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EX-32.1 - EXHIBIT 32.1 - Federal Home Loan Bank of Des Moinesc92368exv32w1.htm
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2009
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 000-51999
 
FEDERAL HOME LOAN BANK OF DES MOINES
(Exact name of registrant as specified in its charter)
     
Federally chartered corporation
(State or other jurisdiction of incorporation or organization)
  42-6000149
(I.R.S. employer identification number)
     
Skywalk Level
801 Walnut Street, Suite 200
Des Moines, IA

(Address of principal executive offices)
 

50309
(Zip code)
Registrant’s telephone number, including area code: (515) 281-1000
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
þ Yes     o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
o Yes     o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer o   Accelerated filer o   Non-accelerated filer þ   Smaller reporting company o
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes     þ No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
     
    Shares outstanding
    as of October 31, 2009
Class B Stock, par value $100   29,849,187
 
 

 

 


 

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 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2

 

 


Table of Contents

PART I–FINANCIAL INFORMATION
Item 1. Financial Statements
FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF CONDITION
(In thousands, except shares)
(Unaudited)
                 
    September 30,     December 31,  
    2009     2008  
ASSETS
               
Cash and due from banks
  $ 26,897     $ 44,368  
Interest-bearing deposits
    20,685       152  
Federal funds sold
    4,485,000       3,425,000  
Investments
               
Trading securities (Note 3)
    5,363,215       2,151,485  
Available-for-sale securities include $0 pledged as collateral at September 30, 2009 and December 31, 2008 that may be repledged (Note 4)
    5,521,251       3,839,980  
Held-to-maturity securities include $0 pledged as collateral at September 30, 2009 and December 31, 2008 that may be repledged (estimated fair value of $5,812,549 and $5,917,288 at September 30, 2009 and December 31, 2008) (Note 5)
    5,743,500       5,952,008  
Advances (Note 6)
    36,303,074       41,897,479  
Mortgage loans held for portfolio, net of allowance for credit losses on mortgage loans of $775 at September 30, 2009 and $500 at December 31, 2008 (Note 7)
    7,838,035       10,684,910  
Accrued interest receivable
    84,305       92,620  
Premises and equipment, net
    9,082       8,550  
Derivative assets (Note 8)
    5,266       2,840  
Other assets
    25,669       29,915  
 
           
 
               
Total assets
  $ 65,425,979     $ 68,129,307  
 
           
 
               
LIABILITIES AND CAPITAL
               
LIABILITIES
               
Deposits
               
Interest-bearing
  $ 1,171,415     $ 1,389,642  
Noninterest-bearing demand
    45,510       106,828  
 
           
Total deposits
    1,216,925       1,496,470  
 
           
 
               
Consolidated obligations, net (Note 9)
               
Discount notes
    12,874,240       20,061,271  
Bonds (includes $4,308,501 at fair value under the fair value option at September 30, 2009)
    46,918,100       42,722,473  
 
           
Total consolidated obligations, net
    59,792,340       62,783,744  
 
           
 
               
Mandatorily redeemable capital stock
    17,504       10,907  
Accrued interest payable
    289,468       320,271  
Affordable Housing Program (AHP)
    40,421       39,715  
Payable to REFCORP
    9,026       557  
Derivative liabilities (Note 8)
    379,501       435,015  
Other liabilities
    294,630       25,261  
 
           
 
               
Total liabilities
    62,039,815       65,111,940  
 
           
 
               
Commitments and contingencies (Note 13)
               
 
               
CAPITAL (Note 10)
               
Capital stock – Class B putable ($100 par value) authorized, issued, and outstanding 29,518,733 and 27,809,271 shares at September 30, 2009 and December 31, 2008
    2,951,873       2,780,927  
Retained earnings
    458,386       381,973  
Accumulated other comprehensive loss
               
Net unrealized loss on available-for-sale securities
    (22,971 )     (144,271 )
Employee retirement plans
    (1,124 )     (1,262 )
 
           
Total capital
    3,386,164       3,017,367  
 
           
 
               
Total liabilities and capital
  $ 65,425,979     $ 68,129,307  
 
           
The accompanying notes are an integral part of these financial statements.

 

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Table of Contents

FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF INCOME
(In thousands)
(Unaudited)
                                 
    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2009     2008     2009     2008  
INTEREST INCOME
                               
Advances
  $ 148,880     $ 371,974     $ 535,131     $ 1,090,671  
Advance prepayment fees, net
    3,471       68       6,719       717  
Interest-bearing deposits
    108       4       339       63  
Securities purchased under agreements to resell
    466             1,625        
Federal funds sold
    2,449       18,294       15,645       64,726  
Investments
                               
Trading securities
    14,667             49,936        
Available-for-sale securities
    17,960       31,695       40,119       101,839  
Held-to-maturity securities
    42,541       57,379       133,868       149,243  
Mortgage loans
    95,057       132,980       348,972       399,789  
Loans to other FHLBanks
          78             92  
 
                       
Total interest income
    325,599       612,472       1,132,354       1,807,140  
 
                       
 
                               
INTEREST EXPENSE
                               
Consolidated obligations
                               
Discount notes
    18,829       173,247       126,539       490,812  
Bonds
    247,929       353,631       873,024       1,075,355  
Deposits
    582       5,662       2,050       20,559  
Borrowings from other FHLBanks
                21       7  
Securities sold under agreements to repurchase
          1             1,961  
Mandatorily redeemable capital stock
    117       265       199       1,081  
 
                       
Total interest expense
    267,457       532,806       1,001,833       1,589,775  
 
                       
 
                               
NET INTEREST INCOME
    58,142       79,666       130,521       217,365  
Provision for credit losses on mortgage loans
    91             341        
 
                       
 
                               
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES
    58,051       79,666       130,180       217,365  
 
                       
 
                               
OTHER INCOME (LOSS)
                               
Service fees
    416       573       1,647       1,734  
Net realized and unrealized (loss) gain on trading securities
    (1,697 )           52,056        
Net gain (loss) on sale of available-for-sale securities
    31,059             (11,710 )      
Net loss on bonds held at fair value
    (3,165 )           (15,392 )      
Net gain on loans held for sale
                1,342        
Net gain (loss) on derivatives and hedging activities
    1,881       (2,143 )     98,297       (12,516 )
(Loss) gain on extinguishment of debt
    (28,567 )           (80,925 )     239  
Other, net
    1,551       (4,994 )     3,896       (3,743 )
 
                       
Total other income (loss)
    1,478       (6,564 )     49,211       (14,286 )
 
                       
 
                               
OTHER EXPENSE
                               
Salaries and benefits
    6,874       6,432       21,053       19,409  
Operating
    3,410       3,437       11,512       10,615  
Federal Housing Finance Agency
    551       421       1,694       1,261  
Office of Finance
    468       444       1,576       1,464  
 
                       
Total other expense
    11,303       10,734       35,835       32,749  
 
                       
 
                               
INCOME BEFORE ASSESSMENTS
    48,226       62,368       143,556       170,330  
 
                       
 
                               
AHP
    3,948       5,099       11,739       13,939  
REFCORP
    8,856       11,450       26,364       31,263  
 
                       
Total assessments
    12,804       16,549       38,103       45,202  
 
                       
 
                               
NET INCOME
  $ 35,422     $ 45,819     $ 105,453     $ 125,128  
 
                       
The accompanying notes are an integral part of these financial statements.

 

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Table of Contents

FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENT OF CHANGES IN CAPITAL
(In thousands)
(Unaudited)
                                         
                            Accumulated        
    Capital Stock             Other        
    Class B (putable)     Retained     Comprehensive     Total  
    Shares     Par Value     Earnings     Loss     Capital  
 
                                       
BALANCE DECEMBER 31, 2008
    27,809     $ 2,780,927     $ 381,973     $ (145,533 )   $ 3,017,367  
 
                             
 
                                       
Proceeds from issuance of capital stock
    1,898       189,804                   189,804  
 
                                       
Repurchase/redemption of capital stock
    (23 )     (2,285 )                 (2,285 )
 
                                       
Net shares reclassified to mandatorily redeemable capital stock
    (165 )     (16,573 )                 (16,573 )
 
                                       
Comprehensive income:
                                       
 
                                       
Net income
                105,453             105,453  
 
                                       
Other comprehensive income:
                                       
 
                                       
Net unrealized gain on available-for-sale securities
                      185,824       185,824  
 
                                       
Reclassification adjustment for gains included in net income relating to sale of available-for-sale securities
                      (64,524 )     (64,524 )
 
                                       
Employee retirement plans
                      138       138  
 
                                     
 
                                       
Total comprehensive income
                                    226,891  
 
                                       
Cash dividends on capital stock (1.34% annualized)
                (29,040 )           (29,040 )
 
                             
 
                                       
BALANCE SEPTEMBER 30, 2009
    29,519     $ 2,951,873     $ 458,386     $ (24,095 )   $ 3,386,164  
 
                             
The accompanying notes are an integral part of these financial statements.

 

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Table of Contents

FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENT OF CHANGES IN CAPITAL
(In thousands)
(Unaudited)
                                         
                            Accumulated        
    Capital Stock             Other        
    Class B (putable)     Retained     Comprehensive     Total  
    Shares     Par Value     Earnings     Loss     Capital  
 
                                       
BALANCE DECEMBER 31, 2007
    27,173     $ 2,717,247     $ 361,347     $ (26,371 )   $ 3,052,223  
 
                             
 
                                       
Proceeds from issuance of capital stock
    49,030       4,903,067                   4,903,067  
 
                                       
Repurchase/redemption of capital stock
    (38,102 )     (3,810,236 )                 (3,810,236 )
 
                                       
Net shares reclassified to mandatorily redeemable capital stock
    (29 )     (2,861 )                 (2,861 )
 
                                       
Comprehensive income (loss):
                                       
 
                                       
Net income
                125,128             125,128  
 
                                       
Other comprehensive (loss) income:
                                       
 
                                       
Net unrealized loss on available-for-sale securities
                      (80,436 )     (80,436 )
 
                                       
Employee retirement plans
                      127       127  
 
                                     
 
                                       
Total comprehensive income
                                    44,819  
 
                                       
Cash dividends on capital stock (4.17% annualized)
                (82,398 )           (82,398 )
 
                             
 
                                       
BALANCE SEPTEMBER 30, 2008
    38,072     $ 3,807,217     $ 404,077     $ (106,680 )   $ 4,104,614  
 
                             
The accompanying notes are an integral part of these financial statements.

 

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FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
                 
    Nine Months Ended
September 30,
 
    2009     2008  
OPERATING ACTIVITIES
               
Net income
  $ 105,453     $ 125,128  
 
               
Adjustments to reconcile net income to net cash provided by operating activities
               
Depreciation and amortization
               
Net premiums, discounts, and basis adjustments on investments, advances, mortgage loans, and consolidated obligations
    (33,799 )     9,526  
Concessions on consolidated obligation bonds
    3,395       6,082  
Premises and equipment
    996       756  
Other
    279       (128 )
Provision for credit losses on mortgage loans
    341        
Loss (gain) on extinguishment of debt
    80,925       (239 )
Net change in fair value on trading securities
    (52,056 )      
Net loss on sale of available-for-sale securities
    11,710        
Net change in fair value on bonds held at fair value
    15,392        
Net gain on loans held for sale
    (1,342 )      
Net change in fair value on derivatives and hedging activities
    (84,618 )     16,812  
Net realized loss on disposal of premises and equipment
    4       12  
Net change in:
               
Accrued interest receivable
    8,398       7,904  
Accrued interest on derivatives
    16,033       37,104  
Other assets
    10,244       (2,160 )
Accrued interest payable
    (27,694 )     66,317  
AHP liability and discount on AHP advances
    692       (203 )
Payable to REFCORP
    8,878       5,170  
Other liabilities
    (1,346 )     (414 )
 
           
 
               
Total adjustments
    (43,568 )     146,539  
 
           
 
               
Net cash provided by operating activities
    61,885       271,667  
 
           
The accompanying notes are an integral part of these financial statements.

 

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Table of Contents

FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF CASH FLOWS (continued from previous page)
(In thousands)
(Unaudited)
                 
    Nine Months Ended
September 30,
 
    2009     2008  
INVESTING ACTIVITIES
               
Net change in:
               
Interest-bearing deposits
    171,967       (47 )
Federal funds sold
    (1,060,000 )     (251,000 )
Trading securities:
               
Proceeds from sales
    754,626        
Purchases
    (3,844,300 )      
Available-for-sale securities:
               
Proceeds from sales and maturities
    3,270,871       2,706,719  
Purchases
    (4,638,468 )     (3,405,971 )
Held-to-maturity securities:
               
Net decrease in short-term
    384,933       300,097  
Proceeds from maturities
    1,082,735       493,070  
Purchases
    (1,249,913 )     (2,544,821 )
Advances to members:
               
Principal collected
    35,776,149       256,009,755  
Originated
    (30,551,036 )     (279,449,831 )
Mortgage loans held for portfolio:
               
Principal collected
    1,943,767       1,033,010  
Originated or purchased
    (1,368,885 )     (813,233 )
Mortgage loans held for sale:
               
Principal collected
    128,045        
Proceeds from sales
    2,123,595        
Additions to premises and equipment
    (1,717 )     (937 )
Proceeds from sale of premises and equipment
    185       10  
 
           
 
               
Net cash provided (used) by investing activities
    2,922,554       (25,923,179 )
 
           
 
FINANCING ACTIVITIES
               
Net change in:
               
Deposits
    (276,045 )     494,003  
Net decrease in securities sold under agreement to repurchase
          (200,000 )
Net payments on derivative contracts with financing elements
    (7,787 )      
Net proceeds from issuance of consolidated obligations:
               
Discount notes
    607,196,488       1,057,476,138  
Bonds
    20,766,716       16,628,956  
Payments for maturing, transferring and retiring consolidated obligations:
               
Discount notes
    (614,333,936 )     (1,037,228,631 )
Bonds
    (16,495,849 )     (11,993,496 )
Proceeds from issuance of capital stock
    189,804       4,903,067  
Net payments for repurchase/issuance of mandatorily redeemable capital stock
    (9,976 )     (37,938 )
Payments for repurchase/redemption of capital stock
    (2,285 )     (3,810,236 )
Cash dividends paid
    (29,040 )     (82,398 )
 
           
 
               
Net cash (used) provided by financing activities
    (3,001,910 )     26,149,465  
 
           
 
               
Net (decrease) increase in cash and due from banks
    (17,471 )     497,953  
Cash and due from banks at beginning of the period
    44,368       58,675  
 
           
 
               
Cash and due from banks at end of the period
  $ 26,897     $ 556,628  
 
           
 
               
Supplemental disclosures
               
Cash paid during the period for:
               
Interest
  $ 1,552,789     $ 1,529,511  
AHP
  $ 11,135     $ 14,105  
REFCORP
  $ 17,486     $ 26,093  
Mortgage loans held for portfolio transferred to mortgage loans held for sale
  $ 2,413,843     $  
Mortgage loans held for sale transferred to mortgage loans held for portfolio
  $ 162,800     $  
Unpaid principal balance transferred from mortgage loans held for portfolio to real estate owned
  $ 11,896     $ 9,460  
The accompanying notes are an integral part of these financial statements.

 

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FEDERAL HOME LOAN BANK OF DES MOINES
CONDENSED NOTES TO THE FINANCIAL STATEMENTS (UNAUDITED)
Background Information
The Federal Home Loan Bank of Des Moines (the Bank) is a federally chartered corporation that is exempt from all federal, state, and local taxation except real property taxes and is one of 12 district Federal Home Loan Banks (FHLBanks). The FHLBanks were created under the authority of the Federal Home Loan Bank Act of 1932 (FHLBank Act), which was amended by the Housing and Economic Recovery Act of 2008 (Housing Act). The Federal Housing Finance Agency (Finance Agency) supervises and regulates the FHLBanks and the FHLBank’s Office of Finance (Office of Finance), as well as Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac). The Finance Agency’s principal purpose is to ensure the FHLBanks operate in a safe and sound manner. In addition, the Finance Agency ensures the FHLBanks carry out their housing finance mission and remain adequately capitalized. The Finance Agency establishes policies and regulations governing the operations of the FHLBanks. Each FHLBank operates as a separate entity with its own management, employees, and board of directors.
The FHLBanks serve the public by enhancing the availability of funds (advances and mortgage loans) for residential mortgages and targeted community development. The Bank provides a readily available, low cost source of funds to its member institutions and eligible housing associates in Iowa, Minnesota, Missouri, North Dakota, and South Dakota. Commercial banks, savings institutions, credit unions, and insurance companies may apply for membership. State and local housing associates that meet certain statutory criteria may also borrow from the Bank; while eligible to borrow, housing associates are not members of the Bank and, as such, are not permitted to hold capital stock.
The Bank is a cooperative. This means the Bank is owned by its customers, whom the Bank calls members. As a condition of membership in the Bank, all members must purchase and maintain membership capital stock based on a percentage of their total assets as of the preceding December 31st. Each member is also required to purchase and maintain activity-based capital stock to support certain business activities with the Bank. The Bank conducts business with its stockholders in the normal course of business.

 

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Note 1—Basis of Presentation
The accompanying unaudited financial statements of the Bank for the three and nine months ended September 30, 2009, have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information. Accordingly, it does not include all of the information required by GAAP for full year information and should be read in conjunction with the audited financial statements for the year ended December 31, 2008, which are contained in the Bank’s annual report on Form 10-K filed with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934 on March 13, 2009 (Form 10-K). In the opinion of management, the unaudited financial information is complete and reflects all adjustments, consisting of normal recurring adjustments, for a fair statement of results for the interim periods. The presentation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year ending December 31, 2009.
Descriptions of the Bank’s significant accounting policies are included in “Note 1 — Summary of Significant Accounting Policies” of the Bank’s 2008 audited financial statements in the Form 10-K, with the exception of one change noted below.
Mortgage Loans Held for Sale. During the second quarter of 2009 the Bank classified certain mortgage loans as held for sale and reported them at the lower of cost basis or fair value. Cost basis included principal amount outstanding and unamortized premiums, discounts, and basis adjustments. At the time of sale, all unamortized premiums, discounts, and basis adjustments were recognized in the gain/loss calculation. For more information related to the sale of the mortgage loans held for sale see “Note 7 — Mortgage Loans Held for Portfolio.”
Reclassifications. During the first quarter of 2009 the Bank enhanced its calculation of adjusted net interest income by segment. Prior period amounts were reclassified to be consistent with the enhanced calculation presented at September 30, 2009. Refer to “Note 11 — Segment Information” for further information.
Subsequent Events. The Bank has evaluated events and transactions for potential recognition or disclosure in the financial statements through the time of filing its third quarter 2009 Form 10-Q with the SEC on November 12, 2009.

 

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Note 2—Recently Issued and Adopted Accounting Guidance
Measuring Liabilities at Fair Value. On August 28, 2009, the Financial Accounting Standards Board (FASB) issued amended guidance for the fair value measurement of liabilities. The update provides clarification in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more of the following techniques: (i) a valuation technique that uses: (a) the quoted price of the identical liability when traded as an asset; (b) quoted prices for similar liabilities or similar liabilities when traded as assets; (ii) another valuation technique that is consistent with the principles of this topic. This guidance is effective for the first reporting period beginning after issuance (October 1, 2009 for the Bank). The Bank does not believe the adoption of this guidance will have a material effect on the Bank’s financial condition, results of operations, or cash flows.
Codification of Accounting Standards. On June 29, 2009, the FASB established FASB’s Accounting Standards Codification (Codification) as the single source of authoritative GAAP recognized by the FASB to be applied by non-governmental entities. SEC rules and interpretative releases are also sources of authoritative GAAP for SEC registrants. This guidance modifies the GAAP hierarchy to include only two levels of GAAP: authoritative and non-authoritative. In addition, the FASB no longer considers new accounting standard updates as authoritative in their own right. Instead, new accounting standard updates will serve only to update the Codification, provide background information about the guidance, and provide the basis for conclusions regarding changes in the Codification. The Codification is effective for interim and annual periods ending after September 15, 2009. The Bank adopted the Codification for the interim period ended September 30, 2009. As the Codification is not intended to change or alter previous GAAP, its adoption did not affect the Bank’s financial condition, results of operations, or cash flows.
Accounting for the Consolidation of Variable Interest Entities. On June 12, 2009, the FASB issued guidance to improve financial reporting by enterprises involved with variable interest entities (VIEs) and to provide more relevant and reliable information to users of financial statements. This guidance amends the manner in which entities evaluate whether consolidation is required for VIEs. An entity must first perform a qualitative analysis in determining whether it must consolidate a VIE, and if the qualitative analysis is not determinative, the entity must perform a quantitative analysis. The guidance also requires an entity continually evaluate VIEs for consolidation, rather than making such an assessment based upon the occurrence of triggering events. Additionally, the guidance requires enhanced disclosures about how an entity’s involvement with a VIE affects its financial statements and its exposure to risks. This guidance is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009 (January 1, 2010 for the Bank), for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Earlier application is prohibited. The Bank has not yet determined the effect that the adoption of this guidance will have on its financial condition, results of operations, or cash flows.

 

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Accounting for Transfers of Financial Assets. On June 12, 2009, the FASB issued guidance intended to improve the relevance, representational faithfulness, and comparability of the information a reporting entity provides in its financial reports about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement in transferred financial assets. Key provisions of the guidance include: (i) the removal of the concept of qualifying special purpose entities; (ii) the introduction of the concept of a participating interest, in circumstances in which a portion of a financial asset has been transferred; and (iii) the requirement that in order to qualify for sale accounting, the transferor must evaluate whether it maintains effective control over transferred financial assets either directly or indirectly. The guidance also requires enhanced disclosures about transfers of financial assets and a transferor’s continuing involvement. This guidance is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009 (January 1, 2010 for the Bank), for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Earlier application is prohibited. The Bank has not yet determined the effect that the adoption of this guidance will have on its financial condition, results of operations, or cash flows.
Subsequent Events. On May 28, 2009, the FASB issued guidance establishing general standards of accounting for and disclosure of events occurring after the balance sheet date but before financial statements are issued or available to be issued. This guidance sets forth: (i) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; (ii) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and (iii) the disclosures an entity should make about events or transactions occurring after the balance sheet date, including disclosure of the date through which an entity has evaluated subsequent events and whether that represents the date the financial statements were issued or available to be issued. This guidance does not apply to subsequent events or transactions within the scope of other applicable GAAP that provide different guidance on the accounting treatment for subsequent events or transactions. This guidance is effective for interim and annual financial periods ending after June 15, 2009. The Bank adopted this guidance effective June 30, 2009.
Recognition and Presentation of Other-Than-Temporary Impairments. On April 9, 2009, the FASB issued guidance amending the other-than-temporary impairment (OTTI) guidance for debt securities to make the guidance more operational and to improve the presentation and disclosure of OTTI on debt securities in the financial statements. This OTTI guidance clarifies the interaction of the factors to be considered when determining whether a debt security is other-than-temporarily impaired and changes the presentation and calculation of the OTTI on debt securities recognized in earnings in the financial statements. This guidance does not amend existing recognition and measurement guidance related to OTTI of equity securities. This guidance expands and increases the frequency of existing disclosures about OTTI for debt and equity securities and requires new disclosures to help users of financial statements understand the significant inputs used in determining a credit loss, as well as a rollforward of that amount each period.

