swaps to posted any collateral with these counterparties due to increase the duration of its equity from approximately its AAA credit rating. three months to approximately five years. This If the credit-risk related contingent features strategy seeks to increase the stability of operating underlying these agreements had been triggered to income by taking a greater exposure to long-term the extent that IBRD would have been required to interest rates. post collateral on September 30, 2012, the amount of IBRD is not required to post collateral under its collateral required to be posted by IBRD would have derivative agreements as long as it maintains a AAA been $91 million. In contrast, IBRD received credit rating. The aggregate fair value of all collateral totaling $14,507 million as of September derivative instruments with credit-risk related 30, 2012, in relation to swap transactions (see Note contingent features that are in a liability position on C-Investments). The following tables provide information on the fair value amounts and the location of the derivative instruments on the Condensed Balance Sheet, as well as notional amounts and credit risk exposures of those derivative instruments as of September 30, 2012 and June 30, 2012: Fair value of derivative instruments on the Condensed Balance Sheet: In millions of U.S. dollars Derivative assets Derivative liabilities Condensed Condensed Balance Sheet September June 30, Balance Sheet September 30, June 30, location 30, 2012 2012 location 2012 2012 Derivatives not designated as hedging instruments Options and Futures contracts– Investments Other assets $ — $ 5 Other liabilities $ 6 $ — Derivative Derivative Interest rate swaps assets 12,743 12,140 liabilities 6,310 6,153 Derivative Derivative a Currency swaps assets 149,715 148,673 liabilities 139,109 138,684 Derivative Derivative b Other assets 1 * liabilities — — Total Derivatives $162,459 $160,819 $145,425 $144,837 a. Includes currency forward contracts and structured swaps. b. These relate to TBA securities. * Indicates amount less than $0.5 million. 26 IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) Notional amounts and credit risk exposure of the derivative instruments: In millions of U.S. dollars September 30, 2012 June 30, 2012 Type of contract Investment portfolio Interest rate swaps Notional principal $ 7,361 $ 7,319 Credit exposure 142 135 Currency swaps (including currency forward contracts) Credit exposure 113 413 a Exchange traded Options and Futures contracts Notional long position 2,575 272 Notional short position 3,712 2,009 b Other derivatives Notional long position 95 95 Credit exposure 1 * Client operations Interest rate swaps Notional principal 18,264 18,215 Credit exposure 1,801 1,720 Currency swaps Credit exposure 1,777 1,446 Borrowing portfolio Interest rate swaps Notional principal 146,814 147,872 Credit exposure 6,977 6,647 Currency swaps Credit exposure 16,656 15,506 Other derivatives Interest rate swaps Notional principal 38,799 38,563 Credit exposure 4,371 4,021 Currency swaps Credit exposure 237 229 a. Exchange traded instruments are generally subject to daily margin requirements and are deemed to have no material credit risk. All options and futures contracts are interest rate contracts. b. These relate to TBA securities. * Indicates amount less than $0.5 million. The following table provides information on the location and amount of gains and losses on the non-trading derivatives during the three months ended September 30, 2012 and September 30, 2011, and their location on the Condensed Statement of Income: In millions of U.S. dollars Three Months Ended September 30, Condensed Statement of Income location Gains (Losses) 2012 2011 Derivatives not designated as hedging instruments, and not held in a a trading portfolio Interest rate swaps Fair value adjustment on non-trading portfolios, net $376 $1,233 Currency swaps (including currency forward contracts and structured swaps) Fair value adjustment on non-trading portfolios, net 413 1,750 Total $789 $2,983 a. For alternative disclosures about trading derivatives, see the following table. IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) 27 All of the instruments in IBRD's investment portfolio are held for trading purposes. Within the investment portfolio, IBRD holds highly rated fixed income instruments, equity securities as well as derivatives. The following table provides information on the location and amount of gains and