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EX-32.1 - EX-32.1 - Federal Home Loan Bank of Pittsburghl39615exv32w1.htm
EX-31.1 - EX-31.1 - Federal Home Loan Bank of Pittsburghl39615exv31w1.htm
EX-32.2 - EX-32.2 - Federal Home Loan Bank of Pittsburghl39615exv32w2.htm
EX-31.2 - EX-31.2 - Federal Home Loan Bank of Pittsburghl39615exv31w2.htm
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
 
     
     
[√] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
     
For the quarterly period ended March 31, 2010
   
     
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: 000-51395
 
FEDERAL HOME LOAN BANK OF PITTSBURGH
(Exact name of registrant as specified in its charter)
 
     
Federally Chartered Corporation   25-6001324
(State or other jurisdiction of
incorporation or organization)
  (IRS Employer Identification No.)
     
601 Grant Street
Pittsburgh, PA 15219
  15219
(Address of principal executive offices)   (Zip Code)
 
(412) 288-3400
(Registrant’s telephone number, including area code)
 
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.  xYes  o No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  o Yes o No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
  o Large accelerated filer  o Accelerated filer  x Non-accelerated filer  oSmaller reporting company  
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o Yes     x No
 
There were 40,076,009 shares of common stock with a par value of $100 per share outstanding at April 30, 2010.


 

 
FEDERAL HOME LOAN BANK OF PITTSBURGH
 
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PART I – FINANCIAL INFORMATION
 
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
This Overview should be read in conjunction with the Bank’s unaudited financial statements and footnotes to financial statements in the quarterly report filed on this Form 10-Q as well as the Bank’s 2009 Annual Report filed on Form 10-K.
 
Overview
 
The Federal Home Loan Bank of Pittsburgh’s (the Bank) mission is to provide a readily available, low-cost source of funds for housing and community lenders. The Bank strives to enhance the availability of credit for residential mortgages and targeted community development. The Bank manages its own liquidity so that funds are available to meet members’ demand. By providing needed liquidity and enhancing competition in the mortgage market, the Bank’s lending programs benefit homebuyers and communities.
 
Financial and housing markets have been in turmoil for the last two years, both here in the U.S. and worldwide, as failure to adhere to sound underwriting standards, an increase in mortgage delinquencies and higher foreclosures impacted the economy. As a result of the extensive efforts of the U.S. government and other governments around the world to stimulate economic activity and provide liquidity to the capital markets, the economic environment remains uncertain. Unemployment and underemployment remain at higher levels. In addition, many government programs that support the financial and housing markets are beginning to wind down in 2010. There may be risks to the economy as these programs wind down and the government withdraws its support.
 
Housing prices are still low and falling in some areas. Delinquency and foreclosure rates continue to run at high levels. While the agency mortgage-backed securities (MBS) market is active in funding new mortgage originations, the private label MBS market has not yet recovered. In addition, the commercial real estate market continues to trend downward.
 
The conditions noted above continued to affect the Bank’s business, results of operations and financial condition, as well as that of the Bank’s members, in the first quarter of 2010, and are expected to continue to exert a significant negative effect in the future.
 
General
 
The Bank is one of twelve Federal Home Loan Banks (FHLBanks). The FHLBanks operate as separate entities with their own managements, employees and boards of directors. The twelve FHLBanks, along with the Office of Finance (OF - the FHLBanks’ fiscal agent) and the Federal Housing Finance Agency (Finance Agency - the FHLBanks’ regulator) make up the Federal Home Loan Bank System (FHLBank System). The FHLBanks were organized under the authority of the Federal Home Loan Bank Act of 1932, as amended (Act). The FHLBanks are commonly referred to as government-sponsored enterprises (GSEs), which generally means they are a combination of private capital and public sponsorship. The public sponsorship attributes include: (1) being exempt from federal, state and local taxation, except real estate taxes; (2) being exempt from registration under the Securities Act of 1933 (1933 Act) (although the FHLBanks are required by Finance Agency regulation and the Housing and Economic Recovery Act of 2008 (the Housing Act) to register a class of their equity securities under the Securities Exchange Act of 1934 (1934 Act)) and (3) having a line of credit with the U.S. Treasury.
 
The Bank is a cooperative institution, owned by financial institutions that are also its primary customers. Any building and loan association, savings and loan association, commercial bank, homestead association, insurance company, savings bank, credit union or insured depository institution that maintains its principal place of business in Delaware, Pennsylvania or West Virginia and that meets varying requirements can apply for membership in the


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Bank. The Housing Act expanded membership to include Community Development Financial Institutions (CDFIs). Pursuant to the Housing Act, the Finance Agency has amended its membership regulations to authorize non-federally insured CDFIs to become members of an FHLBank. The newly eligible CDFIs would include community development loan funds, venture capital funds and state-chartered credit unions without federal insurance. The regulation was effective February 4, 2010 and sets out the eligibility and procedural requirements for CDFIs that wish to become members of an FHLBank. All members are required to purchase capital stock in the Bank as a condition of membership. The capital stock of the Bank can be purchased only by members.
 
The Bank’s primary mission is to intermediate between the capital markets and the housing market through member financial institutions. The Bank provides credit for housing and community development through two primary programs. First, it provides members with loans against the security of residential mortgages and other types of high-quality collateral. Second, the Bank purchases residential mortgage loans originated by or through member institutions. The Bank also offers other types of credit and noncredit products and services to member institutions. These include letters of credit, interest rate exchange agreements (interest rate swaps, caps, collars, floors, swaptions and similar transactions), affordable housing grants, securities safekeeping, and deposit products and services. The Bank issues debt to the public (consolidated obligation bonds and discount notes) in the capital markets through the OF and uses these funds to provide its member financial institutions with a reliable source of credit for these programs. The U.S. government does not guarantee the debt securities or other obligations of the Bank or the FHLBank System.
 