 

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If the fair value of a debt security is less than its amortized cost basis at the measurement date an entity is required to assess whether (i) it has the intent to sell the debt security or (ii) it is more likely than not that it will be required to sell the debt security before its anticipated recovery. If either of these conditions is met, an OTTI on the security must be recognized.
In instances in which a determination is made that a credit loss (the difference between the present value of the cash flows expected to be collected and the amortized cost basis) exists but the entity does not intend to sell the debt security and it is not more likely than not that the entity will be required to sell the debt security before the anticipated recovery of its remaining amortized cost basis (i.e., the amortized cost basis less any current-period credit loss), the OTTI guidance changes the presentation and amount of the OTTI recognized in the Statements of Income. In these instances, the OTTI is separated into (i) the amount of the total OTTI related to the credit loss, and (ii) the amount of the total OTTI related to all other factors. The amount of the total OTTI related to the credit loss is recognized in earnings. The amount of the total OTTI related to all other factors is recognized in accumulated other comprehensive loss. Subsequent non-OTTI-related increases and decreases in the fair value of available-for-sale securities will be included in accumulated other comprehensive loss. The OTTI recognized in accumulated other comprehensive loss for debt securities classified as held-to-maturity will be amortized over the remaining life of the debt security as an increase in the carrying value of the security (with no effect on earnings unless the security is subsequently sold or there is additional OTTI recognized). The total OTTI is presented in the Statements of Income with an offset for the amount of the total OTTI recognized in accumulated other comprehensive loss. Previously, if an impairment was determined to be other-than-temporary, an impairment loss was recognized in earnings in an amount equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date of the reporting period for which the assessment was made. The new presentation provides additional information about the amounts the entity does not expect to collect related to a debt security. The Bank adopted this OTTI guidance effective January 1, 2009 and recognized no cumulative-effect adjustment because it had not previously recognized OTTI.
Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. On April 9, 2009, the FASB issued guidance which clarifies the approach to, and provides additional factors to consider in estimating fair value when the volume and level of activity for the asset or liability have significantly decreased. It also includes guidance on identifying circumstances indicating a transaction is not orderly. The guidance is effective and should be applied prospectively for financial statements issued for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for reporting periods ending after March 15, 2009. If an entity elected to early adopt this guidance, it must also have concurrently adopted the OTTI guidance discussed in the previous paragraphs. The Bank elected to early adopt this guidance effective January 1, 2009. Its adoption did not have a material effect on the Bank’s financial condition, results of operations, or cash flows.

 

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Interim Disclosures about Fair Value of Financial Instruments. On April 9, 2009, the FASB issued guidance to require disclosures about the fair value of financial instruments, including disclosure of the method(s) and significant assumptions used to estimate the fair value of financial instruments, in interim financial statements as well as in annual financial statements. Previously, these disclosures were required only in annual financial statements. The guidance is effective and should be applied prospectively for financial statements issued for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for reporting periods ending after March 15, 2009. An entity may early adopt this guidance only if it also concurrently adopted guidance discussed in the previous paragraphs regarding fair value and the OTTI guidance. The Bank elected to early adopt this guidance effective January 1, 2009. Its adoption resulted in increased interim financial statement disclosures, but did not affect the Bank’s financial condition, results of operations, or cash flows.
Enhanced Disclosures about Derivative Instruments and Hedging Activities. On March 19, 2008, the FASB issued guidance which is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. This guidance is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early adoption allowed. The Bank adopted this guidance effective January 1, 2009. Its adoption resulted in increased financial statement disclosures.
Note 3—Trading Securities
Major Security Types. Trading securities were as follows (dollars in thousands):
                 
    September 30,     December 31,  
    2009     2008  
 
               
Non-mortgage-backed securities
               
TLGP1
  $ 5,111,348     $ 2,151,485  
Taxable municipal bonds2
    251,867        
 
           
 
               
Total
  $ 5,363,215     $ 2,151,485  
 
           
     
1   Temporary Liquidity Guarantee Program (TLGP) securities represented corporate debentures of the issuing party that are backed by the full faith and credit of the U.S. Government.
 
2   Taxable municipal bonds represented investments in Build America Bonds.

 

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The following table summarizes net realized and unrealized (loss) gain on trading securities (dollars in thousands):
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2009     2008     2009     2008  
 
                               
Realized gain on sale of trading securities
  $ 3,038     $     $ 3,626     $  
Unrealized holding (loss) gain on trading securities
    (4,735 )           48,430        
 
                       
 
                               
Net realized and unrealized (loss) gain on trading securities
  $ (1,697 )   $     $ 52,056     $  
 
                       
Note 4—Available-for-Sale Securities
Major Security Types. Available-for-sale securities at September 30, 2009 were as follows (dollars in thousands):
                                         
                    Amounts Recorded in        
                    Accumulated Other        
                    Comprehensive Loss        
                    Gross     Gross        
    Amortized     Hedging     Unrealized     Unrealized     Estimated  
    Cost     Adjustments     Gains     Losses     Fair Value  
Non-mortgage-backed securities
                                       
TLGP1
  $ 563,688     $ 44     $ 3,477     $     $ 567,209  
Government-sponsored enterprise obligations2
    456,093       2,655       7,299             466,047  
 
                             
Total non-mortgage-backed securities
    1,019,781       2,699       10,776             1,033,256  
 
                                       
Mortgage-backed securities
                                       
Government-sponsored enterprise3
    4,521,743             28,081       61,829       4,487,995  
 
                             
 
                                       
Total
  $ 5,541,524     $ 2,699     $ 38,857     $ 61,829     $ 5,521,251  
 
                             

 

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Available-for-sale securities at December 31, 2008 were as follows (dollars in thousands):
                                 
            Gross     Gross        
    Amortized     Unrealized     Unrealized     Estimated  
    Cost     Gains     Losses     Fair Value  
 
                               
Non-mortgage-backed securities
                               
State or local housing agency obligations4
  $ 580     $     $     $ 580  
 
                       
 
                               
Mortgage-backed securities
                               
Government-sponsored enterprise3
    3,983,671             144,271       3,839,400  
 
                       
 
                               
Total
  $ 3,984,251     $     $ 144,271     $ 3,839,980  
 
                       
     
1   TLGP securities represented corporate debentures of the issuing party that are backed by the full faith and credit of the U.S. Government.
 
2   GSE obligations represented Tennessee Valley Authority (TVA) and Federal Farm Credit Bank (FFCB) bonds.
 
3   GSE mortgage-backed securities (MBS) represented Fannie Mae and Freddie Mac securities.
 
4   State or local housing agency obligations represented Housing Finance Agency (HFA) bonds that were purchased by the Bank from housing associates in the Bank’s district.
The following table summarizes the available-for-sale securities with unrealized losses at September 30, 2009. The unrealized losses are aggregated by major security type and the length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands):
                                                 
    Less than 12 Months     12 Months or More     Total  
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized  
    Value     Losses     Value     Losses     Value     Losses  
 
                                               
Mortgage-backed securities
                                               
Government-sponsored enterprise
  $ 723,071     $ 4,189     $ 3,043,954     $ 57,640     $ 3,767,025     $ 61,829  
 
                                   

 

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The following table summarizes the available-for-sale securities with unrealized losses at December 31, 2008. The unrealized losses are aggregated by major security type and the length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands):
                                                 
    Less than 12 Months     12 Months or More     Total  
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized  
    Value     Losses     Value     Losses     Value     Losses  
 
                                               
Mortgage-backed securities
                                               
Government-sponsored enterprise
  $ 1,487,246     $ 45,639     $ 2,352,154     $ 98,632     $ 3,839,400     $ 144,271  
 
                                   
Redemption Terms. The following table summarizes the amortized cost and estimated fair value of available-for-sale securities categorized by contractual maturity (dollars in thousands). Expected maturities of some securities and MBS may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.
                                 
    September 30, 2009     December 31, 2008  
    Amortized     Estimated     Amortized     Estimated  
Year of Maturity   Cost     Fair Value     Cost     Fair Value  
 
                               
Due after one year through five years
  $ 573,411     $ 577,246     $     $  
Due after five years through ten years
    390,967       399,387              
Due after ten years
    55,403       56,623       580       580  
 
                       
 
    1,019,781       1,033,256       580       580  
 
                               
Mortgage-backed securities
    4,521,743       4,487,995       3,983,671       3,839,400  
 
                       
 
                               
Total
  $ 5,541,524     $ 5,521,251     $ 3,984,251     $ 3,839,980  
 
                       
The amortized cost of the Bank’s MBS classified as available-for-sale includes net discounts of $1.8 million and $7.3 million at September 30, 2009 and December 31, 2008.
Gains and Losses on Sales. The Bank sold U.S. Treasury obligations with a total par value of $1.9 billion and $2.7 billion out of its available-for-sale portfolio and recognized a gain of $31.1 million and a loss of $11.7 million in other income (loss) during the three and nine months ended September 30, 2009. There were no sales of available-for-sale securities during the three and nine months ended September 30, 2008.

 

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Other-than-Temporary Impairment Analysis on Available-for-Sale Securities. The Bank evaluates its individual available-for-sale securities in an unrealized loss position for OTTI on at least a quarterly basis. At September 30, 2009 the Bank’s available-for-sale securities portfolio consisted of TLGP securities, GSE debt obligations, and GSE MBS that were all guaranteed by either the U.S. Government or a GSE. This portfolio has experienced unrealized losses due to interest rate volatility, illiquidity in the marketplace, and credit deterioration in the U.S. mortgage markets. However, the decline is considered temporary as the Bank expects to recover the entire amortized cost basis on its available-for-sale securities due to the U.S. Government or GSE guarantees. The Bank does not intend to sell these securities, and it is not more likely than not that the Bank will be required to sell these securities, before its anticipated recovery of each security’s remaining amortized cost basis.
Note 5—Held-to-Maturity Securities
Major Security Types. Held-to-maturity securities at September 30, 2009 were as follows (dollars in thousands):
                                 
            Gross     Gross        
    Amortized     Unrealized     Unrealized     Estimated  
    Cost     Gains     Losses     Fair Value  
 
                               
Non-mortgage-backed securities
                               
Negotiable certificates of deposit
  $ 450,000     $ 900     $     $ 450,900  
Government-sponsored enterprise obligations1
    313,302       13,241             326,543  
State or local housing agency obligations2
    124,878       4,052             128,930  
TLGP3
    1,250       31             1,281  
Other4
    6,627       138             6,765  
 
                       
Total non-mortgage-backed securities
    896,057       18,362             914,419  
 
                               
Mortgage-backed securities
                               
Government-sponsored enterprise5
    4,731,670       97,312       38,192       4,790,790  
U.S. government agency-guaranteed6
    45,048       28       465       44,611  
MPF shared funding
    34,813             1,157       33,656  
Other7
    35,912             6,839       29,073  
 
                       
Total mortgage-backed securities
    4,847,443       97,340       46,653       4,898,130  
 
                       
 
                               
Total
  $ 5,743,500     $ 115,702     $ 46,653     $ 5,812,549  
 
                       

 

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Held-to-maturity securities at December 31, 2008 were as follows (dollars in thousands):
                                 
            Gross     Gross        
    Amortized     Unrealized     Unrealized     Estimated  
    Cost     Gains     Losses     Fair Value  
 
                               
Non-mortgage-backed securities
                               
Commercial paper
  $ 384,757     $ 146     $ 1     $ 384,902  
State or local housing agency obligations2
    92,765       1,878       80       94,563  
Other4
    6,906       166             7,072  
 
                       
Total non-mortgage-backed securities
    484,428       2,190       81       486,537  
 
                               
Mortgage-backed securities
                               
Government-sponsored enterprise5
    5,329,884       64,310       87,540       5,306,654  
U.S. government agency-guaranteed6
    52,006             981       51,025  
MPF shared funding
    47,156             2,573       44,583  
Other7
    38,534             10,045       28,489  
 
                       
Total mortgage-backed securities
    5,467,580       64,310       101,139       5,430,751  
 
                       
 
                               
Total
  $ 5,952,008     $ 66,500     $ 101,220     $ 5,917,288  
 
                       
     
1   GSE obligations represented TVA and FFCB bonds.
 
2   State or local housing agency obligations represented HFA bonds that were purchased by the Bank from housing associates in the Bank’s district.
 
3   TLGP securities represented corporate debentures issued by the Bank’s members that are backed by the full faith and credit of the U.S. Government.
 
4   Other non-MBS investments represented investments in municipal bonds and Small Business Investment Company.
 
5   GSE MBS represented Fannie Mae and Freddie Mac securities.
 
6   U.S. government agency-guaranteed MBS represented Government National Mortgage Association securities and Small Business Administration (SBA) Pool Certificates. SBA Pool Certificates represent undivided interests in pools of the guaranteed portions of SBA loans. The SBA’s guarantee of the Pool Certificates is backed by the full faith and credit of the U.S. Government.
 
7   Other MBS investments represented private-label MBS, which are backed by prime loans.

 

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The following table summarizes the held-to-maturity securities with unrealized losses at September 30, 2009. The unrealized losses are aggregated by major security type and the length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands):
                                                 
    Less than 12 Months     12 Months or More     Total  
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized  
    Value     Losses     Value     Losses     Value     Losses  
 
                                               
Mortgage-backed securities
                                               
Government-sponsored enterprise
  $ 530,840     $ 4,872     $ 1,890,805     $ 33,320     $ 2,421,645     $ 38,192  
U.S. government agency-guaranteed
    11,589       67       31,682       398       43,271       465  
MPF shared funding
                33,656       1,157       33,656       1,157  
Other
                29,073       6,839       29,073       6,839  
 
                                   
 
                                               
Total
  $ 542,429     $ 4,939     $ 1,985,216     $ 41,714     $ 2,527,645     $ 46,653  
 
                                   

 

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The following table summarizes the held-to-maturity securities with unrealized losses at December 31, 2008. The unrealized losses are aggregated by major security type and the length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands):
                                                 
    Less than 12 Months     12 Months or More     Total  
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized  
    Value     Losses     Value     Losses     Value     Losses  
 
                                               
Non-mortgage-backed securities
                                               
Commercial paper
  $ 99,903     $ 1     $     $     $ 99,903     $ 1  
State or local housing agency obligations
    19,920       80                   19,920       80  
 
                                   
 
    119,823       81                   119,823       81  
 
                                               
Mortgage-backed securities
                                               
Government-sponsored enterprise
    1,933,043       61,049       653,825       26,491       2,586,868       87,540  
U.S. government agency-guaranteed
    47,939       901       3,085       80       51,024       981  
MPF shared funding
                44,583       2,573       44,583       2,573  
Other
    321       2       28,168       10,043       28,489       10,045  
 
                                   
 
    1,981,303       61,952       729,661       39,187       2,710,964       101,139  
 
                                               
Total
  $ 2,101,126     $ 62,033     $ 729,661     $ 39,187     $ 2,830,787     $ 101,220  
 
                                   

 

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Redemption Terms. The following table summarizes the amortized cost and estimated fair value of held-to-maturity securities by contractual maturity (dollars in thousands). Expected maturities of some securities and MBS may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.
                                 
    September 30, 2009     December 31, 2008  
    Amortized             Amortized        
Year of Maturity   Cost     Fair Value     Cost     Fair Value  
 
                               
Due in one year or less
  $ 452,989     $ 454,026     $ 384,757     $ 384,902  
Due after one year through five years
    1,250       1,281       2,989       3,154  
Due after five years through ten years
    2,600       2,646       3,205       3,261  
Due after ten years
    439,218       456,466       93,477       95,220  
 
                       
 
    896,057       914,419       484,428       486,537  
 
                               
Mortgage-backed securities
    4,847,443       4,898,130       5,467,580       5,430,751  
 
                       
 
                               
Total
  $ 5,743,500     $ 5,812,549     $ 5,952,008     $ 5,917,288  
 
                       
The amortized cost of the Bank’s MBS classified as held-to-maturity included net discounts of $18.5 million and $22.6 million at September 30, 2009 and December 31, 2008.
Other-than-Temporary Impairment Analysis on Held-to-Maturity Securities. The Bank evaluates its individual held-to-maturity securities in an unrealized loss position for OTTI on at least a quarterly basis. As part of its securities’ evaluation for OTTI, the Bank considers its intent to sell each debt security and whether it is more likely than not that it will be required to sell the debt security before its anticipated recovery. If either of these conditions is met, the Bank recognizes an OTTI in earnings equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date. For securities in an unrealized loss position meeting neither of these conditions, the Bank performs analyses to determine if any of these securities are other-than-temporarily impaired.
To support consistency among the FHLBanks, the FHLBanks formed an OTTI Governance Committee with the responsibility for reviewing and approving the key modeling assumptions, inputs, and methodologies to be used by the FHLBanks to generate cash flow projections used in analyzing credit losses and determining OTTI for private-label MBS. In accordance with this methodology, the Bank may engage another designated FHLBank to perform the cash flow analysis underlying its OTTI determination. In order to promote consistency in the application of the assumptions, inputs, and implementation of the OTTI methodology, the FHLBanks established control procedures whereby the FHLBanks performing the cash flow analysis select a sample group of private-label MBS and each perform cash flow analyses on all such test MBS, using the assumptions approved by the OTTI Governance Committee. These FHLBanks exchange and discuss the results and make any adjustments necessary to achieve consistency among their respective cash flow models.

 

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Utilizing this methodology, the Bank is responsible for making its own determination of impairment, which includes determining the reasonableness of assumptions, inputs, and methodologies used. At September 30, 2009 the Bank obtained its cash flow analysis from its designated FHLBanks on all five of its private-label MBS. The cash flow analysis uses two third-party models. The first model considers borrower characteristics and the particular attributes of the loans underlying the Bank’s private-label MBS, in conjunction with assumptions about future changes in home prices and interest rates, to project prepayments, defaults, and loss severities. A significant input to the first model is the forecast of future housing price changes for the relevant states and core based statistical areas (CBSAs), which are based upon an assessment of the individual housing markets. CBSA refers collectively to metropolitan and micropolitan statistical areas as defined by the U.S. Office of Management and Budget; as currently defined, a CBSA must contain at least one urban area with a population of 10,000 or more. The Bank’s housing price forecast assumed CBSA level current-to-trough home price declines ranging from zero percent to 20 percent over the next 9 to 15 months. Thereafter, home prices are projected to increase zero percent in the first six months, 0.5 percent in the next six months, three percent in the second year, and four percent in each subsequent year.
The month-by-month projections of future loan performance derived from the first model, which reflect projected prepayments, defaults, and loss severities, are then input into a second model that allocates the projected loan level cash flows and losses to the various security classes in the securitization structure in accordance with its prescribed cash flow and loss allocation rules. If this estimate results in a present value of expected cash flows that is less than the amortized cost basis of the security (that is, a credit loss exists), an OTTI is considered to have occurred. If there is no credit loss and the Bank does not intend to sell or it is not more likely than not it will be required to sell, any impairment is considered temporary.
At September 30, 2009 the Bank’s private-label MBS cash flow analysis did not project any credit losses and therefore, no OTTI was considered to have occurred. The remainder of the Bank’s held-to-maturity securities portfolio has experienced unrealized losses due to interest rate volatility, illiquidity in the marketplace, and credit deterioration in the U.S. mortgage markets. However, the decline is considered temporary as the Bank expects to recover the entire amortized cost basis on its held-to-maturity securities in an unrealized loss position. The Bank does not intend to sell these securities, and it is not more likely than not that the Bank will be required to sell these securities, before its anticipated recovery of the remaining amortized cost basis. As a result of the Bank’s analysis on the held-to-maturity securities portfolio, no OTTI was required to be taken.

 

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Note 6—Advances
Members and eligible housing associates use the Bank’s various advance programs as sources of funding for mortgage lending, affordable housing and other community lending (including economic development), and general asset-liability management.
Redemption Terms. The following table shows the Bank’s advances outstanding (dollars in thousands):
                                 
    September 30, 2009     December 31, 2008  
            Weighted             Weighted  
            Average             Average  
            Interest             Interest  
Year of Maturity   Amount     Rate %     Amount     Rate %  
 
                               
Overdrawn demand deposit accounts
  $ 424           $ 623        
Due in one year or less
    8,053,840       2.69       9,332,574       2.70  
Due after one year through two years
    5,255,178       3.11       5,212,502       3.97  
Due after two years through three years
    4,561,309       2.27       3,656,941       3.45  
Due after three years through four years
    5,871,447       1.66       5,014,300       2.25  
Due after four years through five years
    1,269,647       3.17       4,893,217       2.37  
Thereafter
    10,425,989       3.51       12,552,790       3.32  
 
                           
 
                               
Total par value
    35,437,834       2.78       40,662,947       3.03  
 
                               
Commitment fees
                  *          
Discounts on AHP advances
    (20 )             (34 )        
Premiums
    325               380          
Discounts
    (4 )             (9 )        
Hedging fair value adjustments
                               
Cumulative fair value gain
    756,657               1,082,129          
Basis adjustments from terminated and ineffective hedges
    108,282               152,066          
 
                           
 
                               
Total
  $ 36,303,074             $ 41,897,479          
 
                           
     
*   Amount is less than one thousand.
The Bank offers advances to members that may be prepaid on pertinent dates (call dates) without incurring prepayment or termination fees (callable advances). Other advances may only be prepaid by paying a fee to the Bank (prepayment fee) that makes the Bank financially indifferent to the prepayment of the advance. At September 30, 2009 and December 31, 2008, the Bank had callable advances outstanding totaling $6.0 billion and $7.9 billion.