losses on the net investment portfolio and their location on the Condensed Statement of Income during the three months ended September 30, 2012 and September 30, 2011: In millions of U.S. dollars Three Months Ended September 30, Condensed Statement of Income Location Investments-Trading, net Gains (Losses) 2012 2011 Type of instrument Fixed income $45 $ (8) Equity 5 (125) Total $50 $(133) Fair Value Disclosures IBRD’s fair value hierarchy for derivative assets and liabilities measured at fair value on a recurring basis as of September 30, 2012 and June 30, 2012 is as follows: In millions of U.S. dollars Fair Value Measurements on a Recurring Basis As of September 30, 2012 Level 1 Level 2 Level 3 Total Derivative Assets: Investments Currency forward contracts $— $ 7,217 $ — $ 7,217 Currency swaps — 9,653 — 9,653 Interest rate swaps — 142 — 142 a Other — 1 — 1 — 17,013 — 17,013 Client operations Currency swaps — 25,958 — 25,958 Interest rate swaps — 1,710 — 1,710 — 27,668 — 27,668 Borrowings Currency swaps — 92,081 14,011 106,092 Interest rate swaps — 6,822 12 6,834 — 98,903 14,023 112,926 Other assets/liabilities Currency swaps — 795 — 795 Interest rate swaps — 4,057 — 4,057 — 4,852 — 4,852 Total derivative assets $— $148,436 $14,023 $162,459 Derivative Liabilities: Investments Currency forward contracts $— $ 7,369 $ — $ 7,369 Currency swaps — 9,948 — 9,948 Interest rate swaps — 313 — 313 — 17,630 — 17,630 Client operations Currency swaps — 25,955 — 25,955 Interest rate swaps — 1,704 — 1,704 — 27,659 — 27,659 Borrowings Currency swaps — 83,471 11,808 95,279 Interest rate swaps — 4,006 15 4,021 — 87,477 11,823 99,300 Other assets/liabilities Currency swaps — 558 — 558 Interest rate swaps — 272 — 272 — 830 — 830 Total derivative liabilities $— $133,596 $11,823 $145,419 a. These relate to TBA securities. 28 IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) In millions of U.S. dollars Fair Value Measurements on a Recurring Basis As of June 30, 2012 Level 1 Level 2 Level 3 Total Derivative Assets: Investments Currency forward contracts $— $ 6,542 $ — $ 6,542 Currency swaps — 11,876 — 11,876 Interest rate swaps — 135 — 135 a Other — * — * — 18,554 — 18,554 Client operations Currency swaps — 25,891 — 25,891 Interest rate swaps — 1,669 — 1,669 — 27,560 — 27,560 Borrowings Currency swaps — 89,614 13,962 103,576 Interest rate swaps — 6,520 7 6,527 — 96,134 13,969 110,103 Other assets/liabilities Currency swaps — 788 — 788 Interest rate swaps — 3,809 — 3,809 — 4,597 — 4,597 Total derivative assets $— $146,845 $13,969 $160,814 Derivative Liabilities: Investments Currency forward contracts $— $ 6,448 $ — $ 6,448 Currency swaps — 11,876 — 11,876 Interest rate swaps — 307 — 307 — 18,631 — 18,631 Client operations Currency swaps — 25,889 — 25,889 Interest rate swaps — 1,662 — 1,662 — 27,551 — 27,551 Borrowings Currency swaps — 81,915 11,998 93,913 Interest rate swaps — 3,903 23 3,926 — 85,818 12,021 97,839 Other assets/liabilities Currency swaps — 558 — 558 Interest rate swaps — 258 — 258 — 816 — 816 Total derivative liabilities $— $132,816 $12,021 $144,837 a. These relate to TBA securities. * Indicates amount less than $0.5 million. The following tables provide a summary of changes in the fair value of IBRD’s Level 3 derivatives, net during the three months ended September 30, 2012 and September 30, 2011: In millions of U.S. dollars Three Months Ended Three Months Ended September 30,2012 September 30,2011 Currency Interest Currency Interest Swaps Rate Swaps Total Swaps Rate Swaps Total Beginning of the fiscal year $1,964 $(16) $1,948 $1,303 $ 40 $1,343 Total realized/unrealized gains or (losses) in: Net income 90 13 103 439 (37) 402 Other comprehensive income 246 — 246 429 — 429 Issuances (4) — (4) (5) — (5) Settlements (15) — (15) (199) — (199) Transfers (out of) into, net (78) — (78) (17) — (17) End of the period $2,203 $ (3) $2,200 $1,950 $ 3 $1,953 IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) 29 Unrealized gains or losses included in income for the In millions of U.S. dollars three months ended September 30, 2012 and Three Months Ended Three Months Ended September 30, 2012 September 30, 2011 September 30, 2011, relating to IBRD’s Level 3 Level 2 Level 3 Level 2 Level 3 derivatives, net still held at the reporting dates as well Derivatives, as where those amounts are included in the net Condensed Statement of Income, are presented in the Transfers into (out of) $78 $(78) $17 $(17) following table: In millions