The Bank is a GSE, chartered by Congress to assure the flow of liquidity through its member financial institutions into the American housing market. As a GSE, the Bank’s principal strategic position has historically been derived from its ability to raise funds in the capital markets at narrow spreads to the U.S. Treasury yield curve. Typically, this fundamental competitive advantage, coupled with the joint and several cross-guarantee on FHLBank System debt, has distinguished the Bank in the capital markets and has enabled it to provide attractively priced funding to members. However, as the financial crisis worsened in 2008, the spread between FHLBank System debt and U.S. Treasury debt widened, making it more difficult for the Bank to provide term funding to members at attractive rates in the beginning of 2009. However, during the last part of the first quarter of 2009 spreads narrowed, allowing the Bank to offer more attractive pricing.
 
Though chartered by Congress, the Bank is privately capitalized by its member institutions, which are voluntary participants in its cooperative structure. The characterization of the Bank as a voluntary cooperative with the status of a federal instrumentality differentiates the Bank from a traditional banking institution in three principal ways.
 
First, members voluntarily commit capital required for membership principally in order to gain access to the funding and other services provided by the Bank. The value in membership may be derived from the access to liquidity and the availability of favorably priced liquidity, as well as the potential for a dividend on the capital investment.
 
Second, because the Bank’s customers and shareholders are predominantly the same group of 318, normally there is a need to balance the pricing expectations of customers with the dividend expectations of shareholders, although both are the same institutions. This is a challenge in the current economic environment. By charging wider spreads on loans to customers, the Bank could potentially generate higher earnings and potentially dividends for shareholders. Yet these same shareholders viewed as customers would generally prefer narrower loan spreads. In normal market conditions, the Bank strives to achieve a balance between the goals of providing liquidity and other services to members at advantageous prices and potentially generating a market-based dividend. The Bank typically does not strive to maximize the dividend yield on the stock, but to produce an earned dividend that compares favorably to short-term interest rates, compensating members for the cost of the capital they have invested in the Bank. As previously announced on December 23, 2008, in an effort to build retained earnings the Bank, on a voluntary basis, temporarily has suspended its dividend payments until the Bank believes it is prudent to restore them.


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Third, the Bank is different from a traditional banking institution because its GSE charter is based on a public policy purpose to assure liquidity for housing and community development and to enhance the availability of affordable housing for lower-income households. In upholding its public policy mission, the Bank offers a number of programs that consume a portion of earnings that might otherwise become available to its shareholders. The cooperative GSE character of this voluntary membership organization leads management to strive to optimize the primary purpose of membership, access to funding, as well as the overall value of Bank membership.
 
In November 2008, the Bank experienced a significant increase in its risk-based capital (RBC) requirements due to deterioration in the market values of the Bank’s private label MBS. The Bank was narrowly in compliance with its RBC requirement. As a result, the Bank submitted an initial Capital Stabilization Plan (CSP) to the Finance Agency on February 27, 2009. During 2009, there were numerous changes in the economic environment affecting the Bank, including a change in Financial Accounting Standards Board (FASB) guidance regarding other-than-temporary impairment (OTTI), significant downgrades of the Bank’s private label MBS securities, and a larger than expected decrease in advances. Collectively, these developments merited an update of the CSP in late 2009. The CSP submitted to the Finance Agency requests that the Bank not be required to increase member capital requirements unless it becomes significantly undercapitalized, which by definition would mean the Bank meets less than 75% of its risk-based, total or leverage capital requirements. As part of that effort, the Bank has reviewed its risk governance structure, risk management practices and expertise and has begun to make certain enhancements. The most recent CSP was accepted by the Finance Agency.
 
On August 4, 2009, the Finance Agency issued its final Prompt Corrective Action Regulation (PCA Regulation) incorporating the terms of the Interim Final Regulation issued on January 30, 2009. On March 31, 2010, the Bank received final notification from the Finance Agency that it was considered adequately capitalized for the quarter ended December 31, 2009. In its determination, the Finance Agency expressed concerns regarding the Bank’s capital position and earnings prospects. Retained earnings levels and poor quality of the Bank’s private label MBS portfolio have created uncertainties about the Bank’s ability to maintain permanent capital above RBC requirements. As of the date of this filing, the Bank has not received notice from the Finance Agency regarding its capital classification for the quarter ended March 31, 2010. The Bank was in compliance with its risk-based, total and leverage capital requirements at March 31, 2010, as discussed in detail in the Capital Resources section of this Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Management’s Discussion and Analysis) in the quarterly report filed on this Form 10-Q.
 
Advances and Collateral
 
The Bank makes advances (loans to members and eligible nonmember housing associates) on the security of pledged mortgage loans and other eligible types of collateral. The Act requires the Bank to obtain and maintain a security interest in eligible collateral at the time it originates or renews a loan.
 
Advance Products. The Bank offers a number of various loan products to its members. These products are discussed in detail in the “Advances” discussion in Item 1. Business in the Bank’s 2009 Annual Report filed on Form 10-K.
 
Collateral. The Bank provides members with two options regarding collateral agreements: a blanket collateral pledge agreement or a specific collateral pledge agreement. Under a blanket agreement, the Bank obtains a lien against all of the member’s unencumbered eligible collateral assets and most ineligible collateral assets, to secure the member’s obligations with the Bank. Under a specific agreement, the Bank obtains a lien against the specific eligible collateral assets of a member, to secure the member’s obligations with the Bank. These agreements require one of three types of collateral status: undelivered, detailed listing or delivered status. Partial listing or delivery requirements may also be assigned at the Bank’s discretion. A member is assigned a collateral status based on the Bank’s determination of the member’s current financial condition and credit product usage, as well as other information that may have been obtained. All collateral securing advances is discounted to help protect the Bank from losses resulting from a decline in the values of the collateral in adverse market conditions and if the Bank had to take title to the collateral and liquidate in a worst case scenario. Eligible collateral value represents either book


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value or fair value of pledged collateral multiplied by the applicable discounts. These discounts, also referred to as collateral weightings, vary by collateral type and whether the calculation is based on book value or fair value of the collateral. They also typically include consideration for estimated costs to sell or liquidate collateral and the risk of a decline in the collateral value due to market or credit volatility. The Bank reviews the collateral weightings periodically and may adjust them for individual borrowers on a case-by-case basis. The Bank may also require different levels of collateral reporting depending on the member’s current financial condition, types of collateral pledged and credit product usage. The reporting may take the form of detailed loan level listings and/or a Qualifying Collateral Report (QCR) filed on a quarterly or monthly basis. A summary of the collateral weightings is presented in detail in the tables entitled “Lending Value Assigned to the Collateral as a Percentage of Value” in Item 1. Business in the Bank’s 2009 Annual Report filed on Form 10-K. As additional security for each member’s indebtedness, the Bank has a statutory lien on the member’s capital stock in the Bank.
 
