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Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549



FORM 10-K


ý

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2009

OR

 

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM              TO              .

Commission file number: 000-51402

FEDERAL HOME LOAN BANK OF BOSTON
(Exact name of registrant as specified in its charter)

Federally chartered corporation
(State or other jurisdiction of
incorporation or organization)
  04-6002575
(I.R.S. Employer
Identification Number)

111 Huntington Avenue
Boston, Massachusetts
(Address of principal executive offices)

 


02199
(Zip Code)

(617) 292-9600
(Registrant's telephone number, including area code)

         Securities registered pursuant to Section 12(b) of the Act: None

         Securities registered pursuant to Section 12(g) of the Act:
Class B Stock, par value $100 per share



         Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o     No ý

         Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o    No ý

         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. Yes ý    No o

         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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o    No o

         Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

         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 ý
(Do not check if a
smaller reporting company)
  Smaller reporting company o

         Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o    No ý

         Registrant's stock is not publicly traded and is only issued to members of the registrant. Such stock is issued and redeemed at par value, $100 per share, subject to certain regulatory and statutory limits. At June 30, 2009 the aggregate par value of the stock held by members of the registrant was $3,706,351,500. As of February 28, 2010, we had 37,357,575 outstanding shares of common stock.

DOCUMENTS INCORPORATED BY REFERENCE

None


Table of Contents


Table of Contents

Description
   
   

PART I

       

ITEM 1.

 

BUSINESS

  1

ITEM 1A.

 

RISK FACTORS

  27

ITEM 1B.

 

UNRESOLVED STAFF COMMENTS

  38

ITEM 2.

 

PROPERTIES

  38

ITEM 3.

 

LEGAL PROCEEDINGS

  38

PART II

       

ITEM 4.

 

(REMOVED AND RESERVED)

  39

ITEM 5.

 

MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

  39

ITEM 6.

 

SELECTED FINANCIAL DATA

  41

ITEM 7.

 

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

  42

ITEM 7A.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

  120

ITEM 8.

 

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

  155

ITEM 9.

 

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

  156

ITEM 9A.

 

CONTROLS AND PROCEDURES

  157

ITEM 9B.

 

OTHER INFORMATION

  157

PART III

       

ITEM 10.

 

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

  157

ITEM 11.

 

EXECUTIVE COMPENSATION

  167

ITEM 12.

 

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

  185

ITEM 13.

 

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

  187

ITEM 14.

 

PRINCIPAL ACCOUNTING FEES AND SERVICES

  189

PART IV

       

ITEM 15.

 

EXHIBITS, FINANCIAL STATEMENT SCHEDULES

  190

Table of Contents


PART I

ITEM 1.    BUSINESS

General

        The Federal Home Loan Bank of Boston (the Bank) is a federally chartered corporation organized by Congress in 1932 and is a government-sponsored enterprise (GSE). The Bank is privately capitalized and its mission is to serve the residential-mortgage and community-development lending activities of its member institutions and housing associates located in the New England region. Altogether, there are 12 district Federal Home Loan Banks (FHLBanks) located across the United States (U.S.), each supporting the lending activities of member financial institutions within their specific regions. Each FHLBank is a separate entity with its own board of directors, management, and employees.

        Unless otherwise indicated or unless the context requires otherwise, all references in this discussion to "the Bank," "we," "us," "our" or similar references mean the Federal Home Loan Bank of Boston.

        The Bank combines private capital and public sponsorship that enables its member institutions and housing associates to assure the flow of credit and other services for housing and community development. The Bank serves the public through its member institutions and housing associates by providing these institutions with a readily available, low-cost source of funds, thereby enhancing the availability of residential-mortgage and community-investment credit. In addition, the Bank provides members a means of liquidity through a mortgage-loan finance program. Under this program, members are offered the opportunity to originate mortgage loans for sale to the Bank. The Bank's primary source of income is derived from the spread between interest-earning assets and interest-bearing liabilities. The Bank is generally able to borrow funds at favorable rates due to its GSE status.

        The Bank's members and housing associates are comprised of institutions located throughout the New England region. The region is comprised of Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, and Vermont. Institutions eligible for membership include thrift institutions (savings banks, savings and loan associations, and cooperative banks), commercial banks, credit unions, community development financial institutions (CDFIs), and insurance companies that are active in housing finance. The Bank is also authorized to lend to certain nonmember institutions (called housing associates) such as state housing-finance agencies located in New England. Members are required to purchase and hold the Bank's capital stock for advances and certain other activities transacted with the Bank. The par value of the Bank's capital stock is $100 per share and is not publicly traded on any stock exchange. The U.S. government does not guarantee either the member's investment in or any dividend on the Bank's stock. The Bank is capitalized by the capital stock purchased by its members and by retained earnings. Members may receive dividends, which are determined by the Bank's board of directors, and may redeem their capital stock at par value after satisfying certain requirements discussed further in Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Capital.

        The Federal Housing Finance Board (the Finance Board), an independent agency in the executive branch of the U.S. government, supervised and regulated the FHLBanks through July 29, 2008. With the passage of the Housing and Economic Recovery Act of 2008 (HERA), the newly-established, independent Federal Housing Finance Agency (the Finance Agency) became the new regulator of the FHLBanks, effective July 30, 2008. All existing regulations, orders, and decisions of the Finance Board remain in effect until modified or superseded. In accordance with HERA, the Finance Board was abolished one year after the date of enactment of HERA.

        The Office of Finance was established by the predecessor of the Finance Board to facilitate the issuing and servicing of debt in the form of consolidated obligations (COs) of the FHLBanks. COs are issued on a joint basis. The FHLBanks, through the Office of Finance as their agent, are the issuers of COs for which they are jointly and severally liable. The Office of Finance also provides the FHLBanks

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with credit and market data and maintains the FHLBanks' joint relationships with credit-rating agencies. Additionally, the Office of Finance manages the Resolution Funding Corporation (REFCorp) and Financing Corporation programs.

Available Information

        The Bank's web site (www.fhlbboston.com) provides a link to the section of the Electronic Data Gathering and Reporting (EDGAR) web site, as maintained by the Securities and Exchange Commission (the SEC), containing all reports electronically filed, or furnished, including the Bank's annual report on Form 10-K, the Bank's quarterly reports on Form 10-Q, and current reports on Form 8-K as well as any amendments to such reports. These reports are made available free of charge on the Bank's web site as soon as reasonably practicable after electronically filing or being furnished to the SEC. These reports may also be read and copied at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. Further information about the operation of the Public Reference Room may be obtained by calling 1-800-SEC-0330. In addition, the SEC maintains a web site that contains reports and other information regarding the Bank's electronic filings located at (http://www.sec.gov). The web site addresses of the SEC and the Bank have been included as inactive textual references only. Information on those web sites is not part of this report.

Employees

        As of February 28, 2010, the Bank had 182 full-time and one part-time employee.

Membership

        The Bank's members are financial institutions with their principal places of business located in the six New England states. The following table summarizes the Bank's membership, by type of institution, as of December 31, 2009, 2008, and 2007.

Membership Summary
Number of Members by Institution Type(1)

 
  December 31,  
 
  2009   2008   2007  

Commercial banks

    71     72     77  

Thrift institutions

    221     225     225  

Credit unions

    147     145     142  

Insurance companies

    23     19     13  
               

Total members

    462     461     457  
               

(1)
CDFIs have also become eligible for Bank membership as of February 4, 2010, pursuant to a Finance Agency regulation issued January 5, 2010. CDFIs are private institutions that provide financial services dedicated to economic development and community revitalization in underserved markets. For additional information, see Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Recent Legislative and Regulatory Developments.

        As of December 31, 2009, 2008, and 2007, approximately 76.0 percent, 80.3 percent, and 77.2 percent, respectively, of the Bank's members had outstanding advances from the Bank. These usage rates are calculated excluding housing associates and nonmember borrowers. While eligible to borrow, housing associates are not members of the Bank and, as such, are not required to hold capital stock. Nonmember borrowers consist of institutions that are former members or that have acquired

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former members and assumed the advances held by those former members. Nonmember borrowers are required to hold capital stock to support outstanding advances with the Bank until those advances either mature or are paid off, at which time the nonmember borrower's affiliation with the Bank is terminated. In addition, nonmember borrowers are required to deliver all required collateral to the Bank or the Bank's safekeeping agent until all outstanding advances either mature or are paid off. During the period that the advances remain outstanding, nonmember borrowers may not request new advances and are not permitted to extend or renew the assumed advances.

        The Bank's membership includes the majority of Federal Deposit Insurance Corporation (FDIC)-insured institutions and large credit unions in its district that are eligible to become members. The Bank does not anticipate that a substantial number of additional FDIC-insured institutions will become members. Many other eligible nonmembers, such as insurance companies, smaller credit unions, and CDFIs have thus far elected not to join the Bank.

        The Bank is managed with the primary objectives of enhancing the value of membership for member institutions and fulfilling its public purpose. The value of membership includes access to readily available credit from the Bank, the value of the cost differential between Bank advances and other potential sources of funds, and rights to any dividends declared on members' investment in the Bank's capital stock.

Business Segments

        The Bank has identified two main operating business segments: traditional business activities and mortgage-loan finance, which are further described below. The products and services provided reflect the manner in which financial information is evaluated by management. Refer to Item 8—Financial Statements and Supplementary Data—Financial Statements—Note 17—Segment Information for additional financial information related to the Bank's business segments.

Traditional Business Activities

        The Bank's traditional business segment includes products such as advances and investments and their related funding. Income from this segment is derived primarily from the difference, or spread, between the yield on advances and investments and the borrowing and hedging costs related to those assets. Capital is allocated to the segments based upon asset size.

        Advances.    The Bank serves as a source of liquidity and makes loans, called advances, to its members and eligible housing associates on the security of mortgages and other collateral that members pledge. The Bank offers a wide array of fixed and variable-rate advances, with maturities ranging from one day to 30 years or even longer with the approval of the Bank's credit committee. The Bank had 351 members, four eligible housing associates, and three nonmember institutions with advances outstanding as of December 31, 2009.

        The Bank establishes either a blanket lien on all financial assets of the member that may be eligible to be pledged as collateral or, for insurance company members in some instances and subject to the Bank's receipt of additional safeguards from such a member, a specific lien on assets specifically pledged as collateral to the Bank to secure outstanding advances. The Bank also reserves the right to require either specific listing of eligible collateral or delivery of eligible collateral to secure a member's outstanding advances obligations. All advances, at the time of issuance, must be secured by eligible collateral. Eligible collateral for Bank advances includes: fully disbursed whole first mortgage loans on improved residential real estate; debt instruments issued or guaranteed by the U.S. or any agency thereof; mortgage-backed securities (MBS) issued or guaranteed by the U.S. or any agency thereof; certain private-label MBS representing an interest in whole first mortgage loans on improved residential real estate; and cash on deposit at the Bank that is specifically pledged to the Bank as collateral. The Bank also accepts as collateral secured small-business, small agri-business, and

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small-farm loans from member community financial institutions (CFIs). In certain circumstances, other real-estate-related collateral may be considered by the Bank. Such real-estate-related collateral must have a readily ascertainable value, and the Bank must be able to perfect a security interest in it. In accordance with Finance Agency regulations, the Bank accepts home-equity loans, home-equity lines of credit, and first mortgage loans on commercial real estate as well as other real-estate-related collateral. The Bank applies a collateral discount to all eligible collateral, based on the Bank's analysis of the risk factors inherent in the collateral. The Bank reserves the right, in its sole discretion, to refuse certain collateral, or to adjust collateral discounts applied. Qualified loan collateral must not have been in default within the most recent 12-month period, except that whole first-mortgage collateral on one- to four-family residential property is acceptable collateral provided that no payment is overdue by more than 45 days. In addition, mortgages and other loans are considered qualified collateral, regardless of delinquency status, to the extent that the mortgages or loans are insured or guaranteed by the U.S. government or any agency thereof. The Bank's collateral policy complies with all applicable regulatory requirements.

        All parties that pledge collateral to the Bank are required to execute a representations and warranties document with respect to any mortgage loans and MBS pledged as collateral to the Bank. This document requires the pledging party to certify to knowledge of the Bank's anti-predatory lending policies, and to their compliance with those policies. In the event that any loan in a collateral pool or MBS that is pledged as collateral is (1) found not to comply in all material respects with applicable local, state, and federal laws, or (2) not accepted as qualified collateral as defined by the Bank, the pledging party must immediately remove the collateral and replace it with qualified collateral of equivalent value. The pledging party also agrees to indemnify and hold the Bank harmless for any and all claims of any kind relating to the loans and MBS pledged to the Bank as collateral.

        Insurance company members may borrow from the Bank pursuant to a structure that uses either the Bank's ordinary advance agreements or a funding agreement. From the Bank's perspective, advances provided pursuant to funding agreements are treated in the same manner as advances under the Bank's ordinary advances agreement. As of December 31, 2009, the Bank had approximately $325.0 million of advances outstanding to Metlife Insurance Company of Connecticut pursuant to a funding agreement.

        Members that have an approved line of credit with the Bank may from time to time overdraw their demand-deposit account. These overdrawn demand-deposit accounts are reported as advances in the statements of condition. These line of credit advances are fully secured by eligible collateral pledged by the member to the Bank. In cases where the member overdraws its demand-deposit account by an amount that exceeds its approved line of credit, the Bank may assess a penalty fee to the member.

        In addition to making advances to member institutions, the Bank is permitted under the Federal Home Loan Bank Act of 1932 (FHLBank Act) to make advances to eligible housing associates that are approved mortgagees under Title II of the National Housing Act. These eligible housing associates must be chartered under law and have succession, be subject to inspection and supervision by a governmental agency, and lend their own funds as their principal activity in the mortgage field. Housing associates are not subject to capital-stock-purchase requirements; however, they are subject to the same underwriting standards as members, but may be more limited in the forms of collateral that they may pledge to secure advances.

        Advances support the Bank's members' and housing associates' short-term and long-term borrowing needs, including their liquidity and funding requirements as well as funding mortgage loans and other assets retained in their portfolios. Advances may also be used to provide funds to any member CFIs. Because members may originate loans that they are unwilling or unable to sell in the secondary mortgage market, the Bank's advances can serve as a funding source for a variety of conforming and nonconforming mortgages. Thus, advances support important housing markets,

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including those focused on low- and moderate-income households. For those members and housing associates that choose to sell or securitize their mortgages, the Bank's advances can provide interim funding.

        Additionally, the Bank's advances can provide funding to smaller members that lack diverse funding sources generally available to larger financial entities. The Bank gives these smaller members access to competitively priced wholesale funding.

        Through a variety of specialized advance programs, the Bank provides funding for targeted initiatives that meet defined criteria for providing assistance either to very low- or moderate-income households or for economic development of areas that are economically disadvantaged. As such, these programs help members meet their Community Reinvestment Act (CRA) responsibilities. Through programs such as the Affordable Housing Program (AHP) and the Community Development Advance (CDA), members have access to subsidized and other low-cost funding to create affordable rental and homeownership opportunities, and for commercial and economic-development activities that benefit low- and moderate-income neighborhoods, thus contributing to the revitalization of these communities.

        The Bank's advances products can also help members in their asset-liability management. The Bank offers advances that members can use to match the cash-flow patterns of their mortgage loans. Such advances can reduce a member's interest-rate risk associated with holding long-term, fixed-rate mortgages. Principal repayment terms may be structured as 1) interest-only to maturity (sometimes referred to as bullet advances) or to an optional early termination date (see putable and callable advances as described below) or 2) as amortizing advances, which are fixed-rate and term structures with equal monthly payments of interest and principal. Repayment terms are offered up to 20 years. Amortizing advances are also offered with partial principal repayment and a balloon payment at maturity. At December 31, 2009, the Bank held $2.2 billion in amortizing advances.

        Advances with original fixed maturities of greater than six months may be prepaid at any time, subject to a prepayment fee that makes the Bank economically indifferent to the member's decision to prepay the advance. Certain advances contain provisions that allow the member to receive a prepayment fee in the event that interest rates have increased. Advances with original maturities of six months or less may not be prepaid. Adjustable-rate advances are prepayable at rate-reset dates with a fee equal to the present value of a predetermined spread for the remaining life of the advance, or without a fee. The formulas for the calculation of prepayment fees for the Bank's advances products are included in the advance application for each product. The formulas are standard for each product and apply to all members.

        In November 2009, the Bank began offering an advances restructuring program under which the prepayment fee on prepaid advances may be satisfied by the member's agreement to pay an interest rate on a new advance to the same member sufficient to amortize the prepayment fee by the maturity date of the new advance, rather than paid in immediately available funds to the Bank. During the year ended December 31, 2009, members restructured $306.2 million of advances under this program, resulting in a deferred payment of $10.9 million of prepayment fees to be collected from the members over the life of the replacement advances.

        In addition to fixed-rate and simple variable-rate advances, the Bank's advances program includes products with embedded caps and floors, callable advances, putable advances, and combinations of these features.

    Putable advances are intermediate- and long-term advances for which the Bank holds the option to cancel the advance on certain specified dates after an initial lockout period. Putable advances are offered with fixed rates, with an adjustable rate to the first put date, or with a capped floating rate. Borrowers may also choose a structure that will be terminated automatically if the London Interbank Offered Rate (LIBOR) hits or exceeds a predetermined strike rate on

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      specified dates. At December 31, 2009, the Bank held $8.4 billion in outstanding putable advances.

    Callable advances are fixed-rate, fixed term structures that include a provision whereby the borrower may prepay the advance prior to maturity on certain specified call dates without fee. At December 31, 2009, the Bank held $11.5 million in outstanding callable advances.

    LIBOR-indexed advances with declining-rate participation are floating-rate advances with a defined strike rate, below which the advance's rate changes at twice the rate at which its LIBOR index changes (to a minimum rate of zero). At December 31, 2009, the Bank held $5.5 million in outstanding LIBOR-indexed advances with declining-rate participation.

        Advances that have embedded options and advances with coupon structures containing derivatives are usually hedged in order to offset the embedded derivative feature. See the Interest-Rate-Exchange Agreements discussion below for additional information.

        Because advances are a wholesale funding source for the Bank's members that must be competitively priced relative to other potential sources of wholesale funds to the Bank's members, and because they are fully secured and possess very little credit risk, advances are priced at profit margins that are much smaller than those realized by most banking institutions. By regulation, the Bank may not price advances at rates that are less than the Bank's cost of funds for the same maturity, inclusive of the cost of hedging any embedded call or put options in the advance.

        Investments.    The Bank maintains a portfolio of investments for liquidity purposes and to provide additional earnings. To better meet potential member credit needs at times when access to the CO debt market is unavailable (either due to requests that follow the end of daily debt issuance activities or due to a market disruption event impacting CO issuance) and in support of certain statutory and regulatory liquidity requirements, as discussed in Item 7A—Quantitative and Qualitative Disclosures About Market Risk, the Bank maintains a portfolio of short-term investments issued by highly rated institutions, including overnight federal funds, term federal funds, interest-bearing certificates of deposits, and securities purchased under agreements to resell (secured by securities that have the highest rating from a nationally recognized statistical-rating organization [NRSRO]).

        The Bank also endeavors to enhance interest income and further support its contingent liquidity needs and mission by maintaining a longer-term investment portfolio, which includes debentures issued by U.S. government agencies and instrumentalities, supranational banks, MBS, and asset-backed securities (ABS) that are issued either by GSE mortgage agencies or by other private-sector entities provided that they carried the highest ratings from an NRSRO as of the date of purchase. The Bank's ABS holdings are limited to securities backed by loans secured by real estate. The Bank has also purchased bonds issued by housing-finance agencies that have at least the second-highest rating from an NRSRO as of the date of purchase. The long-term investment portfolio is intended to provide the Bank with higher returns than those available in the short-term money markets.

        Under Finance Agency regulations, the Bank is prohibited from investing in certain types of securities, including:

    instruments, such as common stock, that represent ownership in an entity, other than stock in small-business investment companies, or certain investments targeted to low-income persons or communities;

    instruments issued by non-U.S. entities, other than those issued by U.S. branches and agency offices of foreign commercial banks;

    non-investment-grade debt instruments, other than certain investments targeted to low-income persons or communities and instruments that were downgraded after purchase by the Bank;

    non-U.S. dollar-denominated securities; and

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    whole mortgages or other whole loans, or other interests in mortgages or loans, other than 1) those acquired under the Bank's mortgage-purchase program; 2) certain investments targeted to low-income persons or communities; 3) certain marketable direct obligations of state, local, or tribal-government units or agencies, having at least the second-highest credit rating from an NRSRO; 4) MBS or ABS backed by manufactured-housing loans or home-equity loans; and 5) certain foreign housing loans authorized under Section 12(b) of the FHLBank Act.

        The Finance Agency's requirements limit the Bank's investment in MBS and ABS to 300 percent of the Bank's previous monthend capital on the day it purchases the securities. In addition, the Bank is prohibited from purchasing:

    interest-only or principal-only stripped MBS;

    residual-interest or interest-accrual classes of collateralized mortgage obligations and real-estate mortgage-investment conduits, except as described in the following paragraph; or

    fixed-rate MBS or floating-rate MBS that on the trade date are at rates equal to their contractual cap and that have average lives that vary by more than six years under an assumed instantaneous interest-rate change of plus or minus 300 basis points.

        A Finance Agency resolution authorizes each FHLBank to invest up to an additional 300 percent of its total capital in MBS issued or backed by pools of mortgage loans guaranteed by either the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac), including collateralized mortgage obligations or real estate mortgage-investment conduits backed by such MBS. The mortgage loans underlying any securities that are purchased under this expanded authority must be originated after January 1, 2008, and underwritten to conform to standards imposed by the federal banking agencies in the Interagency Guidance on Nontraditional Mortgage Product Risks, dated October 4, 2006, and the Statement on Subprime Mortgage Lending, dated July 10, 2007. Among other things, the FHLBank is required to notify the Finance Agency prior to its first acquisition under the expanded authority and include in its notification a description of the risk-management practices underlying its purchases. On July 18, 2008, the board of directors of the Bank authorized the Bank to invest up to an additional 100 percent of its capital in agency MBS pursuant to the Finance Agency's resolution. At this time the Bank does not intend to use this expanded authority which expires on March 31, 2010.

        Other Banking Activities.    The Bank offers standby letters of credit (LOC), which are financial instruments issued by the Bank at the request of a member, promising payment to a third party (beneficiary) on behalf of a member. The Bank agrees to honor drafts or other payment demands made by the beneficiary in the event the member cannot fulfill its obligations. In guaranteeing the obligations of the member, the Bank assists the member in facilitating its transaction with the beneficiary and receives a fee in return. The Bank evaluates a member for eligibility, collateral requirements, limits on maturity, and other credit standards required by the Bank before entering into any LOC transactions. Members must fully collateralize the face amount of LOCs to the same extent that they are required to collateralize advances. The Bank may also issue LOCs on behalf of housing associates such as state and local housing agencies upon approval by the Bank. For the years ended December 31, 2009 and 2008, the fee income earned in connection with the issuance of LOC totaled $1.5 million and $2.0 million, respectively. During those two years, the Bank did not make any payment to any beneficiary to satisfy its obligation for the guarantee.

        The Bank enters into standby bond-purchase agreements with state-housing-finance agencies whereby the Bank, for a fee, agrees to purchase and hold the agency's bonds until the designated marketing agent can find a suitable investor or the housing agency repurchases the bond according to a schedule established by the standby agreement. Each standby agreement dictates the specific terms that would require the Bank to purchase the bond. Each of the outstanding bond-purchase commitments

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entered into by the Bank expires either three or five years following the start of the commitment. For the years ended December 31, 2009 and 2008, the fee income earned in connection with standby bond-purchase agreements totaled $712,000 and $759,000, respectively.

        In June 2009, the Bank resumed offering members the service of intermediating interest-rate derivatives, including caps and floors, which is a service the Bank had previously offered until March 2007. For each intermediated derivative, the Bank enters into a mirror derivative with a credit-worthy derivatives counterparty. The related participating member bears the expense of the mirror derivative and pays the Bank additional spread income for the service. The Bank bears the credit risk of the participating members and requires participating members to pledge collateral to cover this risk. The Bank did not earn any income from the service in 2009.

        The Bank also acts as a correspondent for deposit, disbursement, funds transfer and safekeeping services on behalf of and solely at the direction of its members. For the years ended December 31, 2009 and 2008, the fee income earned in connection with these correspondent services totaled $1.7 million and $1.6 million, respectively.

Mortgage-Loan Finance

Introduction

        The Bank participates in the Mortgage Partnership Finance® (MPF®) program, which is a secondary mortgage market structure under which the Bank either purchases or facilitates Fannie Mae's purchase of eligible mortgage loans from participating financial institution members (PFIs) (collectively, MPF loans). MPF loans are conforming conventional mortgage loans or government mortgage loans (MPF Government loans) that are insured or guaranteed by the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), the Rural Housing Service of the Department of Agriculture (RHS), or the Department of Housing and Urban Development (HUD) secured by one- to-four family residential properties with maturities ranging from five years to 30 years or participations in such mortgage loans.

        The Bank offers five MPF loan products from which PFIs may choose. These products (Original MPF, MPF 125, MPF Plus, MPF Government, and MPF Xtra) are closed-loan products in which either the Bank, or Fannie Mae in the case of MPF Xtra, purchases loans that have been acquired or have already been closed by the PFI with its own funds. The PFI performs all the traditional retail loan origination functions under these MPF products.

        The FHLBank of Chicago (MPF Provider) developed the MPF program in order to help fulfill the housing mission of the FHLBanks, to diversify assets beyond the traditional member finance segment, and to provide an additional source of liquidity to our members that choose to sell mortgage loans into the secondary market rather than holding them in their own portfolio. Finance Agency regulations (the AMA regulation) define the acquisition of acquired member assets as a core mission activity of the FHLBanks. In order for MPF loans to meet the AMA regulation requirements, purchases are structured so that the credit risk associated with MPF loans is shared with PFIs.

        The MPF program is designed to allocate the risks of MPF loans among the FHLBanks that participate in the MPF Program (the MPF Banks) and PFIs and to take advantage of their respective strengths. PFIs have direct knowledge of their mortgage markets and have developed expertise in underwriting and servicing residential mortgage loans. By allowing PFIs to originate MPF loans, whether through retail or wholesale operations, and to retain or acquire servicing of MPF loans, the MPF program gives control of those functions that most impact credit quality to PFIs. The MPF Banks are responsible for managing the interest-rate risk, prepayment risk, and liquidity risk associated with the MPF loans in which they invest.


®
"Mortgage Partnership Finance," "MPF," "eMPF" and "MPF Xtra" are registered trademarks of the Federal Home Loan Bank of Chicago.

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        For conventional MPF loan products (MPF loan products other than MPF Government and MPF Xtra), PFIs assume or retain a portion of the credit risk on the MPF loans they sell to an MPF Bank by providing credit enhancement (CE amount) either through a direct liability to pay credit losses up to a specified amount or through a contractual obligation to provide supplemental mortgage guaranty insurance (SMI). The PFI's CE amount covers losses for MPF loans under a master commitment in excess of the MPF Bank's first loss account (FLA). PFIs are paid a credit enhancement fee (CE fee) for managing credit risk and in some instances all or a portion of the CE fee may be performance based. See MPF Credit Enhancement Structure section, below, for a detailed discussion of the credit enhancement and risk-sharing arrangements for the MPF program.