 

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The Bank also offers putable advances. With a putable advance, the Bank has the right to terminate the advance at predetermined exercise dates, which the Bank typically would exercise when interest rates increase, and the borrower may then apply for a new advance at the prevailing market rate. At September 30, 2009 and December 31, 2008, the Bank had putable advances outstanding totaling $7.8 billion and $8.5 billion.
Interest Rate Payment Terms. The following table shows the Bank’s advances by interest rate payment type (dollars in thousands):
                 
    September 30,     December 31,  
    2009     2008  
Par amount of advances
               
Fixed rate
  $ 25,607,370     $ 28,050,033  
Variable rate
    9,830,464       12,612,914  
 
           
 
               
Total
  $ 35,437,834     $ 40,662,947  
 
           
Note 7—Mortgage Loans Held for Portfolio
The Mortgage Partnership Finance (MPF) program (Mortgage Partnership Finance and MPF are registered trademarks of the FHLBank of Chicago) involves investment by the Bank in mortgage loans that are held for portfolio which are either funded by the Bank through, or purchased from, member participating financial institutions (PFIs). The Bank’s members originate, service, and credit enhance home mortgage loans that are sold to the Bank. Members participating in the servicing released program do not service the loans owned by the Bank. The servicing on these loans is sold concurrently by the member to a designated mortgage servicer.
Mortgage loans with an original contractual maturity of 15 years or less are classified as medium-term, and all other mortgage loans are classified as long-term. The following table presents information on the Bank’s mortgage loans held for portfolio (dollars in thousands):
                 
    September 30,     December 31,  
    2009     2008  
Real Estate:
               
Fixed rate medium-term single family mortgages
  $ 1,973,785     $ 2,409,977  
Fixed rate long-term single family mortgages
    5,860,958       8,266,134  
 
           
 
               
Total par value
    7,834,743       10,676,111  
 
               
Premiums
    54,460       86,355  
Discounts
    (54,754 )     (81,547 )
Basis adjustments from mortgage loan commitments
    4,361       4,491  
Allowance for credit losses
    (775 )     (500 )
 
           
 
               
Total mortgage loans held for portfolio, net
  $ 7,838,035     $ 10,684,910  
 
           

 

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The par value of mortgage loans held for portfolio outstanding at September 30, 2009 and December 31, 2008 consisted of government-insured loans totaling $383.0 million and $423.4 million and conventional loans totaling $7.4 billion and $10.3 billion, respectively. During the second quarter of 2009 the Bank sold $2.1 billion of mortgage loans held for sale to the FHLBank of Chicago, who immediately resold these loans to Fannie Mae.
The Bank’s management of credit risk in the MPF program involves several layers of contractual loss protection defined in agreements among the Bank and its participating members. Though the nature of these layers of loss protection differs slightly among the MPF products the Bank offers, each product contains similar credit risk structures. For conventional loans, the credit risk structure contains the following layers of loss protection in order of priority:
    Homeowner equity.
    Primary Mortgage Insurance for all loans with home owner equity of less than 20 percent of the original purchase price or appraised value.
    First Loss Account (FLA) established by the Bank. FLA is a memorandum account for tracking losses. Such losses are either recoverable from future payments of performance based credit enhancement fees to the member or absorbed by the Bank. The Bank records credit enhancement fees paid to participating members as a reduction of mortgage loan interest income. Credit enhancement fees totaled $3.2 million and $4.7 million for the three months ended September 30, 2009 and 2008 and $12.5 million and $14.4 million for the nine months ended September 30, 2009 and 2008.
    Credit enhancements (including supplemental mortgage insurance (SMI)) provided by participating members. The size of the participating member’s credit enhancement is calculated so that any losses in excess of the FLA are limited to those of an investor in a mortgage-backed security that is rated the equivalent of AA by a nationally recognized statistical rating organization. To cover losses equal to all or a portion of the credit enhancement obligations, participating members are required to either collateralize their credit enhancement obligations or to purchase SMI from a highly rated mortgage insurer for the benefit of the Bank. Currently, all of the Bank’s SMI providers have had their external ratings for claims-paying ability or insurer financial strength downgraded below AA-. Rating downgrades imply an increased risk that these SMI providers will be unable to fulfill their obligations to reimburse the Bank for claims under insurance policies. On August 7, 2009, the Finance Agency granted a waiver for one year on the AA- rating requirement of SMI providers for existing loans and commitments in the program and granted the same waiver for six months on new commitments.
    Losses greater than credit enhancements provided by members are the responsibility of the Bank. The Bank utilizes an allowance for any estimated losses beyond the above layers.

 

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The following table presents the Bank’s allowance for credit losses activity (dollars in thousands):
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2009     2008     2009     2008  
 
                               
Balance at beginning of period
  $ 697     $ 232     $ 500     $ 300  
Provision for credit losses
    91             341        
Charge-offs
    (13 )     (24 )     (66 )     (92 )
 
                       
 
                               
Balance at end of period
  $ 775     $ 208     $ 775     $ 208  
 
                       
In accordance with the Bank’s allowance for credit losses methodology, the allowance estimate is based on historical loss experience, current delinquency levels, economic data, the ability to recapture losses through member credit enhancements, and other relevant factors using a pooled loan approach. On a regular basis, we monitor delinquency levels, loss rates, and portfolio characteristics such as geographic concentration, loan-to-value ratios, property types, and loan age. Other relevant factors evaluated in our methodology include changes in national/local economic conditions, changes in the nature of the portfolio, changes in the portfolio performance, and the existence and effect of geographic concentrations. The Bank monitors and reports portfolio performance regarding delinquency, nonperforming loans, and net charge-offs monthly. Adjustments to the allowance for credit losses are considered at least quarterly based upon charge-offs, the amount of nonperforming loans, as well as other relevant factors discussed above.
During the three and nine months ended September 30, 2009, the Bank increased its allowance for credit losses through a provision of $0.1 million and $0.3 million due to increased loss severity on its mortgage loan portfolio and higher levels of nonperforming loans.
At September 30, 2009 and December 31, 2008, the Bank had $82.2 million and $48.4 million of nonaccrual loans. Interest income that was contractually owed to the Bank but not received on nonaccrual loans was $0.8 million and $0.5 million at September 30, 2009 and December 31, 2008. At September 30, 2009 and December 31, 2008, the Bank had $9.2 million and $7.6 million of real estate owned recorded as a component of “other assets” in the Statements of Condition.

 

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Effective February 26, 2009, the MPF program was expanded to include a new off-balance sheet product called MPF Xtra (MPF Xtra is a registered trademark of the FHLBank of Chicago). Under this product, the Bank assigns 100 percent of its interests in PFI master commitments to the FHLBank of Chicago. The FHLBank of Chicago then purchases mortgage loans from the Bank’s PFIs under the master commitments and sells those loans to Fannie Mae. Currently, only PFIs that retain servicing of their MPF loans are eligible for the MPF Xtra product. As of September 30, 2009, the FHLBank of Chicago had funded $96.0 million of MPF Xtra mortgage loans under the master commitments of the Bank’s PFIs. The Bank recorded approximately $21,000 and $44,000 in MPF Xtra fee income from the FHLBank of Chicago during the three and nine months ended September 30, 2009.
Note 8—Derivatives and Hedging Activities
Nature of Business Activity
Consistent with Finance Agency regulation, the Bank enters into derivatives to manage the interest rate risk exposures inherent in otherwise unhedged assets and funding positions and to achieve its risk management objectives. The Bank’s Enterprise Risk Management Policy prohibits trading in or the speculative use of these derivative instruments and limits credit risk arising from these instruments. Derivatives are an integral part of the Bank’s financial management strategy.
The most common ways in which the Bank uses derivatives are to:
    reduce the interest rate sensitivity and repricing gaps of assets and liabilities;
    reduce funding costs by combining a derivative with a consolidated obligation, as the cost of a combined funding structure can be lower than the cost of a comparable consolidated obligation;
    preserve a favorable interest rate spread between the yield of an asset (i.e., an advance) and the cost of the related liability (i.e., the consolidated obligation used to fund the advance). Without the use of derivatives, this interest rate spread could be reduced or eliminated when a change in the interest rate on the advance does not match a change in the interest rate on the consolidated obligation;
    mitigate the adverse earnings effects of the shortening or extension of certain assets (i.e., advances or mortgage assets) and liabilities; and
    manage embedded options in assets and liabilities.

 

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Types of Derivatives
The Bank can enter into the following instruments to manage its exposure to interest rate risks inherent in its normal course of business:
    interest rate swaps;
    options;
    swaptions;
    interest rate caps or floors; and
    future/forward contracts.
The goal of the Bank’s interest rate risk management strategy is not to eliminate interest rate risk, but to manage it within appropriate limits. To mitigate the risk of loss, the Bank has established policies and procedures, which include guidelines on the amount of exposure to interest rate changes it is willing to accept.
Interest Rate Swaps. An interest rate swap is an agreement between two entities to exchange cash flows in the future. The agreement sets the dates on which the cash flows will be paid and the manner in which the cash flows will be calculated. One of the simplest forms of an interest rate swap involves the promise by one party to pay cash flows equivalent to the interest on a notional principal amount at a predetermined fixed rate for a given period of time. In return for this promise, this party receives cash flows equivalent to the interest on the same notional principal amount at a variable interest rate index for the same period of time. The variable interest rate received or paid by the Bank in most derivative agreements is the London Interbank Offered Rate (LIBOR).
Options. An option is an agreement between two entities that conveys the right, but not the obligation, to engage in a future transaction on some underlying security or other financial asset at an agreed upon price during a certain period of time or on a specific date. Premiums or swap fees paid to acquire options in a fair value hedge relationship are considered the fair value of the option at inception of the hedge and are reported in “derivative assets” or “derivative liabilities” in the Statements of Condition.
Swaptions. A swaption is an option on a swap that gives the buyer the right to enter into a specified interest rate swap at a certain time in the future. When used as a hedge, a swaption can protect the Bank against future interest rate changes. The Bank purchases both payer swaptions and receiver swaptions to decrease its interest rate risk exposure related to the prepayment of certain assets. A payer swaption is the option to enter into a pay-fixed swap at a later date and a receiver swaption is the option to enter into a receive-fixed swap at a later date.
Interest Rate Caps and Floors. In an interest rate cap agreement, a cash flow is generated if the price or interest rate of an underlying variable rises above a certain threshold (or “cap”) price. In an interest rate floor agreement, a cash flow is generated if the price or interest rate of an underlying variable falls below a certain threshold (or “floor”) price. Interest rate caps and floors are designed as protection against the interest rate on a variable interest rate asset or liability rising above or falling below a certain level.

 

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Futures/Forwards Contracts. Certain mortgage purchase commitments entered into by the Bank are considered derivatives. The Bank hedges these commitments by selling “to-be-announced” (TBA) MBS for forward settlement. A TBA represents a forward contract for the sale of MBS at a future agreed upon date for an established price.
Application of Derivatives
Derivative financial instruments are used by the Bank in two ways:
    as a hedge of the fair value of a recognized asset or liability or an unrecognized firm commitment (a fair value hedge); or
    as a non-qualifying hedge of an asset, liability, or firm commitment (an economic hedge) for asset/liability management purposes.
Bank management uses derivatives when they are considered to be a cost-effective alternative to achieve the Bank’s financial and risk management objectives. The Bank reevaluates its hedging strategies from time to time and may change the hedging techniques it uses or adopt new strategies.
Types of Assets and Liabilities Hedged
The Bank documents at inception all relationships between derivatives designated as hedging instruments and hedged items, its risk management objectives and strategies for undertaking various hedge transactions, and its method of assessing effectiveness. This process includes linking all derivatives that are designated as fair value hedges to (i) assets and liabilities in the Statements of Condition, or (ii) firm commitments. The Bank also formally assesses (both at the hedge’s inception and at least monthly) whether the derivatives it uses in hedging transactions have been effective in offsetting changes in the fair value of hedged items and whether those derivatives may be expected to remain effective in future periods. The Bank uses regression analysis to assess hedge effectiveness prospectively and retrospectively.
Consolidated Obligations—While consolidated obligations are the joint and several obligations of the 12 FHLBanks, the Bank is the primary obligor for the consolidated obligations recorded on the Bank’s Statements of Condition. To date, the Bank has never had to assume or pay the consolidated obligations of another FHLBank. The Bank may enter into derivatives to hedge the interest rate risk associated with its consolidated obligations. The Bank manages the risk arising from changing market prices and volatility of a consolidated obligation by matching the cash inflow on the derivative with the cash outflow on the consolidated obligation.

 

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For instance, in a typical transaction, fixed rate consolidated obligations are issued and the Bank simultaneously enters into a matching interest rate swap in which the counterparty pays fixed cash flows to the Bank designed to mirror in timing and amount the cash outflows the Bank pays on the consolidated obligation. The Bank in turn pays a variable cash flow on the interest rate swap that closely matches the interest payments it receives on short-term or variable interest rate advances (typically one- or three-month LIBOR). These transactions are treated as fair value hedges. The Bank may also issue variable interest rate consolidated obligations indexed to LIBOR or the Federal funds rate and simultaneously execute interest rate swaps to hedge the basis risk of the variable interest rate debt. Interest rate swaps used to hedge the basis risk of variable interest rate debt indexed to the Federal funds rate do not qualify for hedge accounting. As a result, this type of hedge is treated as an economic hedge.
Advances—The Bank offers a wide array of advance structures to meet members’ funding needs. These advances may have maturities up to 30 years with variable or fixed interest rates and may include early termination features or options. The Bank may use derivatives to adjust the repricing and/or options characteristics of advances in order to more closely match the characteristics of its funding liabilities. In general, whenever a member executes a fixed interest rate advance or a variable interest rate advance with embedded options, the Bank will simultaneously execute a derivative with terms that offset the terms and embedded options, if any, in the advance. For example, the Bank may hedge a fixed interest rate advance with an interest rate swap where the Bank pays a fixed interest rate coupon and receives a variable interest rate coupon, effectively converting the fixed interest rate advance to a variable interest rate advance. This type of hedge is treated as a fair value hedge.
When issuing putable advances, the Bank effectively purchases a put option from the member that allows the Bank to put or extinguish the fixed interest rate advance, which the Bank normally would exercise when interest rates increase, and the borrower may elect to enter into a new advance. The Bank may hedge these advances by entering into a cancelable interest rate swap.
Mortgage Loans—The Bank invests in fixed interest rate mortgage loans. The prepayment options embedded in mortgage loans can result in extensions or contractions in the expected repayment of these investments, depending on changes in estimated prepayment speeds. The Bank manages the interest rate and prepayment risks associated with mortgages through a combination of debt issuance and derivatives. The Bank may issue both callable and noncallable debt and prepayment linked consolidated obligations to achieve cash flow patterns and liability durations similar to those expected on the mortgage loans.

 

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The Bank may purchase interest rate caps and floors, swaptions, calls, and puts to minimize sensitivity to changes in interest rates due to mortgage loan prepayments. Although these derivatives are valid economic hedges, they are not specifically linked to individual loans and, therefore, do not receive fair-value hedge accounting. The derivatives are marked-to-market through earnings with no offsetting hedged item marked-to-market.
Certain mortgage purchase commitments are considered derivatives. The Bank normally hedges these commitments by selling TBA MBS for forward settlement. A TBA represents a forward contract for the sale of MBS at a future agreed upon date for an established price. The mortgage purchase commitment and the TBA used in the firm commitment hedging strategy (economic hedge) are recorded as a derivative asset or derivative liability at fair value, with changes in fair value recognized in current period earnings. When the mortgage purchase commitment derivative settles, the current market value of the commitment is included with the basis of the mortgage loan and amortized using the level-yield method.
Investments—The Bank’s investments include but are not necessarily limited to certificates of deposit, commercial paper, U.S. Treasury obligations, municipal bonds, TVA and FFCB bonds, MBS, TLGP securities, and the taxable portion of state or local HFA obligations, which may be classified as held-to-maturity, available-for-sale, or trading securities. The interest rate and prepayment risk associated with these investment securities is managed through a combination of debt issuance and derivatives. The Bank may also manage the prepayment and interest rate risk by funding investment securities with either callable or non-callable consolidated obligations or by hedging the prepayment risk with interest rate caps or floors, interest rate swaps, or swaptions.
Managing Credit Risk on Derivatives
The Bank is subject to credit risk due to nonperformance by counterparties to the derivative agreements. The degree of counterparty credit risk depends on the extent to which master netting arrangements are included in such contracts to mitigate the risk. The Bank manages counterparty credit risk through credit analysis, collateral requirements and adherence to the requirements set forth in Bank policies and regulations.
The contractual or notional amount of derivatives reflects the involvement of the Bank in the various classes of financial instruments. The notional amount of derivatives does not measure the credit risk exposure of the Bank, and the maximum credit exposure of the Bank is substantially less than the notional amount. The maximum credit risk is the estimated cost of replacing interest rate swaps, forward interest rate agreements, mandatory delivery contracts for mortgage loans, and purchased caps and floors that have a net positive market value, assuming the counterparty defaults and the related collateral, if any, is of no value to the Bank.

 

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At September 30, 2009 and December 31, 2008, the Bank’s maximum credit risk, as defined above, was approximately $8.8 million and $2.8 million. These totals include $6.5 million and $0.6 million of net accrued interest receivable. In determining maximum credit risk, the Bank considers accrued interest receivables and payables, and the legal right to offset derivative assets and liabilities by counterparty. The Bank held $3.5 million of cash as collateral at September 30, 2009. The Bank did not hold any cash as collateral at December 31, 2008. Based on credit analysis and collateral requirements, the Bank does not anticipate any credit losses on its derivative agreements.
The valuation of derivative assets and liabilities must reflect the value of the instrument including the values associated with counterparty risk and the Bank’s own credit standing. The Bank has collateral agreements with all its derivative counterparties that take into account both the Bank’s and the counterparty’s credit ratings. As a result of these practices and agreements, the Bank has concluded that the impact of the credit differential between the Bank and its derivative counterparties was sufficiently mitigated to an immaterial level and no further adjustments for credit were deemed necessary to the recorded fair values of “derivative assets” and “derivative liabilities” in the Statements of Condition at September 30, 2009.
Some of the Bank’s derivative instruments contain provisions that require the Bank to post additional collateral with its counterparties if there is deterioration in the Bank’s credit rating. If the Bank’s credit rating is lowered by a major credit rating agency, the Bank may be required to deliver additional collateral on derivative instruments in net liability positions. The aggregate fair value of all derivative instruments with credit-risk related contingent features that were in a net liability position at September 30, 2009 was $454.9 million. This amount includes $64.1 million of net accrued interest payable. The Bank has posted collateral of $75.4 million in the normal course of business. If the Bank’s credit rating had been lowered one notch (i.e., from its current rating to the next lower rating), the Bank would have been required to deliver up to an additional $206.3 million of collateral to its derivative counterparties at September 30, 2009. However, the Bank’s credit rating has not changed during the previous 12 months.
Financial Statement Effect and Additional Financial Information
The notional amount of derivatives reflects the volume of the Bank’s hedges, but it does not measure the credit exposure of the Bank because there is no principal at risk.

 

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The following table summarizes the Bank’s fair value of derivative instruments, without the effect of netting arrangements or collateral at September 30, 2009 (dollars in thousands). For purposes of this disclosure, the derivative values include fair value of derivatives and related accrued interest.
                         
    Notional     Derivative     Derivative  
Fair Value of Derivative Instruments   Amount     Assets     Liabilities  
 
                       
Derivatives designated as hedging instruments
                       
Interest rate swaps
  $ 36,075,393     $ 352,124     $ 816,421  
 
                 
 
                       
Derivatives not designated as hedging instruments (economic hedges)
                       
Interest rate swaps
    6,586,399       21,601       16,783  
Interest rate caps
    2,340,000       13,412        
Forward settlement agreements (TBAs)
    61,000       3       385  
Mortgage delivery commitments
    60,980       315       9  
 
                 
Total derivatives not designated as hedging instruments
    9,048,379       35,331       17,177  
 
                 
 
                       
Total derivatives and related accrued interest before netting and collateral adjustments
  $ 45,123,772       387,455       833,598  
 
                     
 
                       
Netting adjustments1
            (378,689 )     (378,689 )
Cash collateral and related accrued interest
            (3,500 )     (75,408 )
 
                   
Total netting adjustments and cash collateral
            (382,189 )     (454,097 )
 
                   
 
                       
Derivative assets and liabilities
          $ 5,266     $ 379,501  
 
                   
     
1   Amounts represent the effect of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions by counterparty.
The following table presents the components of “Net gain (loss) on derivatives and hedging activities” as presented in the Statements of Income (dollars in thousands):
                 
    Three Months Ended     Nine Months Ended  
    September 30, 2009     September 30, 2009  
Derivatives and hedged items in fair value hedging relationships
               
Interest rate swaps
  $ 8,935     $ 95,403  
 
           
 
               
Derivatives not designated as hedging instruments (economic hedges)
               
Interest rate swaps
    (8,697 )     (5,864 )
Interest rate caps
    1,804       10,930  
Forward settlement agreements (TBAs)
    (1,037 )     1,721  
Mortgage delivery commitments
    876       (3,893 )
 
           
Total net (loss) gain related to derivatives not designated as hedging instruments
    (7,054 )     2,894  
 
           
 
               
Net gain on derivatives and hedging activities
  $ 1,881     $ 98,297  
 
           

 

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During the three and nine months ended September 30, 2009 the Bank purchased and sold 30-year U.S. Treasury obligations on three separate occasions. On each occasion, the Bank entered into interest rate swaps to convert the fixed rate investments to floating rate. The relationships were accounted for as a fair value hedge relationship with changes in LIBOR (benchmark interest rate) reported as hedge ineffectiveness through “net gain (loss) on derivative and hedging activities.” The Bank sold these securities and terminated the related interest rate swaps. The impact of the sale of the securities was accounted for through “net gain (loss) on sale of available-for-sale securities” and the impact of the termination of the swaps was accounted for through “net gain (loss) on derivatives and hedging activities.” The impact of each of the sales of U.S. Treasury obligations and termination of the related interest rate swaps are summarized as follows:
    In June 2009 the Bank sold $800.0 million of U.S. Treasury obligations and terminated the related interest rate swaps resulting in a $90.1 million gain on the termination of the related interest rate swaps and a $42.8 million loss on the sale of the available-for-sale securities. In addition, the Bank realized $14.3 million in hedge ineffectiveness losses. The overall impact of this transaction was a net gain of $33.0 million.
    In July 2009 the Bank sold $900.0 million of U.S. Treasury obligations and terminated the related interest rate swaps resulting in a $11.8 million loss on the termination of the related interest rate swaps and a $26.1 million gain on the sale of the available-for-sale securities. In addition, the Bank realized $1.3 million in hedge ineffectiveness losses. The overall impact of this transaction was a net gain of $13.0 million.
    In September 2009 the Bank sold $1.0 billion of U.S. Treasury obligations and terminated the related interest rate swaps resulting in a $18.4 million gain on the termination of the related interest rate swaps and a $5.0 million gain on the sale of the available-for-securities. In addition, the Bank realized $1.5 million in hedge ineffectiveness gains. The overall impact of this transaction was a net gain of $24.9 million.
Based on the above details the Bank recorded a net gain on the sale of available-for-sale securities of $31.1  million during the three months ended September 30, 2009 and a net loss of $11.7 million during the nine months ended September 30, 2009. In addition, the termination of related interest rate swaps and the ineffectivenes resulted in a total net gain on derivatives and hedging activities of $6.8 million and $82.6 million for the three and nine months ended September 30, 2009.