of U.S. dollars Three Months Ended Transfers from Level 3 to Level 2 are due to September 30, increased price transparency. Unrealized Gains (Losses) 2012 2011 The fair value of IBRD’s Level 3 borrowings related Condensed Statement of Income Location derivatives is estimated using valuation models that Fair value adjustment on incorporate model parameters, observable market non-trading portfolios, net $105 $377 inputs and unobservable inputs. The significant unobservable inputs used in the fair value measurement of these derivatives are correlations and The following table provides the details of all long dated interest rate volatilities. See Note E – inter-level transfers during the three months ended Borrowings for details on these unobservable inputs. September 30, 2012 and September 30, 2011: The following table provides a summary of the valuation technique applied in determining fair values of these Level 3 instruments and quantitative information regarding the significant unobservable inputs used. In millions of U.S. dollars Fair Value at Fair Value at September 30, June 30, Valuation Range (average) Range (average) Portfolio 2012 2012 Technique Unobservable input September 30, 2012 June 30, 2012 Currency -40% to 84% -44% to 83% Correlations swaps, Discounted (13%) (13%) $2,200 $1,948 interest Cash Flow Long-dated interest 18 % to 32 % 17% to 35% rates swaps rate volatilities (24%) (26%) Valuation Methods and Assumptions On August 9, 2012, IBRD’s Executive Directors approved the allocation of $390 million out of the net Derivative contracts include currency forward income earned in the fiscal year ended June 30, 2012 contracts, TBAs, currency swaps and interest rate to the General Reserve. In addition, the Executive swaps. Currency swaps and interest rate swaps are Directors also approved a reduction in the Pension either plain vanilla or structured. Currency forward Reserve by $3 million, an increase in Restricted contracts and plain vanilla currency and interest rate Retained Earnings by $13 million, and a reduction in swaps are valued using the standard discounted cash the LTIP Reserve by $225 million. flow methods using market observable inputs such as yield curves, foreign exchange rates, basis spreads Subsequent event: On October 12, 2012, IBRD’s and funding spreads. For structured currency and Board of Governors approved an immediate transfer interest rate swaps, which primarily consist of to IDA of $608 million. This transfer was made on callable swaps linked to interest rates, foreign October 16, 2012. exchange rates, and equity indices, valuation models Retained earnings comprise the following and inputs similar to the ones applicable to structured components at September 30, 2012 and June 30, bonds valuation are used. Where applicable, the 2012: models also incorporate significant unobservable In millions of U.S. dollars inputs such as correlations and long-dated interest September 30, June 30, rate volatilities. 2012 2012 Special Reserve $ 293 $ 293 NOTE G—RETAINED EARNINGS, General Reserve 26,742 26,351 ALLOCATIONS AND TRANSFERS Pension Reserve 1,159 1,162 Surplus 172 172 IBRD makes net income allocation decisions on the LTIP Reserve — 225 a basis of reported net income, adjusted to exclude the Cumulative fair value adjustments 48 857 fair value adjustment on non-trading portfolios, net, Unallocated Net Income (Loss) 1,500 (26) Restricted Retained Earnings 25 13 restricted income, LTIP adjustment and Board of Total $29,939 $29,047 Governors-approved transfers, and after considering the allocation to the pension reserve. a. Applicable to non-trading portfolios reported at fair value. 30 IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) NOTE H—PENSION AND OTHER POST RETIREMENT BENEFITS IBRD, IFC and the Multilateral Investment Guarantee Agency (MIGA) participate in a defined benefit Staff Retirement Plan (SRP), a Retired Staff Benefits Plan (RSBP) and PEBP that cover substantially all of their staff members. All costs, assets and liabilities associated with these pension plans are allocated between IBRD, IFC and MIGA based upon their employees’ respective participation in the plans. Costs allocated to IBRD are then shared between IBRD and IDA based on an agreed cost sharing ratio. The net periodic pension cost (credit) for the SRP, RSBP and PEBP is included in Administrative expenses, in the Condensed Statement of Income. The following table summarizes the benefit costs associated with the