The least restrictive collateral status, and the most widely used by the Bank’s members, is the undelivered collateral status. This status is generally assigned to lower risk institutions pledging collateral. Under undelivered collateral status, the Bank calculates and monitors the eligible collateral using regulatory financial reports or QCRs, which are typically submitted quarterly along with collateral certifications. At March 31, 2010, nine of the Bank’s top ten borrowers were in an undelivered collateral status and one was in a delivery collateral status. The Bank also obtains detailed listings on some of the pledged loan collateral on five of the top ten borrowers.
 
Under the Bank’s policy, the Bank may require members to provide a detailed listing of eligible advance collateral being pledged to the Bank due to their high usage of Bank credit products, the type of assets being pledged or the credit condition of the member. This is referred to as detailed listing collateral status. In this case, the member typically retains physical possession of collateral pledged to the Bank but provides a loan level listing of assets pledged. The loan level listing includes the reporting characteristics on the individual loan. Examples include loan amount, zip code, appraised amount and FICO score. In some cases, the member may benefit by listing collateral, in lieu of undelivered status, since it may result in a higher collateral weighting being applied to the collateral. The Bank benefits from listing collateral status because it provides more loan information to calculate a more precise valuation on the collateral. Typically, those members with large, frequent borrowings are covered under listing status with a blanket agreement.
 
The third collateral status used by the Bank’s members is delivered, or in possession collateral status. In this case, the Bank requires the member to physically deliver, or grant control of, eligible collateral to the Bank, including through a third party custodian for the Bank to sufficiently secure all outstanding member obligations. Typically, the Bank would take physical possession/control of collateral if the financial condition of the member was deteriorating or if the member exceeded certain credit product usage triggers. Delivery of collateral may also be required if there is a regulatory action taken against the member by its regulator that would indicate inadequate controls or other conditions that would be of concern to the Bank. Delivery collateral status may apply to both blanket lien and specific agreements. The Bank requires delivery to a restricted account of all securities pledged as collateral. The Bank also requires delivery of collateral from de novo institution members at least during their first two years of operation.
 
With respect to specific collateral agreement borrowers (typically housing finance agencies (HFAs) and insurance companies), the Bank takes control of all collateral pledged at the time the loan is made through the delivery of securities or mortgage loans to the Bank or its custodian.
 
The Bank determines the type and amount of collateral each member has available to pledge as security for Bank advances by reviewing, on a quarterly basis, call reports the members file with their primary banking regulators. Depending on a member’s credit product usage and current financial condition, that member may also be required to file a QCR on a quarterly or monthly basis. The resulting total value of collateral available to be pledged to the Bank after any collateral weighting is referred to as a member’s maximum borrowing capacity (MBC).
 
At March 31, 2010, the principal form of eligible collateral to secure loans made by the Bank was single-family residential mortgage loans, which included a very low amount of manufactured housing loans. High-quality


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securities, including U.S. Treasuries, U.S. agency securities, GSE MBS, and select private label MBS, were also accepted as collateral. FHLBank deposits and multi-family residential mortgages, as well as other real estate related collateral (ORERC), comprised the remaining portion of qualifying collateral. See the “Credit and Counterparty Risk” discussion in the Risk Management section of this Item 2. Management’s Discussion and Analysis in the quarterly report filed on this Form 10-Q for further information on collateral policies and practices and details regarding eligible collateral, including amounts and percentages of eligible collateral securing member advances as of March 31, 2010.
 
At March 31, 2010 and December 31, 2009, respectively, on a borrower-by-borrower basis, the Bank had a perfected interest in eligible collateral with an eligible collateral value (after collateral weightings) in excess of the book value of all advances. Management believes that adequate policies and procedures are in place to effectively manage the Bank’s credit risk associated with lending to members and nonmember housing associates.
 
Although subprime mortgages are no longer considered an eligible collateral asset class by the Bank, it is possible that the Bank may have subprime mortgages pledged as collateral through the blanket-lien pledge.
 
Nationally, during the first three months of 2010, 41 Federal Deposit Insurance Corporation (FDIC)−insured institutions have failed. None of the FHLBanks have incurred any losses on advances outstanding to these institutions. Although many of these institutions were members of the System, none was a member of the Bank.
 
Investments
 
The Bank maintains a portfolio of investments for three main purposes: liquidity, collateral for derivative counterparties and additional earnings. For liquidity purposes, the Bank invests in shorter-term instruments, including overnight Federal funds, to ensure the availability of funds to meet member requests. In addition, the Bank invests in other short-term instruments, including term Federal funds, interest-bearing certificates of deposit and commercial paper. The Bank also maintains a secondary liquidity portfolio, which includes FDIC-guaranteed Temporary Liquidity Guarantee Program (TLGP) investments, U.S. Treasury and agency securities that can be financed under normal market conditions in securities repurchase agreement transactions to raise additional funds. U.S. Treasury securities are the primary source for derivative counterparty collateral.
 
The Bank further enhances interest income by maintaining a long-term investment portfolio, including securities issued by GSEs and state and local government agencies as well as agency and private label MBS. All private label MBS currently in the portfolio, excluding the Shared Funding securities, were required to carry the top rating from Moody’s Investors Service, Inc. (Moody’s), Standard & Poor’s (S&P) or Fitch Ratings (Fitch) at the time 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. Investment income also bolsters the Bank’s capacity to meet its commitment to affordable housing and community investment, to cover operating expenses, and to satisfy its statutory Resolution Funding Corporation (REFCORP) assessment.
 