 

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The following table presents, by type of hedged item, the gain (loss) on derivatives and the related hedged items in fair value hedging relationships and the impact of those derivatives on the Bank’s net interest income (dollars in thousands):
                                 
    Three Months Ended September 30, 2009  
                    Net Fair Value     Effect on  
    (Loss) Gain on     Gain (Loss) on     Hedge     Net Interest  
Hedged Item Type   Derivative     Hedged Item     Ineffectiveness     Income1  
 
                               
Advances
  $ (107,096 )   $ 107,986     $ 890     $ (102,274 )
Investments
    22,063       (14,210 )     7,853       (7,654 )
Bonds
    28,077       (27,885 )     192       71,266  
 
                       
Total
  $ (56,956 )   $ 65,891     $ 8,935     $ (38,662 )
 
                       
                                 
    Nine Months Ended September 30, 2009  
                    Net Fair Value     Effect on  
    Gain (Loss) on     (Loss) Gain on     Hedge     Net Interest  
Hedged Item Type   Derivative     Hedged Item     Ineffectiveness     Income1  
 
                               
Advances
  $ 328,517     $ (325,470 )   $ 3,047     $ (254,880 )
Investments
    79,720       2,699       82,419       (10,030 )
Bonds
    (137,653 )     147,590       9,937       181,062  
 
                       
Total
  $ 270,584     $ (175,181 )   $ 95,403     $ (83,848 )
 
                       
     
1   The net interest on derivatives in fair value hedge relationships is presented in the interest income/expense line item of the respective hedged item.
Note 9—Consolidated Obligations
Consolidated obligations are the joint and several obligations of the FHLBanks and consist of bonds and discount notes. The FHLBanks issue consolidated obligations through the Office of Finance as their agent. Bonds are typically issued to raise intermediate- and long-term funds for the FHLBanks and are not subject to any statutory or regulatory limits on maturity. Discount notes are typically issued to raise short-term funds of one year or less. These discount notes sell at less than their face amount and are redeemed at par value when they mature. See the Bank’s Form 10-K for additional information regarding consolidated obligations.
The par amounts of the outstanding consolidated obligations of the 12 FHLBanks were approximately $973.6 billion and $1,251.5 billion at September 30, 2009 and December 31, 2008.

 

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The FHLBank Act authorizes the U.S. Treasury to purchase consolidated obligations directly from the FHLBanks up to an aggregate principal amount of $4.0 billion. As a result of the passage of the Housing Act in 2008, this authorization was supplemented with a temporary authorization for the U.S. Treasury to directly purchase consolidated obligations from the FHLBanks in any amount deemed appropriate under certain conditions. This temporary authorization expires December 31, 2009. At September 30, 2009, no such purchases had been made by the U.S. Treasury.
Bonds. The following table shows the Bank’s bonds outstanding by year of maturity (dollars in thousands):
                                 
    September 30, 2009     December 31, 2008  
            Weighted             Weighted  
            Average             Average  
            Interest             Interest  
Year of Maturity   Amount     Rate %     Amount     Rate %  
 
Due in one year or less
  $ 22,109,400       1.73     $ 15,962,600       3.10  
Due after one year through two years
    8,566,250       2.65       6,159,050       4.01  
Due after two years through three years
    3,813,150       3.32       4,670,100       4.34  
Due after three years through four years
    2,329,900       4.23       2,231,050       4.54  
Due after four years through five years
    805,700       4.45       2,417,500       4.35  
Thereafter
    6,959,510       5.07       8,408,700       5.13  
Index amortizing notes
    2,033,215       5.12       2,420,099       5.12  
 
                           
 
                               
Total par value
    46,617,125       2.85       42,269,099       4.04  
 
                               
Premiums
    44,862               50,742          
Discounts
    (34,324 )             (40,699 )        
Hedging fair value adjustments
                               
Cumulative fair value loss
    254,262               348,214          
Basis adjustments from terminated and ineffective hedges
    17,674               95,117          
Fair value option loss
    18,501                        
 
                       
 
                               
Total
  $ 46,918,100             $ 42,722,473          
 
                           
The following table shows the Bank’s total bonds outstanding (dollars in thousands):
                 
    September 30,     December 31,  
    2009     2008  
Par amount of bonds
               
Noncallable or nonputable
  $ 42,605,125     $ 39,214,099  
Callable
    4,012,000       3,055,000  
 
           
 
               
Total par value
  $ 46,617,125     $ 42,269,099  
 
           

 

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Interest Rate Payment Terms. The following table shows the Bank’s bonds by interest rate payment type (dollars in thousands):
                 
    September 30,     December 31,  
    2009     2008  
Par amount of bonds
               
Fixed rate
  $ 40,055,125     $ 37,954,099  
Simple variable rate
    6,015,000       4,315,000  
Step-up
    547,000        
 
           
 
               
Total par value
  $ 46,617,125     $ 42,269,099  
 
           
Extinguishment of Debt. Losses on extinguishment of debt totaled $28.5 million and $80.9 million for the three and nine months ended September 30, 2009 due to the Bank extinguishing bonds with a total par value of $266.8 million and $853.3 million. Losses on extinguishment of debt exclude basis adjustment amortization of $1.2 million for the three months ended September 30, 2009 and basis adjustment accretion of $4.5 million for the nine months ended September 30, 2009 recorded in net interest income. As a result, for the three and nine months ended September 30, 2009, net losses on extinguishment of debt totaled $29.7 million and $76.4 million. For the three months ended September 30, 2008, the Bank did not extinguish any debt. For the nine months ended September 30, 2008, the Bank extinguished debt with a total par value of $500.0 million and recorded a gain of $0.2 million.
Discount Notes. Discount notes are typically issued to raise short-term funds that have original maturities up to 365/366 days. These notes are issued at less than their face amount and redeemed at par value when they mature.
The Bank’s discount notes were as follows (dollars in thousands):
                                 
    September 30, 2009     December 31, 2008  
            Weighted             Weighted  
            Average             Average  
            Interest             Interest  
    Amount     Rate %     Amount     Rate %  
 
                               
Par value
  $ 12,879,255       0.04     $ 20,153,370       1.83  
Discounts
    (5,015 )             (92,099 )        
Hedging fair value adjustments
                  *          
 
                       
 
                               
Total
  $ 12,874,240             $ 20,061,271          
 
                           
     
*   Amount is less than one thousand.

 

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Note 10—Capital
The Bank is subject to three regulatory capital requirements. The Bank must maintain at all times permanent capital in an amount at least equal to the sum of its credit, market, and operations risk capital requirements, calculated in accordance with Bank policy and rules and regulations of the Finance Agency. Only permanent capital, defined as Class B stock and retained earnings, satisfies this risk based capital requirement. Regulatory capital, as defined by the Finance Agency, includes mandatorily redeemable capital stock and excludes accumulated other comprehensive loss. For reasons of safety and soundness, the Finance Agency may require the Bank to maintain a greater amount of permanent capital than is required by the risk based capital requirements. Additionally, the Bank is required to maintain at least a four percent total capital-to-asset ratio and at least a five percent leverage ratio at all times. The leverage ratio is defined as the sum of permanent capital weighted 1.5 times and nonpermanent capital weighted 1.0 time divided by total assets. For reasons of safety and soundness, the Finance Agency may require the Bank to maintain a higher total capital-to-asset ratio.
The following table shows the Bank’s compliance with the Finance Agency’s capital requirements (dollars in thousands):
                                 
    September 30, 2009     December 31, 2008  
    Required     Actual     Required     Actual  
Regulatory capital requirements
                               
Risk based capital
  $ 893,215     $ 3,427,763     $ 1,967,981     $ 3,173,807  
Total capital-to-asset ratio
    4.00 %     5.24 %     4.00 %     4.66 %
Total regulatory capital
  $ 2,617,039     $ 3,427,763     $ 2,725,172     $ 3,173,807  
Leverage ratio
    5.00 %     7.86 %     5.00 %     6.99 %
Leverage capital
  $ 3,271,299     $ 5,141,644     $ 3,406,465     $ 4,760,711  
The Bank issues a single class of capital stock (Class B stock). The Bank’s Class B stock has a par value of $100 per share, and all shares are purchased, repurchased, redeemed, or transferred only at par value. The Bank has two subclasses of Class B stock: membership stock and activity-based stock.
Our members are required to maintain a certain minimum capital stock investment in the Bank. The minimum investment requirements are designed so that we remain adequately capitalized as member activity changes. To ensure we remain adequately capitalized within ranges established in the Capital Plan, these requirements may be adjusted upward or downward by the Bank’s Board of Directors.
Capital stock owned by members in excess of their minimum investment requirements is known as excess capital stock. At September 30, 2009 and December 31, 2008 the Bank had excess capital stock of $540.1 million and $61.1 million.

 

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Under the Bank’s Capital Plan, the Bank, at its discretion and upon 15 days written notice, may repurchase excess membership and activity-based capital stock. If a member’s stock balance exceeds an operational threshold set forth in the Capital Plan as a result of a merger or consolidation, the Bank may repurchase the amount of excess stock necessary to make the member’s stock balance equal to the operational threshold.
In late 2008, as a result of market conditions, the Bank temporarily discontinued its practice of voluntarily repurchasing excess membership and activity-based capital stock. Members are able to continue using excess activity-based capital stock to satisfy their activity-based capital stock requirements. The Bank’s Board of Directors will continue to monitor market conditions and assess the need for this temporary action. Certain exceptions to this temporarily discontinued practice have been approved by the Bank’s Board of Directors, such as when a member is taken over by the Federal Deposit Insurance Corporation and when a member is in financial distress. During the nine months ended September 30, 2009 the Bank repurchased $12.3 million of excess capital stock (including mandatorily redeemable capital stock) under these exceptions. In these circumstances, the Bank reviews each member’s required collateral on advances, standby letters of credit, and MPF credit enhancements prior to the repurchase to ensure the Bank will remain adequately secured subsequent to the repurchase.
As a condition of membership in the Bank, all members must purchase and maintain membership capital stock based on a percentage of their total assets as of the preceding December 31st. For 2009, the Bank allowed members to use their excess activity-based capital stock to satisfy updated membership capital stock requirements. During the second quarter of 2009 the Bank transferred $21.0 million of excess activity-based capital stock from certain members to membership capital stock in order to meet the members’ updated membership capital stock requirement. In addition, members with insufficient excess activity-based capital stock to cover their updated membership capital stock requirement were required to purchase $13.4 million of additional membership capital stock.
Mandatorily Redeemable Capital Stock. At September 30, 2009 and December 31, 2008, the Bank had $17.5 million and $10.9 million in capital stock subject to mandatory redemption. These amounts have been classified as “mandatorily redeemable capital stock” in the Statements of Condition.

 

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The following table summarizes the Bank’s activity related to mandatorily redeemable capital stock (dollars in thousands):
                 
    September 30,     December 31,  
    2009     2008  
 
               
Balance, beginning of year
  $ 10,907     $ 46,039  
 
               
Mandatorily redeemable stock issued
    7       49  
Capital stock subject to mandatory redemption reclassified from capital stock
    16,573       2,861  
Repurchase of mandatorily redeemable capital stock
    (9,983 )     (38,042 )
 
           
 
               
Balance, end of period
  $ 17,504     $ 10,907  
 
           
Note 11—Segment Information
The Bank has identified two primary operating segments based on its method of internal reporting: Member Finance and Mortgage Finance. A summary of each segment’s products and services can be found below.
The Member Finance segment includes advances, investments (excluding MBS, HFA, and SBA investments), and the related funding and hedging of those assets. Member deposits are also included in this segment. Income from the Member Finance segment is derived primarily from the spread between the yield on advances and investments and the borrowing and hedging costs related to those assets. Additionally, expenses associated with member deposits impact income from the Member Finance segment.
The Mortgage Finance segment includes mortgage loans acquired through the MPF program, MBS, HFA, and SBA investments, and the related funding and hedging of those assets. Income from the Mortgage Finance segment is derived primarily from the spread between the yield on mortgage loans, MBS, HFA, and SBA investments and the borrowing and hedging costs related to those assets.
Capital is allocated to the Member Finance and Mortgage Finance segments based on each segment’s amount of capital stock, retained earnings, and accumulated other comprehensive loss.
The Bank evaluates performance of the segments based on adjusted net interest income after providing for a mortgage loan credit loss provision. Previously, adjusted net interest income was net interest income adjusted for economic hedging costs included in other income (loss). During the first quarter of 2009, the Bank enhanced its calculation of adjusted net interest income and concluded that adjusted net interest income should be net interest income adjusted for basis adjustment amortization on called and extinguished debt included in interest expense, economic hedging costs included in other income (loss), and concession expense on fair value option bonds included in other expense.

 

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The following table shows the Bank’s financial performance by operating segment for the three months ended September 30, 2009 and 2008 (dollars in thousands). Prior period amounts have been adjusted to reflect the Bank’s enhanced calculation of adjusted net interest income.
                         
    Member     Mortgage        
    Finance     Finance     Total  
Three months ended September 30, 2009
                       
Adjusted net interest income
  $ 45,636     $ 15,178     $ 60,814  
Provision for credit losses on mortgage loans
          91       91  
 
                 
Adjusted net interest income after mortgage loan credit loss provision
  $ 45,636     $ 15,087     $ 60,723  
 
                 
 
                       
Average assets for the period
  $ 50,834,791     $ 17,047,675     $ 67,882,466  
Total assets at period end
  $ 48,155,207     $ 17,270,772     $ 65,425,979  
 
                       
Three months ended September 30, 2008
                       
Adjusted net interest income
  $ 43,456     $ 36,794     $ 80,250  
Provision for credit losses on mortgage loans
                 
 
                 
Adjusted net interest income after mortgage loan credit loss provision
  $ 43,456     $ 36,794     $ 80,250  
 
                 
 
                       
Average assets for the period
  $ 55,233,574     $ 19,808,500     $ 75,042,074  
Total assets at period end
  $ 66,687,877     $ 20,380,681     $ 87,068,558  
The following table shows the Bank’s financial performance by operating segment for the nine months ended September 30, 2009 and 2008 (dollars in thousands). Prior period amounts have been adjusted to reflect the Bank’s enhanced calculation of adjusted net interest income.
                         
    Member     Mortgage        
    Finance     Finance     Total  
Nine months ended September 30, 2009
                       
Adjusted net interest income
  $ 92,387     $ 57,644     $ 150,031  
Provision for credit losses on mortgage loans
          341       341  
 
                 
Adjusted net interest income after mortgage loan credit loss provision
  $ 92,387     $ 57,303     $ 149,690  
 
                 
 
                       
Average assets for the period
  $ 52,508,125     $ 18,941,228     $ 71,449,353  
Total assets at period end
  $ 48,155,207     $ 17,270,772     $ 65,425,979  
 
                       
Nine months ended September 30, 2008
                       
Adjusted net interest income
  $ 137,423     $ 88,437     $ 225,860  
Provision for credit losses on mortgage loans
                 
 
                 
Adjusted net interest income after mortgage loan credit loss provision
  $ 137,423     $ 88,437     $ 225,860  
 
                 
 
                       
Average assets for the period
  $ 50,015,549     $ 18,664,887     $ 68,680,436  
Total assets at period end
  $ 66,687,877     $ 20,380,681     $ 87,068,558  

 

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For adjusted net interest income, the Bank includes interest income and interest expense associated with economic hedges as well as concession expense associated with fair value option bonds in its evaluation of financial performance for its two operating segments and excludes interest expense associated with basis adjustment amortization/accretion on called and extinguished debt. Interest income and interest expense associated with economic hedges are recorded as a component of “Net gain (loss) on derivatives and hedging activities” in other income (loss) in the Statements of Income. Concession expense associated with fair value option bonds is recorded in “other expense” in the Statements of Income. Interest expense associated with basis adjustment amortization/accretion on called and extinguished debt is recorded as a component of “Bonds” in interest expense in the Statements of Income. The following table reconciles the Bank’s financial performance by operating segment to total income before assessments (dollars in thousands):
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2009     2008     2009     2008  
 
                               
Adjusted net interest income after mortgage loan credit loss provision
  $ 60,723     $ 80,250     $ 149,690     $ 225,860  
Interest expense on basis adjustment accretion (amortization) of called debt
    89       (356 )     (17,836 )     (10,792 )
Interest expense on basis adjustment (amortization) accretion of extinguished debt
    (1,229 )           4,462        
Concession expense on fair value option bonds
                37        
Net interest (income) expense on economic hedges
    (1,532 )     (228 )     (6,173 )     2,297  
 
                       
Net interest income after mortgage loan credit loss provision
    58,051       79,666       130,180       217,365  
 
                               
Other income (loss)
    1,478       (6,564 )     49,211       (14,286 )
Other expense
    11,303       10,734       35,835       32,749  
 
                       
 
                               
Income before assessments
  $ 48,226     $ 62,368     $ 143,556     $ 170,330  
 
                       

 

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Note 12—Estimated Fair Values
The Bank records trading investments, available-for-sale investments, derivative assets, derivative liabilities, and certain bonds, for which the fair value option was elected, at fair value in the Statements of Condition. Fair value is a market-based measurement and is defined as the price received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant holding the asset or owing the liability. In general, the transaction price will equal the exit price and, therefore, represent the fair value of the asset or liability at initial recognition. In determining whether a transaction price represents the fair value of the asset or liability at initial recognition, each reporting entity is required to consider factors specific to the asset or liability, the principal or most advantageous market for the assets or liability, and market participants with whom the entity would transact in that market.
Fair Value Option. The fair value option permits entities to elect fair value as an alternative measurement for selected financial assets, financial liabilities, unrecognized firm commitments, and written loan commitments not previously carried at fair value in the financial statements. It requires entities to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. Fair value is used for both the initial and subsequent measurement of the designated assets, liabilities, and commitments, with the changes in fair value recognized in net income.
During the first quarter of 2009, the Bank elected to record bonds indexed to the Federal funds rate at fair value under the fair value option. The Bank entered into a derivative to swap the Federal funds rate to LIBOR. The hedge relationship does not qualify for fair value hedge accounting; therefore the Bank accounts for the derivative as an economic hedge. To offset the derivative mark-to-market the Bank elected the fair value option on the bonds and records the offsetting mark-to-market in the Bank’s Statements of Income.
Fair Value Hierarchy. The fair value hierarchy is used to prioritize the inputs of valuation techniques used to measure fair value. The inputs are evaluated and an overall level for the measurement is determined. This overall level is an indication of how market observable the fair value measurement is and defines the level of disclosure. Fair value is the price in an orderly transaction between market participants to sell an asset or transfer a liability in the principal (or most advantageous) market for the asset or liability at the measurement date (an exit price). In order to determine the fair value or the exit price, the Bank must determine the unit of account, highest and best use, principal market, and market participants. These determinations allow the Bank to define the inputs for fair value and level of hierarchy.

 

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The following describes the application of the fair value hierarchy to the Banks’ financial assets and financial liabilities that are carried at fair value in the Statements of Condition.
Level 1 — inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. An active market for the asset or liability is a market in which the transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. The types of assets and liabilities carried at Level 1 fair value include certain derivative contracts such as forward settlement agreements that are highly liquid and actively traded in over-the-counter markets.
Level 2 — inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. The types of assets and liabilities carried at Level 2 fair value include the Bank’s investment securities such as municipal bonds, GSE obligations, TLGP debt, and MBS, including U.S. government agency, as well as certain derivative contracts and bonds the Bank elected to record at fair value under the fair value option.
Level 3 — inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs supported by little or no market activity or by the entity’s own assumptions. The Bank does not currently have any assets and liabilities carried at Level 3 fair value.
The Bank utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Fair value is first determined based on quoted market prices or market-based prices, where available. If quoted market prices or market-based prices are not available, fair value is determined based on valuation models that use market-based information available to the Bank as inputs to the models.

 

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Fair Value on a Recurring Basis. The following table presents, for each hierarchy level, the Banks’ assets and liabilities that are measured at fair value in the Statements of Condition at September 30, 2009 (dollars in thousands):
                                         
    Fair Value Measurements at September 30, 2009 Using:  
                            Netting        
    Level 1     Level 2     Level 3     Adjustment1     Total  
Assets
                                       
Trading securities
                                       
TLGP
  $     $ 5,111,348     $     $     $ 5,111,348  
Taxable municipal bonds
          251,867                   251,867  
Available-for-sale securities
                                       
TLGP
          567,209                   567,209  
Government-sponsored enterprise
          4,954,042                   4,954,042  
Derivative assets
    3       387,452             (382,189 )     5,266  
 
                             
 
                                       
Total assets at fair value
  $ 3     $ 11,271,918     $     $ (382,189 )   $ 10,889,732  
 
                             
 
                                       
Liabilities
                                       
Bonds2
  $     $ (4,308,501 )   $     $     $ (4,308,501 )
Derivative liabilities
    (385 )     (833,213 )           454,097       (379,501 )
 
                             
 
                                       
Total liabilities at fair value
  $ (385 )   $ (5,141,714 )   $     $ 454,097     $ (4,688,002 )
 
                             
     
1   Amounts represent the effect of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions and also cash collateral held or placed with the same counterparties. Net cash collateral plus accrued interest totaled $71.9 million at September 30, 2009.
 