        The Bank also offers the MPF Xtra product which provides the Bank's PFIs with the ability to sell certain fixed-rate loans to Fannie Mae, as a third-party investor. Loans sold under MPF Xtra are first sold to the MPF Provider which concurrently sells them to Fannie Mae. The MPF Provider is the master servicer for such loans. Such loans are not held on the Bank's balance sheet and the related credit and market risk are transferred to Fannie Mae. Unlike other MPF products, under the MPF Xtra product, PFIs do not provide any CE amount and do not receive CE fees because the credit risk of such loans is transferred to Fannie Mae. The MPF Provider receives a transaction fee for its master servicing, and custodial and administrative activities for such loans from the PFIs, and the MPF Provider pays the Bank a counterparty fee for the costs and expenses of marketing activities for these loans. The Bank indemnifies the MPF Provider for certain retained risks, including the risk of the MPF Provider's required repurchase of loans in the event of fraudulent or inaccurate representations and warranties from the PFI regarding the sold loans. The Bank may, in turn, seek reimbursement from the related PFI in any such circumstance, however the value of such a reimbursement right may be limited in the event of the related PFI's insolvency. See Item 7A—Quantitative and Qualitative Disclosures About Market Risk—Credit Risk—Mortgage Loans for additional discussion of such credit risk.

MPF Provider

        The MPF Provider establishes the eligibility standards under which an MPF Bank member may become a PFI, the structure of MPF loan products and the eligibility rules for MPF loans. In addition, the MPF Provider manages the pricing and delivery mechanism for MPF loans and the back-office processing of MPF loans as master servicer and master custodian. The MPF Provider has engaged Wells Fargo Bank N.A. as the vendor for master servicing and as the primary custodian for the MPF program. The MPF Provider also has contracted with other custodians meeting MPF program eligibility standards at the request of certain PFIs. These other custodians are typically affiliates of PFIs, and in some cases a PFI may act as self-custodian.

        The MPF Provider publishes and maintains the MPF Origination Guide, MPF Servicing Guide and MPF Underwriting Guide (together, the MPF guides), which detail the requirements PFIs must follow in originating or selling and servicing MPF loans. They maintain the infrastructure through which MPF Banks may purchase MPF loans through their PFIs. This infrastructure includes both a telephonic delivery system and a web-based delivery system accessed through the eMPF® web site. In exchange for providing these services, the MPF Provider receives a fee from each of the MPF Banks.

PFI Eligibility

        Members and eligible housing associates may apply to become a PFI of their respective MPF Bank. If a member is an affiliate of a holding company, which has another affiliate that is an active PFI, the member is only eligible to become a PFI if it is a member of the same MPF Bank as the existing PFI. The MPF Bank reviews the general eligibility of the member, its servicing qualifications and ability to supply documents, data, and reports required to be delivered by PFIs under the MPF program. The member and its MPF Bank sign an MPF Program Participating Financial Institution Agreement (the PFI Agreement) that provides the terms and conditions for the sale of MPF loans,

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including required credit enhancement, and establishes the terms and conditions for servicing MPF loans. All of the PFI's obligations under the PFI Agreement are secured in the same manner as the other obligations of the PFI under its regular advances agreement with the MPF Bank. The MPF Bank has the right under the advances agreement to request additional collateral to secure the PFI's obligations.

Mortgage Standards

        Mortgage loans delivered under the MPF program must meet the underwriting and eligibility requirements in the MPF guides, as amended by any waiver granted to a PFI exempting it from complying with specified provisions of the MPF guides. PFIs may utilize an approved automated underwriting system or underwrite MPF loans manually. The current underwriting and eligibility guidelines under the MPF guides with respect to MPF loans are broadly summarized as follows:

    Mortgage characteristics.  MPF loans must be qualifying five-year to 30-year conforming conventional or government fixed-rate, fully amortizing mortgage loans, secured by first liens on owner-occupied one- to -four unit single-family residential properties, and single unit second homes. Conforming loan size is established annually as required by Finance Agency regulations. Condominium, planned unit development, and manufactured homes are acceptable property types as are mortgages on leasehold estates (though manufactured homes must be on land owned in fee simple by the borrower). Loans secured by manufactured homes are subject to additional restrictions as set forth in the MPF guides.

    Loan-to-Value Ratio and Primary Mortgage Insurance.  The maximum loan-to-value ratio (LTV) for conventional MPF loans may not exceed 95 percent, or 90 percent for loans sold under MPF Xtra that are for amounts in excess of generally applicable agency loan limits but are within agency requirements for high-cost areas, while FHLBank AHP mortgage loans may have LTVs up to 100 percent (but may not exceed 105 percent total LTV, which compares the property value with the total amount of all mortgages outstanding against a property). Government MPF loans may not exceed the LTV limits set by the applicable federal agency. Conventional MPF loans with LTVs greater than 80 percent require certain amounts of mortgage guaranty insurance (MI), called primary MI, from an MI company that is rated at least triple-B by Standard & Poor's Ratings Services (S&P) and is acceptable to S&P.

    Documentation and Compliance with Applicable Law.  The mortgage documents and mortgage transaction must comply with all applicable laws and mortgage loans must be documented using standard Fannie Mae/Freddie Mac Uniform Instruments.

    Ineligible Mortgage Loans.  The following types of mortgage loans are not eligible for delivery under the MPF program: (1) mortgage loans that are not ratable by S&P; (2) mortgage loans not meeting the MPF program eligibility requirements as set forth in the MPF guides and agreements; and (3) mortgage loans that are classified as high cost, high rate, high risk, Home Ownership and Equity Protection Act loans or loans in similar categories defined under predatory lending or abusive lending laws.

        PFIs are required to comply with the MPF program policies contained in the MPF guides which include anti-predatory lending policies, eligibility requirements for PFIs such as insurance requirements and annual certification requirements, loan documentation, and custodian requirements. The MPF guides also detail the PFI's servicing duties and responsibilities for reporting, remittances, default management, and disposition of properties acquired by foreclosure or deed in lieu of foreclosure.

        A majority of the states, and some municipalities, have enacted laws against mortgage loans considered predatory or abusive. Some of these laws impose liability for violations not only on the originator, but also upon purchasers and assignees of mortgage loans. We take measures that we consider reasonable and appropriate to reduce our exposure to potential liability under these laws and

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are not aware of any claim, action, or proceeding asserting that we are liable under these laws. However, we cannot assure that we will never have any liability under predatory or abusive lending laws.

MPF Loan Delivery Process

        In order to deliver mortgage loans under the MPF program, the PFI and MPF Bank enter into a best efforts master commitment (master commitment), which provides the general terms under which the PFI will deliver mortgage loans to either an MPF Bank or the MPF Provider for concurrent transfers to Fannie Mae in the case of MPF Xtra, including a maximum loan delivery amount, maximum CE amount, if applicable, and expiration date. For MPF Xtra, the Bank assigns each master commitment entered into with its PFIs to the MPF Provider. PFIs may then request to enter into one or more mandatory purchase commitments (each, a delivery commitment), which is a mandatory commitment of the PFI to sell or originate eligible mortgage loans. Each MPF loan delivered must conform to specified ranges of interest rates, maturity terms, and business days for delivery (which may be extended for a fee) detailed in the delivery commitment or it will be rejected as ineligible by the MPF Provider. Each MPF loan under a delivery commitment is linked to a master commitment so that the cumulative credit enhancement level can be determined for each master commitment.

        The sum of MPF loans delivered by the PFI under a specific delivery commitment cannot exceed the amount specified in the delivery commitment without the assessment of a price adjustment fee. Delivery commitments that are not fully funded by their expiration dates are subject to pair-off fees (fees charged to a PFI for failing to deliver the amount of loans specified in a delivery commitment) or extension fees (fees charged to a PFI for extending the time deadline to deliver loans on a delivery commitment), which protect the MPF Bank, or Fannie Mae in the case of MPF Xtra, against changes in market prices.

        In connection with each sale to an MPF Bank, or the MPF Provider for concurrent transfer to Fannie Mae in the case of MPF Xtra, the PFI makes customary representations and warranties in the PFI Agreement and under the MPF guides. These include eligibility and conformance of the MPF loans with the requirements in the MPF guides, compliance with predatory lending laws, and the integrity of the data transmitted to the MPF Provider. In addition, the MPF guides require each PFI to maintain errors and omissions insurance and a fidelity bond and to provide an annual certification with respect to its insurance and its compliance with the MPF program requirements. Once an MPF loan is purchased, the PFI must deliver a qualifying promissory note and certain other required documents to the designated custodian, who reports to the MPF Provider whether the documentation package meets MPF program requirements.

        The MPF Provider conducts an initial quality assurance review of a selected sample of MPF loans from each PFI's initial MPF loan delivery. The MPF Provider also performs periodic reviews of a sample of MPF loans to determine whether the reviewed MPF loans complied with the MPF program requirements at the time of acquisition. Any exception that indicates a negative trend is discussed with the PFI and can result in the suspension or termination of a PFI's ability to deliver new MPF loans if the concern is not adequately addressed.

        Reasons for which a PFI could be required to repurchase an MPF loan include but are not limited to, MPF loan ineligibility, breach of representation or warranty under the PFI Agreement or the MPF guides, failure to deliver the required MPF loan documents to an approved custodian, servicing breach, or fraud.

        The Bank does not currently conduct any quality assurance reviews of MPF Government loans. However, the Bank does allow its PFIs to repurchase delinquent MPF Government loans so that they may comply with loss-mitigation requirements of the applicable government agency in order to preserve the insurance or guaranty coverage. The repurchase price for each such delinquent loan is equal to the

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current scheduled principal balance and accrued interest on the MPF Government loan. In addition, as with conventional MPF loans, if a PFI fails to comply with the requirements of the PFI Agreement, MPF guides, applicable laws, or terms of mortgage documents, the PFI may be required to repurchase the affected MPF Government loans.

MPF Products

        A variety of MPF loan products have been developed to meet the differing needs of PFIs. The Bank offers five MPF products that its PFIs may choose from: Original MPF, MPF Government, MPF 125, MPF Plus, , and MPF Xtra. The products have different credit-risk-sharing characteristics based upon the different levels for the FLA and CE amount and the types of CE fees (performance-based, fixed amount or none). There is no FLA, CE amount, or CE fees for MPF Xtra because the credit risk for such loans is transferred to Fannie Mae. The table below provides a comparison of the MPF products.


MPF Product Comparison Chart

Product Name
  Bank's
First-Loss
Account
Size
  PFI Credit-
Enhancement
Size
Description
  Credit-
Enhancement
Fee Paid to
the Member
  Credit-
Enhancement
Fee Offset(1)
  Servicing Fee
to Servicer

Original MPF

  3 to 6 basis points added each year   Equivalent to double-A rating.   7 to 11 basis points per year paid monthly   No   25 basis points per year

MPF Government

 

N/A

 

N/A Unreimbursed servicing expenses.

 

N/A(2)

 

N/A

 

44 basis points per year(2)

MPF 125

 

100 basis points fixed based on the size of loan pool at closing

 

After first-loss account, up to double-A rating.

 

7 to 10 basis
points per year paid monthly; performance based

 

Yes

 

25 basis points per year

MPF Plus

 

An agreed upon amount no less than expected losses

 

0 to 20 basis points, after first-loss account and supplemental mortgage insurance, up to double-A rating.

 

7 basis
points/year fixed plus 6 to 7 basis
points per year performance based (delayed for 1 year) all fees paid monthly

 

Yes

 

25 basis points per year

MPF Xtra

 

N/A

 

N/A

 

None

 

N/A

 

25 basis points per year


(1)
Future payouts of performance-based CE fees are reduced when losses are allocated to the FLA.

(2)
For master commitments issued prior to February 2, 2007, the PFI is paid a monthly government loan fee equal to 0.02 percent (two basis points) per annum based on the month-end outstanding aggregate principal balance of the master commitment which is in addition to the customary 0.44 percent (44 basis points) per annum servicing fee that continues to apply for master commitments issued after February 2, 2007, and that is retained by the PFI on a monthly basis based on the outstanding aggregate principal balance of the MPF Government loans.

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MPF Loan Participations

        The Bank may purchase participation interests in MPF loans originated by other MPF Banks and may sell participation interests in MPF loans originated by it to other MPF Banks, excluding loans sold pursuant to MPF Xtra, which cannot be participated. The Bank has previously sold participation interests to other MPF Banks at the time the MPF loans were acquired, but has not purchased participation interests in MPF loans originated by other MPF Banks, although it may do so in the future.

        Participation interests may be full (a 100 percent participation) or partial (any percentage between zero and 100 percent) as determined by agreement among the MPF Bank selling the participation interests (the Owner Bank), the MPF Provider, and the MPF Bank purchasing the participation interests (the participant MPF Bank).

        The Owner Bank is responsible for:

    evaluating, monitoring, and certifying to each participant MPF Bank the creditworthiness of each PFI initially, and at least annually thereafter;

    ensuring that adequate collateral is available from each of its PFIs to secure any direct obligation portion of the PFI's CE amount; and

    enforcing the PFI's obligations under its PFI Agreement.

        The risk-sharing and rights of the Owner Bank and participating MPF Bank(s) are as follows:

    each pays its pro rata share of each MPF loan acquired under a delivery commitment and related master commitment based upon the participation percentage in effect at the time;

    each receives its pro rata share of principal and interest payments and is responsible for CE fees based upon its participation percentage for each MPF loan under the related delivery commitment;

    each is responsible for its pro rata share of FLA exposure and losses incurred with respect to the master commitment based upon the overall risk-sharing percentage for the master commitment; and

    each may economically hedge its share of the delivery commitments as they are issued during the open period.

        The FLA and CE amount apply to all MPF loans in a master commitment regardless of participation arrangements, so an MPF Bank's share of credit losses is based on its respective participation interest in the entire master commitment. For example, assume an MPF Bank's specified participation percentage was 25 percent under a $100 million master commitment and that no changes were made to the master commitment. The MPF Bank risk-sharing percentage of credit losses would be 25 percent. In the case where an MPF Bank changed its initial percentage in the master commitment, the risk-sharing percentage will also change. For example, if an MPF Bank were to acquire 25 percent of the first $50 million and 50 percent of the second $50 million of MPF loans delivered under a master commitment, the MPF Bank would share in 37.5 percent of the credit losses in that $100 million master commitment, while it would receive principal and interest payments on the individual MPF loans that remain outstanding in a given month, some in which it may own a 25 percent interest and the others in which it may own a 50 percent interest.

MPF Servicing

        The PFI or its servicing affiliate generally retains the right and responsibility for servicing MPF loans it delivers. The PFI is responsible for collecting the borrower's monthly payments and otherwise managing the relationship with the borrower with respect to the MPF loan and the mortgaged

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property. Based on monthly reports the PFI is required to provide the master servicer, appropriate withdrawals are made from the PFI's deposit account with the applicable MPF Bank. In some cases, the PFI has agreed to advance principal and interest payments on the scheduled remittance date when the borrower has failed to pay, provided that the collateral securing the MPF loan is sufficient to reimburse the PFI for advanced amounts. The PFI recovers the advanced amounts either from future collections or upon the liquidation of the collateral securing the MPF loans.

        If an MPF loan becomes delinquent, the PFI is required to contact the borrower to determine the cause of the delinquency and whether the borrower will be able to cure the default. Upon any MPF loan becoming 90 days or more delinquent, the master servicer monitors and reviews the PFI's default management activities for that MPF loan, including timeliness of notices to the mortgagor, forbearance proposals, property protection activities, and foreclosure referrals, all in accordance with the MPF guides. Upon liquidation of any MPF loan and submission of each realized loss calculation from the PFI, the master servicer reviews the realized loss calculation for conformity with the primary mortgage insurance (MI) requirements, if applicable, and conformity to the cost and timeliness standards of the MPF guides. The master servicer disallows the reimbursement to the PFI of any servicing advances related to the PFI's failure to perform in accordance with the MPF guides. If there is a loss on a conventional MPF loan, the loss is allocated to the master commitment and shared in accordance with the risk-sharing structure for that particular master commitment. The servicer pays any gain on sale of real-estate-owned property to the MPF Bank, or in the case of a participation, to the MPF Banks based upon their respective interest in the MPF loan. However, the amount of the gain is available to reduce subsequent losses incurred under the master commitment before such losses are allocated between the MPF Bank and the PFI.

        The MPF Provider monitors the PFI's compliance with MPF program requirements throughout the servicing process and brings any material concerns to the attention of the MPF Bank. Minor lapses in servicing are charged to the PFI via offsets against amounts owed to the PFI. Major lapses in servicing could result in a PFI's servicing rights being terminated for cause and the servicing of the particular MPF loans being transferred to a new, qualified servicing PFI.

        Although PFIs or their servicing affiliates generally service the MPF loans delivered by the PFI, certain PFIs choose to sell the servicing rights on a concurrent basis (servicing released) or in a bulk transfer to another PFI which is permitted with the consent of the MPF Banks involved. One PFI has been designated to acquire servicing under the MPF program's concurrent sale of servicing option. In addition, several PFIs have acquired servicing rights on a concurrent servicing-released basis or bulk transfer basis without the direct support from the MPF program.

MPF Credit Enhancement Structure

Overview

        Other than for MPF Xtra under which all credit and market risk is transferred to Fannie Mae, the MPF Bank and PFI share the risk of credit losses on MPF loans under the MPF programs by structuring potential losses on conventional MPF loans into layers with respect to each master commitment. The first layer or portion of credit losses that an MPF Bank is potentially obligated to incur is determined based upon the MPF product selected by the PFI and is referred to as the FLA. The FLA functions as a tracking mechanism for determining the point after which the PFI, in its role as credit enhancer, would be required to cover losses. The FLA is not a cash collateral account, and does not give an MPF Bank any right or obligation to receive or pay cash or any other collateral. For MPF products with performance-based CE fees, the MPF Bank may withhold CE fees to recover losses at the FLA level, essentially transferring a portion of the first layer risk of credit loss to the PFI.

        The portion of credit losses that a PFI is potentially obligated to incur is referred to as its CE amount. The PFI's CE amount represents a direct liability to pay credit losses incurred with respect to

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a master commitment or the requirement of the PFI to obtain and pay for a supplemental mortgage guaranty insurance (SMI) policy insuring the MPF Bank for a portion of the credit losses arising from the master commitment. The PFI may procure SMI to cover losses equal to all or a portion of the CE amount. SMI does not cover special hazard losses, which are the direct liability of the PFI or the MPF Bank. The final CE amount is determined once the master commitment is closed (that is, when the maximum amount of MPF loans are delivered or the expiration date has occurred). For a description of how each PFI's CE amount is determined, see Mortgage-Loan Finance—Setting Credit Enhancement Levels below.

        The PFI receives a CE fee in exchange for providing the CE amount which may be used to pay for SMI. CE fees are paid monthly and are determined based on the remaining unpaid principal balance of the MPF loans under the master commitment. The CE fee and CE amount may vary depending on the MPF product selected. CE fees payable to a PFI as compensation for assuming credit risk are recorded as an offset to MPF loan interest income when paid by us. We also pay performance CE fees which are based on actual performance of the pool of MPF loans in each master commitment. For the Original MPF product, the CE fee is a fixed payment to the PFI. For the MPF 125 product, the CE fee is performance-based and losses to the MPF Bank can be reimbursed by the MPF Bank withholding the performance-based CE fee. Under the MPF Plus product, we also pay performance-based and fixed CE fees. Losses experienced by the MPF Bank in this product can be reimbursed by the MPF Bank withholding the performance-based CE fee. The fixed fee can be used to pay the SMI premium. To the extent that losses in the current month exceed performance CE fees accrued, the remaining losses may be recovered from withholding future performance CE fees payable to the PFI. For the MPF Government product, the PFI is paid a CE fee equal to 0.02 percent (two basis points) per annum for master commitments issued prior to February 2, 2007 but no CE fee for master commitments issued after that date. There are no CE fees for the MPF Xtra product.

Loss Allocation

        Other than MPF Xtra, credit losses on conventional MPF loans not absorbed by the borrower's equity in the mortgaged property, property insurance, or primary mortgage insurance are allocated between the MPF Bank and PFI as follows:

    First, to the MPF Bank, up to an agreed-upon amount, called the FLA.

    Original MPF.    The FLA starts out at zero on the day the first MPF loan under a master commitment is purchased but increases monthly over the life of the master commitment at a rate that ranges from 0.03 percent to 0.06 percent (three to six basis points) per annum based on the monthend outstanding aggregate principal balance of the master commitment. The FLA is structured so that over time, it should cover expected losses on a master commitment, though losses early in the life of the master commitment could exceed the FLA and be charged in part to the PFI's CE amount.

    MPF 125.    The FLA is equal to 1.00 percent (100 basis points) of the aggregate principal balance of the MPF loans funded under the master commitment. Once the master commitment is fully funded, the FLA is expected to cover expected losses on that master commitment, although the MPF Bank may economically recover a portion of losses incurred under the FLA by withholding performance CE fees payable to the PFI.

    MPF Plus.    The FLA is equal to an agreed-upon number of basis points of the aggregate principal balance of the MPF loans funded under the master commitment that is not less than the amount of expected losses on the master commitment. Once the master commitment is fully funded, the FLA is expected to cover expected losses on that master commitment, although the MPF Bank may economically recover a portion of losses incurred under the FLA by withholding performance CE fees payable to the PFI.

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    Second, to the PFI under its CE obligation, losses for each master commitment in excess of the FLA, if any, up to the CE amount. The CE amount may consist of a direct liability of the PFI to pay credit losses up to a specified amount, a contractual obligation of the PFI to provide SMI or a combination of both. For a description of the CE amount calculation see Mortgage-Loan Finance—Setting Credit Enhancement Levels below.

    Third, any remaining unallocated losses are absorbed by the MPF Bank.

        With respect to participation interests, MPF loan losses allocable to the MPF Bank are allocated among the participating MPF Banks pro rata based upon their respective participation interests in the related master commitment. For a description of the risk sharing by participant MPF Banks see MPF Loan Participations, above.

Setting Credit Enhancement Levels

        Other than for MPF Xtra under which all credit and market risk is transferred to Fannie Mae, Finance Agency regulations require that MPF loans be sufficiently credit enhanced at the time of purchase so that the Bank's risk of loss is limited to the losses of an investor in a double-A-rated MBS. In cases where the Bank's risk of loss is greater than that of an investor in a double-A-rated MBS, the Bank holds additional credit risk-based capital in accordance with Finance Agency regulations based on the putative credit rating of the pool. The MPF Provider analyzes the risk characteristics of each MPF loan (as provided by the PFI) using S&P's LEVELS® model in order to determine the required CE amount for a loan or group of loans to be acquired by an MPF Bank (MPF program methodology). The PFI's CE amount (including the SMI policy for MPF Plus) is calculated using the MPF program methodology to equal the difference between the amount needed for the master commitment to have a rating equivalent to a double-A-rated MBS and our initial FLA exposure (which is zero for the Original MPF product).

        For MPF Plus, the PFI is required to provide an SMI policy covering the MPF loans in the master commitment and having a deductible initially equal to the FLA. Depending upon the amount of the SMI policy (determined in part by the amount of the CE fees paid to the PFI), the PFI may or may not have any direct liability on the CE amount.

        The Bank is required to recalculate the estimated credit rating of a master commitment if there is evidence of a decline in credit quality of the related MPF loans.

Credit Enhancement Fees

        The structure of the CE fee payable to the PFI depends upon the product type selected. There is no CE amount and accordingly no CE fee payable to the PFI for MPF Xtra. For Original MPF, the PFI is paid a monthly CE fee between 0.07 percent and 0.11 percent (seven and 11 basis points) per annum and paid monthly based on the aggregate outstanding principal balance of the MPF loans in the master commitment.

        For MPF 125, the PFI is paid a monthly CE fee between 0.07 percent and 0.10 percent (seven and 10 basis points) per annum and paid monthly on the aggregate outstanding principal balance of the MPF loans in the master commitment. The PFI's monthly CE fee is performance-based in that it is reduced by losses charged to the FLA. For MPF 125, the CE fee is performance-based for the entire life of the master commitment.


®
"Standard & Poor's LEVELS" and "LEVELS" are registered trademarks of Standard & Poor's, a division of the McGraw-Hill Companies, Inc.

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        For MPF Plus, the performance-based portion of the CE fee is typically 0.06 percent (six basis points) per annum and paid monthly on the aggregate outstanding balance of the MPF loans in the master commitment. The performance-based CE fee is reduced by losses charged to the FLA and is paid one year after accrued, based on monthly outstanding balances. The fixed portion of the CE fee is typically 0.07 percent (seven basis points) per annum and paid monthly on the aggregate outstanding principal balance of the MPF loans in the master commitment. The lower performance CE fee is for master commitments without a direct PFI CE amount.

        For MPF Government, the PFI provides and maintains insurance or a guaranty from the applicable federal agency (that is, the FHA, VA, RHS, or HUD) for MPF Government loans and the PFI is responsible for compliance with all federal agency requirements and for obtaining the benefit of the applicable insurance or guaranty with respect to defaulted MPF Government loans. Only PFIs that are licensed or qualified to originate and service government loans by the applicable federal agency or agencies and that maintain a mortgage loan delinquency ratio that is acceptable to the Bank and that is comparable to the national average and/or regional delinquency rates as published by the Mortgage Bankers Association are eligible to sell and service MPF Government loans under the MPF program.

        The table below summarizes the average PFI CE fee of all master commitments:

Average PFI CE Fee as a Percent of Master Commitments

 
  December 31,  
Loan Type
  2009   2008  

Original MPF

    0.10 %   0.10 %

MPF 125

    0.10     0.10  

MPF Plus

    0.13     0.13  

MPF Government(1)

    N/A     N/A  

MPF Xtra

    N/A     N/A  

(1)
For master commitments for issued prior to February 2, 2007, the PFI is paid a monthly government loan fee equal to 0.02 percent (two basis points) per annum based on the month-end outstanding aggregate principal balance of the master commitments. As a percent of these master commitments, these fees averaged 0.02 percent (two basis points) at each of December 31, 2009 and December 31, 2008.

Credit Risk Exposure on MPF Loans

        The Bank's credit risk from the MPF loans in which it invests is the potential for financial loss due to borrower default. The amount of any such loss may be impacted by depreciation in the value of the real estate collateral securing the MPF loan, offset by the PFI's CE amount. Under the MPF program, the PFI's CE amount may take the form of a contingent performance-based CE fee whereby such fees are reduced by losses up to a certain amount arising under the master commitment and the CE amount (which represents a direct liability to pay credit losses incurred with respect to that master commitment or may require the PFI to obtain and pay for an SMI policy insuring the MPF Bank for a portion of the credit losses arising from the master commitment). Under the AMA regulation, any portion of the CE amount that is a PFI's direct liability must be collateralized by the PFI in the same way that advances are collateralized. The PFI Agreement provides that the PFI's obligations under the PFI Agreement are secured along with other obligations of the PFI under its regular advances agreement and further, that we may request additional collateral to secure the PFI's obligations.