See the “Credit and Counterparty Risk – Investments” discussion in Risk Management in this Item 2. Management’s Discussion and Analysis in the quarterly report filed on this Form 10-Q for discussion of the credit risk of the investment portfolio, including OTTI charges, and further information on these securities’ current ratings.
 
The Bank does not consolidate any off-balance sheet special-purpose entities or other conduits.
 
Mortgage Partnership Finance (MPF) Program
 
The Bank participates in the Mortgage Partnership Finance (MPF®) Program under which the Bank invests in qualifying 5- to 30-year conventional conforming and government-insured fixed-rate mortgage loans secured by one-to-four family residential properties.


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The Bank currently offers three products under the MPF Program to Participating Financial Institutions (PFIs): Original MPF, MPF Government and MPF Xtra. Further details regarding the credit risk structure for each of the products, as well as additional information regarding the MPF Program and the products offered by the Bank is provided in the “Mortgage Partnership Finance Program” section in Item 7. Management’s Discussion and Analysis in the Bank’s 2009 Annual Report filed on Form 10-K.
 
The Bank held approximately $5.0 billion and $5.1 billion in mortgage loans at par under the MPF Program at March 31, 2010 and December 31, 2009, respectively. These balances represented approximately 8.4% and 7.8% of total assets at March 31, 2010 and December 31, 2009, respectively. Mortgage loans contributed approximately 25.9% and 16.1% of total interest income for first quarter 2010 and 2009, respectively. While interest income on mortgage loans dropped 17.1% in the quarter-over-quarter comparison, the Bank’s total interest income decreased 48.5%. Total interest income decreased more rapidly than interest income on mortgage loans as the Bank had significant funds invested in short-term assets, which experienced sharp rate declines in the quarter-over-quarter comparison.
 
As of March 31, 2010, 35 PFIs were eligible to participate in the MPF Xtra program. Of these, 10 have sold $12.4 million of mortgage loans through the MPF Xtra program year-to-date.
 
Effective July 15, 2009, the Bank introduced a temporary loan payment modification plan (loan modification plan) for participating PFIs, which will be available until December 31, 2011 unless further extended by the MPF Program. Borrowers with conventional loans secured by their primary residence, which were closed prior to January 1, 2009 are eligible for the loan modification plan. This plan pertains to borrowers currently in default or in imminent danger of default. In addition, there are specific eligibility requirements that must be met and procedures that the PFIs must follow to participate in the loan modification plan. Applicants are initially under a 90-day trial period prior to final approval of the loan modification. As of March 31, 2010, there have been minimal requests for loan modifications under this loan modification plan; these modifications are still in the 90-day trial period.
 
The FHLBank of Chicago, in its role as MPF Provider, provides the programmatic and operational support for the MPF Program and is responsible for the development and maintenance of the origination, underwriting and servicing guides.
 
“Mortgage Partnership Finance,” “MPF” and “MPF Extra” are registered trademarks of the FHLBank of Chicago.
 
Debt Financing – Consolidated Obligations
 
The primary source of funds for the Bank is the sale of debt securities, known as consolidated obligations. These consolidated obligations are issued as both bonds and discount notes, depending on maturity. Consolidated obligations are the joint and several obligations of the FHLBanks, backed by the financial resources of the twelve FHLBanks. Consolidated obligations are not obligations of the U.S. government, and the U.S. government does not guarantee them. The OF has responsibility for issuing and servicing consolidated obligations on behalf of the FHLBanks. On behalf of the Bank, the OF issues bonds that the Bank uses primarily to provide advances. The Bank also uses bonds to fund the MPF Program and its investment portfolio. Typically, the maturity of these bonds ranges from one year to ten years, but the maturity is not subject to any statutory or regulatory limit. The OF also sells discount notes to provide short-term funds to the FHLBanks. The Bank uses these funds to provide loans to members for seasonal and cyclical fluctuations in savings flows and mortgage financing, short-term investments, and other funding needs. Discount notes are sold at a discount and mature at par. These securities have maturities of up to 365 days.
 
See the “Liquidity and Funding Risk” discussion in the Risk Management section of Management’s Discussion and Analysis in the quarterly report filed on this Form 10-Q and the “Current Financial and Mortgage Market Events and Trends” discussion below for further information regarding consolidated obligations and related liquidity risk.


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Current Financial and Mortgage Market Events and Trends
 
Conditions in the Financial Markets. Government programs put in place in 2008 worked throughout 2009 to create more confidence in the credit markets and helped to get capital flowing once again. As financial conditions have shown some improvement and as further evidence of the stabilization of the credit markets, the Federal Reserve has substantially phased out the lending programs activated during the crisis without significant effect on the markets. Some were closed over the course of 2009, and most others expired on February 1, 2010. Total credit outstanding under all programs, including the regular discount window, has fallen sharply from a peak of approximately $1.5 trillion at year-end 2008 to approximately $71 billion at mid-March 2010. The Term Auction Facility, under which fixed amounts of discount window credit were auctioned to depository institutions, was discontinued in March 2010. Reflecting notably better conditions in many markets for ABS, the Term Asset-Backed Securities Loan Facility (TALF) closed on March 31, 2010 for securities backed by all types of collateral except newly issued commercial MBS (CMBS) and will close on June 30, 2010 for securities backed by newly issued CMBS. The later scheduled closing of the CMBS portion of the facility reflects the Federal Reserve Board’s (Federal Reserve’s) assessment that conditions in that sector remain highly stressed, as well as the fact that CMBS securitizations are more complex and take longer to complete than other types of arrangements.
 
Renewed economic growth, particularly employment growth, remains uncertain. The unemployment rate remained at 9.7% in March 2010, but the nation added 162,000 nonfarm jobs, the largest one-month gain in three years. The job growth was below what economists were predicting, but the government hired fewer census workers than expected and the economic recovery continues to be slow.
 