2   Represents bonds recorded under the fair value option.

 

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The following table presents, for each hierarchy level, the Banks’ assets and liabilities that are measured at fair value in the Statements of Condition at December 31, 2008 (dollars in thousands):
                                         
    Fair Value Measurements at December 31, 2008 Using:  
                            Netting        
    Level 1     Level 2     Level 3     Adjustment1     Total  
Assets
                                       
Trading securities
  $     $ 2,151,485     $     $     $ 2,151,485  
Available-for-sale securities
          3,839,980                   3,839,980  
Derivative assets
    248       403,728             (401,136 )     2,840  
 
                             
 
                                       
Total assets at fair value
  $ 248     $ 6,395,193     $     $ (401,136 )   $ 5,994,305  
 
                             
 
                                       
Liabilities
                                       
Derivative liabilities
  $ (2,571 )   $ (1,101,501 )   $     $ 669,057     $ (435,015 )
 
                             
 
                                       
Total liabilities at fair value
  $ (2,571 )   $ (1,101,501 )   $     $ 669,057     $ (435,015 )
 
                             
     
1   Amounts represent the effect of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions and also cash collateral held or placed with the same counterparties. Net cash collateral plus accrued interest totaled $267.9 million at December 31, 2008.
For instruments carried at fair value in the Statements of Condition, the Bank reviews the fair value hierarchy classifications on a quarterly basis. Changes in the observability of the valuation attributes may result in a reclassification to the hierarchy level for certain financial assets or liabilities. At September 30, 2009 the Bank had made no reclassifications to its fair value hierarchy.
The following table presents the changes in fair value included in the Statements of Income for bonds in which the fair value option has been elected (dollars in thousands):
                 
    Three Months Ended     Nine Months Ended  
    September 30, 2009     September 30, 2009  
 
               
Interest expense
  $ 6,710     $ 13,780  
Net loss on bonds held at fair value
    3,165       15,392  
 
           
 
               
Total change in fair value
  $ 9,875     $ 29,172  
 
           

 

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For bonds recorded under the fair value option, the related contractual interest expense is recorded as part of net interest income in the Statements of Income. The remaining changes are recorded as “Net loss on bonds held at fair value” in the Statements of Income. The changes in fair value, as shown in the previous table, do not include changes in instrument-specific credit risk. The Bank has determined that no adjustments to the fair values of bonds recorded under the fair value option were necessary for instrument-specific credit risk. Concessions paid on bonds under the fair value option are expensed as incurred and recorded in “other expense” in the Statements of Income. The Bank recorded $0 and $37,000 in concession expense associated with fair value option bonds during the three and nine months ended September 30, 2009.
The following table reflects the difference between the aggregate fair value and the aggregate remaining contractual principal balance outstanding of bonds for which the fair value option has been elected (dollars in thousands):
         
    September 30,  
    2009  
 
       
Principal balance
  $ 4,290,000  
Fair value
    4,308,501  
 
     
 
       
Fair value over principal balance
  $ 18,501  
 
     
Estimated Fair Values. The following estimated fair value amounts have been determined by the Bank using available market information and management’s best judgment of appropriate valuation methods. These estimates are based on pertinent information available to the Bank at September 30, 2009 and December 31, 2008. Although management uses its best judgment in estimating the fair value of these financial instruments, there are inherent limitations in any estimation technique or valuation methodology. For example, because an active secondary market does not exist for a portion of the Bank’s financial instruments, in certain cases fair values are not subject to precise quantification or verification and may change as economic and market factors and evaluation of those factors change. Therefore, these estimated fair values are not necessarily indicative of the amounts that would be realized in current market transactions.
Cash and Due from Banks and Securities Purchased under Agreements to Resell. The estimated fair value approximates the recorded book balance.
Interest-bearing Deposits. For instruments with less than three months to maturity the estimated fair value approximates the recorded book balance. For instruments with more than three months to maturity the estimated fair value is determined by calculating the present value of the expected future cash flows.
Federal Funds Sold. The estimated fair value approximates the recorded book balance of overnight and term Federal funds sold with three months or less to maturity. The estimated fair value is determined by calculating the present value of the expected future cash flows for term Federal funds sold with more than three months to maturity. Term Federal funds sold are discounted at comparable current market rates.

 

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Investment Securities. The estimated fair value of the Bank’s investment securities is determined by using information from specialized pricing services that use pricing models and/or quoted prices of securities with similar characteristics. Inputs into the pricing models are market based and observable. The estimated fair value is determined based on each security’s quoted price excluding accrued interest as of the last business day of the reporting period. The Bank performs several validation steps in order to verify the accuracy and reasonableness of the investment fair values provided by the pricing services. These steps may include, but are not limited to, a detailed review of instruments with significant price changes and a comparison of fair values to those derived by an alternative pricing service. Certain investments for which quoted prices are not readily available are valued by third parties or internal pricing models. The Bank’s trading and available-for-sale securities are recorded in the Bank’s Statements of Condition at fair value.
During the quarter ended September 30, 2009 the Bank changed the methodology used to estimate the fair value of its private-label MBS. Under the new methodology, the Bank requests prices for all of its private-label MBS from four specific third-party pricing services and, depending on the number of prices received for each security, selects a median or average price as defined by the methodology. The methodology also incorporates variance thresholds to assist in identifying median or average prices that may require further review. In certain limited circumstances (i.e., prices are outside of variance thresholds or the third-party pricing services do not provide a price), the Bank will obtain a price from securities dealers or internally model a price that is deemed appropriate after consideration of all relevant facts and circumstances that would be considered by market participants. Since the Bank’s private-label MBS are all classified as held-to-maturity securities, this change in pricing methodology had no impact on the Bank’s financial condition or results of operations at September 30, 2009.
Advances and Other Loans. The Bank determines the estimated fair value of advances by calculating the present value of expected future cash flows from the advances and excluding accrued interest receivable. The Bank’s primary inputs for measuring the fair value of advances are the consolidated obligation yield curve (CO Curve) published by the Office of Finance and available to the public, LIBOR swap curves, and volatilities. The Bank considers these inputs to be market based and observable as they can be directly corroborated by market participants.
Under Bank policy and Finance Agency regulations, advances with a maturity and repricing period greater than six months generally require a prepayment fee sufficient to make the Bank financially indifferent to the borrower’s decision to prepay the advances. Therefore, the estimated fair value of advances does not assume prepayment risk.
Mortgage Loans. The estimated fair values for mortgage loans are determined based on contractual cash flows adjusted for prepayment assumptions and credit risk factors, discounted using the quoted market prices of similar mortgage loans, and reduced by the amount of accrued interest receivable. These prices, however, can change rapidly based on market conditions and are highly dependent on the underlying prepayment assumptions.
Accrued Interest Receivable and Payable. The estimated fair value approximates the recorded book balance.

 

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Derivative Assets and Liabilities. The Bank bases the estimated fair values of derivatives with similar terms on available market prices including accrued interest receivable and payable. The estimated fair value is based on the LIBOR swap curve and forward rates at period end and, for agreements containing options, the market’s expectations of future interest rate volatility implied from current market prices of similar options. The estimated fair values use standard valuation techniques for derivatives, such as discounted cash-flow analysis and comparisons to similar instruments. The fair values are netted with cash collateral by counterparty where such legal right of offset exists. If these amounts are positive, they are classified as an asset and if negative a liability.
Deposits. The Bank determines estimated fair values of deposits by calculating the present value of expected future cash flows from the deposits and reducing this amount by accrued interest payable. The discount rates used in these calculations are LIBOR rates with similar terms. The estimated fair value approximates the recorded book balance for deposits with three months or less to maturity.
Consolidated Obligations. The Bank estimates fair values based on the cost of issuing debt with comparable terms. We determine the fair value of our consolidated obligations by calculating the present value of expected future cash flows discounted by the CO Curve published by the Office of Finance, excluding the amount of accrued interest. The discount rates used are the consolidated obligation rates for instruments with similar terms.
Consolidated Obligations Elected Under the Fair Value Option. The Bank estimates fair values using models that use primarily market observable inputs. The Bank’s primary inputs for measuring the fair value of bonds are market-based CO Curve inputs obtained from the Office of Finance. The Bank has determined that the CO Curve is based on market observable data.
Adjustments may be necessary to reflect the Bank’s credit quality or the credit quality of the FHLBank System when valuing bonds measured at fair value. The Bank monitors its own creditworthiness, the creditworthiness of the other 11 FHLBanks, and the FHLBank System to determine whether any adjustments are necessary for creditworthiness in its fair value measurement of bonds. The credit ratings of the FHLBank System and any changes to the credit ratings are the basis for the Bank to determine whether the fair values of bonds have been significantly affected during the reported period by changes in the instrument-specific credit risk.

 

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Borrowings. The Bank determines the estimated fair value of borrowings by calculating the present value of expected future cash flows from the borrowings and reducing this amount by accrued interest payable. The discount rates used in these calculations are the estimated cost of borrowings with similar terms. For borrowings with three months or less to maturity, the estimated fair value approximates the recorded book balance.
Mandatorily Redeemable Capital Stock. The fair value of capital subject to mandatory redemption is generally reported at par value. Fair value also includes estimated dividends earned at the time of the reclassification from equity to liabilities, until such amount is paid. Stock can only be acquired by members at par value and redeemed at par value. Stock is not traded and no market mechanism exists for the exchange of stock outside the cooperative structure.
Commitments to Extend Credit for Mortgage Loans. The estimated fair value of the Bank’s commitments to table fund mortgage loans is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. The estimated fair value of these fixed rate loan commitments also takes into account the difference between current and committed interest rates.
Standby Letters of Credit. The estimated fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties.
Standby Bond Purchase Agreements. The estimated fair value of standby bond purchase agreements is calculated using the present value of expected future fees related to the agreements. The discount rates used in the calculations are based on municipal spreads over the Treasury curve, which are comparable to discount rates used to value the underlying bonds. Upon purchase of any bonds under these agreements, the Bank estimates fair value based upon the Investment Securities fair value methodology.

 

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The carrying values and estimated fair values of the Bank’s financial instruments were as follows (dollars in thousands):
FAIR VALUE SUMMARY TABLE
                                 
    September 30, 2009     December 31, 2008  
    Carrying     Estimated     Carrying     Estimated  
Financial Instruments   Value     Fair Value     Value     Fair Value  
Assets
                               
Cash and due from banks
  $ 26,897     $ 26,897     $ 44,368     $ 44,368  
Interest-bearing deposits
    20,685       20,594       152       152  
Federal funds sold
    4,485,000       4,485,000       3,425,000       3,425,000  
Trading securities
    5,363,215       5,363,215       2,151,485       2,151,485  
Available-for-sale securities
    5,521,251       5,521,251       3,839,980       3,839,980  
Held-to-maturity securities
    5,743,500       5,812,549       5,952,008       5,917,288  
Advances
    36,303,074       36,614,890       41,897,479       41,864,640  
Mortgage loans, net
    7,838,035       8,169,608       10,684,910       10,984,668  
Accrued interest receivable
    84,305       84,305       92,620       92,620  
Derivative assets
    5,266       5,266       2,840       2,840  
 
                               
Liabilities
                               
Deposits
    (1,216,925 )     (1,216,922 )     (1,496,470 )     (1,495,865 )
 
                               
Consolidated obligations
                               
Discount notes
    (12,874,240 )     (12,877,298 )     (20,061,271 )     (20,141,287 )
Bonds (includes $4,308,501 at fair value under the fair value option at September 30, 2009)
    (46,918,100 )     (48,186,139 )     (42,722,473 )     (44,239,835 )
 
                       
Consolidated obligations, net
    (59,792,340 )     (61,063,437 )     (62,783,744 )     (64,381,122 )
 
                       
 
                               
Mandatorily redeemable capital stock
    (17,504 )     (17,504 )     (10,907 )     (10,907 )
Accrued interest payable
    (289,468 )     (289,468 )     (320,271 )     (320,271 )
Derivative liabilities
    (379,501 )     (379,501 )     (435,015 )     (435,015 )
 
                               
Other
                               
Standby letters of credit
    (1,523 )     (1,523 )     (1,945 )     (1,945 )
Commitments to extend credit for mortgage loans
                (1,406 )     (1,426 )
Standby bond purchase agreements
          4,401       482       263  

 

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Note 13—Commitments and Contingencies
As described in Note 9, the 12 FHLBanks have joint and several liability for all consolidated obligations issued. Accordingly, if one or more of the FHLBanks is unable to repay its participation in the consolidated obligations, each of the other FHLBanks could be called upon by the Finance Agency to repay all or part of such obligations, as determined or approved by the Finance Agency. No FHLBank has ever had to assume or pay the consolidated obligation of another FHLBank. The par amounts of the outstanding consolidated obligations issued on behalf of other FHLBanks for which the Bank is jointly and severally liable were approximately $914.1 billion and $1,189.1 billion at September 30, 2009 and December 31, 2008.
In 2008 the Bank entered into a Lending Agreement with the U.S. Treasury in connection with the U.S. Treasury’s establishment of the Government Sponsored Enterprise Credit Facility (GSECF), as authorized by the Housing Act. The GSECF is designed to serve as a contingent source of liquidity for the housing government-sponsored enterprises, including the 12 FHLBanks, and expires on December 31, 2009. Any borrowings by one or more of the FHLBanks under the GSECF are considered consolidated obligations with the same joint and several liability as all other consolidated obligations. The terms of any borrowings are agreed to at the time of issuance. Loans under the Lending Agreement are to be secured by collateral acceptable to the U.S. Treasury, which consists of FHLBank advances to members that have been collateralized in accordance with regulatory standards and MBS issued by Fannie Mae or Freddie Mac. The Bank is required to submit to the Federal Reserve Bank of New York, acting as fiscal agent of the U.S. Treasury, a list of eligible collateral, updated on a weekly basis. At September 30, 2009 the Bank had provided the U.S. Treasury with a listing of advance collateral amounting to $10.6 billion, which provides for maximum borrowings of $9.2 billion. The amount of collateral can be increased or decreased (subject to the approval of the U.S. Treasury) at any time through the delivery of an updated listing of collateral. As of September 30, 2009 the Bank has not drawn on this available source of liquidity.
Standby letters of credit are executed with members for a fee. A standby letter of credit is a short-term financing arrangement between the Bank and a member. If the Bank is required to make payment for a beneficiary’s draw, these amounts are withdrawn from the member’s demand account. Any resulting overdraft is converted into a collateralized advance to the member. Outstanding standby letters of credit were approximately $3.5 billion at September 30, 2009, and had original terms between 6 days and 13 years with a final expiration in 2020. Outstanding standby letters of credit were approximately $3.4 billion at December 31, 2008, and had original terms between 4 days and 13 years with a final expiration in 2020. Unearned fees are recorded in other liabilities and amounted to $1.5 million and $1.9 million at September 30, 2009 and December 31, 2008. Based on management’s credit analyses and collateral requirements, the Bank does not deem it necessary to have any provision for credit losses on these commitments. The estimated fair value of standby letters of credit at September 30, 2009 and December 31, 2008 is reported in Note 12.

 

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Commitments that unconditionally obligate the Bank to fund/purchase mortgage loans from members in the MPF program totaled $61.0 million and $289.6 million at September 30, 2009 and December 31, 2008. Commitments are generally for periods not to exceed 45 business days. Commitments obligating the Bank to purchase closed mortgage loans from its members are considered derivatives, and their estimated fair value at September 30, 2009 and December 31, 2008 is reported in Note 8 as mortgage delivery commitments. Commitments obligating the Bank to table fund mortgage loans are not considered derivatives, and the estimated fair value at September 30, 2009 and December 31, 2008 is reported in Note 12 as commitments to extend credit for mortgage loans.
As described in Note 7, for managing the inherent credit risk in the MPF program, participating members receive base and performance based credit enhancement fees from the Bank. When the Bank incurs losses for certain MPF products, it reduces performance based credit enhancement fee payments to applicable members until the amount of the loss is recovered up to the limit of the FLA. The FLA is an indicator of the potential losses for which the Bank is liable (before the member’s credit enhancement is used to cover losses). The FLA amounted to $115.5 million and $105.9 million at September 30, 2009 and December 31, 2008.
The Bank entered into $1.0 billion par value traded but not settled bonds at September 30, 2009 and December 31, 2008. The Bank had derivatives with a notional value of $1.1 billion and $1.0 billion that had traded but not settled at September 30, 2009 and December 31, 2008. The Bank had $75.4 million and $267.9 million of cash pledged as collateral to broker-dealers at September 30, 2009 and December 31, 2008. The Bank generally executes derivatives with large highly rated banks and broker-dealers and enters into bilateral collateral agreements.
At September 30, 2009, the Bank had 20 standby bond purchase agreements with housing associates within its district whereby the Bank would be required to purchase bonds under circumstances defined in each agreement. The Bank would hold investments in the bonds until the designated remarketing agent could find a suitable investor or the housing associate repurchases the bonds according to a schedule established by the standby bond purchase agreement. The 20 outstanding standby bond purchase agreements total $567.6 million and expire seven years after execution, with a final expiration in 2016. The Bank received fees for the guarantees that amounted to $0.3 million and $0.7 million for the three and nine months ended September 30, 2009. The Bank executed 2 and 11 standby bond purchase agreements during the three and nine months ended September 30, 2009. At September 30, 2009, the Bank had not been required to purchase any HFA bonds under the executed standby bond purchase agreements. The estimated fair value of standby bond purchase agreements at September 30, 2009 and December 31, 2008 is reported in Note 12.

 

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On March 31, 2009, the Bank entered into an agreement with the Missouri Housing Development Commission to purchase up to $75 million of taxable single family mortgage revenue bonds. The agreement was set to expire October 8, 2009 however, was extended 30 days through November 6, 2009. As of September 30, 2009, the Bank had purchased $15.0 million in mortgage revenue bonds under this agreement.
On September 25, 2009, the Bank entered into an agreement with the Iowa Finance Authority to purchase up to $100 million of taxable single family mortgage revenue bonds. The agreement expires on September 24, 2010. As of September 30, 2009, the Bank had not purchased any mortgage revenue bonds under this agreement.
In conjunction with its sale of certain mortgage loans to the FHLBank of Chicago, whereby the mortgage loans were immediately resold by the FHLBank of Chicago to Fannie Mae, the Bank entered into an agreement with the FHLBank of Chicago on June 11, 2009 to indemnify the FHLBank of Chicago for potential losses on mortgage loans remaining in four master commitments from which the mortgage loans were sold. The Bank and the FHLBank of Chicago each hold certain participation interests in the four master commitments and therefore share, on a proportionate basis, any losses incurred after considering PFI credit enhancement provisions. The sale of mortgage loans under these master commitments reduced the amount of future credit enhancement fees available for recapture by the FHLBank of Chicago and the Bank. Therefore, under the agreement, the Bank agreed to indemnify the FHLBank of Chicago for any losses not otherwise recovered through credit enhancement fees, subject to an indemnification cap of $2.1 million by December 31, 2010, $1.2 million by December 31, 2012, $0.8 million by December 31, 2015, and $0.3 million by December 31, 2020. At September 30, 2009 the Bank was not aware of any losses incurred by the FHLBank of Chicago that would not otherwise be recovered through credit enhancement fees.
The Bank is not currently aware of any material pending legal proceedings other than ordinary routine litigation incidental to the business, to which the Bank is a party or of which any of its property is the subject.

 

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Note 14—Activities with Stockholders and Housing Associates
Under the Bank’s Capital Plan, voting rights conferred upon the Bank’s members are for the election of member directors and independent directors. Member directorships are designated to one of the five states in the Bank’s district and a member is entitled to nominate and vote for candidates for the state in which the member’s principal place of business is located. A member is entitled to cast, for each applicable member directorship, one vote for each share of capital stock that the member is required to hold, subject to a statutory limitation. Under this limitation, the total number of votes that a member may cast is limited to the average number of shares of the Bank’s capital stock that were required to be held by all members in that state as of the record date for voting. The independent directors are nominated by the Bank’s Board of Directors after consultation with the FHLBank’s Affordable Housing Advisory Council, and then voted upon by all members within the Bank’s five-state district. Non-member stockholders are not entitled to cast votes for the election of directors. At September 30, 2009 and December 31, 2008, no member owned more than ten percent of the voting interests of the Bank due to statutory limits on members’ voting rights as mentioned above.
Transactions with Stockholders. The Bank is a cooperative, which means that current members own nearly all of the outstanding capital stock of the Bank and may receive dividends on their investment. Former members own the remaining capital stock to support business transactions still carried in the Bank’s Statements of Condition. All advances are issued to members and all mortgage loans held for portfolio are purchased from members. The Bank also maintains demand deposit accounts for members primarily to facilitate settlement activities that are directly related to advances and mortgage loan purchases. The Bank may not invest in any equity securities issued by its stockholders. The Bank extends credit to members in the ordinary course of business on substantially the same terms, including interest rates and collateral that must be pledged to us, as those prevailing at the time for comparable transactions with other members unless otherwise discussed. These extensions of credit do not involve more than the normal risk of collectibility and do not present other unfavorable features.

 

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The following table shows transactions with members and their affiliates, former members and their affiliates, and eligible housing associates (dollars in thousands):
                 
    September 30,     December 31,  
    2009     2008  
 
               
Assets:
               
Cash
  $ 3,588     $ 18,839  
Interest-bearing deposits1
    19,818        
Federal funds sold
    505,000       1,110,000  
Trading securities2
    130,803        
Available-for-sale securities2
          580  
Held-to-maturity securities2
    126,129       377,619  
Advances
    36,303,074       41,897,479  
Accrued interest receivable
    9,281       21,555  
Derivative assets
    315       2,655  
Other assets
    509       615  
 
           
 
               
Total
  $ 37,098,517     $ 43,429,342  
 
           
 
               
Liabilities:
               
Deposits
  $ 1,179,282     $ 1,394,198  
Mandatorily redeemable capital stock
    17,504       10,907  
Accrued interest payable
    229       853  
Derivative liabilities
    46,079       57,519  
Other liabilities
    1,523       1,945  
 
           
 
               
Total
  $ 1,244,617     $ 1,465,422  
 
           
 
               
Capital:
               
Capital stock — Class B putable
  $ 2,951,873     $ 2,780,927  
 
           
 
               
Notional amount of derivatives
  $ 4,051,670     $ 939,650  
Notional amount of standby letters of credit
  $ 3,524,229     $ 3,400,001  
Notional amount of standby bond purchase agreements
  $ 567,619     $ 259,677  
     
1   Interest-bearing deposits consist of non-negotiable certificates of deposit purchased by the Bank from its members.
 
2   Trading securities, available-for-sale securities and held-to-maturity securities consist of state or local housing agency obligations, commercial paper, and TLGP debt purchased by the Bank from its members or eligible housing associates.

 

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Transactions with Directors’ Financial Institutions. In the normal course of business, the Bank extends credit to its members whose directors and officers serve as its directors (Directors’ Financial Institutions). Finance Agency regulations require that transactions with Directors’ Financial Institutions be subject to the same eligibility and credit criteria, as well as the same terms and conditions, as all other transactions. At September 30, 2009 and December 31, 2008, advances outstanding to the Bank Directors’ Financial Institutions aggregated $676.8 million and $561.6 million, representing 1.9 percent and 1.4 percent of the Bank’s total outstanding advances. There were $13.8 million and $1.3 million in mortgage loans originated by the Bank Directors’ Financial Institutions during the three months ended September 30, 2009 and 2008. There were $38.8 million and $3.0 million in mortgage loans originated by the Bank Directors’ Financial Institutions during the nine months ended September 30, 2009 and 2008. At September 30, 2009 and December 31, 2008, capital stock outstanding to the Bank Directors’ Financial Institutions aggregated $47.1 million and $33.0 million, representing 1.6 percent and 1.2 percent of the Bank’s total outstanding capital stock. The Bank did not have any investment or derivative transactions with Directors’ Financial Institutions during the three and nine months ended September 30, 2009 and 2008.
Business Concentrations. The Bank has business concentrations with stockholders whose capital stock outstanding was in excess of ten percent of the Bank’s total capital stock outstanding.
Capital Stock — The following tables present members and their affiliates holding ten percent or more of outstanding capital stock (including stock classified as mandatorily redeemable) (shares in thousands):
                                 
                    Shares at     Percent of  
                    September 30,     Total Capital  
Name   City     State     2009     Stock  
 
                               
Superior Guaranty Insurance Company1
  Minneapolis   MN     4,054       13.7 %
 
                           
                                 
                    Shares at     Percent of  
                    December 31,     Total Capital  
Name   City     State     2008     Stock  
 
                               
Superior Guaranty Insurance Company1
  Minneapolis   MN     4,499       16.2 %
 
                           
     
1   Superior Guaranty Insurance Company (Superior) is an affiliate of Wells Fargo Bank, N.A. (Wells Fargo).
In the normal course of business, the Bank invested in overnight Federal funds from Wells Fargo during the three and nine months ended September 30, 2009 and 2008.