        The Bank also has credit risk of loss on MPF loans to the extent such losses are not recoverable from the PFI either directly or indirectly through performance-based CE fees, or from an SMI insurer,

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as applicable. See Item 7A—Quantitative and Qualitative Disclosures About Market Risk—Credit Risk—Mortgage Loans.

        The risk sharing of credit losses between MPF Banks for participations is based on each MPF Banks' percentage interest in the participated MPF loans, with each MPF Bank assuming its percentage share of such losses. See MPF Loan Participations, above.

Deposits

        The Bank offers demand and overnight-deposit programs to its members and housing associates. Term deposit programs are also offered to members. The Bank cannot predict the timing and amount of deposits that it receives from members and therefore does not rely on deposits as a funding source for advances, investments and loan purchases. Proceeds from deposit issuance are generally invested in short-term investments to ensure that the Bank can liquidate deposits on request.

        The Bank must maintain compliance with statutory liquidity requirements that require the Bank to hold cash, obligations of the U.S., and advances with a maturity of less than five years in an amount not less than the amount of deposits of members. The following table provides the Bank's liquidity position with respect to this requirement.

Liquidity Reserves for Deposits
(dollars in thousands)

 
  December 31,  
 
  2009   2008  

Liquid assets

             
 

Cash and due from banks

  $ 191,143   $ 5,735  
 

Interest-bearing deposits

    81     3,279,075  
 

Advances maturing within five years

    32,131,742     50,390,148  
           

Total liquid assets

    32,322,966     53,674,958  

Total deposits

    772,457     611,070  
           

Excess liquid assets

  $ 31,550,509   $ 53,063,888  
           

        Refer to the Liquidity Risk section in Item 7A—Quantitative and Qualitative Disclosures about Market Risk for further information regarding the Bank's liquidity requirements.

Consolidated Obligations

        The Bank funds its assets primarily through the sale of debt securities known as consolidated obligations, and referred to herein as COs. The Bank's ability to access the money and capital markets—across a wide maturity spectrum, in a variety of debt structures through the sale of COs—has historically allowed the Bank to manage its balance sheet effectively and efficiently. The FHLBanks compete with Fannie Mae, Freddie Mac, and other GSEs for funds raised through the issuance of unsecured debt in the agency debt market.

        COs, consisting of bonds and discount notes, represent the primary source of debt used by the Bank to fund advances, mortgage loans, and investments. All COs are issued on behalf of an FHLBank (as the primary obligor) through the Office of Finance, but all COs are the joint and several obligation of each of the 12 FHLBanks. COs are not obligations of the U.S. government and the U.S. government does not guarantee them. Moody's Investors Service (Moody's) currently rates COs Aaa/P-1, and S&P currently rates them AAA/A-1+. These ratings measure the predicted likelihood of timely payment of principal and interest on the COs. The GSE status of the FHLBanks and the ratings of the COs have

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historically provided the FHLBanks with ready capital-market access. The credit crisis, which commenced in mid-2007 and deepened greatly in the second half of 2008, resulted in the Bank's increasing reliance on short-term COs based on funding costs for longer-term COs that were higher than historical norms due to investor preference for short-term investments at that time. The Bank's long-term funding costs improved during 2009 relative to the higher long-term funding costs experienced in 2008 due to the credit crisis and government responses thereto. The improvement in long-term funding costs is due in part to general improvement in the confidence of investors as markets stabilized in 2009; lower demand by the FHLBanks for proceeds of CO debt issuances primarily due to declining advances balances across all the FHLBanks (the FHLBank System) from the historical highs experienced during the credit crisis; purchases of GSE debt by the Federal Reserve Bank of New York pursuant to the GSE debt-purchase initiative, described under Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Recent Legislative and Regulatory Developments; and improved investor demand for long-term CO bonds both through negotiated transactions and public issuances. See Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Liquidity for more information.

        CO Bonds.    CO bonds may have maturities of up to 30 years (although there is no statutory or regulatory limit on maturities), and CO bonds have been traditionally issued to raise intermediate and long-term funds. However, during the recent credit crisis, CO bonds were used to raise more short-term and intermediate funds.

        CO bonds may be issued with either fixed-rate coupon-payment terms, zero-coupon terms, or variable-rate coupon-payment terms that use a variety of indices for interest-rate resets including LIBOR, Constant Maturity Treasury (CMT), and others. CO bonds may also contain embedded options that affect the term or yield structure of the bond. Such options include call options under which the Bank can redeem bonds prior to maturity.

        CO bonds can be issued and distributed through negotiated or competitively bid transactions with approved underwriters or selling group members. The FHLBanks are among the world's most active issuers of debt, issuing on a near-daily basis, including sometimes multiple issuances in a single day. The Bank frequently participates in these issuances. Each FHLBank requests funding through the Office of Finance and the Office of Finance endeavors to issue the requested bonds and allocate proceeds in accordance with each FHLBank's requested funding. In some cases, proceeds from partially fulfilled offerings must be allocated in accordance with predefined rules that apply to particular issuance programs. The Office of Finance also prorates the amounts paid to dealers in connection with the sale of COs to the Bank based upon the percentage of debt issued that is assumed by the Bank.

        Discount Notes.    CO discount notes are short-term obligations issued at a discount to par with no coupon. Terms range from overnight up to one year. The Bank generally participates in CO discount note issuance on a daily basis as a means of funding short-term assets and managing its short-term funding gaps. During 2009, the Bank also periodically funded longer-term assets through the issuance of CO discount notes rather than CO bonds when CO discount notes could be issued at more favorable pricing than CO bonds, as further discussed under Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operation—Liquidity and Capital Resources—Liquidity. Each FHLBank submits commitments to issue CO discount notes in specific amounts with specific terms to the Office of Finance, which in turn, aggregates these commitments into offerings to securities dealers. Such commitments may specify yield limits that the Bank has specified in its commitment, above which the Bank will not accept funding. CO discount notes are sold either at auction on a scheduled basis or through a direct bidding process on an as-needed basis through a group of dealers known as the selling group, who may turn to other dealers to assist in the ultimate distribution of the securities to investors. The selling group dealers receive no selling concession if the bonds are sold at auction. Otherwise, the Bank pays the dealer a selling concession.

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        Finance Agency regulations require that each FHLBank maintain the following types of assets, free from any lien or pledge, in an amount at least equal to the amount of that FHLBank's participation in the total COs outstanding:

    Cash;

    Obligations of, or fully guaranteed by, the U.S. government;

    Secured advances;

    Mortgages, which have any guaranty, insurance, or commitment from the U.S. government or any agency of the U.S.;

    Investments described in Section 16(a) of the FHLBank Act, which, among other items, includes securities that a fiduciary or trust fund may purchase under the laws of the state in which the FHLBank is located; and

    Other securities that are assigned a rating or assessment by an NRSRO that is equivalent or higher than the rating or assessment assigned by that NRSRO to COs.

        The following table illustrates the Bank's compliance with this regulatory requirement:

Ratio of Non-Pledged Assets to Total Consolidated Obligations by Carrying Value
(dollars in thousands)

 
  December 31,  
 
  2009   2008  

Non-pledged asset totals

             
 

Cash and due from banks

  $ 191,143   $ 5,735  
 

Advances

    37,591,461     56,926,267  
 

Investments(1)

    20,947,464     18,864,899  
 

Mortgage loans, net

    3,505,975     4,153,537  
 

Accrued interest receivable

    147,689     288,753  
 

Less: pledged assets

    (443,098 )   (916,068 )
           

Total non-pledged assets

  $ 61,940,634   $ 79,323,123  
           

Total consolidated obligations

  $ 57,686,832   $ 74,726,268  
           

Ratio of non-pledged assets to consolidated obligations

    1.07     1.06  

(1)
Investments include interest-bearing deposits, securities purchased under agreements to resell, federal funds sold, trading securities, available-for-sale securities, and held-to-maturity securities.

        Although each FHLBank is primarily liable for the portion of COs corresponding to the proceeds received by that FHLBank, each FHLBank is also jointly and severally liable with the other 11 FHLBanks for the payment of principal and interest on all COs. Under Finance Agency regulations, if the principal or interest on any CO issued on behalf of one of the FHLBanks is not paid in full when due, then the FHLBank responsible for the payment may not pay dividends to, or redeem or repurchase shares of stock from, any member of such FHLBank. The Finance Agency, in its discretion, may require any FHLBank to make principal or interest payments due on any COs, whether or not the primary obligor FHLBank has defaulted on the payment of that obligation.

        To the extent that an FHLBank makes any payment on a CO on behalf of another FHLBank, the paying FHLBank shall be entitled to reimbursement from the FHLBank otherwise responsible for the payment. However, if the Finance Agency determines that an FHLBank is unable to satisfy its

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obligations, then the Finance Agency may allocate the outstanding liability among the remaining FHLBanks on a pro rata basis in proportion to each FHLBank's participation in all COs outstanding, or on any other basis the Finance Agency may determine.

        Neither the Finance Agency nor any predecessor regulator of the Bank has ever required the Bank to repay obligations in excess of the Bank's participation nor have they allocated to the Bank any outstanding liability of any other FHLBank's COs.

Capital Resources

        Capital Plan.    The Bank's Class B stock may be issued, redeemed, and repurchased by the Bank only at its par value of $100 per share. The Bank's Class B stock is exempt from registration under the Securities Act of 1933. The Bank's capital plan is provided as Exhibit 4 to this Form 10-K.

        Activity-Based Stock-Investment Requirement (ABSIR).    Members must hold Class B stock based on certain outstanding activity with the Bank. The ABSIR for advances is as follows:

For advances with a term of:
  The ABSIR
is the following
percentage of
outstanding
advance balances
 

Overnight (one business day)

    3.0 %

More than one business day through three months

    4.0  

Greater than three months

    4.5  

        For standby letters of credit, the ABSIR is 4.5 percent of the credit equivalent amount of the standby letter of credit as defined in Finance Agency regulations (currently 50 percent of the face amount of the standby letter of credit). For outstanding member-intermediated derivatives, the ABSIR is 4.5 percent of the sum of 1) the current credit exposure of the derivative, and 2) the potential future exposure as defined in Finance Agency regulations.

        For loans purchased on or after November 2, 2009, the ABSIR for MPF activities was suspended to encourage growth in this business line as part of the revised operating plan, which is discussed in Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Overview and Executive Summary—Principal Business Developments. For loans purchased prior to November 2, 2009, the ABSIR for MPF activities is either zero percent or 4.5 percent, as determined by the date the loan was funded and/or the date the master commitment was entered into.

        Membership Stock-Investment Requirement (MSIR).    In addition to the ABSIR, members must hold the MSIR. The MSIR is equal to 0.35 percent of the value of certain member assets eligible to secure advances subject to a current minimum balance of $10,000 and a current maximum balance of $25.0 million.

        Total Stock-Investment Requirement (TSIR).    The sum of the ABSIR and the MSIR is the TSIR. Any stock held by a member in excess of its TSIR is considered excess capital stock. At December 31, 2009, members and nonmembers with capital stock outstanding held excess capital stock totaling $1.5 billion, representing approximately 40.9 percent of total capital stock outstanding.

        Members may submit a written request for redemption of excess capital stock. The stock subject to the request will be redeemed at par value by the Bank upon expiration of a five-year stock-redemption period. Also subject to a five-year redemption period are shares of stock held by a member that (1) gives notice of intent to withdraw from membership, or (2) becomes a nonmember due to merger or acquisition, charter termination, or involuntary termination of membership. At the end of the five-year stock-redemption period, the Bank must comply with the redemption request unless doing so would cause the Bank to fail to comply with its minimum regulatory capital requirements, would cause

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the member to fail to comply with its total stock-investment requirements, or would violate any other regulatory prohibitions.

        Repurchases of Excess Capital Stock.    The Bank may, at its sole discretion, repurchase excess capital stock from any member at par value upon 15 days prior written notice to the member, unless a shorter notice period is agreed to in writing with the member, if the repurchase will not cause the Bank to fail to meet any of its regulatory capital requirements or violate any other regulatory prohibitions. However, in accordance with the moratorium on excess stock repurchases described below, the Bank did not complete any repurchases of excess capital stock in 2009, except for $1.5 million of excess stock repurchase requests that had been submitted to the Bank prior to the commencement of the moratorium.

        The Bank has an Excess Stock Repurchase Program (the ESRP) that is intended to enhance the Bank's ability to manage the level of excess stock and, therefore, more efficiently utilize its capital. Under the ESRP, on a monthly basis, management determines available capital required to support incremental business activity and determines the desired amount of stock, if any, to repurchase from members. Under the ESRP, the Bank may unilaterally repurchase this amount of excess capital stock from members of the Bank whose ratio of total capital stock held to their TSIR amount exceeds a periodically defined level in accordance with timing and notice provisions established by the plan. This program is intended to enable the Bank to manage its capital and financial leverage in order to address asset fluctuations. In some months, management may decide not to exercise its discretion to initiate repurchases under the ESRP. Under the program the Bank will not repurchase any excess capital stock from a member if such repurchase would result in that member's capital-stock balance being less than the member's TSIR amount plus $200,000. However, in accordance with the moratorium on excess stock repurchases described below, the Bank did not repurchase excess capital stock under the ESRP during the year ended December 31, 2009.

        The Bank implemented a moratorium on excess stock repurchases which was adopted on December 8, 2008. This is designed to help the Bank preserve capital in the light of the challenges the Bank continues to face, which principally arise from losses on its investment portfolio of private-label MBS, which is discussed under Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operation—Financial Condition—Investments.

        The Bank's board of directors has a right and an obligation to call for additional capital-stock purchases by the Bank's members, as a condition of membership, as needed to satisfy statutory and regulatory capital requirements. These requirements include the maintenance of a stand-alone credit rating of no lower than double-A from an NRSRO. Since the adoption of the Bank's capital plan on April 19, 2004, the Bank's board of directors has not called for any additional capital-stock purchases by members for this reason.

        Mandatorily Redeemable Capital Stock.    The Bank reclassifies stock subject to redemption from equity to a liability once a member exercises a written redemption right, gives notice of intent to withdraw from membership, or attains a nonmember status by merger or acquisition, charter termination, or involuntary termination from membership, since the member shares will then meet the definition of a mandatorily redeemable financial instrument. We do not take into consideration our members' right to cancel a redemption request in determining when shares of capital stock should be classified as a liability, because such cancellation would be subject to a cancellation fee equal to two percent of the par amount of the shares of Class B stock that is the subject of the redemption notice. Member shares meeting this definition are reclassified to a liability at fair value. Dividends declared on member shares classified as a liability are accrued at the expected dividend rate and reflected as interest expense in the statement of operations. The repayment of these mandatorily redeemable financial instruments is reflected as financing cash outflows in the statement of cash flows once settled. At December 31, 2009, the Bank had $90.9 million in capital stock subject to mandatory redemption

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from eight former members or withdrawing members. This amount has been classified as a liability for mandatorily redeemable capital stock in the statement of condition. The Bank is not required to redeem or repurchase activity-based stock until the later of the expiration of the five-year notice of redemption or until the activity no longer remains outstanding. If activity-based stock becomes excess capital stock as a result of an activity no longer outstanding, the Bank may, at its sole discretion, repurchase the excess activity-based stock as described above.

        Retained Earnings.    The Bank's methodology for determining retained earnings adequacy incorporates the Bank's assessment of the various risks that could potentially adversely affect retained earnings if trigger stress scenario conditions occurred. Principal elements of this risk are market risk and credit risk. Market risk is represented through the Bank's value-at-risk (VaR) market-risk measurement which captures 99 percent of potential changes in the Bank's market value of equity due to potential parallel and nonparallel shifts in yield curves applicable to the Bank's assets, liabilities, and off-balance-sheet transactions. Credit risk is represented through incorporation of valuation deterioration due to but not limited to actual and potential adverse ratings migrations for the Bank's assets and actual and potential defaults.

        The Bank's current retained earnings target is $925.0 million, a target adopted to accumulate capital in light of the various challenges to the Bank, including the growth in accumulated other comprehensive losses primarily related to the Bank's portfolio of held-to-maturity private-label MBS, discussed in Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operation—Financial Condition—Investments. For further discussion of the Bank's retained earnings target, see Item 5—Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. The Bank's retained earnings target could be revised in response to potential Finance Agency mandates or due to potential changes in the Bank's risk profile. See Item 1A—Risk Factors. At December 31, 2009, the Bank had retained earnings of $142.6 million.

        Dividends.    The Bank may pay dividends from current net earnings or previously retained earnings, subject to certain limitations and conditions. Refer to Item 5—Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. The Bank's board of directors may declare and pay dividends in either cash or capital stock. In no event may the Bank pay a dividend if, having done so, the Bank's retained earnings level would be less than zero. The Bank's board of directors has a policy under which the Bank may pay up to 50 percent of the prior quarter's net income while the Bank's retained earnings are less than its retained earnings target. However, on February 22, 2010, the Bank announced that its board of directors does not expect to declare any dividends during at least the first half of 2010 irrespective of net income as the Bank continues to focus on building retained earnings. The Bank's board of directors will re-examine the issue during the second half of the year to assess progress toward retained earnings goals and determine the likelihood of quarterly dividend declarations for the remainder of 2010.

Interest-Rate-Exchange Agreements

        Finance Agency regulations establish guidelines for interest-rate-exchange agreements. The Bank can use interest-rate swaps, swaptions, interest-rate-cap and floor agreements, calls, puts, futures, and forward contracts as part of its interest-rate-risk management and funding strategies. Finance Agency regulations require the documentation of non-speculative use of these instruments and the establishment of limits to credit risk arising from these instruments.

        In general, the Bank uses interest-rate-exchange agreements in three ways: 1) as a fair-value or cash-flow hedge of a hedged financial instrument, firm commitments, or a forecasted transaction, 2) as economic hedges in asset-liability management that are not designated as hedges, or 3) by acting as an intermediary between members and the capital markets. In addition to using interest-rate-exchange agreements to manage mismatches of interest rates between assets and liabilities, the Bank also uses

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interest-rate-exchange agreements to manage embedded options in assets and liabilities; to hedge the market value of existing assets, liabilities, and anticipated transactions; to hedge the duration risk of prepayable instruments; and to reduce funding costs.

        The Bank may enter into interest-rate-exchange agreements concurrently with the issuance of COs to reduce funding costs. This allows the Bank to create synthetic floating-rate debt at a cost that is lower than the cost of a floating-rate cash instrument issued directly by the Bank. This strategy of issuing bonds while simultaneously entering into interest-rate-exchange agreements enables the Bank to offer a wider range of attractively priced advances to its members. The attractiveness of the debt depends on price relationships in both the bond market and interest-rate-exchange markets. When conditions in these markets change, the Bank may alter the types or terms of COs issued.

        The most common ways in which the Bank uses derivatives are:

    To reduce funding costs by combining a derivative and a CO. The combined funding structure can be lower in cost than a comparable CO bond;

    To preserve a favorable interest-rate spread between the yield of an asset (for example, an advance) and the cost of the supporting liability (for example, the CO bond used to fund the advance). Without the use of derivatives, this interest-rate spread could be reduced or eliminated when the interest rate on the advance and/or the interest rate on the bond change differently or change at different times;

    To mitigate the adverse earnings effects of the shortening or extension of certain assets (for example, advances or mortgage assets) and liabilities; and

    To protect the value of existing asset or liability positions or of anticipated transactions.

Competition

        Advances.    Demand for the Bank's advances is affected by, among other things, the cost of other available sources of liquidity for its members, including deposits. The Bank competes with other suppliers of wholesale funding, both secured and unsecured. Such other suppliers may include investment-banking concerns, commercial banks, the Federal Reserve and, in certain circumstances, other FHLBanks. Smaller members may have access to alternative funding sources, including sales of securities under agreements to repurchase and brokered certificates of deposit, while larger members may also have access to federal funds, negotiable certificates of deposit, bankers' acceptances, and medium-term notes, and may also have independent access to the national and global credit markets. Since 2008 and throughout 2009, members have also been able to access a myriad of liquidity programs established in response to the continuing credit crisis, including the Troubled Assets Relief Program's (TARP's) capital injections which directly increases each recipient's ability to lend, favorable changes to the Federal Reserve Board's requirements for borrowing directly from the Federal Reserve Banks, the Federal Reserve Board's commercial paper facility, and the FDIC's Temporary Liquidity Guarantee Program (the Temporary Liquidity Guarantee Program), pursuant to which the FDIC has guaranteed certain debt issuances by financial institutions, as surrogates to the Bank's traditional advance products. However, these alternative liquidity facilities either have been or are beginning to be scaled back and/or phased out, and this competition is expected to diminish in 2010. The availability of alternative funding sources to members can significantly influence the demand for the Bank's advances and can vary as a result of other factors including, among others, market conditions, members' creditworthiness, and availability of collateral. Further, demand for the Bank's advances may be adversely impacted by certain legislative and regulatory developments. For example, on February 27, 2009, the FDIC approved a final rule to increase deposit insurance premium assessments based on secured liabilities, including the Bank's advances, to the extent that the institution's ratio of secured liabilities to domestic deposits exceeds 25 percent is further described under Item 7—Management's Discussion and Analysis of

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Financial Condition and Results of Operations—Recent Legislative and Regulatory Developments. Bank members impacted by this final rule may decrease their demand for advances from the Bank due to the increased all-in cost from their increased deposit insurance premium assessments.

        Mortgage Loans Held for Portfolio.    The activities of the Bank's MPF portfolio are subject to significant competition in purchasing conventional, conforming fixed-rate mortgage and government-insured loans. The Bank faces competition in customer service, the prices paid for these assets, and in ancillary services such as automated underwriting. Historically, the most direct competition for mortgages came from other housing GSEs that also purchase conventional, conforming fixed-rate mortgage loans, specifically Fannie Mae and Freddie Mac. Since 2008, a Federal Reserve Board agency MBS purchase program instituted to make housing more affordable has contributed to the ability of Fannie Mae and Freddie Mac to offer low mortgage rates. Comparative MPF mortgage rates, which are a function of the FHLBank debt issuance costs, have not been as competitive from time to time. The net effect, all other things being equal, weakens member demand for MPF products. The Federal Reserve Board agency MBS purchase program, is described in Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Recent Legislation and Regulatory Developments.

        Debt Issuance and Interest-Rate Exchange Agreements.    The Bank competes with corporate, sovereign, and supranational entities for funds raised in the national and global debt markets. Increases in the supply of competing debt products may, in the absence of increases in demand, result in higher debt costs or lesser amounts of debt issued at the same cost than otherwise would be the case. In addition, the availability and cost of funds raised through the issuance of certain types of unsecured debt may be adversely affected by regulatory initiatives that discourage investments by certain institutions in unsecured debt with certain volatility or interest-rate-sensitivity characteristics. These factors may adversely impact the Bank's ability to effectively complete transactions in the swap market. Because the Bank uses interest-rate-exchange agreements to modify the terms of many of its CO bond issues, conditions in the swap market may affect the Bank's cost of funds.

        In addition, the sale of callable debt and the simultaneous execution of callable interest-rate-exchange agreements that mirror the debt have been important sources of competitive funding for the Bank. As such, the availability of markets for callable debt and interest-rate-exchange agreements may be an important determinant of the Bank's relative cost of funds. There is considerable competition among high-credit-quality issuers in the markets for callable debt and for interest-rate-exchange agreements. There can be no assurance that the current breadth and depth of these markets will be sustained.

        Throughout 2009, the FHLBanks have also faced competition in their funding operations from liquidity programs established in response to the credit crisis, as more fully discussed in Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Liquidity.

Assessments

        REFCorp Assessment.    Although the Bank is exempt from all federal, state, and local taxation, except for property taxes, it is obligated to make payments to REFCorp in the amount of 20 percent of net earnings after AHP expenses. There is no REFCorp payment obligation when net earnings are zero or less, as was the case for 2009. The REFCorp contribution requirement was established by Congress in 1989 to provide funds to pay a portion of the interest on debt issued by the Resolution Trust Corporation that was used to assist failed savings and loan institutions. These interest payments totaled $300 million per year, or $75 million per quarter for the 12 FHLBanks through 1999. In 1999, the Gramm-Leach-Bliley Act of 1999 (GLB Act) changed the annual assessment to a flat rate of 20 percent of net earnings (defined as net income determined in accordance with accounting principles generally

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accepted in the United States of America (GAAP)) after AHP expense. Since 2000, the FHLBanks have been required to make payments to REFCorp until the total amount of payments made is equivalent to a $300 million annual annuity with a final maturity date of April 15, 2030. The expiration of the obligation is shortened as the 12 FHLBanks make payments in excess of $75 million per quarter.

        Because the FHLBanks contribute a fixed percentage of their net earnings to REFCorp, the aggregate amounts paid have exceeded the required $75 million per quarter for the past several years. As specified in the Finance Agency regulation that implements Section 607 of the GLB Act, the payment amount in excess of the $75 million required quarterly payment is used to simulate the purchase of zero-coupon bonds issued by the U.S. Department of the Treasury (the U.S. Treasury) to defease all or a portion of the most distant remaining $75 million quarterly payment. The Finance Agency, in consultation with the Secretary of the U.S. Treasury, selects the appropriate zero-coupon yields used in this calculation. Through December 31, 2009, the FHLBanks' aggregate payments have satisfied $2.3 million of the $75 million requirement for April 15, 2012, and all scheduled payments thereafter. These defeased payments, or portions thereof, could be restored in the future if actual REFCorp payments of the 12 FHLBanks fall short of $75 million in any given quarter. Contributions to REFCorp will be discontinued once all obligations have been fulfilled. However, due to the interrelationships of all future earnings of the 12 FHLBanks, the total cumulative amount to be paid by the Bank to REFCorp is not determinable.

        If the Bank experienced a net loss during a quarter, but still had net income for the year, the Bank's obligation to the REFCorp would be calculated based on the Bank's year-to-date GAAP net income. The Bank would be able to reduce future assessment payments by the amounts paid in excess of its calculated annual obligation. If the Bank experienced a net loss for a full year, the Bank would have no obligation to the REFCorp for the year.

        The Bank recorded an annual net loss of $186.8 million for the year ended December 31, 2009, and so had no REFCorp obligation for the year. During the fourth quarter of 2008, the Bank recorded a loss before assessments of $331.5 million which resulted in an overpayment of the Bank's 2008 REFCorp obligation. The amount of the overpayment is recorded as a prepaid asset on the statement of condition and will be used towards future assessments.

        AHP Assessment.    Annually, the FHLBanks must set aside for the AHP the greater of $100 million or 10 percent of the current year's net income before charges for AHP and interest expense associated with mandatorily redeemable capital stock. The calculation of the AHP assessment has been determined by the Finance Agency.