Given the current economic environment, the financial performance of the Bank has been significantly affected, mainly due to OTTI charges on the private label MBS portfolio. The Bank recognizes this will be an ongoing challenge throughout the remainder of 2010. Additional material credit-related OTTI charges have occurred in the first quarter and could be expected throughout the year. The specific amount of credit-related OTTI charges will depend on several factors, including economic, financial market and housing market conditions and the actual and projected performance of the loan collateral underlying the Bank’s MBS. If delinquency and/or loss rates on mortgages and/or home equity loans continue to increase, and/or there is a further decline in residential real estate values, the Bank could experience further material credit-related OTTI losses or reduced yields on these investment securities.
 
First Quarter 2010. Credit markets continued to trend toward stability through first quarter 2010. In addition, the FHLBanks continued to have access to the capital markets. While GDP showed promising growth towards the end of 2009, first quarter 2010 may see a slowing of GDP growth.
 
Specific Program Activity
 
Federal Reserve Bank of New York (FRBNY). In early February 2010, the Federal Reserve Bank of New York (FRBNY) announced the scheduled expiration of several lending programs. These programs included the Commercial Paper Funding Facility (CPFF), the Primary Dealer Credit Facility (PDCF), and the Term Securities Lending Facility (TSLF), each of which expired on February 1, 2010. The expiration of these programs does not appear to have had a major effect on the agency debt markets.
 
Furthermore, the Federal Reserve’s purchasing of agency debt and agency mortgage-backed securities ended during the first quarter of 2010. During the quarter, the Federal Reserve purchased $12.2 billion in debt issued by the housing GSEs, including $3.2 billion in FHLBank mandated Global bullet bonds. The Federal Reserve purchased a total of $172.1 billion in agency debt securities while the program was in effect; this was just shy of the $175 billion committed to the purchase of agency debt under the program. The Federal Reserve also purchased $207 billion in gross agency MBS during the first quarter of 2010. From the program’s inception to its expiration, the Federal Reserve’s total net purchases of agency MBS equaled $1.25 trillion, the amount originally committed to the purchase of MBS under the program.


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Fannie Mae and Freddie Mac. On December 24, 2009, the U.S. Treasury had announced modifications to the Preferred Stock Purchase Agreements with Fannie Mae and Freddie Mac, including an increased capacity to absorb losses from the housing GSEs beyond the original $200 billion per agency and a portfolio cap of $900 billion for each institution which will shrink by 10 percent each year. These modifications replaced the requirement to reduce the actual portfolio amounts by 10 percent each year starting in 2010. These modifications were fully implemented in first quarter 2010.
 
Also during the first quarter of 2010, Fannie Mae and Freddie Mac announced plans to purchase loans that are at least 120 days delinquent out of mortgage pools. The initial purchases are slated to occur from February 2010 through May 2010, with additional delinquency purchases as needed thereafter. As Fannie Mae and Freddie Mac may need to raise additional funds to complete these loan purchases, funding costs in the short-end of the agency debt market may continue to be affected.
 
Consolidated Obligations of the FHLBanks. During the first quarter of 2010, the FHLBanks issued $154 billion of consolidated bonds, just $2.4 billion more than during the fourth quarter of 2009. However, weighted-average bond funding costs decreased significantly during the first quarter of 2010, with March 2010 witnessing the lowest weighted-average monthly spreads to London Interbank Offered Rate (LIBOR) since February 2009. Swapped funding levels have been driven lower by a variety of factors, including recent spread compression of the swap curve. During the first quarter of 2010, the FHLBanks relied heavily on swapped negotiated callable bonds, floating-rate bonds and step-up callable bonds. In 2010, the FHLBanks continued to use an issuance calendar for FHLBank mandated Global bullet bond pricing; as such, the FHLBanks issued a $1 billion reopening of the most recent two-year mandated Global bullet bond in January 2010, issued $3 billion of a new, three-year mandated Global bullet bond in February 2010, and issued $3 billion of a new, two-year mandated Global bond in March 2010.
 
The FHLBanks’ consolidated obligations outstanding continued to shrink during the first quarter of 2010. Although consolidated obligations outstanding increased slightly in early January 2010, they soon reversed course, and through the first quarter of 2010, have decreased approximately $60 billion since year-end 2009, to $871 billion at March 31, 2010. Contrary to the fourth quarter of 2009, this decline was caused primarily by a decline in consolidated bonds outstanding, which fell $49 billion, while consolidated discount notes dropped $10 billion. The drop in consolidated bonds outstanding may be attributed in part to increased consolidated bond redemptions during the first quarter of 2010. During this period, consolidated bond maturities were $127 billion and consolidated bond calls were $70.5 billion.
 
Primary dealer inventories of agency discount notes and bonds increased during the first quarter of 2010, compared to year-end 2009. During the first quarter of 2010, agency discount note inventories increased $4 billion, to $16 billion, and agency bond inventories increased $6 billion, to $62 billion. However, similar to the previous two calendar quarters, dealer inventories increased during the quarter and then decreased toward the end of the quarter. During the first quarter of 2010, dealer inventories of agency discount notes were as high as $38 billion in early March 2010 and dealer inventories of agency bonds were as high as $83 billion in mid-February 2010.
 
On a stand-alone basis, the Bank’s total consolidated obligations declined $6.8 billion or 11.5% since year end 2009. Discount notes accounted for 19.0% and 17.2% of the Bank’s total consolidated obligations at March 31, 2010 and December 31, 2009, respectively. Total bonds decreased 13.4% in the same comparison, but comprised a smaller percentage of the total debt portfolio, decreasing from 82.8% at December 31, 2009 to 81.0% at March 31, 2010.
 
Foreign Official Holdings and Money Fund Assets. Overall, foreign investor holdings of agencies (both debt and MBS), as reported by the Federal Reserve System, were flat to lower for much of the first quarter of 2010, but started to increase in late February 2010, closing the quarter up $10 billion compared to year-end 2009.
 