SRP, RSBP, and PEBP for IBRD and IDA for the three months ended September 30, 2012 and September 30, 2011: In millions of U.S. dollars Three Months Ended Three Months Ended September 30, 2012 September 30, 2011 SRP RSBP PEBP SRP RSBP PEBP Benefit Costs Service cost $ 92 $ 21 $8 $ 76 $ 16 $5 Interest cost 133 25 6 154 25 7 Expected return on plan assets (180) (25) — (194) (26) — Amortization of prior service cost 2 3 * 2 — * Amortization of unrecognized loss 48 11 8 8 6 5 Net periodic pension cost $ 95 $ 35 $22 $ 46 $ 21 $17 of which: IBRD’s Share $ 46 $ 17 $11 $ 22 $ 10 $ 8 IDA’s Share $ 49 $ 18 $11 $ 24 $ 11 $ 9 * Indicates amount less than $0.5 million. NOTE I—TRANSACTIONS WITH AFFILIATED ORGANIZATIONS IBRD transacts with affiliated organizations by providing loans, administrative and derivative intermediation services, as well as through its pension and other postretirement benefit plans. At September 30, 2012 and June 30, 2012, IBRD had the following receivables from (payables to) its affiliated organizations: In millions of U.S. dollars September 30, 2012 a Derivative Transactions Pension and Other Administrative Postretirement Loans Services Receivable Payable Benefits Total IDA $ — $314 $7,664 $(7,107) $ (980) $(109) IFC 238 33 — — (124) 147 MIGA — 3 — — (6) (3) $238 $350 $7,664 $(7,107) $(1,110) $ 35 In millions of U.S. dollars June 30, 2012 a Derivative Transactions Pension and Other Administrative Postretirement Loans Services Receivable Payable Benefits Total IDA $— $375 $7,714 $(7,327) $(1,006) $(244) IFC 42 48 — — (120) (30) MIGA — 1 — — (5) (4) $42 $424 $7,714 $(7,327) $(1,131) $(278) a. For details on derivative transactions relating to the client operations, see Note F—Derivative Instruments. The receivables from (payables to) these affiliated organizations are reported in the Condensed Balance Sheet as follows: Receivables / Payables related to: Reported as: Loans Loans outstanding Receivable for administrative services Other assets Receivables (payables) for derivative transactions Derivative assets/liabilities – Client operations Payable for pension and other postretirement benefits Other liabilities IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) 31 Loans For the three months ended September 30, 2012 and IBRD has a Local Currency Loan Facility Agreement September 30, 2011, the amount of fee revenue with IFC which is capped at $300 million. At associated with services provided to other affiliated September 30, 2012, the balance of the loan under organizations is included in Other Income on the this facility amounted to $42 million ($42 Condensed Statement of Income, as follows: million—June 30, 2012) and carried a fixed interest In millions of U.S. dollars Three Months Ended September 30, rate of 3.96%. This loan is not eligible for interest 2012 2011 waivers. Fees charged to IFC $7 $7 In addition, on July 5, 2012, the Board of Executive Fees charged to MIGA 1 1 Directors approved for IBRD to lend up to $197 million to IFC. This loan is at LIBOR less 25 basis Pension and Other Postretirement Benefits points (0.32% as of September 30, 2012) and is not The payable to IDA represents IDA’s net share of eligible for interest waivers. At September 30, 2012, prepaid costs for pension and other postretirement the balance of this loan was $196 million. benefit plans and PEBP assets. These will be realized over the life of the plan participants. Administrative expenses Expenses jointly incurred by IBRD and IDA are The payables to IFC and MIGA represent their respective share of PEBP assets. The PEBP assets are allocated based on an agreed cost sharing ratio, and amounts are settled quarterly. For the three months managed by IBRD and are a part of the investment ended September 30, 2012, IBRD’s administrative portfolio. expenses are net of the share of expenses allocated to Derivative transactions IDA of $343 million ($301 million—three months These relate to currency forward contracts entered ended September 30, 2011). into by IDA with IBRD acting as the intermediary Other income with the market. Income jointly earned by IBRD and IDA is allocated NOTE J—COMPREHENSIVE INCOME based on the same agreed cost sharing ratio that is Comprehensive income / loss comprises the effects of used to allocate administrative expenses. Amounts the transition adjustment on adoption of an are settled quarterly. For the three months ended accounting standard on derivatives and hedging on September 30, 2012, IBRD’s other income