        In annual periods where the Bank's regulatory net income is zero or less, as was the case for 2009, the AHP assessment for the Bank is zero. However, if the annual 10 percent contribution provided by each individual FHLBank is less than the minimum $100 million contribution required for FHLBanks as a whole, the shortfall is allocated among the FHLBanks based upon the ratio of each FHLBank's income before AHP and REFCorp to the sum of the income before AHP and REFCorp of the 12 FHLBanks combined, except that the required annual AHP contribution for an FHLBank shall not exceed its net earnings for the year. REFCorp determines allocation of this shortfall. There was no such shortfall in any of the preceding three years.

        The actual amount of the AHP contribution is dependent upon both the Bank's regulatory net income minus payments to REFCorp, and the income of the other FHLBanks; thus future contributions are not determinable.

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        Through the AHP, the Bank is able to address some of the affordable-housing needs of the communities served by its members. The Bank partners with member financial institutions to work with housing organizations to apply for funds to support initiatives that serve very low- to moderate-income households. The Bank uses funds contributed to the AHP program to award grants and low-interest-rate advances to its member financial institutions that make application for such funds for eligible, largely nonprofit, affordable housing development organizations in their respective communities. Such funds are awarded on the basis of an AHP Implementation Plan adopted by the Bank's board of directors, which implements a nationally based scoring methodology mandated by the Finance Agency.

        The AHP and REFCorp assessments are calculated simultaneously due to their interdependence. The REFCorp has been designated as the calculation agent for AHP and REFCorp assessments. Each FHLBank provides its net income before AHP and REFCorp assessments to the REFCorp, which then performs the calculations at each quarterend date.

        For the year ended December 31, 2009, the Bank experienced a net loss and did not set aside any AHP funding to be awarded during 2010. However, as allowed per AHP regulations, the Bank has elected to allot up to $5.0 million of future periods' required AHP contributions to be awarded during 2010 (referred to as the accelerated AHP). The accelerated AHP allows the Bank to commit and disburse AHP funds to meet the Bank's mission when it would otherwise be unable to do so, based on regulations. The Bank will offset the accelerated AHP contribution against required AHP contributions over the next five years.

ITEM 1A.    RISK FACTORS

        The following discussion summarizes some of the more important risks that the Bank faces. This discussion is not exhaustive, and there may be other risks that the Bank faces, which are not described below. The risks described below, if realized, could result in the Bank being prohibited from paying dividends, and/or repurchasing and redeeming its common stock and may adversely impact the Bank's business operations, financial condition, and future results of operations.

CREDIT RISKS

The Bank is subject to credit risk exposures related to the mortgage loans that back its MBS investments. Increased delinquency rates and credit losses beyond those currently expected may adversely impact the yield on or value of those investments.

        The Bank has invested in private-label MBS, which are backed by prime, subprime, and/or Alt-A mortgage loans. Although the Bank only invested in senior tranches with the highest long-term debt rating when purchasing private-label MBS, many of these securities are projected to sustain credit losses under current assumptions, and have been downgraded by various NRSRO's. See Item 7A—Quantitative and Qualitative Disclosures About Market Risk—Credit Risk—Investments for a description of the Bank's portfolio of investments in these securities.

        As described in Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates, other-than-temporary-impairment assessment is a subjective and complex determination by management. Throughout 2009, increasing delinquency and loss severity trends experienced on the loans underlying MBS, particularly subprime and Alt-A mortgage loans as well as challenging macroeconomic factors, particularly unemployment levels, have caused the FHLBanks' OTTI Governance Committee, and therefore the Bank, to adopt more pessimistic assumptions than in prior periods for other-than-temporary-impairment assessments of private-label MBS. These assumptions resulted in projected future credit losses thereby causing other-than-temporary impairment losses from certain of these securities. The Bank recognized credit losses of $72.4 million and decreases to other comprehensive loss of $24.4 million for MBS that

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management determined were other other-than-temporarily impaired for the quarter ended December 31, 2009. The Bank incurred credit losses of $444.1 million and increases to other comprehensive loss of $885.4 million for MBS that management determined were other-than-temporarily impaired for the year ended December 31, 2009. If macroeconomic trends or collateral credit performance within the Bank's private-label MBS portfolio deteriorate further than currently anticipated, more pessimistic assumptions including but not limited to housing price changes, loan default rates, loss severities, and prepayment speeds may be adopted by the FHLBanks' OTTI Governance Committee. As a possible outcome, the Bank may recognize additional credit losses and increases to other comprehensive loss, which may be substantial. For example, a cash-flow analysis was also performed for each of these securities under a more stressful housing price scenario. The more stressful scenario was based on a housing price forecast that was five percentage points lower at the trough than the base-case scenario followed by a flatter recovery path. Under this more stressful scenario, the Bank would be projected to realize an additional $111.2 million in credit losses and an additional decrease to other comprehensive loss of $51.2 million.

Investment rating downgrades and decreases in the fair value of the Bank's investments may increase the Bank's risk-based capital requirement.

        At December 31, 2009, the Bank's total risk-based capital requirement was approximately $1.5 billion. At December 31, 2009, the Bank had permanent capital of $3.9 billion and so was in excess of its risk-based capital requirement by $2.4 billion. However, further ratings downgrades on the Bank's investments or decreases in the fair value of the Bank's assets may increase the Bank's risk-based capital requirement. If the Bank is unable to satisfy its risk-based capital requirement, the Bank would be subject to certain capital restoration requirements and be prohibited from paying dividends, irrespective of whether the Bank has retained earnings or current net income, and redeeming or repurchasing capital stock without the prior approval of the Finance Agency. For a discussion of our risk-based capital requirements, see Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Capital.

Rising delinquency rates on the Bank's investments in MPF loans may adversely impact the Bank's financial condition.

        As discussed in Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Mortgage Loans, at December 31, 2009, delinquency rates on the Bank's investments in MPF loans had risen to 4.50 percent of total par value of mortgage loans outstanding from 2.61 percent of total par value of mortgage loans outstanding at December 31, 2008. In response to both the rise in delinquency rates and the general deterioration in nationwide housing prices, the Bank has increased its allowance for credit losses on mortgage loans to $2.1 million at December 31, 2009 from $350,000 at December 31, 2008. While the Bank has not changed its base methodology for calculating the allowance for loan losses since December 31, 2008, the Bank increased the loss severity estimates that the Bank applies to projected defaulted loans. This revision in loss assumptions reflects the prolonged deterioration in U.S. housing markets and resulting expectations as to the length and depth of depressed housing prices and impact on realized losses. To the extent that economic conditions further weaken and regional or national home prices continue to decline, the Bank could determine to further increase its allowance for credit losses on mortgage loans. Further, the Bank may be exposed to servicer defaults and PFI failures to satisfy their credit enhancement obligations if the financial condition of PFI members materially deteriorates.

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Declines in the value of mortgage loans that serve as collateral may adversely impact the Bank's business operations and/or financial condition.

        To secure advances, the Bank accepts collateral from members that includes some amounts of prime, subprime, and Alt-A residential mortgage loans, as well as MBS that may be backed by prime mortgage loans. During 2009, delinquencies and losses with respect to residential mortgage loans have increased, particularly for subprime, and Alt-A mortgage loans, including pay-option adjustable-rate mortgage loans. In addition, residential property values in many areas continued to decline throughout 2009. If delinquency and loss rates on residential mortgage loans continue to increase, or if there is a further decline in residential real estate values, the Bank would be exposed to a greater risk that the collateral that has been pledged to secure advances would be inadequate in the event of default on an outstanding advance.

The Bank has geographic concentrations that may adversely impact its business operations and/or financial condition.

        The Bank has concentrations of mortgage loans in some geographic areas based on its investments in MPF loans and private-label MBS and on its receipt of collateral pledged for advances. See Item 7A—Quantitative and Qualitative Disclosures About Market Risk—Credit Risk for additional information on these concentrations. To the extent that any of these geographic areas experiences significant further declines in the local housing markets, declining economic conditions, or a natural disaster, the Bank could experience increased losses on its investments in the MPF loans or the related MBS or be exposed to a greater risk that the pledged collateral securing related advances would be inadequate in the event of default on such an advance.

As mortgage servicers continue their loan modification and liquidation efforts, the yield on or value of the Bank's MBS investments may be adversely impacted.

        Mortgage servicers continue their efforts to modify delinquent loans in order to mitigate losses. Such loan modifications may include reductions in interest rate and/or principal on these loans. Losses from such loan modifications may be allocated to investors in MBS backed by these loans in the form of lower interest payments and/or reductions in future principal amounts received.

        This activity may result in higher losses being allocated to the Bank's MBS investments backed by such loans than the Bank may have expected or experienced to date.

Counterparty credit risk could adversely impact the Bank.

        The Bank assumes some unsecured credit risk when entering into money-market transactions and financial derivatives transactions with counterparties. The insolvency or other inability of a significant counterparty to perform its obligations under such transactions or other agreements could have an adverse effect on the Bank's financial condition and results of operations.

The Bank relies upon derivative instruments to reduce its interest-rate risk, however the Bank may not be able to enter into effective derivative instruments on acceptable terms.

        The Bank uses derivative instruments to reduce its interest-rate risk . If the Bank is unable to manage its hedging positions properly, or is unable to enter into hedging instruments upon acceptable terms, the Bank may be unable to effectively manage its interest-rate and other risks, which could adversely impact the Bank's financial condition and results of operations.

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Changes in the Bank's or other FHLBanks' credit ratings or other negative news may adversely impact the Bank's cost and availability of financing.

        The Bank currently has the highest credit rating from Moody's and S&P. In addition, the COs of the FHLBanks have been rated Aaa/P-1 by Moody's and AAA/A-1+ by S&P. These ratings are subject to reduction or withdrawal at any time by the rating agencies; therefore, the Bank may not be able to maintain these credit ratings. S&P has assigned two FHLBanks a stable rating with long-term ratings of AA+ as of February 28, 2010. Although the credit ratings of the COs of the FHLBanks have not been affected by these ratings, similar ratings actions may adversely affect the Bank's cost of funds and ability to issue COs on acceptable terms, which could adversely impact the Bank's financial condition and results of operations. Similarly, in the absence of rating-agency actions, the revelation of negative news affecting any FHLBank, such as material losses or increased risk of losses, may also adversely impact the Bank's cost of funds.

        A reduction in the Bank's ratings would also trigger additional collateral posting requirements under the Bank's derivative collateral agreements. At December 31, 2009, the impact of a downgrade to AA+ would have required $257.4 million of after-haircut valued collateral to be posted to our derivatives counterparties.

STRATEGIC RISKS

The Bank may fail to meet its minimum regulatory capital requirements and/or maintain a capital classification of adequately capitalized, which would result in prohibitions on dividends, excess capital stock repurchases, and capital stock redemption and could result in additional regulatory prohibitions.

        The Bank is required to satisfy certain minimum regulatory capital requirements, including risk-based capital requirements and certain regulatory capital and leverage ratios, which are described in Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Capital and is subject to the Finance Agency's regulation on FHLBank capital classification and critical capital levels (the Capital Rule). Additionally, the Bank is required to satisfy certain regulatory capital and leverage ratio requirements. Any failure to satisfy these requirements will result in the Bank becoming subject to certain capital restoration requirements and being prohibited from paying dividends, irrespective of whether the Bank has retained earnings or current net income, and redeeming or repurchasing capital stock without the prior approval of the Finance Agency.

        The Capital Rule, among other things, establishes criteria for four capital classifications and corrective action requirements for FHLBanks that are classified in any classification other than adequately capitalized. An adequately capitalized FHLBank is one that has sufficient permanent and total capital to satisfy its risk-based and minimum capital requirements. The Bank satisfied these requirements at December 31, 2009. However, pursuant to the Capital Rule, the Finance Agency has discretion to reclassify an FHLBank and modify or add to corrective action requirements for a particular capital classification. If the Bank becomes classified into a capital classification other than adequately capitalized, the Bank would be subject to the corrective action requirements for that capital classification in addition to being subject to prohibitions on declaring dividends and redeeming or repurchasing capital stock.

The board of directors' decisions not to declare dividends may decrease demand for advance products and increase membership withdrawals.

        The Bank's board of directors has not declared a dividend since the fourth quarter of 2008 as it seeks to preserve capital in light of certain challenges the Bank continues to face, which principally relate to losses from its investments in private-label MBS, as discussed in Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operation—Overview and Executive Summary—Principal Business Developments. On February 22, 2010, the Bank announced that its board

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of directors does not expect to declare a quarterly dividend based on quarterly results until it demonstrates a consistent pattern of positive net income, which will preclude a declaration of dividends for at least the first two quarters of 2010 irrespective of net income in those quarters as the Bank continues to focus on building retained earnings.

        The Bank's ability to pay dividends is also subject to statutory and regulatory requirements. For example, regulations may be issued requiring higher levels of retained earnings. Further, events such as changes in the Bank's market-risk profile, credit quality of assets held, and increased volatility of net income effects of the application of certain GAAP may affect the adequacy of the Bank's retained earnings. This in turn may require the Bank to further increase its retained earnings target and extend the elimination of dividends or reduce its dividends, as the case may be, in order to achieve and maintain the future targeted amounts of retained earnings.

        Should the board of directors continue not to declare dividends or declare dividends of relatively low yield, the Bank may experience decreased member demand for advances requiring capital stock purchases and increased membership requests for withdrawals that may adversely impact the Bank's business operations and financial condition.

The Bank's moratorium on excess stock repurchase may decrease demand for advance products and increase membership withdrawals.

        The Bank must meet its minimum regulatory capital requirements at all times. If the Bank were to fail to maintain an adequate level of total capital to comply with minimum regulatory capital requirements, it would be precluded from repurchasing excess capital stock or from redeeming capital stock until it restored compliance, which could cause members to withdraw from membership.

        Since December 8, 2008, the Bank has continued a moratorium on excess stock repurchases in light of certain challenges the Bank continues to face, which principally relate to losses from its investments in private-label MBS, as discussed in Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operation—Overview and Executive Summary—Principal Business Developments. This moratorium may be an incentive for members to withdraw from membership and a disincentive to prospective members from becoming members, either of which may adversely impact the Bank's business operations and financial condition.

The loss of significant members may result in lower demand for the Bank's products and services.

        At December 31, 2009, the Bank's five largest members held 50.8 percent of the Bank's stock. In addition, the Bank's two largest members held multiple memberships in the FHLBank System, allowing them the flexibility of borrowing from less capital-constrained FHLBanks. The loss of significant members or a significant reduction in the level of business they conduct with the Bank could lower demand for the Bank's products and services in the future and adversely impact the performance of the Bank.

        Also, consolidations within the financial services industry may reduce the number of current and potential members in the Bank's district. Industry consolidation could also cause the Bank to lose members whose business and stock investments are so substantial that their loss could threaten the viability of the Bank. In turn, the Bank might be forced to seek a merger with another FHLBank district.

        A decrease in demand for the Bank's products and services due to the loss of significant members may adversely impact the Bank's results of operations and financial condition, the impact of which may be greater during periods when the Bank is experiencing losses or reduced net income.

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The Bank is subject to a complex body of laws and regulations, which could change in a manner detrimental to the Bank's business operations and/or financial condition.

        The FHLBanks are GSEs, organized under the authority of the FHLBank Act, and, as such, are governed by federal laws and regulations promulgated, adopted, and applied by the Finance Agency, an independent agency in the executive branch of the federal government, that regulates the Bank. Congress may amend the FHLBank Act or other statutes in ways that significantly affect (1) the rights and obligations of the FHLBanks and (2) the manner in which the FHLBanks carry out their housing-finance mission and business operations. New or modified legislation enacted by Congress or regulations adopted by the Finance Agency or other financial services regulators could adversely impact the Bank's ability to conduct business or the cost of doing business. For a discussion of certain recent legislation and regulatory developments that may impact the Bank, see Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operation—Recent Legislative and Regulatory Developments.

        The Bank cannot predict what additional regulations will be issued or what additional legislation will be enacted, and the Bank cannot predict the effect of any such additional regulations or legislation on the Bank's business operations and/or financial condition. Additional changes in regulatory or statutory requirements could result in, for example, an increase in the FHLBanks' cost of funding, a change in permissible business activities, or a decrease in the size, scope, or nature of the FHLBanks' lending, investment, or mortgage-financing activities, which could adversely impact the Bank's financial condition and results of operations. The enactment of legislation and regulations may also have an indirect, adverse impact on the Bank. See Market Risk—The Bank faces competition for loan demand and loan purchases, which could adversely impact results of operations in this Item for discussion of the enactment of certain federal legislation and regulations that have increased competition to the Bank as a supplier of advances and may adversely impact the Bank's earnings. See also Proposed legislation in response to the U.S. housing and economic recession may adversely impact the Bank's advances business and investments below for a discussion of proposed legislation that may adversely impact the Bank's investments and member borrowing capacity.

Proposed legislation in response to the U.S. housing and economic recession may adversely impact the Bank's advance business and investments.

        Certain proposed federal legislation in response to the continuing U.S. housing and economic recession may adversely impact the Bank's investments and advances business. For example, in 2009, federal legislation was proposed that would have allowed bankruptcy cramdowns on first mortgages of owner-occupied homes as a response to the U.S. economic recession and attendant U.S. housing recession. The proposed legislation would have allowed a bankruptcy judge to reduce the principal amount of such mortgages to the current market value of the property (a cramdown), which is currently prohibited by the Bankruptcy Reform Act of 1994. Some of the private-label MBS in which the Bank has invested contain a cap on bankruptcy losses, and when such cap is exceeded, bankruptcy losses are allocated among all classes of such MBS on a pro-rata basis among the classes of such MBS rather than by seniority. In the event that this legislation is enacted so as to apply to all existing mortgage debt (including first mortgages of owner-occupied homes), then the Bank could face increased risk of credit losses on its private-label MBS that include such bankruptcy caps due to the erosion of its credit protection it would have otherwise had via its senior class of such MBS. Any such credit losses may lead to other-than-temporary impairment charges for affected private-label MBS in the Bank's held-to-maturity portfolio. Additionally, bankruptcy cramdowns could adversely impact the value of the collateral held in support of the Bank's loans to members, resulting in reduction of member borrowing capacity, and could adversely impact value of the MPF mortgage loans held by the Bank.

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Compliance with regulatory contingency liquidity guidance could adversely impact the Bank's results of operations.

        The Bank is required to maintain sufficient liquidity through short-term investments in an amount at least equal to the Bank's cash outflows under two different scenarios, as discussed in Item 7A—Quantitative and Qualitative Disclosures About Market Risk—Liquidity Risk. The requirement is designed to enhance the Bank's protection against temporary disruptions in access to the FHLBank debt markets in response to a rise in capital markets volatility. To satisfy this additional requirement, the Bank maintains balances in shorter-term investments, which may earn lower interest rates than alternate investment options and may, in turn, adversely impact net interest income. In certain circumstances, the Bank may need to fund overnight or shorter-term advances with short-term discount notes that have maturities beyond the maturities of the related advances, thus increasing the Bank's short-term advance pricing or reducing net income through lower net interest spread. To the extent these increased prices make the Bank's advances less competitive, advance levels and, therefore, the Bank's net interest income may be adversely impacted.

The Bank may not be able to realize the goals of the revised operating plan.

        As discussed in Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operation—Overview and Executive Summary—Principal Business Developments, management and the board of directors have implemented a revised operating plan that includes goals as to certain revenue enhancement and expense reduction initiatives intended to help restore the Bank to a position where it can once again repurchase excess capital stock, pay members a dividend, and better fund the AHP. The plan calls for enhanced product offerings, strategies to encourage membership and credit products growth, prudent and profitable investment strategies, potential flexibility in capital requirements to promote new credit activity, greater operational efficiencies, and expense reduction. However, certain portions of the plan require the prior approval of the Finance Agency, and there can be no assurance that the Finance Agency will approve such portions of the plan. In addition, the success of many elements of the plan depend on factors outside of the Bank's control. For example, efforts to encourage new credit activity among the Bank's members may be offset by alternative funding sources available to them, including, but not limited to, such sources developed by the federal government in response to the continuing U.S. economic recession, as discussed in Market Risks—The Bank faces competition for loan demand and loan purchases which could adversely impact results of operations.

Required AHP contribution rates could decrease available funds to pay as dividends to members.

        If the total annual net income before AHP expenses of the 12 FHLBanks were to fall below $1 billion, each FHLBank would be required to contribute more than 10 percent of its net income after REFCorp expenses to its AHP to meet the minimum $100 million annual contribution. Increasing the Bank's AHP contribution in such a scenario would reduce the Bank's net income after AHP charges and thereby reduce available funds to pay as dividends.

MARKET RISKS

Any inability of the Bank to access the capital markets could adversely impact its business operations, financial condition, and results of operations.

        The Bank's primary source of funds is the sale of COs in the capital markets. The Bank's ability to obtain funds through the sale of COs depends in part on prevailing conditions in the capital markets at that time, which are beyond the Bank's control. Accordingly, the Bank cannot make any assurance that it will be able to obtain funding on terms acceptable to the Bank, if at all. If the Bank cannot access funding when needed, the Bank's ability to support and continue its operations would be adversely

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impacted, which would thereby adversely impact the Bank's financial condition and results of operations.

        The credit crisis, which commenced in mid-2007 and deepened greatly in the second half of 2008, resulted in the Bank's increasing reliance on short-term COs resulting from funding spreads for longer-term COs that were higher than historical norms due to investor preference for short-term investments at that time. As a result, the Bank has also become more reliant on the ongoing issuance of discount notes, which are COs with maturities of one year or less, for funding, which reliance continued into 2010. If the Bank cannot access funding when needed on acceptable terms, its ability to support and continue its operations could be adversely impacted, which could adversely impact its financial condition and results of operations, and the value of membership in the Bank.

        Notably, the Federal Reserve Board has announced its intention to cease purchasing GSE debt, as discussed in Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operation—Recent Legislative and Regulatory Developments. The Bank's funding costs could be adversely impacted by the removal of this support.

The Bank faces competition for loan demand and loan purchases that could adversely impact results of operations.

        The Bank's primary business is providing liquidity to its members by making advances to, and purchasing mortgage loans from, its members. The Bank competes with other suppliers of wholesale funding, both secured and unsecured, including investment banks, commercial banks, and, in certain circumstances, other FHLBanks. Many of the Bank's competitors are not subject to the same body of regulation applicable to the Bank. This is one factor among several that may enable the Bank's competitors to offer wholesale funding on terms that the Bank is not able to offer and that members deem more desirable than the terms offered by the Bank on its advances.

        The availability to the Bank's members of different products from alternative funding sources, with terms more attractive than the terms of products offered by the Bank, may significantly decrease the demand for the Bank's advances and/or loan purchases. Further, any change made by the Bank in the pricing of its advances in an effort to compete effectively with these competitive funding sources may decrease the profitability on advances, which may reduce earnings. More generally, a decrease in the demand for advances and/or loan purchases, or a decrease in the Bank's profitability on advances and/or loan purchases, may adversely impact the Bank's financial condition and results of operations.

        For example, certain federal government responses to the continuing U.S. economic recession led to increased competition for the Bank's advances products. Examples of such responses are:

    the reduction on the required discount on pledged collateral and lowered interest rates on Federal Reserve Bank loans, which are in direct competition with the Bank's advances products;

    the Federal Reserve Board's establishment of a commercial paper funding facility providing eligible institutions with the ability to raise funds in direct competition with the Bank's advances products;

    a proposed program funded with $30 billion of TARP proceeds that permits financial institutions with fewer than $10 billion in assets to borrow money at a low interest rate from the U.S. Treasury; and

    the Temporary Liquidity Guarantee Program, which may decrease the funding costs of any Bank member that participates in the program which, in turn, may reduce member demand for advances products from the Bank.

        Similarly, certain federal government responses to the continuing U.S. economic recession have increased competition for the Bank's purchases of loans through the MPF program which may have an

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adverse impact on the Bank's earnings. One such response is the Federal Reserve Board's agency MBS purchase program, which was initiated to drive mortgage rates lower. The program has resulted in very low mortgage yields for new mortgage loans. As a result of these pricing pressures, in 2009 the Bank was not able to purchase as many mortgage loans under the MPF program as in prior years, as discussed in Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Mortgage Loans. So long as pricing remains less competitive than other pricing available from other agencies, including Fannie Mae and Freddie Mac, the Bank expects member demand for MPF products to be weak, which may have an adverse impact on the Bank.

The Bank's efforts to maintain adequate capital levels could hamper its ability to generate asset growth including, but not limited to, meeting member advance requests.

        The Bank is mandated to maintain minimum regulatory capital thresholds including, but not limited to, a minimum total regulatory capital ratio of 4.0 percent, which is a percentage equal to permanent capital divided by total assets. This requirement does not permit the Bank to leverage its asset size by borrowing to invest in assets in excess of 4.0 percent of asset financing. As a condition for borrowing advances from the Bank, members are required to invest in capital stock of the Bank, permitting members to leverage their member stock investment to borrow at multiples of that stock investment. In certain scenarios, members seeking to leverage their excess stock availability at the Bank may be unable to borrow at the fullest capacity if overall asset growth causes the Bank's total regulatory capital ratio to fall below 4.0 percent, even after discretionary assets, including, but not limited to, short-term investments, are disposed.

Additional declines in U.S. home prices or in activity in the U.S. housing market could adversely impact the Bank's business operations and/or financial condition.

        The deterioration of the U.S. housing market and national decline in home prices, which began in 2007 and remains depressed in to 2010, may adversely impact the financial condition of a number of the Bank's members, particularly those whose businesses are concentrated in the mortgage industry. One or more of the Bank's members may default on its obligations to the Bank for a number of reasons, such as changes in financial condition, a reduction in liquidity, operational failures, or insolvency. In addition, the value of residential mortgage loans pledged by the Bank's members to the Bank as collateral may further decrease. If a member defaulted, and the Bank was unable to obtain additional collateral to make up for the reduced value of such residential mortgage loan collateral, the Bank could incur losses. A default by a member with significant obligations to the Bank could result in significant financial losses, which would adversely impact the Bank's results of operations and financial condition.

        Further, the deterioration of the U.S. housing market and national decline in home prices, may result in further increases in delinquency rates and loss severities on the mortgage loans underlying the Bank's investments in mortgages and MBS, the risks of which are discussed under Credit Risks—The Bank is subject to credit risk exposures related to the mortgage loans that back its MBS investments. Increased delinquency rates and credit losses beyond those currently expected may adversely impact the yield on or value of those investments and—Rising delinquency rates on the Bank's investments in MPF loans may adversely impact the Bank's financial condition.

The recent announcements by Fannie Mae and Freddie Mac that they intend to purchase seriously delinquent loans at par value from MBS pools may adversely impact the Bank's financial performance.

        In February 2010, Fannie Mae and Freddie Mac announced that they intend to repurchase seriously delinquent loans, defined as loans 120 days or more delinquent, out of collateral pools backing the MBS they have issued at par value. While details of the repurchase programs are not fully known, the repurchase of seriously delinquent loans by Fannie Mae and Freddie Mac would result in

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significant levels of principal received by investors in a short period of time resulting in an increase in market liquidity. This may, in turn, serve to limit the Bank's opportunities to reinvest these prepayments profitably as other investors would be seeking to re-deploy these prepayments simultaneously, elevating purchase prices and reducing effective yields on the new investments.