 

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Advances — The Bank had advances with Wells Fargo of $0.7 billion and $0.2 billion at September 30, 2009 and December 31, 2008 and advances with Superior, an affiliate of Wells Fargo, of $1.3 billion and $2.3 billion at September 30, 2009 and December 31, 2008. The Bank made $0.5 billion of new advances to Wells Fargo during the three and nine months ended September 30, 2009. The Bank made $67.2 billion and $159.9 billion of new advances with Wells Fargo during the three and nine months ended September 30, 2008. The Bank made no new advances with Superior during the three and nine months ended September 30, 2009. The Bank made $0.5 billion of new advances with Superior during the three and nine months ended September 30, 2008. During the third quarter of 2009, Superior transferred a $500.0 million advance to Wells Fargo. This advance matured on September 30, 2009.
Total interest income from Wells Fargo amounted to $4.1 million and $97.5 million for the three months ended September 30, 2009 and 2008 and $9.3 million and $246.3 million for the nine months ended September 30, 2009 and 2008. Total interest income from Superior amounted to $2.8 million and $8.3 million for the three months ended September 30, 2009 and 2008 and $11.0 million and $26.8 million for the nine months ended September 30, 2009 and 2008. The Bank held sufficient collateral to cover the members’ advances and expected to incur no credit losses as a result of them.
Mortgage Loans — At September 30, 2009 and December 31, 2008, 59 percent and 74 percent of the Bank’s mortgage loans outstanding were purchased from Superior. The decrease in percent of mortgage loans outstanding with Superior at September 30, 2009 when compared to December 31, 2008 was due to the mortgage loans sale transaction as discussed in “Note 7 — Mortgage Loans Held for Portfolio” at page 24.
Other — The Bank has a 20 year lease with an affiliate of Wells Fargo for space in a building for the Bank’s headquarters that commenced on January 2, 2007. Future minimum rentals to the Wells Fargo affiliate are as follows (dollars in thousands):
         
Year   Amount  
 
       
Due in one year or less
  $ 869  
Due after one year through two years
    869  
Due after two years through three years
    869  
Due after three years through four years
    869  
Due after four years through five years
    869  
Thereafter
    11,516  
 
     
 
       
Total
  $ 15,861  
 
     

 

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Note 15—Activities with Other FHLBanks
The Bank may invest in other FHLBank consolidated obligations, for which the other FHLBanks are the primary obligor, for liquidity purposes. If made, these investments in other FHLBank consolidated obligations would be purchased in the secondary market from third parties and would be accounted for as available-for-sale securities. The Bank did not have any investments in other FHLBank consolidated obligations at September 30, 2009 and December 31, 2008.
The Bank purchased MPF shared funding certificates from the FHLBank of Chicago. See “Note 5 — Held to Maturity Securities” at page 17 for balances at September 30, 2009 and December 31, 2008.
The Bank recorded service fee expense as an offset to other income (loss) due to its relationship with the FHLBank of Chicago in the MPF program. The Bank recorded $0.3 million in service fee expense to the FHLBank of Chicago for the three months ended September 30, 2009 and 2008 and $1.0 million and $0.7 million for the nine months ended September 30, 2009 and 2008.
On June 24, 2009, the Bank sold $2.1 billion of mortgage loans held for sale to the FHLBank of Chicago, who immediately resold these loans to Fannie Mae. As a result of the mortgage loan sale, the Bank entered into an agreement with the FHLBank of Chicago to indemnify the FHLBank of Chicago for potential losses on mortgage loans remaining in four master commitments from which the mortgage loans were sold. For additional information on the indemnification agreement, refer to “Note 13 — Commitments and Contingencies” at page 52.
Effective February 26, 2009 the Bank signed agreements with the FHLBank of Chicago to participate in a MPF loan product called MPF Xtra. For additional information on the MPF Xtra agreement with the FHLBank of Chicago, refer to “Note 7 — Mortgage Loans Held for Portfolio” at page 24.
The Bank may sell or purchase unsecured overnight and term Federal funds to and from other FHLBanks at market interest rates.

 

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The Bank did not make any loans to other FHLBanks during the nine months ended September 30, 2009. The following table shows loan activity to other FHLBanks during the nine months ended September 30, 2008 (dollars in thousands):
                                 
                    Principal        
    Beginning             Payment     Ending  
Other FHLBank   Balance     Advance     Received     Balance  
 
                               
September 30, 2008
                               
Atlanta
  $     $ 113,000     $ (113,000 )   $  
Boston
          524,000       (524,000 )      
Chicago
          250,000       (250,000 )      
San Francisco
          1,100,000       (1,100,000 )      
Topeka
          201,000       (201,000 )      
 
                       
 
  $     $ 2,188,000     $ (2,188,000 )   $  
 
                       
The following table shows loan activity from other FHLBanks during the nine months ended September 30, 2009 and 2008 (dollars in thousands):
                                 
    Beginning             Principal     Ending  
Other FHLBank   Balance     Borrowings     Payment     Balance  
 
                               
September 30, 2009
                               
San Francisco
  $     $ 6,104,000     $ (6,104,000 )   $  
 
                       
 
                               
September 30, 2008
                               
Cincinnati
  $     $ 63,000     $ (63,000 )   $  
 
                       

 

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ITEM 2–MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our financial statements and condensed notes at the beginning of this Form 10-Q and in conjunction with our Management’s Discussion and Analysis and annual report on Form 10-K filed with the Securities and Exchange Commission (SEC) on March 13, 2009 (Form 10-K). The Bank’s Management’s Discussion and Analysis is designed to provide information that will help the reader develop a better understanding of the Bank’s financial statements, key financial statement changes from quarter to quarter, and the primary factors driving those changes. The Bank’s Management’s Discussion and Analysis is organized as follows:
Contents
         
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Forward-Looking Information
Statements contained in this report, including statements describing the objectives, projections, estimates, or future predictions in our operations, may be forward-looking statements. These statements may be identified by the use of forward-looking terminology, such as believes, projects, expects, anticipates, estimates, intends, strategy, plan, may, and will or their negatives or other variations on these terms. By their nature, forward-looking statements involve risk or uncertainty, and actual results could differ materially from those expressed or implied or could affect the extent to which a particular objective, projection, estimate, or prediction is realized.
These forward-looking statements involve risks and uncertainties including, but not limited to, the following:
    Economic and market conditions;
    Demand for Bank advances resulting from changes in Bank members’ deposit flows and/or credit demands;
    Volume of eligible mortgage loans originated and sold by participating members to the Bank through the Mortgage Partnership Finance (MPF) Program;
    Pricing of various mortgage loans under the MPF Program by the MPF Provider since the Bank has only limited input on pricing through its participation on the MPF Governance Committee;
    Volatility of market prices, rates and indices that could affect the value of investments or the Bank’s ability to liquidate collateral expediently in the event of a default by an obligor;
    Political events, including legislative, regulatory, judicial, or other developments that affect the Bank, its members, counterparties and/or investors in the consolidated obligations of the FHLBanks;
    Competitive forces including, without limitation, other sources of funding available to Bank members including existing and newly created debt programs explicitly guaranteed by the U.S. Government, other entities borrowing funds in the capital markets and the ability of the Bank to attract and retain skilled individuals;
    Changes in domestic and foreign investor demand for consolidated obligations of the FHLBanks and/or the terms of derivatives and similar instruments including, without limitation, changes in the relative attractiveness of consolidated obligations as compared to other investment opportunities including existing and newly created debt programs explicitly guaranteed by the U.S. Government;
    Timing and volume of market activity;
    Risks related to the operations of the other 11 FHLBanks that could trigger our joint and several liability for debt issued by the other 11 FHLBanks; and
    Risk of loss arising from litigation filed against the Bank.
    Member failures may adversely impact the Bank’s business.

 

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There can be no assurance that unanticipated risks will not materially and adversely affect our results of operations. For additional information regarding these and other risks and uncertainties that could cause our actual results to differ materially from the expectations reflected in our forward-looking statements see “Risk Factors” in our Form 10-K incorporated herein by reference. You are cautioned not to place undue reliance on any forward-looking statements made by us or on our behalf. Forward-looking statements are made as of the date of this report. We undertake no obligation to update or revise any forward-looking statement.
Executive Overview
The Federal Home Loan Bank of Des Moines (the Bank, we, us, or our) is a federally chartered corporation that is exempt from all federal, state, and local taxation except real property taxes and is one of 12 district Federal Home Loan Banks (FHLBanks). The FHLBanks were created under the authority of the Federal Home Loan Bank Act of 1932 (FHLBank Act), which was recently amended by the Housing and Economic Recovery Act of 2008 (Housing Act). The Federal Housing Finance Agency (Finance Agency) supervises and regulates the FHLBanks and the FHLBank’s Office of Finance (Office of Finance), as well as Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac). The Finance Agency’s principal purpose is to ensure that the FHLBanks operate in a safe and sound manner. In addition, the Finance Agency ensures that the FHLBanks carry out their housing finance mission and remain adequately capitalized. The Finance Agency establishes policies and regulations governing the operations of the FHLBanks. Each FHLBank operates as a separate entity with its own management, employees, and board of directors.
The Bank is a cooperatively owned government-sponsored enterprise (GSE) serving shareholder members and housing associates in a five-state region (Iowa, Minnesota, Missouri, North Dakota, and South Dakota). The Bank’s mission is to provide funding and liquidity for its members and housing associates. The Bank fulfills its mission by being a stable resource that can make short- and long-term funding available to members and housing associates through advances, standby letters of credit, investment purchases, mortgage purchases, and targeted housing and economic development activities. Our member institutions include commercial banks, savings institutions, credit unions, and insurance companies.
During the three and nine months ended September 30, 2009 the Bank reported net income of $35.5 million and $105.5 million compared to net income of $45.8 million and $125.1 million for the same periods in 2008. Net income during the three and nine months ended September 30, 2009 was primarily impacted by decreased net interest income, net gains on the sale of U.S. Treasury obligations and termination of the related interest rate swaps, and losses on the extinguishment of debt.

 

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During the three and nine months ended September 30, 2009 the Bank’s net interest income declined 27 percent and 40 percent, respectively, when compared to the same periods in 2008 primarily due to decreased average advances and mortgage loans. Average advances declined due to the availability of alternative wholesale funding options for member banks as well as increased deposit growth realized by many members. Average mortgage loans declined primarily due to the sale of a portion of our MPF portfolio during the second quarter of 2009. The declining volumes were partially offset by the impact of market conditions and interest rates.
During the latter half of 2008, the Bank’s longer-term funding was expensive due to illiquidity in the market place and discount note spreads relative to London Interbank Offered Rate (LIBOR) were at historically wide levels. As a result, the Bank funded longer-term assets with short-term debt. This funding methodology decreased the Bank’s debt costs and therefore increased net interest income during the nine months ended September 30, 2009 when compared with the same period in 2008. With this funding methodology the Bank accepted the risk associated with the maturity mismatches. Therefore, to compensate for the risk associated with this funding mismatch as well as the challenging market place that was presenting diminishing liquidity and increasing volatility, the Bank added a risk/liquidity adjustment to its advance pricing beginning in September 2008. As the financial markets have shown signs of stabilization during the three months ended September 30, 2009, the Bank has decreased this risk/liquidity adjustment in its advance pricing.
Improved market conditions during the three months ended September 30, 2009 compared to the same period in 2008 also provided the Bank with the opportunity to better match fund its longer-term assets with longer-term debt (bonds). The Bank was also able to extinguish higher costing debt and replace that debt with lower costing debt. Both the opportunity to better match fund and extinguish debt allowed the Bank to increase our bond issuances at more attractive interest rates, thereby, lowering debt costs and increasing net interest income during the three and nine months ended September 30, 2009 when compared to the same periods in 2008.
Also impacting net interest income is the availability of attractive investment options. Short-term investment rates are low, primarily due to increased deposit levels and the availability of various government funding programs for financial institutions serving as the Bank’s counterparties for short-term investments. The low growth market environment and the relative improvement in funding resulted in decreased interest spreads on investments. Although the Bank continues to explore new investment opportunities that provide favorable returns and has increased average investments through purchases, the compressed spreads decreased net interest income during the nine months ended September 30, 2009 relative to the same period in 2008.

 

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Additionally, the Bank began purchasing investments in U.S. Treasury obligations during the second quarter of 2009. These investments were made possible due to unique opportunities in the financial markets as interest rates on 30-year U.S. Treasury obligations yielded returns above equivalent maturity LIBOR swap rates, therefore allowing the Bank to earn a positive spread on the investment. Management believes that the investment opportunities available in U.S. Treasury obligations are a short-term market anomaly caused by continued uncertainty in the financial markets (i.e. AAA rated U.S. Treasury obligations with interest rates yielding returns in excess of AA rated U.S. LIBOR swap rates). The Bank also entered into interest rate swaps to convert the fixed rate investments to three-month LIBOR plus a spread. At the time of execution, management determined that if and when the market showed signs of correcting this imbalance, prudent action to recognize large short-term gains, combined with any reduction in associated risk of the “net” investment (the Bank’s risk in this investment results from any possible change between the Bank’s cost of funds and LIBOR), was warranted through the subsequent sale and termination of the related interest rate swaps. Therefore, during the three and nine months ended September 30, 2009, the Bank sold $1.9 billion and $2.7 billion of U.S. Treasury obligations and terminated the related interest rate swaps. The overall impact of these transactions was a net gain of $37.9 million and $70.9 million during the three and nine months ended September 30, 2009.
The Bank utilized, in part, the proceeds from the U.S. Treasury transactions described above to extinguish approximately $266.8 million and $853.3 million of higher costing par value debt during the three and nine months ended September 30, 2009 and, as a result, recorded losses of approximately $28.5 million and $80.9 million. The Bank expects such losses will be offset in future periods by improved earnings as a result of lower debt costs.

 

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Conditions in the Financial Markets
Three and Nine Months Ended September 30, 2009 and December 31, 2008
Financial Market Conditions
During the three and nine months ended September 30, 2009, average market interest rates were significantly lower when compared with the same periods in 2008. The following table shows information on key average market interest rates for the three and nine months ended September 30, 2009 and 2008 and key market interest rates at December 31, 2008:
                                         
                    Year-to-date     Year-to-date        
    Third Quarter     Third Quarter     September 30,     September 30,        
    2009     2008     2009     2008     December 31,  
    3-Month     3-Month     9-Month     9-Month     2008  
    Average     Average     Average     Average     Ending Rate  
 
                                       
Fed effective1
    0.15 %     1.96 %     0.17 %     2.41 %     0.14 %
Three-month LIBOR1
    0.41       2.91       0.83       2.98       1.43  
2-year U.S. Treasury1
    1.01       2.35       0.97       2.26       0.77  
10-year U.S. Treasury1
    3.50       3.85       3.17       3.79       2.21  
30-year residential mortgage note2
    5.17       6.33       5.08       6.09       5.14  
     
1   Source is Bloomberg.
 
2   Average calculated using The Mortgage Bankers Association Weekly Application Survey; December 31, 2008 ending rates are from the last week in 2008.
The third quarter of 2009 reflected mixed economic conditions. While there have been some signs of economic improvement (i.e., rising consumer confidence and retail sales, increasing durable goods orders, and record issuance from some asset classes), there have also been signs of uncertainty in the market regarding the timing of the recovery.
The U.S. Government, the Federal Reserve, and a number of foreign governments and foreign central banks continued to take actions to stabilize the credit and liquidity markets. At the conclusion of its September policy meeting, the Federal Reserve acknowledged that “economic activity has picked up”. Although the central bank reiterated its position that an exceptionally low level of interest rates would likely be warranted for an “extended period”, the Federal Reserve also sent clear signals it is preparing to exit from parts of its credit easing.

 

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Agency Spreads
                                         
                    Year-to-date     Year-to-date        
    Third Quarter     Third Quarter     September 30,     September 30,        
    2009     2008     2009     2008     December 31,  
    3-Month     3-Month     9-Month     9-Month     2008  
    Average     Average     Average     Average     Ending Rate  
FHLB spreads to LIBOR
                                       
(basis points)1
                                       
3-month
    (0.2 )     (37.9 )     (56.7 )     (45.7 )     (131.5 )
2-year
    (13.3 )     (15.5 )     6.2       (17.6 )     19.4  
5-year
    9.2       (0.8 )     32.9       (4.1 )     73.1  
10-year
    56.7       21.8       90.5       13.3       109.1  
     
1   Source is Office of Finance.
Agency spreads to LIBOR have worsened in the three months ended September 30, 2009 in each sector when compared to the same period in 2008, resulting in higher funding costs for the Bank. The worsening of spreads to LIBOR is in part due to the significant decrease in 3-month LIBOR since December 31, 2008.
Historically, the FHLBanks’ credit quality and efficiency led to ready access to funding at competitive rates. However, since the fourth quarter of 2008, government intervention and weakening investor confidence has adversely impacted the Bank’s long-term cost of funds. As demonstrated in the table above, average agency spreads on the Bank’s longer dated maturities during the first nine months of 2009 were wider to LIBOR compared with the same period in 2008 resulting in more expensive debt costs to the Bank on its longer-term bonds. As a result, the Bank continued to rely on the issuance of shorter-term discount notes and bonds to fund longer-term assets. Although the Bank relied on the issuance of shorter-term discount notes and bonds to fund both its short- and long-term assets during the nine months ended September 30, 2009, improved market conditions during the third quarter of 2009 allowed the Bank to better match fund its longer-term assets with longer-term debt.
Selected Financial Data
The following selected financial data should be read in conjunction with the financial statements and condensed notes thereto, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this report, and our Form 10-K. The financial position data at September 30, 2009 and results of operations data for the three and nine months ended September 30, 2009 were derived from the unaudited financial statements and condensed notes thereto included in this report. The financial position data at December 31, 2008 was derived from the audited financial statements and notes not included in this report.

 

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In the opinion of management, the unaudited financial information is complete and reflects all adjustments, consisting of normal recurring adjustments, for a fair statement of results for the interim periods and is in conformity with accounting principles generally accepted in the United States of America (GAAP). The results of operations for the three and nine months ended September 30, 2009 are not necessarily indicative of the results that may be achieved for the full year.
                 
Statements of Condition
(Dollars in millions)
  September 30,
2009
    December 31,
2008
 
Short-term investments1
  $ 4,953     $ 3,810  
Mortgage-backed securities
    9,335       9,307  
Other investments2
    6,846       2,252  
Advances
    36,303       41,897  
Mortgage loans, net
    7,838       10,685  
Total assets
    65,426       68,129  
Consolidated obligations3
    59,792       62,784  
Mandatorily redeemable capital stock
    18       11  
Affordable Housing Program
    40       40  
Payable to REFCORP
    9       1  
Total liabilities
    62,040       65,112  
Capital stock — Class B putable
    2,952       2,781  
Retained earnings
    458       382  
Capital-to-asset ratio4
    5.18 %     4.43 %
                                 
    Three Months Ended     Nine Months Ended  
Operating Results and Performance Ratios   September 30,     September 30,  
(Dollars in millions)   2009     2008     2009     2008  
Interest income
  $ 325.5     $ 612.5     $ 1,132.3     $ 1,807.2  
Interest expense
    267.4       532.8       1,001.8       1,589.8  
Net interest income
    58.1       79.7       130.5       217.4  
Provision for credit losses on mortgage loans
    *             0.3        
Net interest income after mortgage loan credit loss provision
    58.1       79.7       130.2       217.4  
 
Other income (loss)
    1.5       (6.6 )     49.2       (14.3 )
Other expense
    11.3       10.8       35.8       32.8  
Total assessments5
    12.8       16.5       38.1       45.2  
Net income
    35.5       45.8       105.5       125.1  
 
                               
Return on average assets
    0.21 %     0.24 %     0.20 %     0.24 %
Return on average capital stock
    4.78       5.63       4.87       5.61  
Return on average total capital
    4.17       5.15       4.34       5.08  
Net interest spread
    0.24       0.26       0.13       0.25  
Net interest margin
    0.34       0.42       0.25       0.42  
Operating expenses to average assets6
    0.06       0.05       0.06       0.06  
Annualized dividend rate
    2.00       4.00       1.34       4.17  
Cash dividends declared and paid
  $ 14.4     $ 30.1     $ 29.0     $ 82.4  
     
1   Short-term investments include: interest-bearing deposits, negotiable certificates of deposit, Federal funds sold and commercial paper. Short-term investments have terms less than one year.
 
2   Other investments include: long-term interest-bearing deposits, Temporary Liquidity Guarantee Program (TLGP) securities, Tennessee Valley Authority (TVA) and Federal Farm Credit Bank (FFCB) bonds, state or local housing agency obligations, Small Business Investment Company, and municipal bonds.
 
3   The par amount of the outstanding consolidated obligations for all 12 FHLBanks was $973.6 billion and $1,251.5 billion at September 30, 2009 and December 31, 2008.
 
4   Capital-to-asset ratio is capital stock plus retained earnings and accumulated other comprehensive loss as a percentage of total assets at the end of the period.
 
5   Total assessments include: Affordable Housing Program (AHP) and Resolution Funding Corporation (REFCORP).
 
6   Operating expenses to average assets ratio is salaries and benefits plus operating expenses as a percentage of average assets.
 
*   Represents an amount less than $0.1 million.

 

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Results of Operations
Three and Nine Months Ended September 30, 2009 and 2008
Net Income
The Bank reported net income of $35.5 million and $105.5 million for the three and nine months ended September 30, 2009 compared with net income of $45.8 million and $125.1 million for the three and nine months ended September 30, 2008. The decrease in net income during the three and nine months ended September 30, 2009 when compared to the same periods in 2008 was primarily attributable to decreased net interest income and activity reported in other income (loss). These items are described further in the sections that follow.