On March 4, 2010, in the Federal Register, the SEC published its final rule on money market fund reform. The rule became effective on May 5, 2010, with certain aspects of the rule phased in over the remainder of 2010. In its


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final rule, the SEC included FHLBank consolidated discount notes with remaining maturities of 60 days or less in its definition of weekly liquid assets, which should help maintain investor demand for shorter-term FHLBank consolidated discount notes. However, this new rule, combined with shrinking yields in the money market sector, have driven investors to seek riskier investment categories that offer a higher rate of return. As such, taxable money market fund assets declined $276 billion during the first quarter of 2010. As a subset of those assets, taxable money market fund investments allocated to the U.S. Other Agency category have also declined, dropping an additional $68 billion since year-end 2009.
 
Interest Rate Trends. The Bank’s net interest income is affected by several external factors, including market interest rate levels and volatility, credit spreads and the general state of the economy. Interest rates prevailing during any reporting period affect the Bank’s profitability for that reporting period. A portion of the Bank’s advances have been hedged with interest-rate exchange agreements in which a short-term, variable rate is received. Interest rates also directly affect the Bank through earnings on invested capital. Generally, due to the Bank’s cooperative structure, the Bank earns relatively narrow net spreads between the yield on assets and the cost of corresponding liabilities.
 
The following table presents key market interest rates for the periods indicated (obtained from Bloomberg L.P.).
 
                                                             
      1st Quarter
    4th Quarter
    1st Quarter
    1st Quarter
    4th Quarter
    1st Quarter
      2010
    2009
    2009
    2010
    2009
    2009
      Average     Average     Average     Ended     Ended     Ended
Target overnight Federal funds rate
      0.25 %       0.25 %       0.25 %       0.25 %       0.25 %       0.25 %
3-month LIBOR(1)
      0.26 %       0.27 %       1.24 %       0.29 %       0.25 %       1.19 %
2-yr U.S. Treasury
      0.91 %       0.87 %       0.89 %       1.02 %       1.14 %       0.80 %
5-yr. U.S. Treasury
      2.41 %       2.29 %       1.75 %       2.55 %       2.68 %       1.66 %
10-yr. U.S. Treasury
      3.70 %       3.45 %       2.70 %       3.83 %       3.84 %       2.67 %
15-yr. mortgage current coupon(2)
      3.54 %       3.52 %       3.74 %       3.62 %       3.78 %       3.59 %
30-yr. mortgage current coupon(2)
      4.40 %       4.28 %       4.13 %       4.52 %       4.57 %       3.89 %
Note:
 
(1)LIBOR - London Interbank Offered Rate
(2)Simple average of Fannie Mae and Freddie Mac mortgage-backed securities current coupon rates.
 
Lehman Brothers Holding, Inc. (Lehman) and Lehman Brothers Special Financing, Inc. On September 15, 2008, Lehman filed for bankruptcy. At that time, Lehman’s subsidiary, Lehman Brothers Special Financing, Inc. (LBSF) was the Bank’s largest derivatives counterparty, with a total of 595 outstanding derivative trades having a total notional value of $16.3 billion. Lehman was a guarantor under the Bank’s agreement with LBSF such that Lehman’s bankruptcy filing triggered an event of default. The Bank posted cash collateral to secure its exposure to Lehman on its derivative transactions. As a result of the bankruptcy filing, the Bank evaluated the outstanding trades it had with LBSF to assess which individual derivatives were most important to the Bank’s overall risk position. Of the 595 trades, 63 represented approximately half of the total LBSF notional value and almost 100% of the base case duration impact of the LBSF portfolio. Therefore, the Bank elected to enter into 63 identical new trades with different counterparties on September 18, 2008.
 
Management determined that it was in the Bank’s best interest to declare an event of default and designate September 19, 2008 as the early termination date of the Bank’s agreement with LBSF, as provided for in the agreement. Accordingly, all LBSF derivatives were legally terminated at that time and the Bank began the process of obtaining third party quotes for all of the derivatives in order to settle its position with LBSF in accordance with the International Swaps Dealers Association, Inc. (ISDA) Master Agreement (Master Agreement). The Bank sent a final settlement notice to LBSF and demanded return of the balance of posted Bank collateral, which, including


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dealer quotes for all trades, the collateral position, and the applicable accrued interest netted to an approximate $41.5 million receivable from LBSF.
 
The Bank filed an adversary proceeding against LBSF to return the cash collateral posted by the Bank associated with the derivative contracts. In its 2008 Annual Report filed on Form 10-K, the Bank disclosed that it was probable that a loss has been incurred with respect to this receivable. However, the Bank had not recorded a reserve with respect to the receivable from LBSF because the Bank was unable to reasonably estimate the amount of loss that had been incurred. Continuing developments in the adversary proceeding occurred during 2009. The discovery phase of the adversary proceeding began, which has provided management information related to its claim. Based on this information, management’s most probable estimated loss was $35.3 million and a reserve was recorded in the first quarter of 2009. As of March 31, 2010, the Bank maintained a $35.3 million reserve on this receivable as this remains the most probable estimated loss.
 
During discovery in the Bank’s adversary proceeding against LBSF, the Bank learned that the Bank’s posted collateral was held in a general operating account of LBSF the balances of which were routinely swept to other Lehman Brother entities, including Lehman Brothers Holdings, Inc. among others.
 
The Bank filed a complaint against Lehman Brothers Holding Inc., Lehman Brothers, Inc., Lehman Brothers Commercial Corporation, Woodlands Commercial Bank, formerly known as Lehman Brothers Commercial Bank, and Aurora Bank FSB (Aurora), formerly known as Lehman Brothers Bank FSB, alleging unjust enrichment, constructive trust, and conversion claims. Aurora is a member of the Bank. Aurora did not hold more than five percent of the Bank’s capital stock as of March 31, 2010.
 
See Item 3. Legal Proceedings in the Bank’s 2009 Annual Report filed on Form 10-K for additional information concerning the adversary proceedings discussed above.
 