        Additionally, if these GSEs access the capital markets to fund these prepayments, the Bank's own funding costs may be adversely impacted. The funding costs for these GSEs and the FHLBanks traditionally track each other closely. Therefore, any material increase in these GSEs accessing the capital markets from these prepayment programs could result in higher funding costs realized by these GSEs and the FHLBanks as well.

The public perception of GSEs may adversely impact the Bank's funding costs.

        The housing-related GSEs—Fannie Mae, Freddie Mac, and the FHLBanks—issue highly rated agency debt to fund their operations. From time to time negative announcements by Fannie Mae and Freddie Mac concerning accounting problems, risk-management issues, and regulatory enforcement actions have created pressure on debt pricing for all GSEs, as investors have perceived such instruments as bearing increased risk. Similar announcements by the FHLBanks may contribute to this pressure on debt pricing.

        The FHLBank System may have to pay a higher rate of interest on its COs to make them attractive to investors. If the Bank maintains its existing pricing on advances, the resulting increased costs of issuing COs may adversely impact the Bank's financial condition and results of operations and could cause advances to be less profitable for the Bank. If, in response to this decrease in spreads, the Bank changes the pricing of its advances, the advances may be less attractive to members, and the amount of new advances and the Bank's outstanding advance balances may decrease. In either case, the increased cost of issuing COs may adversely impact the Bank's financial condition and results of operations.

The Bank may become liable for all or a portion of the consolidated obligations of the FHLBanks, which could adversely impact the Bank's financial condition and results of operations.

        Each of the FHLBanks relies upon the issuance of COs as a primary source of funds. COs are the joint and several obligations of all of the FHLBanks, backed only by the financial resources of the FHLBanks. Accordingly, the Bank is jointly and severally liable with the other FHLBanks for the COs issued by the FHLBanks through the Office of Finance, regardless of whether the Bank receives all or any portion of the proceeds from any particular issuance of COs. The Finance Agency, at its discretion, may require any FHLBank to make principal or interest payments due on any COs, whether or not the primary obligor FHLBank has defaulted on the payment of that obligation. Accordingly, the Bank could incur significant liability beyond its primary obligation under COs due to the failure of other FHLBanks to meet their obligations, which could adversely impact the Bank's financial condition and results of operations.

        Additionally, due to the Bank's relationship with other FHLBanks, the Bank could be impacted by events other than the default of a CO. Events that impact other FHLBanks such as member failures, capital deficiencies, and other-than-temporary impairment charges may cause the Finance Agency, at its discretion, to require another FHLBank to either provide capital to or purchase assets of another FHLBank. The Bank's financial condition and results of operations could be adversely impacted if it were required to either so provide capital or purchase assets.

Changes in interest rates could adversely impact the Bank's financial condition and results of operations.

        Like many financial institutions, the Bank realizes income primarily from the spread between interest earned on the Bank's outstanding loans and investments and interest paid on the Bank's

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borrowings and other liabilities, as measured by its net interest spread. Although the Bank uses various methods and procedures to monitor and manage exposures due to changes in interest rates, the Bank may experience instances when either the Bank's interest-bearing liabilities will be more sensitive to changes in interest rates than its interest-earning assets, or vice versa. These impacts could be exacerbated by prepayment and extension risk, which is the risk that mortgage-related assets will be refinanced in low-interest-rate environments, or will remain outstanding at below-market yields when interest rates increase. In any case, interest-rate moves could adversely impact the Bank's financial condition and results of operations.

OPERATIONAL RISKS

The Bank relies heavily upon information systems and other technology and any failure of such information systems or other technology could adversely impact the Bank's financial condition and results of operations.

        The Bank relies heavily upon information systems and other technology to conduct and manage its business. To the extent that the Bank experiences a failure or interruption in any of these systems or other technology, the Bank may be unable to conduct and manage its business effectively, including, without limitation, its hedging and advances activities. While the Bank has implemented a disaster recovery and business continuity plan, the Bank can make no assurance that it will be able to prevent, or timely and adequately address, the negative effects of any such failure or interruption. Any failure or interruption could significantly harm the Bank's customer relations, risk management, and profitability, and could adversely impact the Bank's financial condition and results of operations.

The Bank relies on the FHLBank of Chicago in participating in the MPF program in that FHLBank's capacity as MPF provider and could be adversely impacted if the FHLBank of Chicago changed or ceased to operate the MPF program, or experienced information systems or other technological interruptions, or failures in its capacity as MPF Provider.

        As part of its business, the Bank participates in the MPF program with the FHLBank of Chicago, which accounts for 5.6 percent of the Bank's total assets and 16.9 percent of interest income as of December 31, 2009. The Bank relies on the FHLBank of Chicago as the MPF provider to operate and administer the MPF program. If the FHLBank of Chicago changes, or ceases to operate the MPF program or experiences a failure or interruption in its information systems and other technology in its operation of the MPF program, the Bank's mortgage-purchase business could be adversely affected, and the Bank could experience a related decrease in its net interest margin, financial condition, and profitability. In the same way, the Bank could be adversely affected if any of the FHLBank of Chicago's third-party vendors it engages in the operation of the MPF program were to experience operational or technological difficulties.

The Bank relies on models to value financial instruments and the assumptions used may have a significant effect on the Bank's financial position, the results of operations, and the assessment of risk exposure.

        The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market parameters. For financial instruments that are actively traded and have quoted market prices or parameters readily available, there is little to no subjectivity in determining fair value. If market quotes are not available, fair values are based on discounted cash flows using market estimates of interest rates and volatility or on dealer prices or prices of similar instruments. Pricing models and their underlying assumptions are based on management's best estimates for discount rates, prepayments, market volatility, and other factors. These assumptions may have a significant effect on the reported fair values of assets and liabilities, including derivatives, the related income and expense, and the expected future behavior of assets and liabilities. While models used by the Bank to value instruments and measure risk exposures are subject to periodic validation by independent parties, rapid changes in market conditions in the

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interim could impact the Bank's financial position. The use of different models and assumptions, as well as changes in market conditions, could significantly impact the Bank's financial position and results of operations.

ITEM 1B.    UNRESOLVED STAFF COMMENTS

        None.

ITEM 2.    PROPERTIES

        The Bank occupies 60,744 square feet of leased office space at 111 Huntington Avenue, Boston, Massachusetts 02199. The Bank also maintains 9,969 square feet of leased property for an off-site back-up facility in Westborough, Massachusetts. The Bank believes its properties are adequate to meet its requirements for the foreseeable future.

ITEM 3.    LEGAL PROCEEDINGS

        The Bank from time to time is subject to various pending legal proceedings arising in the normal course of business. After consultation with legal counsel, management does not anticipate that the ultimate liability, if any, arising out of these matters will have a material adverse effect on the Bank's financial condition or results of operations.

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PART II

ITEM 4.    (REMOVED AND RESERVED)

ITEM 5.    MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

        Bank capital stock is issued and redeemed at its par value of $100 per share. The Bank's stock is not publicly traded and can be purchased only by the Bank's members. As of February 28, 2010, 460 members and three nonmembers held a total of 37.4 million shares of the Bank's Class B stock, which is the only class of stock outstanding.

        During 2009, the Bank did not declare any dividends. In 2008 the Bank declared quarterly cash dividends as outlined in the following table. Dividend rates are quoted in the form of an interest rate, which is then applied to each member's average capital-stock-balance outstanding during the quarter to determine the dollar amount of the dividend that each member will receive. Dividends are solely within the discretion of the Bank's board of directors. Historically, the dividend rate has been based upon a spread to average short-term interest rates experienced during the quarter.


Quarterly Dividends Declared
(dollars in thousands)

 
  2008  
Dividends Declared in the Quarter Ending
  Average
Capital
Stock(1)
  Dividend
Amount(2)
  Annualized
Dividend
Rate
 

March 31

  $ 3,281,473   $ 49,627     6.00 %

June 30

    3,263,508     32,456     4.00  

September 30

    3,356,801     25,456     3.05  

December 31

    3,549,547     22,306     2.50  

(1)
Average capital stock amounts do not include average balances of mandatorily redeemable stock.

(2)
The dividend amounts do not include the interest expense on mandatorily redeemable stock.

        Dividends are declared and paid in accordance with a schedule adopted by the board of directors that enables the Bank's board of directors to declare each quarterly dividend after net income is known, rather than basing the dividend on estimated net income. For example, in 2008, quarterly dividends were declared in February, May, August, and November based on the immediately preceding quarter's net income and were paid on the second business day of the month that followed the month of declaration.

        Dividends may be paid only from current net earnings or previously retained earnings. In accordance with the FHLBank Act and Finance Agency regulations, the Bank may not declare a dividend if the Bank is not in compliance with its minimum capital requirements or if the Bank would fall below its minimum capital requirements or would not be adequately capitalized as a result of a dividend except, in this latter case, with the Director of the Finance Agency's permission. Further, the Bank may not pay dividends to its members if the principal and interest due on any CO issued through the Office of Finance on which it is the primary obligor has not been paid in full, or under certain circumstances, if the Bank becomes a noncomplying FHLBank as that term is defined in Finance Agency regulations as a result of its inability to either comply with regulatory liquidity requirements or satisfy its current obligations.

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        Additionally, the Bank may not pay dividends in the form of capital stock or issue new excess stock to members if the Bank's excess stock exceeds one percent of its total assets or if the issuance of excess stock would cause the Bank's excess stock to exceed one percent of its total assets. At December 31, 2009, the Bank had excess capital stock outstanding totaling $1.5 billion or 2.4 percent of its total assets.

        The Bank's board of directors has adopted a quarterly dividend payout restriction that limits the quarterly dividend payout to no more than 50 percent of quarterly earnings in the event that the retained earnings target exceeds the Bank's current level of retained earnings. The Bank's retained earnings target is $925.0 million and the Bank had retained earnings of $142.6 million at December 31, 2009. On February 22, 2010, the Bank announced that its board of directors does not expect to declare any dividends until it demonstrates a consistent pattern of positive net income, which will likely preclude a declaration of dividends for at least the first two quarters of 2010 irrespective of net income as the Bank continues to focus on its plan to build retained earnings. The Bank's board of directors will re-examine the issue during the second half of the year to assess progress toward retained earnings goals and determine the likelihood of quarterly dividend declarations for the remainder of the year.

        In addition, as part of the revised operating plan, the Bank adopted a minimum capital level in excess of regulatory requirements to provide further protection for the Bank's capital base. This adopted minimum capital level provides that the Bank will maintain a minimum capital level equal to four percent of its total assets plus its retained earnings target, an amount equal to $3.4 billion at December 31, 2009. The Bank's permanent capital level was $3.9 billion at December 31, 2009, so the Bank was in excess of this higher requirement by $452.1 million on that date. If necessary to satisfy this adopted minimum capital level, however, the Bank will take steps to control asset growth and/or maintain capital levels, the latter of which could limit future dividends. For additional information on the Bank's revised operating plan, see Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Overview and Executive Summary—Principal Business Developments.

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ITEM 6.    SELECTED FINANCIAL DATA

        The following selected financial data for each of the five years ended December 31, 2009, 2008, 2007, 2006, and 2005, have been derived from the Bank's audited financial statements. Financial information is included elsewhere in this report in regards to the Bank's financial condition as of December 31, 2009 and 2008, and the Bank's results of operations for the years ended December 31, 2009, 2008, and 2007. This selected financial data should be read in conjunction with the Bank's financial statements and the related notes thereto appearing in this report.


SELECTED FINANCIAL DATA
(dollars in thousands)

 
  December 31,  
 
  2009   2008   2007   2006   2005  

Statement of Condition

                               

Total assets

  $ 62,487,000   $ 80,353,167   $ 78,200,338   $ 57,387,952   $ 57,675,766  

Investments(1)

    20,947,464     18,864,899     17,862,559     15,242,161     14,466,788  

Advances

    37,591,461     56,926,267     55,679,740     37,342,125     38,067,896  

Mortgage loans held for portfolio, net(2)

    3,505,975     4,153,537     4,091,314     4,502,182     4,886,494  

Deposits and other borrowings

    772,457     611,070     713,126     1,040,560     577,305  

Consolidated obligations

                               
 

Bonds

    35,409,147     32,254,002     30,421,987     35,518,442     29,442,073  
 

Discount notes

    22,277,685     42,472,266     42,988,169     17,723,515     24,339,903  
                       

Total consolidated obligations

    57,686,832     74,726,268     73,410,156     53,241,957     53,781,976  

Mandatorily redeemable capital stock

    90,896     93,406     31,808     12,354     8,296  

Class B capital stock outstanding—putable(3)

    3,643,101     3,584,720     3,163,793     2,342,517     2,531,145  

Retained earnings (accumulated deficit)

    142,606     (19,749 )   225,922     187,304     135,086  

Accumulated other comprehensive (loss) income

    (1,021,649 )   (134,746 )   (2,201 )   2,693     11,518  

Total capital

    2,764,058     3,430,225     3,387,514     2,532,514     2,677,749  

Results of Operations

                               

Net interest income

  $ 311,714   $ 332,667   $ 312,446   $ 302,188   $ 253,607  

Provision for credit losses

    1,750     225     (9 )   (1,704 )   502  

Net impairment losses on held-to-maturity securities recognized in earnings

    (444,068 )   (381,745 )            

Other income (loss)

    7,421     (10,215 )   11,137     11,750     (29,734 )

Other expense

    60,068     56,308     53,618     49,055     46,184  

AHP and REFCorp assessments

            71,740     70,796     49,045  

Net (loss) income

    (186,751 )   (115,826 )   198,234     195,791     135,260  

Other Information

                               

Dividends declared

  $   $ 129,845   $ 159,616   $ 143,573   $ 96,040  

Dividend payout ratio(4)

    N/A     N/A     80.52 %   73.33 %   71.00 %

Weighted-average dividend rate(5)

    N/A     3.86 %   6.62     5.51     4.36  

Return on average equity(6)

    (6.49 )   (3.17 )   6.96     7.19     5.79  

Return on average assets

    (0.27 )   (0.14 )   0.30     0.33     0.27  

Net interest margin(7)

    0.44     0.41     0.48     0.51     0.51  

Average equity to average assets

    4.09     4.42     4.35     4.57     4.66  

Total regulatory capital ratio(8)

    6.20     4.55     4.37     4.42     4.64  

(1)
Investments include available-for-sale securities, held-to-maturity securities, trading securities, interest-bearing deposits, securities purchased under agreements to resell and federal funds sold.

(2)
The allowance for credit losses amounted to $2.1 million, $350,000, $125,000, $125,000 and $1.8 million for the years ended December 31, 2009, 2008, 2007, 2006, and 2005, respectively.

(3)
Capital stock is putable at the option of a member.

(4)
The dividend payout ratio for 2009 and 2008 is not meaningful.

(5)
Weighted-average dividend rate is dividend amount declared divided by the average daily balance of capital stock eligible for dividends.

(6)
Return on average equity is net income divided by the total of the average daily balance of outstanding Class B capital stock, accumulated other comprehensive (loss) income and retained earnings.

(7)
Net interest margin is net interest income before mortgage-loan-loss provision as a percentage of average earning assets.

(8)
Total regulatory capital ratio is capital stock (including mandatorily redeemable capital stock) plus retained earnings as a percentage of total assets. See Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Capital regarding the Bank's regulatory capital ratios.

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ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

        This document includes statements describing anticipated developments, projections, estimates, or future predictions of the Bank that are "forward-looking statements". These statements may use forward-looking terminology such as, but not limited to, "anticipates," "believes," "could," "estimates," "may," "should," "will," "likely," or their negatives or other variations on these terms. The Bank cautions that, by their nature, forward-looking statements are subject to a number of risks or uncertainties, including the risk factors set forth in Item 1A and the risks set forth below, and that actual results could differ materially from those expressed or implied in these forward-looking statements. As a result, you are cautioned not to place undue reliance on such statements. The Bank does not undertake to update any forward-looking statement herein or that may be made from time to time on behalf of the Bank.

        Forward-looking statements in this annual report include, among others, the following:

    the Bank's projections regarding income, retained earnings, and dividend payouts;

    the Bank's projections regarding credit losses on advances, purchased whole mortgages and mortgage-related securities;

    the Bank's expectations relating to future balance-sheet growth;

    the Bank's targets under the Bank's retained earnings plan;

    the Bank's expectations regarding the size of its mortgage-loan portfolio, particularly as compared to prior periods; and

    statements about the Bank's expectations of its ability to achieve the goals of the revised operating plan and related projections and expectations, such as meeting the target for retained earnings.

        Actual results may differ from forward-looking statements for many reasons, including but not limited to:

    changes in interest rates, housing prices, employment rates and the general economy;

    changes in the size and volatility of the residential mortgage market;

    changes in demand for Bank advances and other products resulting from changes in members' deposit flows and credit demands or otherwise;

    the willingness of the Bank's members to do business with the Bank despite the absence of dividend payments in 2009 and the continuing moratorium on the repurchase of excess capital stock;

    changes in the financial health of the Bank's members;

    insolvencies of the Bank's members;

    increases in borrower defaults on mortgage loans and fluctuations in the housing market;

    deterioration in the loan credit performance of the Bank's private-label MBS portfolio beyond forecasted assumptions concerning loan default rates, loss severities, and prepayment speeds resulting in the realization of additional other-than-temporary impairment charges;

    an increase in advance prepayments as a result of changes in interest rates or other factors;

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    the volatility of market prices, rates, and indices that could affect the value of collateral held by the Bank as security for obligations of Bank members and counterparties to interest-rate-exchange agreements and similar agreements;

    political events, including legislative, regulatory, judicial, or other developments that affect the Bank, its members, counterparties, and/or investors in the COs of the FHLBanks;

    competitive forces including, without limitation, other sources of funding available to Bank members, other entities borrowing funds in the capital markets, and the ability to attract and retain skilled employees;

    the pace of technological change and the ability of the Bank to develop and support technology and information systems sufficient to manage the risks of the Bank's business effectively;

    the loss of large members through mergers and similar activities;

    changes in investor demand for COs and/or the terms of interest-rate-exchange-agreements and similar agreements;

    the timing and volume of market activity;

    the volatility of reported results due to changes in the fair value of certain assets and liabilities, including, but not limited to, private-label MBS;

    the ability to introduce new—or adequately adapt current—Bank products and services and successfully manage the risks associated with those products and services, including new types of collateral used to secure advances;

    the availability of derivative financial instruments of the types and in the quantities needed for risk management purposes from acceptable counterparties;

    the realization of losses arising from litigation filed against one or more of the FHLBanks;

    the realization of losses arising from the Bank's joint and several liability on COs;

    inflation or deflation;

    issues and events within the FHLBank System and in the political arena that may lead to regulatory, judicial, or other developments may affect the marketability of the COs, the Bank's financial obligations with respect to COs, and the Bank's ability to access the capital markets.

    significant business disruptions resulting from natural or other disasters, acts of war or terrorism; and

    the effect of new accounting standards, including the development of supporting systems.

        Risks and other factors could cause actual results of the Bank to differ materially from those implied by any forward-looking statements. Our risk factors are not exhaustive. The Bank operates in a changing economic and regulatory environment, and new risk factors will emerge from time to time. Management cannot predict such new risk factors nor can it assess the impact, if any, of such new risk factors on the business of the Bank or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those implied by any forward-looking statements.

Overview and Executive Summary

Principal Business Developments

        The Bank recognized a net loss of $186.8 million for the year ended December 31, 2009 versus a net loss of $115.8 million for the year ended December 31, 2008. The primary challenge for the Bank continues to be losses due to the other-than-temporary impairment of many of its investments in

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private-label MBS resulting in a credit loss of $444.1 million and a net increase to accumulated other comprehensive loss of $885.4 million for the year ended December 31, 2009. The annual net loss left the Bank with $142.6 million in retained earnings at December 31, 2009. The outstanding par balance of advances was $36.9 billion at December 31, 2009, as such balances continued to decline from the levels of 2008 that were historically high due to the credit related liquidity crisis. The Bank remains in compliance with all regulatory capital ratios as of December 31, 2009.

        The credit quality of the loans underlying the Bank's portfolio of private-label MBS was the principal cause of the 2009 net loss and it remains vulnerable to the housing and capital markets, which could result in additional losses. Accordingly, the Bank has taken the following steps in an effort to protect its capital base and build retained earnings:

    The Bank has not declared any dividends since the fourth quarter of 2008, and the Bank's board of directors has announced that it does not expect to declare any dividends until the Bank demonstrates a consistent pattern of positive net income, which will likely preclude a declaration of dividends for at least the first two quarters of 2010 as the Bank continues to focus on building retained earnings. The Bank's dividend policy is discussed in Item 5—Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

    The Bank has adopted a retained earnings target of $925.0 million. The Bank's retained earnings target is discussed in Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.

    The moratorium on excess stock repurchases that commenced December 8, 2008, remains in effect.

    The Bank has implemented a revised operating plan (the revised operating plan) that includes goals as to certain revenue-enhancement and expense-reduction initiatives as well as a capital use limitation, as described in greater detail below.

        Additional information on the Bank's principal business developments for the year ending December 31, 2009, follows:

    Investments in Private-Label MBS.  As of December 31, 2009, management has determined that 106 of its private-label MBS, representing an aggregated par value of $2.6 billion as of December 31, 2009, were other-than-temporarily impaired resulting in a credit loss of $444.1 million for the year and a net increase to accumulated other comprehensive loss of $885.4 million. The Bank continues to use modeling assumptions reflecting current and forecasted market conditions, inputs, and methodologies in its analyses of these securities for other-than-temporary-impairment, as is described under Item 8—Notes to the Financial Statements—Note 7—Held-to-Maturity Securities and Critical Accounting Estimates—Other-Than-Temporary-Impairment of Securities in this Item. Given the ongoing deterioration in the performance of many Alt-A mortgage loans originated in the 2005 to 2007 period, which comprise a significant portion of loans backing private-label MBS owned by the Bank, the Bank has used increasingly stressful assumptions on an ongoing basis to reflect current developments in experienced loan performance and attendant forecasts. Despite some signs of economic recovery observed over the recent quarter, many of the factors impacting the underlying loans continued to show little if any improvement and resulted in slower recovery assumptions; such factors include prolonged, elevated unemployment rates, some further decline in housing prices followed by slower housing price recovery, and extremely limited refinancing opportunities for borrowers whose houses are now worth less than the balance of their mortgages.

    Revised Operating Plan.  Management and the board of directors have completed a detailed analysis of the Bank's operations, risks, and growth opportunities and adopted a revised operating plan that includes certain revenue enhancement and expense reduction initiatives as

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      well as a capital use limitation. The plan calls for enhanced product offerings, strategies to encourage membership and credit products growth, investment strategies that we believe are prudent and profitable, potential flexibility in capital requirements to promote new credit activity, greater operational efficiencies, and expense reduction.

      The plan has been further revised since it was initially adopted in September 2009 to adopt a required minimum capital level in excess of regulatory requirements in an effort to provide further protection for the Bank's capital base and to build retained earnings. This adopted minimum capital level provides that the Bank will maintain a minimum capital level equal to four percent of its total assets plus its retained earnings target, an amount equal to $3.4 billion at December 31, 2009. The Bank's permanent capital level was $3.9 billion at December 31, 2009, so the Bank was in excess of this higher adopted minimum capital level by $452.1 million on that date. If necessary to satisfy this adopted minimum capital level, however, the Bank will take steps to control asset growth and/or maintain capital levels, accordingly.

      The revised operating plan has been evaluated under a range of economic scenarios, and under each scenario, the Bank expects to remain in compliance with its regulatory capital ratios. Further, certain portions of the plan have already been implemented. The Bank's efficiency and expense review, for example, resulted in the reduction of approximately five percent of the current operating expense budget, including $3.0 million on an annual basis driven by the reduction or elimination of certain operational expenses and salary due to the elimination of nine percent of staff positions. Also, the activity-based stock investment requirement for participation in its MPF program has been suspended to encourage growth in this business line. In addition, the Bank has undertaken measures to prevent a significant reduction in its net interest spread in the event that interest rates remain at current low levels for an extended period by extending its duration of equity, as discussed under Item 7A—Quantitative and Qualitative Disclosures about Market Risk—Market and Interest-Rate Risk—Measurement of Market and Interest-Rate Risk. Over time, the revised operating plan is expected to help restore the Bank to a position where it can once again repurchase stock, pay members a dividend, and fund the AHP.

    Decline in Advances Balances.  The outstanding par balance of advances to members declined from $55.8 billion at December 31, 2008, to $36.9 billion at December 31, 2009. The reduction is attributable to a significant increase in deposits held by member financial institutions, delevering of balance sheets by member financial institutions, and the use of competing wholesale funding products (including those offered by Federal Reserve Banks and other government-sponsored programs developed in response to the credit market crisis) by member financial institutions. This trend appears to have leveled off in the second half of 2009, however, as illustrated by the following graph of quarter end total advances (dollars in billions):

GRAPHIC

    Growth in Net Interest Margin Contributing to Net Interest Income.  Net interest income declined from $332.7 million for the year ended December 31, 2008, to $311.7 million for the year ended December 31, 2009. The decline was attributable to the decline in advances balances noted

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      above and to the effects of lower short-term interest rates. Average total assets for 2009 were $70.3 billion, a decline of $12.2 billion from $82.5 billion in average total assets for 2008. However, net interest margin for the year ended December 31, 2009, was 0.44 percent, a three basis point increase from net interest margin for the year ended December 31, 2008, while net interest spread for the year ended December 31, 2009, was 0.36 percent, a 10 basis-point increase from net interest spread for the year ended December 31, 2008. The increase in net interest spread was attributable to a steeper interest yield curve, more favorable pricing of the FHLBank System's CO debt, and the effect of refinancing significant volume of callable debt in the historically low interest-rate environment that characterized 2009. The steepness of the yield curve enabled the Bank to earn a higher spread on assets whose average term to repricing were longer than those of corresponding liabilities. As interest rates remained at historically low levels, the Bank also was able to refinance callable debt used to fund its fixed-rate residential mortgage assets, including fixed-rate residential MBS and whole mortgage loans. However, in contrast to typical periods of extraordinarily low interest rates, prepayments of fixed-rate mortgages were relatively muted due to the inability of many homeowners to refinance mortgages because of diminished house prices and tightening credit standards. In addition to these environmental factors, the Bank's net interest income benefitted from elevated prepayment fees as members paid off relatively high-coupon advances, and from the accretion of discounts stemming from credit losses attributable to other-than-temporarily impaired MBS.

    Management Changes.  The Bank has made certain changes to its senior management as part of changes that have been adopted to improve the Bank's operations and financial condition. Specifically, Edward A. Hjerpe III commenced employment as the Bank's president and chief executive officer succeeding M. Susan Elliott who served as interim president and chief executive officer following Michael A. Jessee's retirement on April 30, 2009. Subsequently, Ms. Elliott was appointed executive vice president and chief business officer with continuing responsibility for member services and new responsibility for corporate communications and government and community relations.