 

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Net Interest Income
The following table presents average balances and rates of major interest rate sensitive asset and liability categories for the three months ended September 30, 2009 and 2008. The table also presents the net interest spread between yield on total interest-earning assets and cost of total interest-bearing liabilities and the net interest margin between yield on total assets and the cost of total liabilities and capital (dollars in millions).
                                                 
    For the Three Months Ended     For the Three Months Ended  
    September 30, 2009     September 30, 2008  
                    Interest                     Interest  
    Average             Income/     Average             Income/  
    Balance 1     Yield/Cost     Expense     Balance 1     Yield/Cost     Expense  
Interest-earning assets
                                               
Interest-bearing deposits
  $ 76       0.57 %   $ 0.1     $ 1       2.03 %   $ *  
Securities purchased under agreements to resell
    1,223       0.15       0.4                    
Federal funds sold
    4,787       0.20       2.4       3,609       2.02       18.3  
Short-term investments2
    511       0.47       0.7       376       2.15       2.0  
Mortgage-backed securities2
    9,027       2.12       48.3       9,257       3.69       85.8  
Other investments2
    7,557       1.39       26.1       85       5.92       1.3  
Advances3
    36,578       1.65       152.4       50,931       2.91       372.0  
Mortgage loans4
    7,954       4.74       95.1       10,566       5.01       133.0  
Loans to other FHLBanks
                      50       0.61       0.1  
 
                                   
Total interest-earning assets
    67,713       1.91       325.5       74,875       3.25       612.5  
Noninterest-earning assets
    169                   167              
 
                                   
Total assets
  $ 67,882       1.90 %   $ 325.5     $ 75,042       3.25 %   $ 612.5  
 
                                   
 
                                               
Interest-bearing liabilities
                                               
Deposits
  $ 1,320       0.17 %   $ 0.6     $ 1,308       1.72 %   $ 5.7  
Consolidated obligations
                                               
Discount notes
    18,265       0.41       18.8       30,881       2.23       173.2  
Bonds
    44,009       2.24       247.9       38,724       3.63       353.6  
Other interest-bearing liabilities
    17       2.68       0.1       21       5.09       0.3  
 
                                   
Total interest-bearing liabilities
    63,611       1.67       267.4       70,934       2.99       532.8  
Noninterest-bearing liabilities
    903                   569              
 
                                   
Total liabilities
    64,514       1.64       267.4       71,503       2.96       532.8  
Capital
    3,368                   3,539              
 
                                   
Total liabilities and capital
  $ 67,882       1.56 %   $ 267.4     $ 75,042       2.83 %   $ 532.8  
 
                                   
 
                                               
Net interest income and spread
            0.24 %   $ 58.1               0.26 %   $ 79.7  
 
                                       
 
                                               
Net interest margin
            0.34 %                     0.42 %        
 
                                           
 
                                               
Average interest-earning assets to interest-bearing liabilities
            106.45 %                     105.55 %        
 
                                           
 
                                               
Composition of net interest income
                                               
Asset-liability spread
            0.26 %   $ 44.2               0.28 %   $ 53.3  
Earnings on capital
            1.64 %     13.9               2.96 %     26.4  
 
                                           
Net interest income
                  $ 58.1                     $ 79.7  
 
                                           
     
1   Average balances do not reflect the effect of derivative master netting arrangements with counterparties.
 
2   The average balance of available-for-sale securities is reflected at amortized cost; therefore the resulting yields do not give effect to changes in fair value.
 
3   Advance interest income includes advance prepayment fee income of $3.5 million and $0.1 million for the three months ended September 30, 2009 and 2008.
 
4   Nonperforming loans are included in average balances used to determine average rate.
 
*   Represents an amount less than $0.1 million.

 

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The following table presents average balances and rates of major interest rate sensitive asset and liability categories for the nine months ended September 30, 2009 and 2008. The table also presents the net interest spread between yield on total interest-earning assets and cost of total interest-bearing liabilities and the net interest margin between yield on total assets and the cost of total liabilities and capital (dollars in millions).
                                                 
    For the Nine Months Ended     For the Nine Months Ended  
    September 30, 2009     September 30, 2008  
                    Interest                     Interest  
    Average             Income/     Average             Income/  
    Balance 1     Yield/Cost     Expense     Balance 1     Yield/Cost     Expense  
Interest-earning assets
                                               
Interest-bearing deposits
  $ 121       0.37 %   $ 0.3     $ 3       2.45 %   $ 0.1  
Securities purchased under agreements to resell
    1,239       0.18       1.6                    
Federal funds sold
    6,262       0.33       15.6       3,557       2.43       64.7  
Short-term investments2
    713       0.51       2.7       558       2.61       10.9  
Mortgage-backed securities2
    9,239       2.20       152.2       7,996       3.95       236.5  
Other investments2
    5,809       1.59       69.0       82       5.99       3.7  
Advances3
    38,258       1.89       541.9       45,595       3.20       1,091.4  
Mortgage loans4
    9,662       4.83       349.0       10,660       5.01       399.8  
Loans to other FHLBanks
                      18       0.69       0.1  
 
                                   
Total interest-earning assets
    71,303       2.12       1,132.3       68,469       3.53       1,807.2  
Noninterest-earning assets
    146                   211              
 
                                   
Total assets
  $ 71,449       2.12 %   $ 1,132.3     $ 68,680       3.51 %   $ 1,807.2  
 
                                   
 
                                               
Interest-bearing liabilities
                                               
Deposits
  $ 1,291       0.21 %   $ 2.1     $ 1,302       2.11 %   $ 20.6  
Consolidated obligations
                                               
Discount notes
    23,527       0.72       126.5       27,177       2.41       490.8  
Bonds
    42,303       2.76       873.0       36,218       3.97       1,075.4  
Other interest-bearing liabilities
    45       0.65       0.2       82       4.95       3.0  
 
                                   
Total interest-bearing liabilities
    67,166       1.99       1,001.8       64,779       3.28       1,589.8  
Noninterest-bearing liabilities
    1,038                   608              
 
                                   
Total liabilities
    68,204       1.96       1,001.8       65,387       3.25       1,589.8  
Capital
    3,245                   3,293              
 
                                   
Total liabilities and capital
  $ 71,449       1.87 %   $ 1,001.8     $ 68,680       3.09 %   $ 1,589.8  
 
                                   
 
                                               
Net interest income and spread
            0.13 %   $ 130.5               0.25 %   $ 217.4  
 
                                       
 
                                               
Net interest margin
            0.25 %                     0.42 %        
 
                                           
 
                                               
Average interest-earning assets to interest-bearing liabilities
            106.16 %                     105.70 %        
 
                                           
 
                                               
Composition of net interest income
                                               
Asset-liability spread
            0.16 %   $ 82.8               0.26 %   $ 137.3  
Earnings on capital
            1.96 %     47.7               3.25 %     80.1  
 
                                           
Net interest income
                  $ 130.5                     $ 217.4  
 
                                           
     
1   Average balances do not reflect the effect of derivative master netting arrangements with counterparties.
 
2   The average balance of available-for-sale securities is reflected at amortized cost; therefore the resulting yields do not give effect to changes in fair value.
 
3   Advance interest income includes advance prepayment fee income of $6.7 million and $0.7 million for the nine months ended September 30, 2009 and 2008.
 
4   Nonperforming loans and loans held for sale are included in average balances used to determine average rate.

 

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Average assets decreased $7.2 billion to $67.9 billion during the three months ended September 30, 2009 when compared to the same period in 2008. The decrease was primarily attributable to decreased average advances resulting from decreased member demand as well as decreased average mortgage loans resulting from the mortgage loan sale transaction. The decrease was partially offset by increased average investments. Average assets increased $2.8 billion to $71.4 billion during the nine months ended September 30, 2009 when compared to the same period in 2008. The increase was primarily attributable to increased average investments resulting from the Bank’s efforts to replace mortgage assets sold and improve investment income, partially offset by decreased average advances and mortgage loans. See “Asset-Liability Spread” at page 74 for further discussion.
Average liabilities decreased $7.0 billion to $64.5 billion and increased $2.8 billion to $68.2 billion during the three and nine months ended September 30, 2009 when compared to the same periods in 2008. The decrease during the three months ended September 30, 2009 was primarily attributable to decreased average discount notes as a result of decreased average short-term advances. The increase during the nine months ended September 30, 2009 was primarily attributable to increased average bonds as a result of increased average investments. Due to improved market conditions during the third quarter of 2009, the Bank began issuing bonds rather than discount notes to fund its longer-term assets.
Average capital decreased $171 million and $48 million during the three and nine months ended September 30, 2009 compared to the same periods in 2008. Average capital levels were higher during the three and nine months ended September 30, 2008 due to higher advance balances and therefore higher levels of activity-based capital stock supporting those balances. The decrease was partially offset by decreased average unrealized losses on available-for-sale securities recorded in accumulated other comprehensive loss and increased average retained earnings during the three and nine months ended September 30, 2009.

 

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Our net interest income is affected by changes in the dollar volumes of our interest-earning assets and interest-bearing liabilities and changes in the average rates of those assets and liabilities. The following table presents the changes in interest income and interest expense. Changes that cannot be attributed to either rate or volume have been allocated to the rate and volume variances based on relative size (dollars in millions).
                                                 
    Variance For the Three Months Ended     Variance For the Nine Months Ended  
    September 30, 2009 vs. September 30, 2008     September 30, 2009 vs. September 30, 2008  
    Total Increase     Total     Total Increase     Total  
    (Decrease) Due to     Increase     (Decrease) Due to     Increase  
    Volume     Rate     (Decrease)     Volume     Rate     (Decrease)  
Interest income
                                               
Interest-bearing deposits
  $ 0.1     $     $ 0.1     $ 0.3     $ (0.1 )   $ 0.2  
Securities purchased under agreements to resell
    0.4             0.4       1.6             1.6  
Federal funds sold
    4.6       (20.5 )     (15.9 )     29.3       (78.4 )     (49.1 )
Short-term investments
    0.6       (1.9 )     (1.3 )     2.4       (10.6 )     (8.2 )
Mortgage-backed securities
    (2.1 )     (35.4 )     (37.5 )     32.5       (116.8 )     (84.3 )
Other investments
    26.5       (1.7 )     24.8       70.0       (4.7 )     65.3  
Advances
    (86.7 )     (132.9 )     (219.6 )     (155.1 )     (394.4 )     (549.5 )
Mortgage loans
    (31.2 )     (6.7 )     (37.9 )     (36.7 )     (14.1 )     (50.8 )
Loans to other FHLBanks
    (0.1 )           (0.1 )     (0.1 )           (0.1 )
 
                                   
Total interest income
    (87.9 )     (199.1 )     (287.0 )     (55.8 )     (619.1 )     (674.9 )
 
                                               
Interest expense
                                               
Deposits
    0.1       (5.2 )     (5.1 )     (0.2 )     (18.3 )     (18.5 )
Consolidated obligations
                                               
Discount notes
    (51.5 )     (102.9 )     (154.4 )     (58.5 )     (305.8 )     (364.3 )
Bonds
    43.6       (149.3 )     (105.7 )     161.0       (363.4 )     (202.4 )
Other interest-bearing liabilities
    (0.1 )     (0.1 )     (0.2 )     (0.9 )     (1.9 )     (2.8 )
 
                                   
Total interest expense
    (7.9 )     (257.5 )     (265.4 )     101.4       (689.4 )     (588.0 )
 
                                   
 
Net interest income
  $ (80.0 )   $ 58.4     $ (21.6 )   $ (157.2 )   $ 70.3     $ (86.9 )
 
                                   
The two components of the Bank’s net interest income are earnings from our asset-liability spread and earnings on capital. See further discussion in “Asset-Liability Spread” and “Earnings on Capital” at pages 74 and 75.
The yield on total interest-earning assets and cost of interest-bearing liabilities are impacted by our use of derivatives to adjust the interest rate sensitivity of assets and liabilities. For the net effect of the Bank’s hedging activities by product on net income see “Hedging Activities” at page 78.

 

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Asset-Liability Spread
Asset-liability spread income decreased $9.1 million and $54.5 million during the three and nine months ended September 30, 2009 compared with the same periods in 2008. The Bank’s asset-liability spread income was impacted by the following:
    Interest income on the Bank’s advance portfolio (including advance prepayment fees, net) decreased $219.6 million or 59 percent and $549.5 million or 50 percent during the three and nine months ended September 30, 2009 compared to the same periods in 2008 primarily due to lower interest rates. In addition, average advance volumes decreased $14.4 billion or 28 percent and $7.3 billion or 16 percent during the three and nine months ended September 30, 2009 compared to the same periods in 2008 due to the availability of alternative wholesale funding options for member banks as well as increased deposit growth realized by many members.
    Interest expense on the Bank’s discount notes decreased $154.4 million or 89 percent and $364.3 million or 74 percent during the three and nine months ended September 30, 2009 compared to the same periods in 2008 primarily due to lower interest rates. In addition, average discount note volumes decreased $12.6 billion or 41 percent and $3.7 billion or 13 percent during the three and nine months ended September 30, 2009 compared to the same periods in 2008. Discount note volumes declined as a result of the Bank not replacing maturing discount notes due to decreased short-term funding needs as well as the ability to fund longer-term during the three months ended September 30, 2009.
    Interest expense on the Bank’s bonds decreased $105.7 million or 30 percent and $202.4 million or 19 percent during the three and nine months ended September 30, 2009 compared to the same periods in 2008 primarily due to lower interest rates, partially offset by increased average bond volumes. Capitalizing on the lower interest rates, the Bank also extinguished debt during the three and nine months ended September 30, 2009. A portion of the extinguished debt was replaced with lower costing debt thereby lowering interest costs. Average bond volumes increased during the three and nine months ended September 30, 2009 compared to the same periods in 2008 as a result of increased funding needs due to increased average investments. Additionally, due to improved market conditions during the third quarter of 2009, the Bank was able to issue longer-term bonds rather than discount notes to fund its longer-term assets.
    Interest income on the Bank’s mortgage-backed securities (MBS) decreased $37.5 million or 44 percent and $84.3 million or 36 percent during the three and nine months ended September 30, 2009 compared to the same periods in 2008 primarily due to lower interest rates. At September 30, 2009, $6.6 billion or 71 percent of the Bank’s MBS portfolio was variable rate. As interest rates decline, so will the associated interest income on the variable rate MBS.

 

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    Interest income on the Bank’s other investments increased $24.8 million and $65.3 million during the three and nine months ended September 30, 2009 when compared to the same periods in 2008 primarily due to the Bank purchasing additional investments during the nine months ended September 30, 2009 in an effort to improve investment income and replace mortgage assets. During the nine months ended September 30, 2009 the Bank purchased $2.7 billion of U.S. Treasury obligations, $4.2 billion of TLGP securities, $0.7 billion of TVA and FFCB bonds, and $0.2 billion of taxable municipal bonds.
    Interest income on the Bank’s mortgage loans decreased $37.9 million or 28 percent and $50.8 million or 13 percent during the three and nine months ended September 30, 2009 compared to the same periods in 2008 primarily due to lower volumes resulting from the sale of mortgage loans during the second quarter of 2009 as well as payoffs exceeding originations.
    Interest income on the Bank’s Federal funds sold decreased $15.9 million or 87 percent and $49.1 million or 76 percent during the three and nine months ended September 30, 2009 compared to the same periods in 2008 primarily due to lower interest rates, partially offset by increased average Federal funds sold volumes.
Earnings on Capital
We invest our capital to generate earnings, generally for the same repricing maturity as the assets being supported. Earnings on capital decreased $12.5 million and $32.4 million during the three and nine months ended September 30, 2009 compared with the same periods in 2008 primarily due to the lower interest rate environment as well as the availability of attractive investment opportunities. As short-term interest rates have declined and investment opportunities were limited, the earnings contribution from capital decreased. In addition, average capital balances decreased $171 million and $48 million during the three and nine months ended September 30, 2009 when compared to the same periods in 2008.

 

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Other Income (Loss)
The following table presents the components of other income (loss) (dollars in millions):
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2009     2008     2009     2008  
 
                               
Service fees
  $ 0.4     $ 0.5     $ 1.6     $ 1.7  
Net realized and unrealized (loss) gain on trading securities
    (1.7 )           52.1        
Net gain (loss) on sale of available-for-sale securities
    31.1             (11.7 )      
Net loss on bonds held at fair value
    (3.2 )           (15.4 )      
Net gain on loans held for sale
                1.3        
Net gain (loss) on derivatives and hedging activities
    1.9       (2.1 )     98.3       (12.5 )
(Loss) gain on extinguishment of debt
    (28.5 )           (80.9 )     0.2  
Other, net
    1.5       (5.0 )     3.9       (3.7 )
 
                       
 
                               
Total other income (loss)
  $ 1.5     $ (6.6 )   $ 49.2     $ (14.3 )
 
                       
Other income (loss) can be volatile from period to period depending on the type of financial activity recorded. During the three and nine months ending September 30, 2009 other income (loss) was impacted by the sale of U.S. Treasury obligations and the termination of the related interest rate swaps, debt extinguishments, net realized and unrealized (loss) gain on trading securities, and net losses on bonds held at fair value.

 

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During the three and nine months ended September 30, 2009 the Bank purchased and sold 30-year U.S. Treasury obligations on three separate occasions. On each occasion, the Bank entered into interest rate swaps to convert the fixed rate investments to floating rate. The relationships were accounted for as a fair value hedge relationship with changes in LIBOR (benchmark interest rate) reported as hedge ineffectiveness through “net gain (loss) on derivative and hedging activities.” The Bank sold these securities and terminated the related interest rate swaps. The impact of the sale of the securities was accounted for through “net gain (loss) on sale of available-for-sale securities” and the impact of the termination of the swaps was accounted for through “net gain (loss) on derivatives and hedging activities”. The impact of each of the sales of U.S. Treasury obligations and termination of the related interest rate swaps are summarized as follows:
    In June 2009 the Bank sold $800.0 million of U.S. Treasury obligations and terminated the related interest rate swaps resulting in a $90.1 million gain on the termination of the related interest rate swaps and a $42.8 million loss on the sale of the available-for-sale securities. In addition, the Bank realized $14.3 million in hedge ineffectiveness losses. The overall impact of this transaction was a net gain of $33.0 million.
 
    In July 2009 the Bank sold $900.0 million of U.S. Treasury obligations and terminated the related interest rate swaps resulting in a $11.8 million loss on the termination of the related interest rate swaps and a $26.1 million gain on the sale of the available-for-sale securities. In addition, the Bank realized $1.3 million in hedge ineffectiveness losses. The overall impact of this transaction was a net gain of $13.0 million.
 
    In September 2009 the Bank sold $1.0 billion of U.S. Treasury obligations and terminated the related interest rate swaps resulting in a $18.4 million gain on the termination of the related interest rate swaps and a $5.0 million gain on the sale of the available-for-securities. In addition, the Bank realized $1.5 million in hedge ineffectiveness gains. The overall impact of this transaction was a net gain of $24.9 million.
Based on the above details the Bank recorded a net gain on the sale of available-for-sale securities of $31.1 million during the three months ended September 30, 2009 and a net loss of $11.7 million during the nine months ended September 30, 2009. In addition, the termination of the related interest rate swaps and the ineffectiveness resulted in a total net gain on derivatives and hedging activities of $6.8 million and $82.6 million for the three and nine months ended September 30, 2009.
The Bank extinguished bonds with a total par value of $266.8 million and $853.3 million during the three and nine months ended September 30, 2009 as a result of its desire to reduce future interest costs, the mortgage loan sale transaction during the second quarter of 2009, and mortgage prepayments. This resulted in losses of $28.5 million and $80.9 million during the three and nine months ended September 30, 2009. These losses exclude net losses on basis adjustment amortization of $1.2 million and net gains on basis adjustment accretion of $4.5 million recorded in net interest income for the three and nine months ended September 30, 2009. As a result, total net losses on extinguishment of debt totaled $29.7 million and $76.4 million during the three and nine months ended September 30, 2009.

 

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The trading securities consist of TLGP and taxable municipal bonds. During the third quarter of 2009, the Bank recorded unrealized losses on TLGP due to a decline in investor demand as the programs issuance deadline of October 31, 2009 approached. These losses were partially offset by unrealized gains in taxable municipal bonds. During the nine months ended September 30, 2009 the Bank recorded gains of $52.1 million primarily due to gains on TLGP driven by favorable spreads.
Finally, net losses on bonds held at fair value were primarily attributable to an increase in the Federal funds interest rate during the three and nine months ended September 30, 2009. These losses were offset by gains on interest rate swaps being used to hedge the bonds recorded as a component of “net gains (losses) on derivative and hedging activities” in other income (loss).
Hedging Activities
If a hedging activity qualifies for hedge accounting treatment, the Bank includes the periodic cash flow components of the hedging instrument related to interest income or expense in the relevant income statement caption consistent with the hedged asset or liability. In addition, the Bank reports as a component of other income (loss) in “Net gain (loss) on derivatives and hedging activities”, the fair value changes of both the hedging instrument and the hedged item. The Bank records the amortization of certain upfront fees received on interest rate swaps and cumulative fair value adjustments from terminated hedges in interest income or expense.
If a hedging activity does not qualify for hedge accounting treatment, the Bank reports the hedging instrument’s components of interest income and expense, together with the effect of changes in fair value in other income (loss); however, there is no corresponding fair value adjustment for the hedged asset or liability.
As a result, accounting for derivatives and hedging activities affects the timing of income recognition and the effect of certain hedging transactions are spread throughout the income statement in net interest income and other income (loss).