Mortgage-Based Assets and Related Trends. The Bank is also heavily affected by the residential mortgage market through the collateral securing member loans and holdings of mortgage-related assets. As of March 31, 2010, 55.7% of the Bank’s eligible collateral value, after collateral weightings, was concentrated in 1-4 single family residential mortgage loans or multi-family residential mortgage loans, compared with 56.1% at December 31, 2009. The remaining 44.3% at March 31, 2010 was concentrated in other real estate-related collateral and high quality investment securities, compared to 43.9% at December 31, 2009. For the top ten borrowers, 1-4 single family residential mortgage loans or multi-family residential mortgage loans accounted for 59.2% of total eligible collateral, after collateral weightings, at March 31, 2010, compared to 59.3% at December 31, 2009. The remaining 40.8% at March 31, 2010 was concentrated in other real estate-related collateral and high quality investment securities, compared to 40.7% at December 31, 2009. Due to collateral policy changes implemented in third quarter 2009, the mix of collateral types within the total portfolio shifted. The requirement to deliver all securities pledged as collateral, as well as refinements in collateral reporting and tracking made through the Qualifying Collateral Report (QCR) process, impacted the concentration of collateral types by category.
 
With respect to the investment portfolio, as of March 31, 2010 the Bank’s private label MBS portfolio represented 9.6% of total assets, while net mortgage loans held for portfolio represented 8.5% of total assets. At December 31, 2009, the comparable percentages were 9.1% and 7.9%, respectively.
 
The Bank continues to have high concentrations of its advance portfolio outstanding to its top ten borrowers. The Bank’s advance portfolio declined $4.4 billion, or 10.6%, from December 31, 2009 to March 31, 2010, as members de-levered, increased deposits and utilized government programs aimed at improving liquidity. Also, many of the Bank’s members may have reacted to the Bank’s temporary actions of not paying dividends and not repurchasing excess capital stock by limiting their use of the Bank’s advance products.
 
See the “Credit and Counterparty Risk” and “Market Risk” discussions in the Risk Management section of this Item 2. Management’s Discussion and Analysis in the quarterly report filed on this Form 10-Q for information related to derivative counterparty risk and overall market risk of the Bank.


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Financial Highlights
 
The Statement of Operations data for the three months ended March 31, 2010 and the Condensed Statement of Condition data as of March 31, 2010 are unaudited and were derived from the financial statements included in the quarterly report filed on this Form 10-Q . The Condensed Statement of Condition data as of December 31, 2009 was derived from the audited financial statements in the Bank’s 2009 Annual Report filed on Form 10-K. The Statement of Operations data for the three months ended December 31, 2009 is unaudited and was derived from the Bank’s 2009 Annual Report filed on Form 10-K. The Statement of Operations and Statement of Condition data for all other interim quarterly periods is unaudited and was derived from the applicable quarterly reports filed on Form 10-Q.
 
Statement of Operations
 
                                                   
      For the Three Months Ended
      March 31,
    December 31,
    September 30,
    June 30,
    March 31,
(in millions, except per share data)     2010     2009     2009     2009     2009
Net interest income before provision (benefit)
for credit losses
    $   59.0       $   64.2       $   67.5       $   75.9       $   56.4  
Provision (benefit) for credit losses
      (0.1 )       (5.5 )       1.4         1.1         0.4  
Other income (loss):
                                                 
Net OTTI losses
      (27.6 )       (65.4 )       (93.3 )       (39.3 )       (30.5 )
Net gains (losses) on derivatives and hedging activities
      (4.6 )       5.3         (4.5 )       12.4         (1.2 )
Net realized losses on available-
for-sale securities
      -         (2.2 )       -         -         -  
Net realized gains on held-to-maturity securities
      -         1.8         -         -         -  
Contingency reserve
      -         -         -         -         (35.3 )
All other income
      2.7         2.9         4.5         2.5         2.6  
                                                   
Total other loss
      (29.5 )       (57.6 )       (93.3 )       (24.4 )       (64.4 )
Other expense
      16.2         17.6         16.2         15.3         15.2  
                                                   
Income (loss) before assessments
      13.4         (5.5 )       (43.4 )       35.1         (23.6 )
Assessments
      3.5         -         (3.0 )       3.0         -  
                                                   
Net income (loss)
    $ 9.9       $ (5.5 )     $ (40.4 )     $ 32.1       $ (23.6 )
                                                   
                                                   
Earnings (loss) per share (1)
    $ 0.25       $ (0.14 )     $ (1.01 )     $ 0.80       $ (0.59 )
                                                   
                                                   
                                                   
Dividends
      -         -         -         -         -  
Weighted average dividend rate (2)
      n/a         n/a         n/a         n/a         n/a  
Dividend payout ratio (3)
      n/a         n/a         n/a         n/a         n/a  
Return on average equity
      1.07 %       (0.61 )%       (4.39 )%       3.31 %       (2.30 )%
Return on average assets
      0.06 %       (0.03 )%       (0.23 )%       0.16 %       (0.11 )%
Net interest margin (4)
      0.37 %       0.38 %       0.38 %       0.38 %       0.26 %
Regulatory capital ratio (5)
      7.57 %       6.76 %       6.64 %       5.83 %       5.29 %
Total capital ratio (at period-end) (6)
      6.54 %       5.69 %       5.36 %       4.59 %       4.61 %
Total average equity to average assets
      5.88 %       5.45 %       5.17 %       4.88 %       4.74 %
                                                   
Notes:
 
(1) Earnings (loss) per share calculated based on net income (loss).
 
 
(2) Weighted average dividend rates are calculated as annualized dividends paid in the period divided by the average capital stock balance outstanding during the period on which the dividend is based.
 
 
(3) Dividend payout ratio is dividends declared in the period as a percentage of net income (loss) in the period.
 
 
(4) Net interest margin is net interest income before provision (benefit) for credit losses as a percentage of average interest-earning assets.
 
 
(5) Regulatory capital ratio is the total of period-end capital stock, mandatorily redeemable capital stock, retained earnings and allowance for loan losses as a percentage of total assets at period-end.
 
 
(6) Total capital ratio is capital stock plus retained earnings and accumulated other comprehensive income (loss), in total at period-end, as a percentage of total assets at period-end.