      Additionally, Earl W. Baucom was appointed senior vice president and chief operations officer and assumed responsibility for operations, information technology, and information security with continued oversight of strategic planning. Concurrently, Brian G. Donahue, first vice president and controller, assumed Mr. Baucom's former responsibilities as chief accounting officer.

Financial Market Conditions

        The Bank's primary source of revenues is derived from net interest income from advances, investments, and mortgage loans. These interest-earning asset volumes and yields are primarily impacted by economic conditions, market-interest rates, and other factors such as competition.

        During 2009, the Federal Reserve Board maintained a target overnight federal funds range of between 0.00 percent and 0.25 percent at yearend, a range the Federal Reserve Board began to target in 2008.

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        The following table provides a summary of key market interest rates for 2009 and 2008.

 
  Average Rate for
the Year Ended
December 31,
  Ending Rate as of
December 31,
   
   
 
 
  Average Rate
2009 vs. 2008
Variance
  Ending Rate
2009 vs. 2008
Variance
 
 
  2009   2008   2009   2008  

Federal Funds Target

    0.25 %   2.08 % 0.25 % 0.00 - 0.25 %   (1.83 )% 0.25 - 0.00 %

3-month LIBOR

    0.69     2.93   0.25   1.43     (2.24 ) (1.18 )

2-year U.S. Treasury

    0.96     2.01   1.14   0.76     (1.05 ) 0.38  

5-year U.S. Treasury

    2.20     2.80   2.69   1.55     (0.60 ) 1.14  

10-year U.S. Treasury

    3.26     3.66   3.85   2.25     (0.40 ) 1.60  

15-year residential mortgage note rate

    4.59     5.59   4.57   4.80     (1.00 ) (0.23 )

30-year residential mortgage note rate

    5.03     6.02   5.08   5.03     (0.99 ) 0.05  

        The level of interest rates during a reporting period impacts the Bank's profitability, primarily due to the short-term structure of earning assets and the impact of interest rates on invested shareholder capital. As of December 31, 2009, approximately 29.8 percent of the outstanding advances, had stated original maturities of less than one year. As of December 31, 2008, 45.9 percent of outstanding advances had original maturities of less than one year. Additionally, a significant portion of the Bank's assets either has floating-rate coupons or has been hedged with interest-rate-exchange agreements in which a short-term rate is received.

        The level of interest rates also directly affects the Bank's earnings on invested shareholder capital. Because the Bank operates at relatively low, but stable, net spreads between the yield earned on assets and the cost of liabilities, a relatively high proportion of net interest income is generated from the investment of member-supplied capital at the average asset yield. Because a high proportion of the Bank's assets are short-term, have variable coupons, or are hedged with interest-rate swaps on which the Bank receives a floating rate, changes in asset yields tend to have a relatively significant effect on the Bank's net income.

        The broad-based deterioration of credit performance of residential mortgage loans and the accompanying decline in residential real estate values in many parts of the nation increase the level of credit risk to which the Bank is exposed due to four of our activities:

    making advances to members;

    purchasing whole mortgage loans through the MPF program;

    investing in mortgage-related and other securities, and funds placement; and

    derivatives activities directly with non-member financial institutions

        These risks are discussed in the Credit Risk section of Item 7A—Quantitative and Qualitative Disclosures about Market Risk. The Bank's risk exposure to these areas is elevated in the current environment and is likely to remain so in 2010.

Results for the year ended December 31, 2009, versus the year ended December 31, 2008

        For the years ended December 31, 2009 and 2008, the Bank recognized net losses of $186.8 million and $115.8 million, respectively. This $70.9 million increase in net loss was primarily driven by the increase in other-than-temporary impairment of certain private-label MBS. Other-than-temporary impairment losses of these securities resulted in credit losses of $444.1 million and $381.7 million for the years ended December 31, 2009 and 2008, respectively which are reflected in earnings.

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        In 2008, accounting guidance required that the full decline in fair value on other-than-temporarily impaired securities be recognized through earnings, including both the credit-related component and the non-credit-related component. Effective January 1, 2009 the Bank adopted amended accounting guidance related to other-than-temporary impairment which requires only the credit-related component of an other-than-temporary impairment charge to be recognized in earnings, while the noncredit component is recognized in accumulated other comprehensive income, provided that the Bank does not intend to sell the security and it is not more likely than not that the Bank will be required to sell the security. On January 1, 2009 the Bank recognized the cumulative effect of initially applying the amended guidance as an adjustment to the beginning balance of retained earnings in the amount of $349.1 million. This amount represents the noncredit component of the other-than-temporary impairment charge that had been recorded through earnings in 2008. The credit-related component of the 2008 other-than-temporary impairment losses was $32.6 million. See Item 8—Financial Statements and Supplementary Data—Financial Statements—Note 2—Recently Issued Accounting Standards for additional information on the adoption of this revised guidance.

        Significant inputs to the analyses of these securities include projected prepayment rates, default rates and loss severities. During 2009 the Bank has used increasingly stressful assumptions that reduce its projections of prepayment rates and increase its projections of default rates and loss severities for the loans underlying these securities. Despite some signs of economic recovery the Bank has again increased the severity of its assumptions for the assessment of the quarter ended December 31, 2009 based on trends impacting the underlying loans; such trends including continued elevated unemployment rates, some further decline in housing prices followed by slower housing price recovery, and extremely limited refinancing opportunities for borrowers whose houses are now worth less than the balance of their mortgages.

        For the year ended December 31, 2009 compared to the year ended December 31, 2008 there was a decrease of $21.0 million in net interest income, a $1.5 million increase in the provision for credit losses, and an increase of $2.4 million in operating expenses. These decreases to net income were partially offset by a $2.6 million decrease in loss on early extinguishment of debt, and a $13.1 million increase in net gains on derivatives and hedging activities.

        Net interest income for the year ended December 31, 2009, was $311.7 million, compared with $332.7 million for the same period in 2008, which decrease was primarily attributable to the decline in advances balances, as discussed in Overview and Executive SummaryPrincipal Business Developments in this Item. The average yield on interest-earning assets dropped 170 basis points from 3.33 percent for the year ended December 31, 2008, to 1.63 percent for the year ended December 31, 2009. Prepayment-fee income recognized during the year ended December 31, 2009, compared with the same period in 2008, increased by $5.3 million.

        For the years ended December 31, 2009 and 2008, average total assets were $70.3 billion and $82.5 billion, respectively, a decline primarily attributable to the decline in advances balances, as discussed in Overview and Executive Summary—Principal Business Developments. Annual return on average assets and return on average equity were (0.27 percent) and (6.49 percent), respectively, for the year ended December 31, 2009, compared with (0.14 percent) and (3.17 percent), respectively, for the year ended December 31, 2008.

        Net interest spread for the years ended December 31, 2009, and 2008, was 0.36 percent and 0.26 percent, respectively. Net interest margin for the year ended December 31, 2009, was 0.44 percent, a three basis point increase from net interest margin for the same period of 2008.

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Financial Condition at December 31, 2009, versus December 31, 2008

        The composition of the Bank's total assets changed during the year ended December 31, 2009, as follows:

    Advances decreased to 60.2 percent of total assets at December 31, 2009, down from 70.8 percent of total assets at December 31, 2008. This decrease in the proportion of advances to assets reflects both a decrease in advances outstanding and an increase in investments and cash outstanding at December 31, 2009, as the Bank increased its liquid investments to offset the decline in advances. As of December 31, 2009, advances balances decreased by approximately $19.3 billion, ending the period at $37.6 billion. The reduction is discussed in Overview and Executive Summary—Principal Business Developments.

    Short-term money-market investments increased slightly to 11.1 percent of total assets at December 31, 2009, up from 10.4 percent of total assets at December 31, 2008. As of December 31, 2009, federal funds sold increased $3.1 billion while interest-bearing deposits decreased by $3.3 billion due to the decrease in the Bank's account with the Federal Reserve Bank of Boston, and securities purchased under agreements to resell decreased by $1.3 billion from December 31, 2008, to December 31, 2009.

    Investment securities increased to 22.4 percent of total assets at December 31, 2009, up from 13.1 percent of total assets at December 31, 2008. From December 31, 2008, to December 31, 2009, investment securities increased by $3.5 billion. The increase is largely attributable to a $5.3 billion increase in available-for-sale securities due to the purchase of certificates of deposit, FDIC-insured corporate bonds and GSE debt as the Bank has grown its investments in these assets to improve its operating income without significantly increasing its risk profile. The increase in available-for-sale securities was offset by a $1.8 billion decline in held-to-maturity securities primarily due to $1.3 billion in fair-value write-downs to the held-to-maturity MBS portfolio and a $565.0 million decrease in held-to-maturity certificates of deposit. At December 31, 2009, and December 31, 2008, the Bank's MBS and Small Business Administration (SBA) holdings represented 207 percent and 225 percent of capital, respectively.

    Net mortgage loans increased to 5.6 percent of total assets at December 31, 2009, up from 5.2 percent at December 31, 2008. This increase is due to the overall decrease in total assets of $17.9 billion as mortgage loans decreased by $647.6 million, ending the period at $3.5 billion. The decrease was principally driven by better price execution being offered by other housing GSEs during the year, for reasons more fully described under Financial Condition—Mortgage Loans in this Item.

        The Bank's total GAAP capital declined $666.2 million to $2.8 billion at December 31, 2009, from $3.4 billion at December 31, 2008. The decline was primarily attributable to the recognition of $444.1 million of credit losses as well as $885.4 million of noncredit losses recorded in other comprehensive loss, all associated with other-than-temporary impairments of private-label MBS, which was partially offset by accretion of the noncredit portion of impairment losses on held-to-maturity securities of $305.0 million, and income from other sources of $257.3 million.

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RESULTS OF OPERATIONS

Comparison of the year ended December 31, 2009, versus the year ended December 31, 2008

Net Interest Spread and Net Interest Margin

        Net interest income for the year ended December 31, 2009, was $311.7 million, compared with $332.7 million for the year ended December 31, 2008, decreasing 6.3 percent from the previous year. Net interest margin for 2009 in comparison with 2008 increased to 44 basis points from 41 basis points, and net interest spread increased to 36 basis points from 26 basis points.

        See Overview and Executive Summary—Principal Business Developments for additional information regarding the increase in net interest spread and net interest margin.

        Prepayment-fee income recognized on advances and investments increased $5.3 million to $13.9 million for the year ended December 31, 2009, from $8.6 million for the year ended December 31, 2008.

        The following table presents major categories of average balances, related interest income/expense, and average yields for interest-earning assets and interest-bearing liabilities. The primary source of earnings for the Bank is net interest income, which is the interest earned on advances, mortgage loans, and investments less interest paid on COs, deposits, and other borrowings. Net interest spread is the difference between the yields on interest-earning assets and interest-bearing liabilities. Net interest margin is expressed as the percentage of net interest income to average earning assets.

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Net Interest Spread and Margin
(dollars in thousands)

 
  For the Years Ended December 31,  
 
  2009   2008   2007  
 
  Average
Balance
  Interest
Income /
Expense
  Average
Yield
  Average
Balance
  Interest
Income /
Expense
  Average
Yield
  Average
Balance
  Interest
Income /
Expense
  Average
Yield
 

Assets

                                                       

Advances

  $ 43,330,465   $ 677,709     1.56 % $ 61,578,072   $ 1,984,347     3.22 % $ 44,623,835   $ 2,307,079     5.17 %

Interest-bearing deposits

    4,256,319     10,855     0.26     69,137     178     0.26     55     3     5.45  

Securities purchased under agreements to resell

    2,141,781     4,795     0.22     719,331     12,035     1.67     1,133,904     59,496     5.25  

Federal funds sold

    5,731,424     9,624     0.17     2,427,441     34,593     1.43     3,913,636     204,688     5.23  

Investment securities(1)

    11,216,298     251,231     2.24     12,857,390     480,170     3.73     10,635,415     576,894     5.42  

Mortgage loans

    3,851,510     193,761     5.03     4,065,776     208,841     5.14     4,273,757     217,675     5.09  

Other earning assets

    693     1     0.14                 274     12     4.38  
                                       

Total interest-earning assets

    70,528,490     1,147,976     1.63 %   81,717,147     2,720,164     3.33 %   64,580,876     3,365,847     5.21 %

Other non-interest-earning assets

    561,120                 713,062                 799,836              

Fair value adjustment on investment securities

    (769,436 )               74,315                 44,239              
                                       

Total assets

  $ 70,320,174   $ 1,147,976     1.63 % $ 82,504,524   $ 2,720,164     3.30 % $ 65,424,951   $ 3,365,847     5.14 %
                                       

Liabilities and capital

                                                       

Consolidated obligations

                                                       
 

Discount notes

  $ 32,600,682   $ 153,094     0.47 % $ 43,506,235   $ 1,154,405     2.65 % $ 25,777,636   $ 1,280,158     4.97 %
 

Bonds

    32,384,864     682,336     2.11     33,199,670     1,214,031     3.66     34,953,730     1,730,553     4.95  

Deposits

    761,711     667     0.09     970,153     17,171     1.77     866,926     40,984     4.73  

Mandatorily redeemable capital stock

    91,136             65,063     1,189     1.83     21,044     1,400     6.65  

Other borrowings

    145,948     165     0.11     37,775     701     1.86     8,770     306     3.49  
                                       

Total interest-bearing liabilities

    65,984,341     836,262     1.27 %   77,778,896     2,387,497     3.07 %   61,628,106     3,053,401     4.95 %

Other non-interest-bearing liabilities

    1,457,646                 1,075,120                 948,562              

Total capital

    2,878,187                 3,650,508                 2,848,283              
                                       

Total liabilities and capital

  $ 70,320,174   $ 836,262     1.19 % $ 82,504,524   $ 2,387,497     2.89 % $ 65,424,951   $ 3,053,401     4.67 %
                                       

Net interest income

        $ 311,714               $ 332,667               $ 312,446        
                                                   

Net interest spread

                0.36 %               0.26 %               0.26 %

Net interest margin

                0.44 %               0.41 %               0.48 %

(1)
The average balances of held-to-maturity securities and available-for-sale securities are reflected at amortized cost; therefore the resulting yields do not give effect to changes in fair value.

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Rate and Volume Analysis

        Changes in both average balances (volume) and interest rates influence changes in net interest income and net interest margin. The decrease in net interest income is discussed in Overview and Executive Summary—Principal Business Developments. The following table summarizes changes in interest income and interest expense between the years ended December 31, 2009 and 2008, and between the years ended December 31, 2008 and 2007. Changes in interest income and interest expense that are not identifiable as either volume-related or rate-related, but rather equally attributable to both volume and rate changes, have been allocated to the volume and rate categories based upon the proportion of the absolute value of the volume and rate changes.


Rate and Volume Analysis
(dollars in thousands)

 
  For the Years Ended
December 31, 2009 vs. 2008
  For the Years Ended
December 31, 2008 vs. 2007
 
 
  Increase (decrease) due to
  Increase (decrease) due to
 
 
  Volume   Rate   Total   Volume   Rate   Total  

Interest income

                                     

Advances

  $ (477,447 ) $ (829,191 ) $ (1,306,638 ) $ 710,740   $ (1,033,472 ) $ (322,732 )

Interest-bearing deposits

    10,679     (2 )   10,677     181     (6 )   175  

Securities purchased under agreements to resell

    9,464     (16,704 )   (7,240 )   (16,577 )   (30,884 )   (47,461 )

Federal funds sold

    21,882     (46,851 )   (24,969 )   (58,335 )   (111,760 )   (170,095 )

Investment securities

    (55,357 )   (173,582 )   (228,939 )   105,454     (202,178 )   (96,724 )

Mortgage loans

    (10,843 )   (4,237 )   (15,080 )   (10,670 )   1,836     (8,834 )

Other earning assets

        1     1     (6 )   (6 )   (12 )
                           

Total interest income

    (501,622 )   (1,070,566 )   (1,572,188 )   730,787     (1,376,470 )   (645,683 )
                           

Interest expense

                                     

Consolidated obligations

                                     
 

Discount notes

    (233,734 )   (767,577 )   (1,001,311 )   635,956     (761,709 )   (125,753 )
 

Bonds

    (29,070 )   (502,625 )   (531,695 )   (83,187 )   (433,335 )   (516,522 )

Deposits

    (3,043 )   (13,461 )   (16,504 )   4,392     (28,205 )   (23,813 )

Mandatorily redeemable capital stock

    169     (1,358 )   (1,189 )   1,351     (1,562 )   (211 )

Other borrowings

    339     (875 )   (536 )   597     (202 )   395  
                           

Total interest expense

    (265,339 )   (1,285,896 )   (1,551,235 )   559,109     (1,225,013 )   (665,904 )
                           

Change in net interest income

  $ (236,283 ) $ 215,330   $ (20,953 ) $ 171,678   $ (151,457 ) $ 20,221  
                           

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        The average balance of total advances decreased $18.2 billion, or 29.6 percent, for the year ended December 31, 2009, compared with the same period in 2008. This decrease is discussed in Overview and Executive Summary—Principal Business Developments in this Item. The following table summarizes average balances of advances outstanding during 2009, 2008, and 2007 by product type.


Average Balances of Advances Outstanding
By Product Type
(dollars in thousands)

 
  2009
Average
Balance
  2008
Average
Balance
  2007
Average
Balance
 

Overnight advances—par value

  $ 841,862   $ 2,795,805   $ 1,035,782  

Fixed-rate advances—par value

                   
 

Short-term

    14,613,672     29,510,796     20,822,525  
 

Long-term

    11,562,867     12,116,430     8,904,897  
 

Amortizing

    2,388,128     2,485,658     2,406,454  
 

Putable

    8,679,158     9,103,145     6,483,049  
 

Callable

    10,077     11,779     30,000  
               

    37,253,902     53,227,808     38,646,925  

Variable-rate indexed advances—par value

                   
 

Simple variable

    4,177,075     5,077,852     4,864,487  
 

Putable, convertible to fixed

    193,795     12,000     24,474  
 

LIBOR-indexed with declining-rate participation

    11,007     15,500     21,240  
               

    4,381,877     5,105,352     4,910,201  

Total average par value

    42,477,641     61,128,965     44,592,908  
               

Net premiums and (discounts)

    (12,443 )   (13,385 )   (12,137 )

Hedging adjustments

    865,267     462,492     43,064  
               

Total average advances

  $ 43,330,465   $ 61,578,072   $ 44,623,835  
               

        Putable advances that are classified as fixed-rate advances in the table above are typically hedged with interest-rate-exchange agreements in which a short-term rate is received, typically three-month LIBOR. In addition, 41.7 percent of average long-term fixed- rate advances were similarly hedged with interest-rate swaps. Therefore, a significant portion of the Bank's advances, including overnight advances, short-term fixed-rate advances, fixed-rate putable advances, certain fixed-rate bullet advances, and variable-rate advances, either earn a short-term interest rate or are swapped to a short-term index, resulting in yields that closely follow short-term market-interest-rate trends. The average balance of these advances totaled $33.3 billion for 2009, representing 78.5 percent of the total average balance of advances outstanding during 2009. For 2008, the average balance of these advances totaled $52.9 billion, representing 86.5 percent of the total average balance of advances outstanding during 2008.

Prepayment Fees

        Included in net interest income are prepayment fees related to advances and investment securities. Prepayment fees make the Bank financially indifferent to the prepayment of advances or investments and are net of any hedging fair-value adjustments. For the years ended December 31, 2009 and 2008, net prepayment fees on advances were $13.1 million and $4.7 million, respectively, and prepayment fees on investments were $794,000 and $3.9 million, respectively. Excluding the impact of prepayment-fee

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income, net interest spread increased nine basis points to 34 basis points and net interest margin increased two basis points to 42 basis points from December 31, 2008, to December 31, 2009.

        Prepayment-fee income is unpredictable and inconsistent from period to period, occurring only when advances and investments are prepaid prior to the scheduled maturity or repricing dates. Because prepayment-fee income recognized during these periods does not necessarily represent a trend that will continue in future periods, and due to the fact that prepayment-fee income represents a one-time fee recognized in the period in which the corresponding advance or investment security is prepaid, we believe it is important to review the results of net interest spread and net interest margin excluding the impact of prepayment-fee income. These results are presented in the following table.


Net Interest Spread and Margin without Prepayment-Fee Income
(dollars in thousands)

 
  For the Years Ended December 31,  
 
  2009   2008   2007  
 
  Interest
Income
  Average
Yield
  Interest
Income
  Average
Yield
  Interest
Income
  Average
Yield
 

Advances

  $ 664,647     1.53 % $ 1,979,653     3.21 % $ 2,304,104     5.16 %

Investment securities

    250,437     2.23     476,286     3.70     573,836     5.40  

Total interest-earning assets

    1,134,120     1.61     2,711,586     3.32     3,359,814     5.20  

Net interest income

    297,858           324,089           306,413        

Net interest spread

          0.34 %         0.25 %         0.25 %

Net interest margin

          0.42 %         0.40 %         0.47 %

        Average short-term money-market investments, consisting of interest-bearing deposits, securities purchased under agreements to resell, and federal funds sold, increased $8.9 billion, or 277.2 percent, for the year ended December 31, 2009, from the average balances for the year ended December 31, 2008. The higher average balances for year ended December 31, 2009 resulted from the increased activity in federal funds sold, securities purchased under agreements to resell, and higher balances held as interest-bearing deposits as advances declined during the year. During this period the Bank held interest-bearing deposits averaging $4.3 billion with the Federal Reserve Bank of Boston, which were substantially withdrawn after July 2, 2009, at which time the Federal Reserve Banks stopped paying interest on excess balances held by non member institutions in accordance with an amendment to the Federal Reserve's Regulation D. See Recent Legislative and Regulatory Developments in this Item for additional information on that amendment and its expected impact on the Bank. The yield earned on short-term money-market investments is tied directly to short-term market-interest rates. These investments are used for liquidity management and to manage the Bank's leverage ratio in response to fluctuations in other asset balances.

        Average investment-securities balances decreased $1.6 billion or 12.8 percent for the year ended December 31, 2009, compared with the year ended December 31, 2008. The decrease in average investments is the result of the $2.0 billion decrease in average held-to- maturity certificates of deposit, and a $1.6 billion decrease in average held-to-maturity MBS, which is mainly due to the Bank's credit and noncredit losses incurred in 2009. These decreases were partially offset by a $1.3 billion increase in average available-for-sale securities due to the purchase of certificates of deposit, corporate bonds, and GSE debt.

        Average mortgage-loan balances for the year ended December 31, 2009, were $214.3 million lower than the average balance for the year ended December 31, 2008, representing a decrease of 5.3 percent.

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        Overall, the yield on the mortgage-loan portfolio decreased 11 basis points for the year ended December 31, 2009, compared with the year ended December 31, 2008. This decrease is attributable to the following factors:

    the average stated coupon rate of the mortgage-loan portfolio decreased eight basis points due to the acquisition of loans at lower interest rates in 2009 relative to the coupon rates on pre-existing loans and prepayments of pre-existing loans that had higher coupon rates relative to new loans purchased during the year; and

    premium/discount amortization expense has increased $1.0 million, or 21.4 percent, representing a decrease in the average yield of three basis points, due to an increased volume of loan prepayments in the year ended December 31, 2009, versus the same period in 2008.


Composition of the Yields of Mortgage Loans
(dollars in thousands)

 
  For the Years Ended December 31,  
 
  2009   2008   2007  
 
  Interest
Income
  Average
Yield
  Interest
Income
  Average
Yield
  Interest
Income
  Average
Yield
 

Coupon accrual

  $ 203,542     5.28 % $ 217,975     5.36 % $ 228,255     5.34 %

Premium/discount amortization

    (5,792 )   (0.15 )   (4,770 )   (0.12 )   (5,938 )   (0.14 )

Credit-enhancement fees

    (3,989 )   (0.10 )   (4,364 )   (0.10 )   (4,642 )   (0.11 )
                           

Total interest income

  $ 193,761     5.03 % $ 208,841     5.14 % $ 217,675     5.09 %
                                 

        Average CO balances decreased $11.7 billion, or 15.3 percent, from the year ended December 31, 2008, to the year ended December 31, 2009, based on the Bank's reduced funding needs due to the decline in member demand for advances, as discussed under Overview and Executive Summary—Principal Business Developments in this Item. This decline consisted of decreases of $10.9 billion in CO discount notes and $814.8 million in CO bonds.

        Net interest income includes interest accrued on interest-rate-exchange agreements that are associated with advances, investments, deposits, and debt instruments that qualify for hedge accounting. The Bank generally utilizes derivative instruments that qualify for hedge accounting as an interest-rate-risk management tool. These derivatives serve to stabilize net interest income and net interest margin when interest rates fluctuate. Accordingly, the impact of derivatives on net interest income and net interest margin should be viewed in the overall context of the Bank's risk-management strategy. The following table provides a summary of the impact of derivative instruments on interest income and interest expense.

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Impact of Derivatives on Gross Interest Income and Gross Interest Expense
(dollars in thousands)

 
  For the Years Ended December 31,  
 
  2009   2008   2007  

Gross interest income before effect of derivatives

  $ 1,627,297   $ 2,891,406   $ 3,299,936  

Net interest adjustment for derivatives

    (479,321 )   (171,242 )   65,911  
               

Total interest income reported

  $ 1,147,976   $ 2,720,164   $ 3,365,847  
               

Gross interest expense before effect of derivatives

  $ 1,049,155   $ 2,510,106   $ 3,015,620  

Net interest adjustment for derivatives

    (212,893 )   (122,609 )   37,781  
               

Total interest expense reported

  $ 836,262   $ 2,387,497   $ 3,053,401  
               

        Reported net interest margin for the years ended December 31, 2009 and 2008, was 0.44 percent and 0.41 percent, respectively. If derivative instruments had not been used as hedges to mitigate the impact of interest-rate fluctuations, net interest margin would have been 0.82 percent and 0.47 percent, respectively.

        Interest paid and received on interest-rate-exchange agreements that are used by the Bank in its asset and liability management, but which do not meet hedge-accounting requirements (economic hedges), are classified as net gain (loss) on derivatives and hedging activities in other income. As shown in the Other Income (Loss) and Operating Expenses section below, interest accruals on derivatives classified as economic hedges totaled a net expense of $4.5 million and $2.2 million for the years ended December 31, 2009 and 2008, respectively.

        For more information about the Bank's use of derivative instruments to manage interest-rate risk, see Item 7A—Quantitative and Qualitative Disclosures about Market Risk—Market and Interest-Rate Risk.

Other Income (Loss) and Operating Expenses

        The following table presents a summary of other (loss) income for the years ended December 31, 2009, 2008, and 2007. Additionally, detail on the components of net gain (loss) on derivatives and hedging activities is provided, indicating the source of these gains and losses by type of hedging relationship and hedge accounting treatment.