 

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The following tables categorize the net effect of hedging activities on net income by product (dollars in millions). The table excludes the interest component on derivatives that qualify for hedge accounting as this amount will be offset by the interest component on the hedged item within net interest income. Because the purpose of the hedging activity is to protect net interest income against changes in interest rates, the absolute increase or decrease of interest income from interest-earning assets or interest expense from interest-bearing liabilities is not as important as the relationship of the hedging activities to overall net income.
                                                 
    Three Months Ended September 30, 2009  
Net effect of                   Mortgage     Consolidated     Balance        
Hedging Activities   Advances     Investments     Assets     Obligations     Sheet     Total  
 
                                               
Net (amortization)\ accretion
  $ (12.3 )   $     $ (0.4 )   $ 9.3     $     $ (3.4 )
 
                                   
 
Net realized and unrealized gains on derivatives and hedging activities
    0.8       7.8             0.3             8.9  
(Losses) Gains — Economic Hedges
    (0.4 )     (15.2 )     (0.2 )     7.0       1.8       (7.0 )
 
                                   
Reported in Other Income (Loss)
    0.4       (7.4 )     (0.2 )     7.3       1.8       1.9  
 
                                   
 
Total
  $ (11.9 )   $ (7.4 )   $ (0.6 )   $ 16.6     $ 1.8     $ (1.5 )
 
                                   
                                                 
    Three Months Ended September 30, 2008  
Net effect of                   Mortgage     Consolidated     Balance        
Hedging Activities   Advances     Investments     Assets     Obligations     Sheet     Total  
 
                                               
Net (amortization)\ accretion
  $ (17.8 )   $     $ (0.4 )   $ 14.6     $     $ (3.6 )
 
                                   
 
Net realized and unrealized (losses) gains on derivatives and hedging activities
    (0.6 )                 1.2             0.6  
Gains (Losses) — Economic Hedges
    5.6             1.0       (4.3 )     (5.0 )     (2.7 )
 
                                   
Reported in Other Income (Loss)
    5.0             1.0       (3.1 )     (5.0 )     (2.1 )
 
                                   
 
Total
  $ (12.8 )   $     $ 0.6     $ 11.5     $ (5.0 )   $ (5.7 )
 
                                   

 

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    Nine Months Ended September 30, 2009  
Net effect of                   Mortgage     Consolidated     Balance        
Hedging Activities   Advances     Investments     Assets     Obligations     Sheet     Total  
 
                                               
Net (amortization)\ accretion
  $ (43.8 )   $     $ (1.3 )   $ 23.8     $     $ (21.3 )
 
                                   
 
Net realized and unrealized gains on derivatives and hedging activities
    3.0       82.4             10.0             95.4  
(Losses) Gains — Economic Hedges
    (0.7 )     (15.2 )     (2.2 )     10.1       10.9       2.9  
 
                                   
Reported in Other Income (Loss)
    2.3       67.2       (2.2 )     20.1       10.9       98.3  
 
                                   
 
Total
  $ (41.5 )   $ 67.2     $ (3.5 )   $ 43.9     $ 10.9     $ 77.0  
 
                                   
                                                 
    Nine Months Ended September 30, 2008  
Net effect of                   Mortgage     Consolidated     Balance        
Hedging Activities   Advances     Investments     Assets     Obligations     Sheet     Total  
 
                                               
Net (amortization)\ accretion
  $ (25.8 )   $     $ (1.4 )   $ 14.8     $     $ (12.4 )
 
                                   
 
Net realized and unrealized losses on derivatives and hedging activities
    (0.2 )                 (0.6 )           (0.8 )
Gains (Losses) — Economic Hedges
    3.0             (0.5 )     (5.7 )     (8.5 )     (11.7 )
 
                                   
Reported in Other Income (Loss)
    2.8             (0.5 )     (6.3 )     (8.5 )     (12.5 )
 
                                   
 
Total
  $ (23.0 )   $     $ (1.9 )   $ 8.5     $ (8.5 )   $ (24.9 )
 
                                   

 

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Net amortization/accretion. The effect of hedging on net amortization/accretion varies from period to period depending on the Bank’s activities, including terminating hedge relationships to manage our risk profile and the amount of upfront fees received or paid on derivative transactions. During the three months ended September 30, 2008, the Bank voluntarily terminated certain interest rate swaps that were being used to hedge both advances and consolidated obligations in an effort to reduce the Bank’s counterparty risk profile. This termination activity resulted in basis adjustments that are amortized/accreted level-yield over the remaining life of the advance or consolidated obligation. As a result, basis adjustment amortization/accretion was higher for both advances and consolidated obligations for the three months ended September 30, 2008 when compared to the same period in 2009. During the nine months ended September 30, 2009 advance basis adjustment amortization increased compared with the same period in 2008 primarily due to normal amortization of advance basis adjustments created during the latter half of 2008. Consolidated obligation basis adjustment accretion increased as a result of the Bank extinguishing debt during the nine months ended September 30, 2009.
Net realized and unrealized gains (losses) on derivatives and hedging activities. Hedge ineffectiveness occurs when changes in fair value of the derivative and the related hedged item do not perfectly offset each other. Hedge ineffectiveness is driven by changes in the benchmark interest rate and volatility. As the benchmark interest rate changes and the magnitude of that change intensifies, so will the impact on the Bank’s net realized and unrealized gains (losses) on derivatives and hedging activities. Additionally, volatility in the marketplace may intensify this impact. Hedge ineffectiveness gains (losses) during the three and nine months ended September 30, 2009 was primarily due to investment hedge relationships. During the three and nine months ended September 30, 2009 the Bank sold $1.9 billion and $2.7 billion of U.S. Treasury obligations and terminated the related interest rate swaps recognizing gains on the derivative termination of $6.6 million and $96.7 million. In addition, the Bank recognized ineffectiveness gains of $0.2 million during the three months ended September 30, 2009 and ineffectiveness losses of $14.1 during the nine months ended September 30, 2009. For additional information about the Bank’s sale of U.S. Treasury obligations and termination of the related interest rate swaps, see “Other Income (Loss) at page 76.

 

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(Losses) Gains — Economic Hedges. During the three and nine months ended September 30, 2009, economic hedges were primarily used to manage interest rate and prepayment risks in our balance sheet. Changes in (losses) gains on economic hedges are primarily driven by the Bank’s use of economic hedges due to changes in our balance sheet profile, changes in interest rates and volatility, and the loss of hedge accounting for certain hedge relationships failing retrospective hedge effectiveness testing. Economic hedges do not qualify for hedge accounting and as a result the Bank records a fair market value gain or loss on the derivative instrument without recording the corresponding loss or gain on the hedged item. In addition, the interest accruals on the hedges are recorded as a component of other income (loss) instead of a component of net interest income. (Losses) gains on economic hedges were impacted by the following events during the three and nine months ended September 30, 2009 when compared with the same periods in 2008:
    Consolidated obligation economic hedge gains/losses was primarily impacted by economic hedges on fair value option bonds as well as the effect of failed retrospective hedge effectiveness tests. The Bank had economic hedges protecting against changes in the fair value of variable interest rate bonds indexed to the Federal funds interest rate. During the three and nine months ended September 30, 2009 the Bank recorded $2.6 million and $15.9 million in gains related to these economic hedges. These gains were partially offset by losses on the variable interest rate bonds, as the Bank elected the fair value option, of $3.2 million and $15.4 million reported in “Net loss on bonds held at fair value” in other income (loss) in the Statements of Income. Additionally, the Bank performs a retrospective hedge effectiveness test at least quarterly. If a hedge relationship fails this test, the Bank can no longer receive hedge accounting and the derivative is accounted for as an economic hedge. Due to volatility in the market, the Bank experienced increased losses related to consolidated obligation hedging relationships failing the retrospective hedge effectiveness tests.
    The Bank held interest rate swaps on its balance sheet as economic hedges against adverse changes in the fair value for a portion of its trading securities indexed to LIBOR. During the three and nine months ended September 30, 2009 the Bank experienced $12.7 million and $11.2 million in losses related to these economic hedges. These losses were partially offset by unrealized gains on the trading securities of $9.3 million and $17.2 million.
    The Bank held interest rate caps on its balance sheet as economic hedges to protect against increases in interest rates. Due to volatility in the market, the Bank recorded $1.8 million and $10.9 million in gains on these derivatives during the three and nine months ended September 30, 2009.

 

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Net Interest Income by Segment
The Bank’s segment results are analyzed on an adjusted net interest income basis. Adjusted net interest income is net interest income adjusted for basis adjustment amortization/accretion on called and extinguished debt included in interest expense, economic hedging costs included in other income (loss), and concession expense on fair value option bonds included in other expense.
The following shows the Bank’s financial performance by operating segment and a reconciliation of financial performance to net interest income for the three months ended September 30, 2009 and 2008 (dollars in millions):
                 
    Three Months Ended
September 30,
 
    2009     2008  
Adjusted net interest income after mortgage loan credit loss provision
               
 
               
Member Finance
  $ 45.6     $ 43.4  
Mortgage Finance
    15.1       36.9  
 
           
 
Total
  $ 60.7     $ 80.3  
 
           
 
               
Reconciliation of the Bank’s operating segment results to net interest income
               
 
               
Adjusted net interest income after mortgage loan credit loss provision
  $ 60.7     $ 80.3  
Interest expense on basis adjustment accretion (amortization) of called debt
    0.1       (0.4 )
Interest expense on basis adjustment amortization of extinguished debt
    (1.2 )      
Net interest income on economic hedges
    (1.5 )     (0.2 )
 
           
 
               
Net interest income after mortgage loan credit loss provision
  $ 58.1     $ 79.7  
 
           
 
               
Other income (loss)
    1.5       (6.6 )
Other expense
    11.3       10.8  
 
           
 
               
Income before assessments
  $ 48.3     $ 62.3  
 
           

 

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The following shows the Bank’s financial performance by operating segment and a reconciliation of financial performance to net interest income for the nine months ended September 30, 2009 and 2008 (dollars in millions):
                 
    Nine Months Ended
September 30,
 
    2009     2008  
Adjusted net interest income after mortgage loan credit loss provision
               
 
               
Member Finance
  $ 92.4     $ 137.4  
Mortgage Finance
    57.3       88.5  
 
           
 
               
Total
  $ 149.7     $ 225.9  
 
           
 
               
Reconciliation of the Bank’s operating segment results to net interest income
               
 
               
Adjusted net interest income after mortgage loan credit loss provision
  $ 149.7     $ 225.9  
Interest expense on basis adjustment amortization of called debt
    (17.8 )     (10.8 )
Interest expense on basis adjustment accretion of extinguished debt
    4.5        
Concession expense on fair value option bonds
    *        
Net interest (income) expense on economic hedges
    (6.2 )     2.3  
 
           
 
               
Net interest income after mortgage loan credit loss provision
  $ 130.2     $ 217.4  
 
           
 
               
Other income (loss)
    49.2       (14.3 )
Other expense
    35.8       32.8  
 
           
 
               
Income before assessments
  $ 143.6     $ 170.3  
 
           
     
*   Amount is less than $0.1 million.
The Bank’s adjusted net interest income was approximately $60.7 million and $149.7 million for the three and nine months ended September 30, 2009 compared to unadjusted net interest income of $58.1 million and $130.2 million for the same periods. The difference between the adjusted net interest income and the Bank’s reported net interest income is due to the adjustments reflected above. These adjustments primarily impacted the Mortgage Finance segment as described in the following paragraphs.

 

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Member Finance. Member Finance adjusted net interest income increased $2.2 million and decreased $45.0 million during the three and nine months ended September 30, 2009 when compared with the same periods in 2008. The increase during the three months ended September 30, 2009 was primarily attributable to an increase in non-MBS investments. The decrease during the nine months ended September 30, 2009 was primarily attributable to the decreased interest rate environment, partially offset by increased average assets. The segment’s average assets increased $2.5 billion to $52.5 billion during the nine months ended September 30, 2009 when compared to the same period in 2008 primarily due to the purchase of non-MBS investments, including TLGP debt, Federal funds sold, U.S. Treasury obligations, taxable municipal bonds, and resale agreements. The Bank increased its investment purchases in an effort to improve investment income and replace mortgage assets. In addition, during the nine months ended September 30, 2009, the Bank used a portion of the proceeds from the mortgage loan sale to purchase TVA and FFCB bonds. The purchase of these investments resulted in the Bank transferring a portion of its assets from the Mortgage Finance segment to the Member Finance segment in order to be consistent with its segment methodology. The Bank expects increased future investment income in the Member Finance segment as a result of this asset transfer.
Mortgage Finance. Mortgage Finance adjusted net interest income decreased $21.8 million and $31.2 million during the three and nine months ended September 30, 2009 when compared with the same periods in 2008. The decrease was primarily attributable to the decreased interest rate environment as well as the sale of mortgage loans during the second quarter of 2009. During the nine months ended September 30, 2009, the Bank used a portion of the proceeds from the mortgage loan sale to purchase multi-family agency MBS classified as available-for-sale.
As reflected in the Member Finance segment above, the Bank used a portion of the proceeds from the mortgage loan sale to purchase TVA and FFCB bonds. Since these bonds were recorded under the Member Finance segment, the Bank experienced lower Mortgage Finance income during the third quarter of 2009 as a result of both decreased asset balances and decreased yield.
During the nine months ended September 30, 2009, the Mortgage Finance segment was materially impacted by basis adjustments on called debt. The Bank called $1.2 billion of higher cost par value bonds and consequently amortized $17.2 million of basis adjustment expense related to the outstanding bonds during the nine months ended September 30, 2009. A portion of these bonds was called and not replaced due to mortgage prepayments experienced during the nine months ended September 30, 2009 and the sale of mortgage loans during the second quarter of 2009. A portion was replaced with lower cost debt and will therefore provide future cost savings that will offset the current expense recognized.
Additionally, adjusted net interest income eliminates the impact of basis adjustments on extinguished debt as it is offset by losses recorded in other income (loss). The Bank recognized net losses of approximately $29.7 million and $76.4 million on these extinguishments during the three and nine months ended September 30, 2009. The Bank expects such losses to be offset in future periods by improved earnings as a result of lower debt costs.

 

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Statements of Condition at September 30, 2009 and December 31, 2008
Financial Highlights
The Bank’s total assets decreased four percent to $65.4 billion at September 30, 2009 from $68.1 billion at December 31, 2008. Total liabilities decreased five percent to $62.0 billion at September 30, 2009 from $65.1 billion at December 31, 2008. Total capital increased twelve percent to $3.4 billion at September 30, 2009 from $3.0 billion at December 31, 2008. The overall financial condition for the periods presented has been influenced by changes in investment purchases, changes in member advances, the sale of mortgage loans, funding activities, and the temporary discontinuation of voluntarily repurchasing excess capital stock. See further discussion of changes in the Bank’s financial condition in the appropriate sections that follow.
Advances
At September 30, 2009, advances totaled $36.3 billion, which is a 13 percent decrease from $41.9 billion at December 31, 2008. The decrease is primarily due to the availability of alternative wholesale funding options for member banks as well as increased deposit growth realized by many members. This has driven demand for the Bank’s advances down and allowed members to prepay their advances. During the three and nine months ended September 30, 2009 members prepaid approximately $1.4 billion and $4.0 billion of advances. A portion of the decrease in advances was offset by the Bank offering unique funding opportunities to its members during the three and nine months ended September 30, 2009. These unique funding opportunities increase advance demand for the Bank and allow members to borrow from the Bank at a discounted rate for a particular advance product.
The FHLBank Act requires the Bank to obtain sufficient collateral on advances to protect against losses. The Bank has never experienced a credit loss on an advance to a member or eligible housing associate. Bank management has policies and procedures in place to appropriately manage this credit risk. Accordingly, the Bank has not provided any allowance for losses on advances. See additional discussion regarding our collateral requirements in the “Advances” section within “Risk Management” at page 119.

 

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The composition of our advances based on remaining term to scheduled maturity was as follows (dollars in millions):
                                 
    September 30, 2009     December 31, 2008  
            Percent of             Percent of  
    Amount     Total     Amount     Total  
Simple fixed rate advances
                               
Overdrawn demand deposit accounts
  $ *       * %   $ 1       * %
One month or less
    710       2.0       2,852       7.0  
Over one month through one year
    5,603       15.8       5,220       12.8  
Greater than one year
    10,186       28.8       10,108       24.9  
 
                       
 
    16,499       46.6       18,181       44.7  
Simple variable rate advances
                               
One month or less
                4       *  
Over one month through one year
    552       1.6       418       1.1  
Greater than one year
    3,510       9.9       4,560       11.2  
 
                       
 
    4,062       11.5       4,982       12.3  
 
                               
Callable advances
                               
Fixed rate
    272       0.7       262       0.6  
Variable rate
    5,672       16.0       7,527       18.5  
Putable advances
                               
Fixed rate
    7,371       20.8       8,122       20.0  
Community investment advances
                               
Fixed rate
    982       2.7       1,000       2.5  
Variable rate
    97       0.3       104       0.3  
Callable — fixed rate
    60       0.2       62       0.1  
Putable — fixed rate
    423       1.2       423       1.0  
 
                       
Total par value
    35,438       100.0 %     40,663       100.0 %
 
                               
Hedging fair value adjustments
                               
Cumulative fair value gain
    757               1,082          
Basis adjustments from terminated and ineffective hedges
    108               152          
 
                           
 
                               
Total advances
  $ 36,303             $ 41,897          
 
                           
     
*   Amount is less than one million or 0.1 percent.
Cumulative fair value gains decreased $325 million at September 30, 2009 when compared to December 31, 2008. Substantially all of the cumulative fair value gains on advances are offset by the net estimated fair value losses on the related derivative contracts. Basis adjustments decreased $44 million at September 30, 2009 when compared to December 31, 2008 due to normal amortization of basis adjustments created during the latter half of 2008. For additional details see the “Derivatives” section at page 96.

 

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The following tables show advance balances for our five largest member borrowers (dollars in millions):
                                 
                    September 30,     Percent of  
                    2009     Total  
Name   City   State     Advances1     Advances  
 
                               
Transamerica Life Insurance Company2
  Cedar Rapids   IA   $ 5,450       15.4 %
Aviva Life and Annuity Company2
  Des Moines   IA     2,955       8.3  
TCF National Bank
  Sioux Falls   SD     2,450       6.9  
ING USA Annuity and Life Insurance Company
  Des Moines   IA     1,304       3.7  
Superior Guaranty Insurance Company3
  Minneapolis   MN     1,250       3.5  
 
                           
 
                    13,409       37.8  
 
                               
Housing associates
                    461       1.3  
All others
                    21,568       60.9  
 
                           
 
                               
Total advances (at par value)
                  $ 35,438       100.0 %
 
                           
                                 
                    December 31,     Percent of  
                    2008     Total  
Name   City   State     Advances1     Advances  
 
                               
Transamerica Life Insurance Company2
  Cedar Rapids   IA   $ 5,450       13.4 %
Aviva Life and Annuity Company2
  Des Moines   IA     3,131       7.7  
ING USA Annuity and Life Insurance Company
  Des Moines   IA     2,994       7.4  
TCF National Bank
  Wayzata   MN     2,475       6.1  
Superior Guaranty Insurance Company3
  Minneapolis   MN     2,250       5.5  
 
                           
 
                    16,300       40.1  
 
                               
Housing associates
                    302       0.7  
All others
                    24,061       59.2  
 
                           
 
                               
Total advances (at par value)
                  $ 40,663       100.0 %
 
                           
     
1   Amounts represent par value before considering unamortized commitment fees, premiums and discounts, and hedging fair value adjustments.
 
2   Transamerica Life Insurance Company and Aviva Life and Annuity Company have not signed new collateral maintenance agreements and therefore can not initiate new advances. At September 30, 2009 the remaining weighted average life of advances held by Transamerica Life Insurance Company and Aviva Life and Annuity Company was 5.25 years and 4.71 years. See additional discussion regarding our collateral agreements in the “Advances” section within “Risk Management” at page 119.
 
3   Superior Guaranty Insurance Company (Superior) is an affiliate of Wells Fargo Bank, N.A (Wells Fargo).

 

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Mortgage Loans
The following table shows information on mortgage loans held for portfolio (dollars in millions):
                 
    September 30,     December 31,  
    2009     2008  
Single family mortgages
               
Fixed rate conventional loans
               
Contractual maturity less than or equal to 15 years
  $ 1,972     $ 2,408  
Contractual maturity greater than 15 years
    5,480       7,845  
 
           
Subtotal
    7,452       10,253  
 
               
Fixed rate government-insured loans
               
Contractual maturity less than or equal to 15 years
    2       2  
Contractual maturity greater than 15 years
    381       421  
 
           
Subtotal
    383       423  
 
               
Total par value
    7,835       10,676  
 
               
Premiums
    55       86  
Discounts
    (55 )     (81 )
Basis adjustments from mortgage loan commitments
    4       4  
Allowance for credit losses
    (1 )     *  
 
           
 
               
Total mortgage loans held for portfolio, net
  $ 7,838     $ 10,685  
 
           
     
*   Amount is less than one million.
Mortgage loans decreased approximately $2.8 billion at September 30, 2009 when compared to December 31, 2008. The decrease was primarily due to the Bank selling $2.1 billion of mortgage loans to the FHLBank of Chicago, who immediately resold these loans to Fannie Mae during the second quarter of 2009.

 

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Excluding the mortgage loan sale transaction, mortgage loans decreased approximately $0.7 billion at September 30, 2009 when compared to December 31, 2008. This decrease in mortgage loans was driven by an increase in principal repayments, partially offset by an increase in originations. Total principal repayments amounted to $2.1 billion during the nine months ended September 30, 2009 as compared to $1.0 billion for the same period in 2008. Total originations amounted to $1.4 billion for the nine months ended September 30, 2009 compared to $0.8 billion for the same period in 2008. The increase in principal repayments and originations was a result of the decreased interest rate environment throughout the first half of 2009. During the third quarter of 2009, as interest rates increased and underwriting standards remained stringent, borrowers had less incentive to refinance, and as a result, the Bank experienced fewer principal repayments. The annualized weighted average pay-down rate for mortgage loans for the nine months ended September 30, 2009 was approximately 25 percent compared with 12 percent at September 30, 2008.
Mortgage loans acquired from members are concentrated primarily with Superior, an affiliate of Wells Fargo. At September 30, 2009 and December 31, 2008, mortgage loans acquired from Superior amounted to $4.6 billion and $7.9 billion, respectively. The decrease in mortgage loans held from Superior at September 30, 2009 when compared to December 31, 2008 was due to the mortgage loan sale transaction during the second quarter of 2009.
Effective February 26, 2009, the MPF program was expanded to include a new off-balance sheet product called MPF Xtra (MPF Xtra is a registered trademark of the FHLBank of Chicago). Under this product, the Bank assigns 100 percent of its interests in participating financial institution (PFI) master commitments to the FHLBank of Chicago. The FHLBank of Chicago then purchases mortgage loans from the Bank’s PFIs under the master commitments and sells those loans to Fannie Mae. Currently, only PFIs that retain servicing of their MPF loans are eligible for the MPF Xtra product. As of September 30, 2009, the FHLBank of Chicago had funded $96.0 million of MPF Xtra mortgage loans under the master commitments of the Bank’s PFIs. The Bank recorded approximately $21,000 and $44,000 in MPF Xtra fee income from the FHLBank of Chicago during the three and nine months ended September 30, 2009.
For additional discussion regarding the MPF credit risk sharing arrangements, see “Mortgage Assets” at page 121.

 

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Investments
The following table shows the book value of investments (dollars in millions):
                                 
    September 30, 2009     December 31, 2008  
            Percent of             Percent of  
    Amount     Total     Amount     Total  
Short-term investments
                               
Interest-bearing deposits
  $ 18       * %   $       %
Negotiable certificates of deposit
    450       2.2              
Federal funds sold
    4,485       21.2       3,425       22.3  
Commercial paper
                385       2.5  
 
                       
 
    4,953       23.4       3,810       24.8  
 
                               
Long-term investments
                               
Mortgage-backed securities
                               
Government-sponsored enterprise
    9,219       43.6       9,169       59.7  
U.S. government agency-guaranteed
    45       0.2       52       0.3  
MPF shared funding
    35       0.2       47       0.3  
Other
    36       0.2       39       0.3  
 
                       
 
    9,335       44.2       9,307       60.6  
 
                               
Non-mortgage-backed securities
                               
Interest-bearing deposits
    2       *              
Government-sponsored enterprise obligations
    779       3.7              
State or local housing agency obligations
    125       0.6       93       0.6  
TLGP
    5,680       26.9       2,152       14.0  
Taxable municipal bonds
    252       1.2              
Other
    8       *       7       *  
 
                       
 
    6,846       32.4       2,252       14.6  
 
                               
Total investments
  $ 21,134       100.0 %   $ 15,369       100.0 %
 
                       
 
                               
Investments as a percent of total assets
            32.3 %             22.6 %
 
                           
     
*   Amount is less than 0.1 percent.