is net of July 1, 2000, currency translation adjustments, income allocated to IDA of $35 million ($37 pension-related items and net income. These items million—three months ended September 30, 2011). are presented in the Condensed Statement of Comprehensive Income. The following tables present the changes in Accumulated Other Comprehensive Income balances for the three months ended September 30, 2012 and September 30, 2011: In millions of U.S. dollars Three Months Ended September 30, 2012 Cumulative Effect of Unrecognized Unrecognized Total Change in Net Actuarial Net Prior Accumulated Cumulative Accounting (Loss) Gain Service (Cost) Other Translation Principle, on Benefit Credit on Comprehensive a a Adjustment Net Reclassification Plans Benefit Plans Loss Balance, beginning of the fiscal year $313 $500 $(516) $(4,544) $(170) $(4,417) Changes from period activity 158 — 1 67 5 231 Balance, end of the period $471 $500 $(515) $(4,477) $(165) $(4,186) In millions of U.S. dollars Three Months Ended September 30, 2011 Cumulative Effect of Unrecognized Unrecognized Total Change in Net Actuarial Net Prior Accumulated Cumulative Accounting (Loss) Gain Service (Cost) Other Translation Principle, on Benefit Credit on Comprehensive a a Adjustment Net Reclassification Plans Benefit Plans Loss Balance, beginning of the fiscal year $1,016 $500 $(521) $(2,385) $(29) $(1,419) Changes from period activity (339) — 1 19 2 (317) Balance, end of the period $ 677 $500 $(520) $(2,366) $(27) $(1,736) a. The cumulative effect of change in accounting principle and subsequent reclassification to net income relates to the adoption of FASB’s guidance on derivatives and hedging on July 1, 2000. 32 IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) NOTE K—OTHER FAIR VALUE DISCLOSURES The table below presents IBRD’s estimates of fair value of its financial assets and liabilities along with their respective carrying amounts as of September 30, 2012 and June 30, 2012: In millions of U.S. dollars September 30, 2012 June 30, 2012 Carrying Value Fair Value Carrying Value Fair Value Due from Banks $ 8,877 $ 8,877 $ 5,806 $ 5,806 Investments (including Securities purchased under resale agreements) 33,303 33,303 33,675 33,675 Net Loans Outstanding 136,346 136,138 134,209 132,198 Derivative Assets Investments 17,013 17,013 18,554 18,554 Client operations 27,668 27,668 27,560 27,560 Borrowings 112,926 112,926 110,103 110,103 Other assets/liabilities 4,582 4,582 4,597 4,597 a a Borrowings 147,020 147,019 145,339 145,337 Securities sold/lent under repurchase agreements/securities lending agreements and payable for cash collateral received 6,867 6,867 3,700 3,700 Derivative Liabilities Investments 17,630 17,630 18,631 18,631 Client operations 27,659 27,659 27,551 27,551 Borrowings 99,300 99,300 97,839 97,839 Other assets/liabilities 830 830 816 816 a. Includes $1 million ($2 million—June 30, 2012) relating to transition adjustment on adoption of FASB’s guidance on derivatives and hedging on July 1, 2000. As of September 30, 2012, IBRD’s loans, including the one loan reported at fair value on a recurring basis, are classified as Level 3 within the fair value hierarchy. Valuation Methods and Assumptions As of September 30, 2012 and June 30, 2012, IBRD had no assets or liabilities measured at fair value on a non-recurring basis. For valuation methods and assumptions of the following items refer to the respective notes as follows: Investments: See Note C Loans and other exposures: See Note D Borrowings: See Note E Derivative instruments: See Notes C and F Due from Banks: The carrying amount of unrestricted and restricted currencies is considered a reasonable estimate of the fair value of these positions. Fair Value Adjustment on Non-Trading Portfolios, Net The following table reflects the components of the fair value adjustment on non-trading portfolios, net, for the three months ended September 30, 2012 and September 30, 2011. In millions of U.S. dollars Three months Ended September 30, 2012 2011 Fair value adjustments, net— gains (losses): Borrowings—Note E $(187) $(3,626) Derivatives—Note F a Borrowings derivatives 586 1,718 Other assets/liabilities derivatives 204 1,264 Client operations derivatives (1) 1 Loan—Note D 7 (11) Total $ 609 $ (654) a. Includes derivatives associated with loan portfolio which are used to manage the repricing risks between loans and borrowings. IBRD CONDENSED QUARTERLY FINANCIAL STATEMENTS: SEPTEMBER 30, 2012 (UNAUDITED) 33 34