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Other (Loss) Income
(dollars in thousands)

 
  For the Years Ended December 31,  
 
  2009   2008   2007  

Gains (losses) on derivatives and hedging activities:

                   
 

Net gains related to fair-value hedge ineffectiveness

  $ 2,404   $ 1,210   $ 8,367  
 

Net unrealized gains (losses) related to derivatives not receiving hedge accounting associated with:

                   
   

Advances

    907     (4,997 )   3,281  
   

Trading securities

    3,381     (855 )   (1,695 )
   

Consolidated obligations

        (3,375 )    
   

Mortgage delivery commitments

    (264 )   (945 )   601  
 

Net interest-accruals related to derivatives not receiving hedge accounting

    (4,458 )   (2,183 )   (2,939 )
               

Net gains (losses) on derivatives and hedging activities

    1,970     (11,145 )   7,615  

Net impairment losses on held-to-maturity securities recognized in income

    (444,068 )   (381,745 )    

Loss on early extinguishment of debt

    (66 )   (2,699 )   (641 )

Service-fee income

    4,031     4,564     4,336  

Net unrealized and realized losses on trading securities

    (467 )   (937 )   (267 )

Realized loss from sale of available-for-sale securities

        (80 )    

Realized gain (loss) from sale of held-to-maturity securities

    1,970     (52 )    

Other

    (17 )   134     94  
               

Total other (loss) income

  $ (436,647 ) $ (391,960 ) $ 11,137  
               

        As noted in the Other Income (Loss) table above, accounting for derivatives and hedged items introduces the potential for considerable timing differences between income recognition from assets or liabilities and income effects of hedging instruments entered into to mitigate interest-rate risk and cash-flow activity.

        During the year ended December 31, 2009, it was determined that 106 of the Bank's 215 held-to-maturity private-label MBS, representing an aggregated par value of $2.6 billion as of December 31, 2009, were other-than-temporarily impaired, an increase from 19 securities with an aggregate par value of $586.4 million as of December 31, 2009, that were determined to be other-than-temporarily impaired at December 31, 2008.

        For the securities on which we recognized other-than-temporary impairment during 2009, the average credit enhancement was not sufficient to cover projected expected credit losses. The average credit enhancement at December 31, 2009, was approximately 21.8 percent and the expected average collateral loss was approximately 37.9 percent. Accordingly, the Bank recorded an other-than-temporary impairment related to a credit loss of $72.4 million during the fourth quarter of 2009 while the credit loss for the year ended December 31, 2009, amounted to $444.1 million. The Bank does not intend to sell these securities, and we believe that it is not likely that the Bank will be required to sell these securities before the anticipated recovery of each security's remaining amortized cost basis.

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        In subsequent periods we will account for the other-than-temporarily impaired securities as if the securities had been purchased on the measurement date of the other-than-temporary impairment.

        Although prices of private-label MBS improved somewhat during the year ended December 31, 2009, as demonstrated by the graph labeled Average Monthend MBS Prices by Category under Item 7A—Quantitative and Qualitative Disclosures About Market Risk—Credit Risk—Credit Risk-Investments, the prices continued to reflect a significant discount to cost due to poor underlying loan performance, uncertainty about the future of the housing market and broader economy, and ongoing illiquidity in these markets. As a result, the current fair value of many of these securities may be less than what is indicated by the performance of the collateral underlying the securities and our calculation of the expected cash flows of the securities, although we believe that the gap has narrowed due to the price recovery.

        We will continue to monitor and analyze the performance of these securities to assess the collectability of principal and interest as of each balance-sheet date. As U.S. macroeconomic conditions, including the housing and mortgage markets, continue to change over time, the amount of projected credit losses could also change. Significant additional other-than-temporary impairment amounts may be recognized if economic conditions deteriorate beyond our current expectations, resulting in higher borrower defaults and/or greater loss severities realized on the disposition of the underlying properties. See Item 7A—Quantitative and Qualitative Disclosures about Market Risk—Credit Risk—Investments.

        The following table displays the Bank's held-to-maturity securities for which other-than-temporary impairment was recognized in the year ending December 31, 2009, based on the Bank's impairment analysis of its investment portfolio (dollars in thousands). Securities are classified in the table below based on the classification at the time of issuance.

 
  At December 31, 2009   For the Year Ended December 31, 2009  
Other-Than-Temporarily Impaired Investment:
  Par Value   Amortized
Cost
  Carrying
Value
  Fair Value   Other-than-Temporary
Impairment Related to
Credit Loss
 

Private-label residential MBS—Prime

  $ 98,284   $ 92,639   $ 59,814   $ 65,307   $ (4,915 )

Private-label residential MBS—Alt-A

    2,472,086     2,018,170     1,122,463     1,251,344     (438,586 )

ABS backed by home equity loans—Subprime

    2,536     1,981     1,251     1,388     (567 )
                       

Total other-than-temporarily impaired securities

  $ 2,572,906   $ 2,112,790   $ 1,183,528   $ 1,318,039   $ (444,068 )
                       

        Upon recognition of an other-than-temporary impairment, the carrying value of the investment will be equal to the fair value of the security. Subsequent declines in fair values of held-to-maturity securities are recognized only when there is a subsequent other-than-temporary impairment, and subsequent improvements in fair values of held-to-maturity securities are not recognized. In the absence of a subsequent other-than-temporary impairment, the difference between carrying value and amortized cost of a held-to-maturity security will be accreted to the carrying value of the security over the remaining estimated life of the security.

        Changes in the fair value of trading securities are recorded in other (loss) income. For the years ended December 31, 2009 and 2008, the Bank recorded net unrealized losses on trading securities of $467,000 and $937,000, respectively. These securities are economically hedged with interest-rate-exchange agreements that do not qualify for hedge accounting, but are acceptable hedging strategies under the Bank's risk-management program. Changes in the fair value of these economic

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hedges are recorded in current-period earnings and amounted to a net gain of $3.4 million and a net loss of $855,000 for the years ended December 31, 2009 and 2008, respectively. Also included in other (loss) income are interest accruals on these economic hedges, which resulted in a net expense of $1.5 million and $1.9 million for the years ended December 31, 2009 and 2008, respectively.

        During 2009, the Bank sold held-to-maturity MBS with a book value of $19.6 million and recognized a gain of $2.0 million on the sale of these securities. For these securities, the Bank had already collected at least 85 percent of the principal outstanding at acquisition. As a result, these sales are considered to be maturities and management has determined that these sales do not impact the Bank's ability and intent to hold the remaining investments classified as held-to-maturity through their stated maturity dates.

        Operating expenses for the years ended December 31, 2009, 2008, and 2007, are summarized in the following table:


Operating Expenses
(dollars in thousands)

 
  For the Years Ended December 31,  
 
  2009   2008   2007  

Salaries, incentive compensation, and benefits

  $ 33,575   $ 30,595   $ 30,214  

Occupancy costs

    4,339     4,251     4,142  

Other operating expenses

    15,115     15,811     14,145  
               

Total operating expenses

  $ 53,029   $ 50,657   $ 48,501  
               

Ratio of operating expenses to average assets

    0.08 %   0.06 %   0.07 %

        For the year ended December 31, 2009, total operating expenses increased $2.4 million from the same period in 2008. This increase was mainly due to a $3.0 million increase in salaries and benefits offset by a $696,000 decrease in other operating expenses. The $3.0 million increase in salaries and benefits is due primarily to increases of $1.9 million and $2.0 million in salary expenses and employee benefits, respectively, primarily attributable to the retirement of the Bank's former chief executive officer, which was partially offset by a $691,000 decrease in incentive compensation due to the board of director's decision to not implement an executive incentive plan for 2009.

        The Bank, together with the other FHLBanks, is charged for the cost of operating the Finance Agency and the Office of Finance. The Finance Agency's operating costs are also shared by Fannie Mae and Freddie Mac, and HERA prohibits assessments on the FHLBanks for such costs in excess of the costs and expenses related to the FHLBanks. See the Recent Legislative and Regulatory Developments section for additional information. These expenses totaled $5.8 million and $4.5 million for the years ended December 31, 2009 and 2008, respectively, and are included in other expense.

Comparison of the year ended December 31, 2008, versus the year ended December 31, 2007

Overview

        Net loss for the year ended December 31, 2008, was $115.8 million, compared with net income of $198.2 million for the year ended December 31, 2007. This $314.1 million decrease was primarily due to an other-than-temporary impairment charge of $381.7 million on held-to-maturity securities, which was partially offset by a reduction in assessments of $71.7 million and an increase in net interest income of $20.2 million.

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        Net interest income for the year ended December 31, 2008, was $332.7 million, compared with $312.4 million for the year ended December 31, 2007. This $20.2 million increase was primarily attributable to strong asset and capital growth during 2008, resulting from continued growth in advances due to the liquidity shortage that impacted the U.S. banking system throughout the year that was partially offset by:

    a sharp drop in interest rates associated with deepening weakness in the economy,

    an increasing cost of maintaining short-term liquidity as the short-term yield curve steepened,

    higher relative borrowing costs associated with long-term debt through much of the year, and

    an increased cost arising from the Bank's contingency-liquidity plans, which were modified in accordance with Finance Agency guidance in the second half of 2008 to add a requirement that the Bank maintain sufficient liquidity, through short-term investments, in an amount at least equal to our anticipated cash outflows under two different scenarios. This requirement is discussed in Item 7A—Quantitative and Qualitative Disclosures About Market Risk—Liquidity Risk. To satisfy this additional requirement, the Bank maintained significantly higher balances in shorter-term investments, earning a much lower interest rate than alternate investment options and thereby negatively impacting net interest income.

        Additionally, prepayment-fee income recognized during 2008 compared with 2007 increased modestly by $2.5 million.

        For the years ended December 31, 2008 and 2007, average total assets were $82.5 billion and $65.4 billion, respectively. Return on average assets and return on average equity were (0.14 percent) and (3.13 percent), respectively, for the year ended December 31, 2008, compared with 0.30 percent and 6.97 percent, respectively, for the year ended December 31, 2007. The return on average assets and the return on average equity declined due to the net loss in 2008 primarily resulting from the other-than-temporary impairment charge on held-to-maturity securities.

        Net interest spread was 0.26 percent for both 2008 and 2007. Net interest margin for 2008 was 0.41 percent, a seven-basis-point decline from net interest margin for 2007. See Results of OperationsNet Interest Spread and Net Interest Margin below for additional discussion of these topics.

Financial Condition at December 31, 2008, versus December 31, 2007

        The composition of the Bank's total assets changed during the year ended December 31, 2008, as follows:

    Advances decreased to 70.8 percent of total assets at December 31, 2008, down from 71.2 percent of total assets at December 31, 2007. This decrease in the proportion of advances to assets reflects an increase in investments and cash outstanding at December 31, 2008, as the Bank increased its liquid investments to satisfy its modified contingent-liquidity plans, as discussed above, as well as to maintain an adequate capital to asset ratio based on the Bank's growth in excess capital stock resulting from the Bank's moratorium on the repurchase of excess stock. During 2008, advances balances increased by approximately $1.2 billion, ending the year at $56.9 billion.

    Short-term money-market investments increased to 10.4 percent of total assets at December 31, 2008, up from 4.4 percent of total assets at December 31, 2007. As of December 31, 2008, interest-bearing deposits had increased by $3.3 billion due to the increase in the Bank's account with the Federal Reserve Bank of Boston, and securities purchased under agreements to resell increased by $2.0 billion while federal funds sold decreased by $368.0 million from December 31, 2007, to December 31, 2008.

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    Investment securities declined to 13.1 percent of total assets at December 31, 2008, down from 18.5 percent of total assets at December 31, 2007. From December 31, 2007, to December 31, 2008, investment securities decreased by $3.9 billion. The decrease was due to a $4.8 billion decline in held-to-maturity certificates of deposits, which was partially offset by a $788.5 million increase in held-to-maturity MBS. The increase in held-to-maturity MBS was due to increased purchases of GSE MBS of $3.4 billion during 2008. These purchases were made under the Bank's ongoing authority to purchase MBS up to 300 percent of capital. At December 31, 2008, and December 31, 2007, the Bank's MBS and Small Business Administration (SBA) holdings represented 225 percent and 226 percent of capital, respectively.

    Net mortgage loans remained consistent at 5.2 percent of total assets at December 31, 2007, and December 31, 2008.

Net Interest Spread and Net Interest Margin

        Net interest income for the year ended December 31, 2008, was $332.7 million, compared with $312.4 million for the year ended December 31, 2007, increasing 6.5 percent from the previous year. However, net interest margin for 2008 in comparison with 2007 decreased from 48 basis points to 41 basis points, and net interest spread remained consistent at 26 basis points.

        The increase in net interest income was largely attributable to a significant increase in the average size of the balance sheet in 2008 as compared to 2007. Average total earning assets were $17.1 billion higher in 2008 than in 2007, which was largely attributable to the $17.0 billion increase in average advances balances.

        Net interest margin for 2008 was 0.41 percent, a seven basis point decline from net interest margin for 2007, which was attributable to the following factors:

    The average yield on interest-bearing assets funded by non-interest-bearing equity capital dropped in 2008 as a result of lower interest rates; and

    the amount of low-margin money-market investments and short-term advances has increased. In particular, as the yield curve steepened in the second half of 2008, it became more costly for the Bank to carry a significant portfolio of overnight funds placements that are used as a source of liquidity to fund potential intraday advance demand, as these assets are funded by longer-term debt and capital.

        Both of the above factors have contributed to lower net interest spreads, despite the fact that CO debt funding costs have declined relative to broader market interest rates, such as U.S. dollar interest-rate-swap yields.

        For the year ended December 31, 2008, the average yields on total interest-earning assets decreased 188 basis points and yields on total interest-bearing liabilities decreased 188 basis points, compared with the year ended December 31, 2007.

        Prepayment-fee income recognized on advances and investments increased $2.5 million to $8.6 million for the year ended December 31, 2008, from $6.0 million for the year ended December 31, 2007. Excluding the impact of prepayment-fee income, net interest spread remained at 25 basis points and net interest margin declined seven basis points to 40 basis points from December 31, 2007, to December 31, 2008.

        The average balance of total advances increased $17.0 billion, or 38.0 percent, for the year ended December 31, 2008, compared with the same period in 2007. The increase in average advances was attributable to strong member demand for short-term advances, while long-term fixed-rate and variable-rate advances showed only a moderate increase during 2008 as compared to 2007. The increase

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reflects a continued increase in member demand caused by market conditions during the period and was attributable to the following product types:

    The average balance of short-term fixed-rate advances increased by approximately $8.7 billion during the year ended December 31, 2008. The yield spread to the Bank's funding cost for these advances was generally narrower for short-term products than for other products with longer terms to maturity.

    The average balance of long-term fixed-rate advances increased by approximately $3.2 billion during the year ended December 31, 2008.

    Average fixed-rate putable advances increased by $2.6 billion from the year ended December 31, 2007, to the same period in 2008.

    The average balance of variable-rate indexed advances increased $195.2 million from the year ended December 31, 2007, to the same period in 2008.

    Average overnight advances increased $1.8 billion from the year ended December 31, 2007, to the same period in 2008.

        A significant portion of the Bank's advances, including overnight advances, short-term fixed-rate advances, fixed-rate putable advances, approximately 52.5 percent of fixed-rate bullet advances, and variable-rate advances, either earn a short-term interest rate or are swapped to a short-term index, resulting in yields that closely follow short-term market-interest-rate trends. The average balance of these advances totaled $52.9 billion for 2008, representing 86.5 percent of the total average balance of advances outstanding during 2008. For 2007, the average balance of these advances totaled $36.4 billion, representing 81.6 percent of total average advances outstanding during 2007.

        Average short-term money-market investments, consisting of interest-bearing deposits, securities purchased under agreements to resell, and federal funds sold, decreased $1.8 billion, or 36.3 percent, for the year ended December 31, 2008, from the average balances for the year ended December 31, 2007. The yield earned on short-term money-market investments is tied directly to short-term market-interest rates. These investments are used for liquidity management and to manage the Bank's leverage ratio in response to fluctuations in other asset balances.

        Average investment-securities increased $2.2 billion or 20.9 percent for the year ended December 31, 2008, compared with the year ended December 31, 2007. The growth in average investments was the result of the increase in average held-to-maturity MBS of $1.7 billion, which was mainly due to purchases of agency MBS. The increase was attributable to the Bank's expanded capacity to purchase MBS due to the increase in capital that occurred during the first half of 2008. Average total capital increased by $802.2 million during the year ended December 31, 2008, in comparison with the same period in 2007. Furthermore, due to decreased global demand for agency MBS stemming from the credit crisis and its impact on the mortgage market, net interest spread opportunities with respect to agency MBS improved over the course of 2007 and 2008, as compared with prior periods. Accordingly, the Bank was able to purchase agency MBS at more favorable risk-adjusted net interest spreads during the first half of 2008 than during prior periods.

        Average mortgage-loan balances for the year ended December 31, 2008, were $208.0 million lower than the average balance for the year ended December 31, 2007, representing a decrease of 4.9 percent, although year-ending balances increased $62.2 million or 1.5 percent, from December 31, 2007, to December 31, 2008. The decline in average mortgage-loan balances reflected the fact that balances had been declining steadily through 2007 and the first three quarters of 2008, before beginning to trend modestly upward.

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        Overall, the yield on the mortgage-loan portfolio increased five basis points for the year ended December 31, 2008, compared with the year ended December 31, 2007. This increase was attributable to the following factors:

    The average stated coupon rate of the mortgage-loan portfolio increased two basis points due to the acquisition of loans at higher interest rates in the latter half of 2007 and into 2008 relative to the coupons on pre-existing loans; and

    Premium/discount amortization expense has declined $1.2 million, or 19.7 percent, representing an improvement in the average yield of two basis points, due to a reduced volume of loan prepayments in the year ended December 31, 2008, versus the same period in 2007.

        Average CO balances increased $16.0 billion, or 26.3 percent, from the year ended December 31, 2007, to the year ended December 31, 2008. This increase was due to an increase of $17.7 billion in CO discount notes offset by a decline of $1.8 billion in CO bonds. This increase funded the growth of the advances portfolio.

        Reported net interest margin for the years ended December 31, 2008 and 2007, was 0.41 percent and 0.48 percent, respectively. If derivative instruments had not been used as hedges to mitigate the impact of interest-rate fluctuations, net interest margin would have been 0.47 percent and 0.44 percent, respectively.

Other Income (Loss) and Operating Expenses

        During the fourth quarter of 2008, it was determined that 19 of the Bank's private-label MBS were other-than-temporarily impaired. The estimated credit loss for these securities, which is the difference between the amortized cost basis and the present value of the cash flows expected to be collected, discounted at the effective yield of each security, was $32.6 million. However, the accounting rules in effect during 2008 required that we record the full decline in fair value on these securities as the other-than-temporary impairment charge which totaled a loss of $381.7 million for 2008. This amount is reflected in the statement of operations as total other-than-temporary impairment loss on investment securities.

        Losses on early extinguishment of debt totaled $2.7 million and $641,000 for the years ended December 31, 2008 and 2007, respectively. During the years ended December 31, 2008 and 2007, the Bank extinguished debt with book values totaling $84.0 million and $22.3 million, respectively.

        For the years ended December 31, 2008 and 2007, the Bank recorded net unrealized losses on trading securities of $937,000 and $267,000, respectively. These securities are economically hedged with interest-rate-exchange agreements that do not qualify for hedge accounting, but are acceptable hedging strategies under the Bank's risk-management program. Changes in the fair value of these economic hedges are recorded in current-period earnings and amounted to a loss of $855,000 and $1.7 million for the years ended December 31, 2008 and 2007, respectively. Also included in other (loss) income are interest accruals on these economic hedges, which resulted in net (expense) income of ($1.9 million) and $616,000 for the years ended December 31, 2008 and 2007, respectively.

        During the third quarter of 2008, the Bank sold available-for-sale MBS with a book value of $2.7 million and recognized a loss of $80,000 on the sale of these securities. These MBS had been pledged as collateral to Lehman Brothers Special Financing, Inc. (Lehman) on out-of-the-money derivatives transactions. See Item 8—Financial Statements and Supplementary Data—Financial Statements—Note 6—Available-for-Sale Securities for additional information regarding the transaction. This event was determined by the Bank to be isolated, nonrecurring, and unusual and could not have been reasonably anticipated. As such, management determined that the sale does not impact the Bank's ability and intent to hold the remaining available-for-sale securities that are in an unrealized loss position through to a recovery of fair value, which may be maturity.

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        During the third quarter of 2008, the Bank sold held-to-maturity MBS with a book value of $5.7 million and recognized a loss of $52,000 on the sale of these securities. These MBS had been pledged as collateral to Lehman on out-of-the-money derivatives transactions. See Item 8—Financial Statements and Supplementary Data—Financial Statements—Note 7—Held-to-Maturity Securities for additional information regarding the transaction. Management determined that the sale does not impact the Bank's ability and intent to hold the remaining investments classified as held-to-maturity through their stated maturity dates.

        For the year ended December 31, 2008, total operating expenses increased $2.2 million from the same period in 2007. This increase was mainly due to a $381,000 increase in salaries and benefits and a $1.7 million increase in other operating expenses. The $381,000 increase in salaries and benefits is due primarily to a $2.1 million increase in salary expenses attributable to planned staffing increase and annual merit increases, an increase of $162,000 in employee benefits, and an increase of $133,000 in employee training. These increases were offset by a decline of $2.1 million in incentive compensation, which was impacted by the large growth in unrealized losses in the Bank's portfolio of held-to-maturity private-label MBS and related need to preserve and build capital in 2008. At December 31, 2008, staffing levels increased 3.5 percent to 206.0 full-time equivalent positions compared with 199.0 full-time equivalent positions at December 31, 2007.

        The $1.7 million increase in other operating expenses is largely attributable to a $342,000 increase legal expenses in connection with a review of regulatory compliance matters, a $641,000 increase in contractual services, a $353,000 increase in equipment expenses, and a $277,000 increase in director fees due to the board eliminating prior caps on director fees.

FINANCIAL CONDITION

Advances

        At December 31, 2009, the advances portfolio totaled $37.6 billion, a decrease of $19.3 billion compared with a total of $56.9 billion at December 31, 2008. This decrease was primarily in the following product types:

    a $15.1 billion decline in fixed-rate advances;

    a $2.1 billion decrease in floating-rate advances; and

    a $1.8 billion decrease in overnight advances.

        Reasons for the decline in member demand for advances are discussed in this Item under Overview and Executive Summary—Principal Business Developments.

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        The following table summarizes advances outstanding at December 31, 2009 and 2008, by year of contractual maturity.

Advances Outstanding by Year of Contractual Maturity
(dollars in thousands)

 
  2009   2008  
Year of Contractual Maturity
  Amount   Weighted
Average
Rate
  Amount   Weighted
Average
Rate
 

Overdrawn demand-deposit accounts

  $ 10,316     0.43 % $ 28,444     0.46 %

2009

            32,363,291     2.42  

2010

    17,014,988     1.34     5,418,310     4.23  

2011

    4,802,734     3.04     4,953,624     3.27  

2012

    2,916,158     3.87     2,507,092     4.30  

2013

    5,518,784     2.32     5,119,387     2.43  

2014

    1,868,762     3.64     909,815     4.42  

Thereafter

    4,791,566     3.99     4,530,059     4.08  
                   

Total par value

    36,923,308     2.37 %   55,830,022     2.92 %

Premiums

   
20,632
         
9,279
       

Discounts

    (25,586 )         (20,883 )      

Hedging adjustments

    673,107           1,107,849        
                       

Total

  $ 37,591,461         $ 56,926,267        
                       

        Advances originated by the Bank are recorded at par. However, the Bank may record premiums or discounts on advances in the following cases:

    advances may be acquired from another FHLBank when a member of the Bank acquires a member of another FHLBank. In these cases, the Bank may purchase the advance from the other FHLBank at a price that results in a fair market yield for the acquired advance.

    in the event that a hedge of an advance is discontinued, the cumulative hedging adjustment is recorded as a premium or discount and amortized over the remaining life of the advance.

    when the prepayment of an advance is followed by disbursement of a new advance and the transactions effectively represent a modification of the previous advance the prepayment fee received is deferred, recorded as a discount to the modified advance, and accreted over the life of the new advance.

    when the Bank makes an AHP advance, the present value of the variation in the cash flow caused by the difference in the interest rate between the AHP advance rate and the Bank's related cost of funds for comparable maturity funding is charged against the AHP liability and recorded as a discount on the AHP advance. An AHP advance is an advance with an interest rate that is subsidized with funds from the Bank's AHP program. For additional information on the Bank's AHP program, see Item 1—Business—Assessments—AHP Assessment.

        The Bank offers advances to members that may be prepaid on pertinent dates (call dates) without incurring prepayment or termination fees (callable advances). At December 31, 2009, and December 31, 2008, the Bank had outstanding callable advances of $11.5 million and $5.5 million, respectively. The following table summarizes advances outstanding at December 31, 2009 and 2008, by year of contractual maturity or next call date for callable advances.

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Advances Outstanding by Year of Contractual Maturity or Next Call Date
(dollars in thousands)

 
  2009   2008  
Year of Contractual Maturity or Next Call Date
  Par Value   Percentage
of Total
  Par Value   Percentage
of Total
 

Overdrawn demand-deposit accounts

  $ 10,316     % $ 28,444     %

2009

            32,368,791     58.0  

2010

    17,014,988     46.1     5,418,310     9.7  

2011

    4,802,734     13.0     4,948,124     8.9  

2012

    2,927,658     7.9     2,507,092     4.5  

2013

    5,518,784     15.0     5,119,387     9.2  

2014

    1,862,262     5.0     909,815     1.6  

Thereafter

    4,786,566     13.0     4,530,059     8.1  
                   

Total par value

  $ 36,923,308     100.0 % $ 55,830,022     100.0 %
                   

        The Bank also offers putable advances, in which the Bank purchases a put option from the member that allows the Bank to terminate the related advance on specific dates through its term. At December 31, 2009 and 2008, the Bank had putable advances outstanding totaling $8.4 billion and $9.3 billion, respectively. The following table summarizes advances outstanding at December 31, 2009, and December 31, 2008, by year of contractual maturity or next put date for putable advances.

Advances Outstanding by Year of Contractual Maturity or Next Put Date
(dollars in thousands)

 
  2009   2008  
Year of Contractual Maturity or Next Put Date
  Par Value   Percentage
of Total
  Par Value   Percentage
of Total
 

Overdrawn demand-deposit accounts

  $ 10,316     % $ 28,444     %

2009

            39,061,566     70.0  

2010

    22,710,413     61.5     4,529,960     8.1  

2011

    4,810,434     13.0     4,906,824     8.8  

2012

    2,042,108     5.5     1,599,042     2.9  

2013

    4,707,984     12.8     4,277,587     7.7  

2014

    1,314,762     3.6     360,815     0.6  

Thereafter

    1,327,291     3.6     1,065,784     1.9  
                   

Total par value

  $ 36,923,308     100.0 % $ 55,830,022     100.0 %
                   

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        The following table summarizes advances outstanding by product type at December 31, 2009 and 2008.

Advances Outstanding by Product Type
(dollars in thousands)

 
  December 31, 2009   December 31, 2008  
 
  Par Value   Percent of
Total
  Par Value   Percent of
Total
 

Overnight advances

  $ 583,224     1.6 % $ 2,350,846     4.2 %

Fixed-rate advances

                         
 

Short-term

    11,392,788     30.8     22,893,070     41.0  
 

Long-term

    10,734,687     29.1     12,866,170     23.1  
 

Putable

    8,242,575     22.3     9,273,175     16.6  
 

Amortizing

    2,169,034     5.9     2,565,761     4.6  
 

Callable

    11,500         5,500      
                   

    32,550,584     88.1     47,603,676     85.3  

Variable-rate advances

                         
 

Simple variable

    3,581,000     9.7     5,860,000     10.5  
 

Putable, convertible to fixed

    203,000     0.6          
 

LIBOR-indexed with declining-rate participation

    5,500         15,500      
                   

    3,789,500     10.3     5,875,500     10.5  

Total par value

 
$

36,923,308
   
100.0

%

$

55,830,022
   
100.0

%
                   

        The Bank lends to member financial institutions chartered within the six New England states. Advances are diversified across the Bank's member institutions. December 31, 2009, the Bank had advances outstanding to 351, or 76.0 percent, of its 462 members. At December 31, 2008, the Bank had advances outstanding to 370, or 80.3 percent, of its 461 members.

        The following table provides a summary of advances outstanding to the Bank's members by member institution type for each of the last five fiscal years.

Advances Outstanding by Member Type
(dollars in millions)

 
  Commercial
Banks
  Thrifts   Credit
Unions
  Insurance
Companies
  Other(1)   Total Par
Value
 

December 31, 2009

  $ 18,565.3   $ 14,988.8   $ 2,767.1   $ 487.0   $ 115.1   $ 36,923.3  

December 31, 2008

    32,151.1     18,930.7     3,751.8     857.1     139.3     55,830.0  

December 31, 2007

    35,692.0     16,286.0     2,518.1     757.8     131.0     55,384.9  

December 31, 2006

    18,585.7     15,834.0     1,773.3     938.4     227.4     37,358.8  

December 31, 2005

    20,582.6     14,233.3     1,802.7     1,134.8     295.2     38,048.6  

(1)
"Other" includes advances of former members involved in mergers with nonmembers where the resulting institution is not a member of the Bank, as well as advances outstanding to eligible nonmember housing associates.

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Top Five Advance-Holding Members
(dollars in thousands)

 
   
   
  As of December 31, 2009    
 
 
   
   
  Advances Interest
Income for the
Year Ended
December 31, 2009
 
Name
  City   State   Par Value of
Advances
  Percent of Total
Advances
  Weighted-Average
Rate(1)
 

RBS Citizens, N.A. 

  Providence   RI   $ 10,712,640     29.0 %   0.26 % $ 50,275  

Bank of America Rhode Island, N.A. 

  Providence   RI     3,059,312     8.3     0.71     97,068  

NewAlliance Bank

  New Haven   CT     1,752,412     4.7     4.22     87,858  

Salem Five Cents Savings Bank

  Salem   MA     610,134     1.7     4.42     28,258  

Washington Trust Company

  Westerly   RI     607,325     1.6     4.24     28,140  

(1)
Weighted-average rates are based on the contract rate of each advance without taking into consideration the effects of interest-rate-exchange agreements that may be used by the Bank as a hedging instrument.

        The Bank prices advances based on the marginal cost of funding with a similar maturity profile, as well as market rates for comparable funding alternatives. In accordance with regulations, the Bank prices its advance products in a consistent and nondiscriminatory manner to all members. However, the Bank may price its products on a differential basis, which is based on the creditworthiness of the member, volume, or other reasonable criteria applied consistently to all members. Differences in the weighted-average rates of advances outstanding to the five largest members noted in the table above result from several factors, including the disbursement date of the advances, the product type selected, and the term to maturity.

        Prepayment Fees.    Advances with a maturity of six months or less may not be prepaid, whereas advances with a term to maturity greater than six months generally require a fee to make the Bank financially indifferent should a member decide to prepay an advance. During the year ended December 31, 2009, advances totaling $1.5 billion were prepaid, resulting in gross prepayment-fee income of $40.7 million, which was partially reduced by $18.6 million related to fair-value hedging adjustments on the prepaid advances. Additionally, $9.1 million of the prepayment fees were deferred as a result of disbursement of a new advance to the member and the transactions were deemed to be a modification. During the year ended December 31, 2008, advances totaling $1.0 billion were prepaid, resulting in gross prepayment-fee income of $6.5 million, which was reduced by $1.8 million related to fair-value hedging adjustments and a $7,000 premium write-off on those prepaid advances. Advance prepayments may increase as a result of changes in interest rates or other factors. A declining interest-rate environment may result in an increase in prepayment fees but also a reduced rate of return on the Bank's interest-earning assets. Thus, the amount of future advance prepayments and the impact of such prepayments on the Bank's future earnings is unpredictable.

Investments

        At December 31, 2009, investment securities and short-term money-market instruments totaled $20.9 billion, compared with $18.9 billion at December 31, 2008. Under the Bank's pre-existing authority to purchase MBS, additional investments in MBS and certain securities issued by the Small Business Administration (SBA) are prohibited if the Bank's investments in such securities exceed 300 percent of capital as measured at the previous monthend unless the Bank takes advantage of a temporary increase in MBS investment authority granted to the FHLBanks by the Finance Board in March 2008, which it has not, as described in greater detail under Item 1—Business—Traditional Business Activities—Investments. Capital for this calculation is defined as capital stock, mandatorily redeemable capital stock, and retained earnings. At December 31, 2009 and 2008, the Bank's MBS and SBA holdings represented 207 percent and 225 percent of capital, respectively.

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Held-to-Maturity Securities

        The following table provides a summary of the Bank's held-to-maturity securities.

Investment Securities Classified as Held-to-Maturity
(dollars in thousands)

 
  December 31, 2009   December 31, 2008   December 31, 2007  
 
  Amortized
Cost
  Carrying
Value(1)
  Fair
Value
  Amortized
Cost(2)
  Fair
Value
  Amortized
Cost(2)
  Fair
Value
 

Certificates of deposit

  $   $   $   $ 565,000   $ 565,157   $ 5,330,000   $ 5,332,096  

U.S. agency obligations

    30,801     30,801     33,061     39,995     41,259     51,634     53,465  

State or local housing-finance-agency obligations

    246,257     246,257     215,130     278,128     196,122     299,653     287,228  

Government-sponsored enterprises

    18,897     18,897     18,597                  
                               

    295,955     295,955     266,788     883,123     802,538     5,681,287     5,672,789  

Mortgage-backed securities:

                                           
 

U.S. government guaranteed

    98,610     98,610     98,397     11,870     12,515     13,661     14,297  
 

Government-sponsored enterprises

    4,872,366     4,872,366     4,987,923     4,384,215     4,359,784     1,658,407     1,682,370  
 

Private-label

    3,089,990     2,160,482     2,069,573     3,989,016     2,409,945     5,924,526     5,748,175  
                               

    8,060,966     7,131,458     7,155,893     8,385,101     6,782,244     7,596,594     7,444,842  

Total

 
$

8,356,921
 
$

7,427,413
 
$

7,422,681
 
$

9,268,224
 
$

7,584,782
 
$

13,277,881
 
$

13,117,631
 
                               

(1)
Carrying value of held-to-maturity securities represents the sum of amortized cost and the amount of noncredit related impairment recognized in accumulated other comprehensive income.

(2)
At December 31, 2008 and 2007, carrying value equaled amortized cost.

        State or Local Housing-Finance-Agency Obligations.    Within this category of investment securities in the held-to-maturity portfolio are gross unrealized losses totaling $31.9 million as of December 31, 2009. Management has reviewed the state or local housing-finance-agency obligations and has determined that unrealized losses reflect the impact of normal market yield and spread fluctuations attendant with security markets. The Bank has determined that all unrealized losses are temporary given the creditworthiness of the issuers and the underlying collateral. As of December 31, 2009, none of the Bank's held-to-maturity investments in state or local housing-finance-agency obligations were rated below investment grade by an NRSRO. Because the decline in market value is attributable to changes in interest rates and credit spreads and illiquidity in the credit markets, and not to a deterioration in the fundamental credit quality of these obligations, and because the Bank has the ability and intent to hold these investments through to a recovery of fair value, which may be maturity, the Bank does not consider these investments to be other-than-temporarily impaired at December 31, 2009.

        Mortgage-Backed Securities.    During the year ended December 31, 2009, management has determined that 106 of its private-label MBS were other-than-temporarily impaired resulting in a credit loss of $444.1 million and a net increase to accumulated other comprehensive loss of $885.4 million. The Bank has continued to update its modeling assumptions, inputs, and methodologies in its analyses of these securities for other-than-temporary-impairment, as is described under Critical Accounting Estimates—Other-Than-Temporary Impairment of Securities in this Item and Item 8—Financial Statements and Supplementary Data—Notes to the Financial Statements—Note 7—Held-to-Maturity Securities. Given the ongoing flux in the nation's housing markets and economic outlook, the Bank has used increasingly stressful assumptions on an ongoing basis to reflect current developments in experienced loan performance and attendant forecasts. Despite some signs of economic recovery observed during the second half of 2009, many of the trends impacting the underlying loans continued to show little if any improvement and resulted in slower recovery assumptions; such trends include

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prolonged, elevated unemployment rates, some further decline in housing prices followed by slower housing price recovery, and extremely limited refinancing opportunities for borrowers whose houses are now worth less than the balance of their mortgages.

        The maturities, amortized cost, and weighted-average yields of non-MBS classified as held-to-maturity as of December 31, 2009, are provided in the following table.

Redemption Terms of Held-to-Maturity Securities
(dollars in thousands)

 
  Due in one year
or less
  Due after one year
through five years
  Due after five years
through 10 years
  Due after 10 years    
 
 
  Amortized
Cost
  Weighted
Average
Yield
  Amortized
Cost
  Weighted
Average
Yield
  Amortized
Cost
  Weighted
Average
Yield
  Amortized
Cost
  Weighted
Average
Yield
  Total  

U.S. agency obligations

  $     % $     % $ 30,801     6.06 % $     % $ 30,801  

State or local housing-finance-agency obligations

    355     7.04     5,133     7.41     31,721     6.55     209,048     1.13     246,257  

Government-sponsored enterprises

            18,897     2.18                     18,897  
                                       
 

Total

  $ 355     7.04 % $ 24,030     3.30 % $ 62,522     6.31 % $ 209,048     1.13 % $ 295,955  
                                       

Available-for-Sale Securities

        The Bank classifies certain investment securities as available-for-sale to enable liquidation at a future date or to enable the application of hedge accounting using interest-rate swaps. By classifying investments as available-for-sale, the Bank can consider these securities to be a source of short-term liquidity, if needed. From time to time, the Bank invests in certain securities and simultaneously enters into matched-term interest-rate swaps to achieve a LIBOR-based variable yield, particularly when the Bank can earn a wider interest spread between the swapped yield on the investment and short-term debt instruments than it can earn between the bond's fixed yield and comparable-term fixed-rate debt. Because an interest-rate swap can only be designated as a hedge of an available-for-sale investment security, the Bank classifies these investments as available-for-sale. The following table provides a summary of the Bank's available-for-sale securities.


Investment Securities Classified as Available-for-Sale
(dollars in thousands)

 
  December 31,  
 
  2009   2008   2007  
 
  Amortized
Cost
  Fair
Value
  Amortized
Cost
  Fair
Value
  Amortized
Cost
  Fair
Value
 

Certificates of deposit

  $ 2,600,000   $ 2,600,000   $   $   $   $  

Supranational banks

    415,744     381,011     501,890     458,984     394,678     396,341  

Corporate bonds

    702,754     701,779                  

U.S. government corporations

    253,009     221,502     334,345     275,856     235,200     237,204  

Government-sponsored enterprises

    1,772,115     1,752,319     164,478     143,130     156,221     156,064  

State or local housing-finance-agency obligations

            21,685     21,685          
                           

    5,743,622     5,656,611     1,022,398     899,655     786,099     789,609  

Mortgage-backed securities

                                     
 

U.S. government guaranteed

    16,551     16,704                  
 

Government-sponsored enterprises

    816,519     813,317     322,486     314,749     277,749     274,150  
                           

    833,070     830,021     322,486     314,749     277,749     274,150  

Total

 
$

6,576,692
 
$

6,486,632
 
$

1,344,884
 
$

1,214,404
 
$

1,063,848
 
$

1,063,759
 
                           

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        Unrealized Losses—Supranational Banks, Corporate Bonds,U.S Government Corporations, and Government-Sponsored Enterprises.    Within the supranational banks, corporate bonds, U.S. government corporations, and GSE categories of investment securities held in the available-for-sale portfolio are gross unrealized losses totaling $34.7 million, $2.0 million, $31.5 million, and $19.8 million, respectively, as of December 31, 2009. Regarding those agency debentures that were in an unrealized loss position as of December 31, 2009, the Bank has concluded that the probability of default for Federal National Mortgage Association (Fannie Mae) is remote given its status as a GSE and its support from the U.S. federal government. Corporate bonds held by the Bank are guaranteed by the FDIC through the Temporary Liquidity Guarantee Program. Debentures issued by a supranational entity and owned by the Bank that were in an unrealized loss position as of December 31, 2009 are viewed as being likely to return contractual principal and interest since such supranational entity is rated the highest long-term rating by each of the three NRSROs. Because the decline in market value is largely attributable to illiquidity in the credit markets and not to deterioration in the fundamental credit quality of these securities, and because the Bank has the ability and intent to hold these investments through to a recovery of fair value, which may be maturity, the Bank does not consider these investments to be other-than-temporarily impaired at December 31, 2009.

        Mortgage-Backed Securities.    Within the GSE category of investment securities held in the available-for-sale portfolio are gross unrealized losses totaling $4.9 million as of December 31, 2009. The Bank's available-for-sale securities portfolio has experienced unrealized losses and a decrease in hedged fair value due to interest-rate volatility and reduced liquidity in the marketplace. However, the decline is considered temporary as the Bank expects to recover the entire amortized cost basis on these available-for-sale securities in an unrealized loss position and neither intends to sell these securities nor is it likely that the Bank will be required to sell these securities before the anticipated recovery of each security's remaining amortized cost basis. Further, MBS issued by Fannie Mae are backed by conforming mortgage loans and the GSE's credit guarantee as to full return of principal and interest. Because the decline in market value is largely attributable to illiquidity in the credit markets and not to deterioration in the fundamental credit quality of these securities, and because the Bank has the ability and intent to hold these investments through to a recovery of fair value, which may be maturity, the Bank does not consider these investments to be other-than-temporarily impaired at December 31, 2009.

        The maturities, amortized cost, and weighted-average yields of non-MBS classified as available-for-sale as of December 31, 2009, are provided in the following table.

Redemption Terms of Available-for-Sale Securities
(dollars in thousands)

 
  Due in one year
or less
  Due after one year
through five years
  Due after five years
through 10 years
  Due after 10 years    
 
 
  Amortized
Cost
  Weighted
Average
Yield
  Amortized
Cost
  Weighted
Average
Yield
  Amortized
Cost
  Weighted
Average
Yield
  Amortized
Cost
  Weighted
Average
Yield
  Total  

Certificates of deposit

  $ 2,600,000     0.19 % $     % $     % $     % $ 2,600,000  

Supranational banks

                            415,744     6.79     415,744  

Corporate bonds

            702,754     1.41                     702,754  

U.S. government corporations

                            253,009     6.15     253,009  

Government-sponsored enterprises

            1,664,167     2.55             107,948     6.11     1,772,115  
                                       
 

Total

  $ 2,600,000     0.19 % $ 2,366,921     2.21 % $     % $ 776,701     6.49 % $ 5,743,622  
                                       

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Trading Securities

        The Bank also classifies certain investments acquired for purposes of meeting short-term contingency liquidity needs and asset/liability management as trading securities and carries them at fair value. However, the Bank does not participate in speculative trading practices and holds these investments indefinitely as management periodically evaluates the Bank's liquidity needs. The following table provides a summary of the Bank's trading securities.

Trading Securities
(dollars in thousands)

 
  December 31,  
 
  2009   2008   2007  

Mortgage-backed securities

                   
 

U.S. government guaranteed

  $ 23,972   $ 26,533   $ 32,827  
 

Government-sponsored enterprises

    83,366     36,663     47,754  
 

Other

            32,288  
               

Total

  $ 107,338   $ 63,196   $ 112,869  
               

        At December 31, 2009, the Bank held securities from the following issuers with total book values greater than 10 percent of total capital, as follows:

Issuers with Total Carrying Value Greater than 10 Percent of Total Capital
(dollars in thousands)

Name of Issuer
  Carrying
Value(1)
  Fair
Value
 

Non-Mortgage-backed securities:

             
 

Federal National Mortgage Association

  $ 1,107,598   $ 1,107,598  
 

Federal Home Loan Mortgage Corporation

    663,619     663,319  
 

Citibank, N.A.(2)

    651,054     651,054  
 

Calyon

    515,000     515,000  
 

Banco Bilbao Vizcaya Argentaria

    400,000     400,000  
 

Inter-American Development Bank

    381,011     381,011  
 

Fortis Bank SA/NV

    340,000     340,000  
 

Skandinaviska Enskilda Banken AB

    340,000     340,000  
 

Natixis

    340,000     340,000  
 

Societe Generale

    340,000     340,000  
 

Bank of Nova Scotia

    325,000     325,000  

Mortgage-backed securities:

             
 

Federal National Mortgage Association

  $ 3,643,948   $ 3,738,601  
 

Federal Home Loan Mortgage Corporation

    2,125,101     2,146,005  

(1)
Carrying value for trading securities and available-for-sale securities represents fair value.

(2)
Guaranteed by the FDIC through the Temporary Liquidity Guarantee Program.

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Table of Contents

        The Bank's MBS investment portfolio consists of the following categories of securities by carrying value as of December 31, 2009 and 2008.

Mortgage-Backed Securities

 
  December 31,  
 
  2009   2008  

U.S. government-guaranteed and GSE residential mortgage-backed securities

    73.2 %   54.5 %

Private-label residential mortgage-backed securities

    24.8     43.4  

Private-label commercial mortgage-backed securities

    1.6     1.6  

Home-equity loans

    0.4     0.5  
           

Total mortgage-backed securities

    100.0 %   100.0 %
           

Mortgage Loans

        Under the MPF program (other than MPF Xtra), the Bank invests in fixed-rate mortgages that are purchased from members that are PFIs. In the case of MPF Xtra the Bank facilitates Fannie Mae's investment in certain mortgages purchased from PFIs. The Bank bears the liquidity, interest-rate, and prepayment-option risks of the mortgages it purchases, while the member retains the marketing and servicing activities. PFIs provide a measure of credit-loss protection to the Bank on loans the Bank purchases, for which PFIs receive a CE fee. The MPF program, including MPF Xtra, is further described in Item 1—Business—Mortgage Loan Finance and Item 7A—Quantitative and Qualitative Disclosures about Market Risk—Credit Risk—Mortgage Loans.

        Mortgage loans as of December 31, 2009, totaled $3.5 billion, a decrease of $647.6 million from the December 31, 2008 balance of $4.2 billion. As of December 31, 2009, 149 of the Bank's 462 members have been approved to participate in the MPF program, and for the year ended December 31, 2009, 70 members sold loans into the MPF program. Mortgage-loan purchases amounted to $336.2 million par value, for the year ending December 31, 2009, and $620.3 million par value for the year ending December 31, 2008. This 45.8 percent decrease in mortgage-loan purchases is primarily attributable to competition with Fannie Mae and Freddie Mac.

        The activities of the Bank's MPF portfolio are subject to significant competition in purchasing conventional, conforming fixed-rate mortgages and government-insured loans. The Bank faces competition in customer service, the prices paid for these assets, and in ancillary services such as automated underwriting. Historically, the most direct competition for mortgages came from other housing GSEs that also purchase conventional, conforming fixed-rate mortgage loans, specifically Fannie Mae and Freddie Mac. Since 2008, a Federal Reserve Board agency MBS purchase program instituted to make housing more affordable has contributed to the ability of Fannie Mae and Freddie Mac to offer low mortgage rates. Comparative MPF mortgage rates, which are a function of the FHLBank debt issuance costs, have not been as competitive from time to time as a result. The net pricing effect, all other things being equal, weakens member demand for MPF products.

        To encourage growth in the Bank's MPF program in October 2009, the board of directors approved a suspension of the activity-based stock investment requirement for participating in the MPF program, the suspension will remain in effect at the discretion of the Bank's board of directors. See Item 1—Business—Capital Resources—Activity-Based Stock-Investment Requirement for additional information.

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        The following table presents information relating to the Bank's mortgage portfolio for the five-year period ended December 31, 2009.


Mortgage Loans Held for Investment
(dollars in thousands)

 
  December 31,  
 
  2009   2008   2007   2006   2005  

Real estate

                               

Fixed-rate 15-year single-family mortgages

  $ 821,978   $ 1,027,058   $ 1,129,572   $ 1,321,762   $ 1,480,555  

Fixed-rate 20- and 30-year single-family mortgages

    2,671,482     3,107,424     2,938,886     3,152,175     3,370,391  

Premiums

    25,802     32,476     35,252     42,274     51,501  

Discounts

    (9,444 )   (11,576 )   (11,270 )   (12,758 )   (13,051 )

Deferred derivative gains and losses

    (1,743 )   (1,495 )   (1,001 )   (1,146 )   (1,059 )
                       

Total mortgage loans held for investment

    3,508,075     4,153,887     4,091,439     4,502,307     4,888,337  

Less: allowance for credit losses

    (2,100 )   (350 )   (125 )   (125 )   (1,843 )
                       

Total mortgage loans, net of allowance for credit losses

  $ 3,505,975   $ 4,153,537   $ 4,091,314   $ 4,502,182   $ 4,886,494  
                       

Volume of mortgage-loan purchases

                               

Conventional loans

                               
 

Original MPF

  $ 309,729   $ 479,766   $ 122,487   $ 109,905   $ 220,823  
 

MPF 125

    3,723     74,264     51,293     41,473     56,474  
 

MPF Plus

        60,684         110,032     1,477,647  
                       

Total conventional loans

    313,452     614,714     173,780     261,410     1,754,944  

Government-insured or guaranteed loans

                               
 

MPF Government

    22,793     5,567              
                       

Total par value purchased

  $ 336,245   $ 620,281   $ 173,780   $ 261,410   $ 1,754,944  
                       

Mortgage loans outstanding

                               

Conventional loans

                               
 

Original MPF

  $ 1,121,309   $ 1,120,573   $ 735,629   $ 684,482   $ 642,015  
 

MPF 125

    307,713     403,016     377,046     361,937     361,050  
 

MPF Plus

    1,728,542     2,231,626     2,524,915     2,914,273     3,219,238  
                       

Total conventional loans

    3,157,564     3,755,215     3,637,590     3,960,692     4,222,303  

Government-insured or guaranteed loans

                               
 

MPF Government

    335,896     379,267     430,868     513,245     628,643  
                       

Total par value outstanding

  $ 3,493,460   $ 4,134,482   $ 4,068,458   $ 4,473,937   $ 4,850,946  
                       

        The FHLBank of Chicago, which acts as the MPF provider and provides operational support to the MPF Banks and their PFIs, calculates and publishes daily prices, rates, and fees associated with the various MPF products. The Bank has the option, on a daily basis, to opt out of participation in the MPF program. To date, the Bank has never opted out of daily participation. The FHLBank of Chicago had advised the Bank that, until further notice, it would no longer purchase participation interests in MPF loans acquired by other MPF Banks including the Bank. As a result, (1) the FHLBank of Chicago will not purchase participation interests in loans originated by the Bank's PFIs, and (2) in the event that the Bank elects to opt out of purchasing MPF loans on a given day, the FHLBank of Chicago will forgo its option to purchase 100 percent of the loans originated by the Bank's PFIs on that date. Given currently available information, market conditions, and the Bank's financial management strategies for the MPF loan portfolio, the Bank's management does not believe that this business decision by the FHLBank of Chicago will have any material impact on the Bank's results of operations or financial

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condition, although it could from time to time require the Bank to restrict the volume of loans that it purchases from its PFIs. However, under different business conditions, the decision could have a material impact on the Bank's results of operations and financial condition. For example, if the Bank elected to opt out of purchasing MPF loans, it could adversely affect customer relationships and future business flows.

        The following table presents information relating to the Bank's regional and state concentrations of mortgage loans outstanding at December 31, 2009 and 2008.

Regional Concentration of Mortgage Loans Outstanding(1)

 
  December 31,  
 
  2009   2008  

Regional concentration(2)

             

Midwest

    7 %   8 %

Northeast

    52     49  

Southeast

    11     12  

Southwest

    10     10  

West

    20     21  
           

Total

    100 %   100 %
           

State concentration(3)

             

Massachusetts

    28 %   25 %

California

    15     16  

Connecticut

    9     8  

(1)
Percentages calculated based on unpaid principal balance at the end of each period.

(2)
Midwest includes IA, IL, IN, MI, MN, ND, NE, OH, SD, and WI.
Northeast includes CT, DE, MA, ME, NH, NJ, NY, PA, RI, and VT.
Southeast includes AL, DC, FL, GA, KY, MD, MS, NC, SC, TN, VA, and WV.
Southwest includes AR, AZ, CO, KS, LA, MO, NM, OK, TX, and UT.
West includes AK, CA, HI, ID, MT, NV, OR, WA, and WY.


(3)
State concentrations are provided for any individual state in which the Bank has a concentration of 5 percent or more.

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        The following tables provide the portfolio characteristics of mortgage loans held by the Bank.

Characteristics of the Bank's Mortgage-Loan Portfolio(1)

 
  December 31,  
 
  2009   2008  

Loan-to-value ratio at origination

             

< 60.00%

    44 %   46 %

60.01% to 70.00%

    14     14  

70.01% to 80.00%

    18     17  

80.01% to 90.00%

    14     13  

Greater than 90.00%

    10     10  
           

Total

    100 %   100 %
           

Weighted average loan-to-value ratio

    64 %   63 %

FICO score

             

< 620

    3 %   3 %

620 to < 660

    7     7  

660 to < 700

    14     13  

700 to < 740

    20     20  

³ 740

    55     56  

Not available

    1     1  
           

Total

    100 %   100 %
           

Weighted average FICO score

    737     738  

(1)
Percentages calculated based on unpaid principal balance at the end of each period.

        Government MPF loans may not exceed the loan-to-value limits set by the applicable federal agency. Conventional MPF loans with loan-to-value limits greater than 80 percent require certain amounts of primary mortgage insurance, from a mortgage insurance company rated at least triple-B (or equivalent rating).

        The Bank has certain customer concentrations in connection with its mortgage-loan purchases. The following table presents the Bank's retained mortgage-loan purchases from PFIs that represent greater than 10 percent of total mortgage-loan purchases for the year ended December 31, 2009.

Mortgage-Loan Purchases from PFIs
(dollars in thousands)

 
  For the Year Ended December 31,  
 
  2009   2008   2007   2006