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Condensed Statement of Condition
 
                                                   
      March 31,
    December 31,
    September 30,
    June 30,
    March 31,
(in millions)     2010     2009     2009     2009     2009
Cash and due from banks
    $ 251.6       $ 1,418.8       $ 373.3       $ 69.6       $ 68.7  
Investments (1)
      16,241.0         17,173.5         19,039.9         24,444.3         24,525.4  
Advances
      36,823.8         41,177.3         41,363.4         45,799.6         52,260.3  
Mortgage loans held for portfolio, net (2)
      4,991.2         5,162.8         5,339.1         5,607.5         5,922.4  
Prepaid REFCORP assessment
      37.2         39.6         39.6         37.5         39.6  
Total assets
      58,656.0         65,290.9         66,510.5         76,401.6         83,294.8  
Consolidated obligations, net:
                                                 
Discount notes
      9,990.4         10,208.9         11,462.5         15,538.1         14,381.9  
Bonds
      42,477.1         49,103.9         49,022.3         54,090.5         61,831.2  
                                                   
Total consolidated obligations, net (3)
      52,467.5         59,312.8         60,484.8         69,628.6         76,213.1  
Deposits and other borrowings
      1,418.4         1,284.3         1,023.8         2,097.2         1,899.0  
Mandatorily redeemable capital stock
      8.3         8.3         8.2         8.2         8.0  
AHP payable
      22.1         24.5         28.0         32.7         36.1  
REFCORP payable
      -         -         -         -         -  
Capital stock – putable
      4,035.1         4,018.0         4,013.1         4,007.1         3,999.2  
Retained earnings
      398.9         389.0         394.5         434.9         402.8  
AOCI
      (596.0 )       (693.9 )       (845.2 )       (938.1 )       (560.2 )
Total capital
      3,838.0         3,713.1         3,562.4         3,503.9         3,841.8  
                                                   
Notes:
 
(1) Includes trading, available-for-sale and held-to-maturity investment securities, Federal funds sold, and interest-bearing deposits. None of these securities were purchased under agreements to resell.
 
(2) Includes allowance for loan losses of $2.9 million, $2.7 million, $7.5 million, $6.3 million and $5.5 million at March 31, 2010, December 31, 2009, September 30, 2009, June 30, 2009 and March 31, 2009, respectively.
 
(3) Aggregate FHLBank System-wide consolidated obligations (at par) were $870.9 billion, $930.6 billion, $1.0 trillion, $1.1 trillion and $1.1 trillion at March 31, 2010, December 31, 2009, September 30, 2009, June 30, 2009 and March 31, 2009, respectively.


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Because of the nature of (1) the contingency reserve resulting from the Lehman-related transactions and (2) the OTTI charges recorded during the three months ended March 31, 2010 and 2009, the Bank believes that the presentation of adjusted non-GAAP financial measures below provides a greater understanding of ongoing operations and enhances comparability of results with prior periods.
 
Statement of Operations
Reconciliation of GAAP Earnings to Adjusted Earnings to Exclude Impact of
Lehman-Related Transactions, Net OTTI Charges and Related Assessments
 
                                   
      For The Three Months Ended March 31, 2010
      GAAP
  Lehman
  OTTI
  Adjusted
(in millions)     Earnings   Impact   Charges   Earnings
Net interest income before provision (benefit)
for credit losses
    $ 59.0     $      -     $      -     $  59.0  
Benefit for credit losses
      (0.1 )     -       -       (0.1 )
Other income (loss):
                                 
Net OTTI losses
      (27.6 )     -       27.6       -  
Net losses on derivatives and
hedging activities
      (4.6 )     -       -       (4.6 )
All other income
      2.7       -       -       2.7  
                                   
Total other income (loss)
      (29.5 )             27.6       (1.9 )
Other expense
      16.2       -       -       16.2  
                                   
Income before assessments
      13.4       -       27.6       41.0  
Assessments
      3.5       -       7.4       10.9  
                                   
Net income
    $ 9.9     $ -     $ 20.2     $ 30.1  
                                   
                                   
Earnings per share
    $ 0.25     $ -     $ 0.50     $ 0.75  
                                   
                                   
                                   
Return on average equity
      1.07 %     -       2.18 %     3.25 %
Return on average assets
      0.06 %     -       0.13 %     0.19 %
 
                                   
      For The Three Months Ended March 31, 2009
      GAAP
  Lehman
  OTTI
  Adjusted
(in millions)     Earnings   Impact   Charges   Earnings
Net interest income before provision for credit losses
    $ 56.4     $ -     $ -     $ 56.4  
Provision for credit losses
      0.4       -       -       0.4  
Other income (loss):
                                 
Net OTTI losses
      (30.5 )     -       30.5       -  
Net losses on derivatives and
hedging activities
      (1.2 )     -       -       (1.2 )
Contingency reserve
      (35.3 )     35.3       -       -  
All other income
      2.6       -       -       2.6  
                                   
Total other income (loss)
      (64.4 )     35.3       30.5       1.4  
Other expense
      15.2       -       -       15.2  
                                   
Income (loss) before assessments
      (23.6 )     35.3       30.5       42.2  
Assessments (1)
      -       6.0       5.2       11.2  
                                   
Net income (loss)
    $ (23.6 )   $ 29.3     $ 25.3     $ 31.0  
                                   
                                   
Earnings (loss) per share
    $ (0.59 )   $ 0.73     $ 0.64     $ 0.78  
                                   
                                   
                                   
Return on average equity
      (2.30 )%     2.86 %     2.46 %     3.02 %
Return on average assets
      (0.11 )%     0.14 %     0.11 %     0.14 %
Notes:
 
 
(1) Assessments on the Lehman impact and OTTI charges were prorated based on the required adjusted earnings assessment expense to take into account the impact of the first quarter 2009 GAAP net loss.


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For further information regarding the Lehman-related transactions, see the “Current Financial and Mortgage Market Events and Trends” discussion in Earnings Performance in Item 7. Management’s Discussion and Analysis in the Bank’s 2009 Annual Report filed on Form 10-K. For additional information on OTTI, see Critical Accounting Policies and Risk Management, both in Item 7. Management’s Discussion and Analysis, and Note 8 to the audited financial statements in Item 8. Financial Statements and Supplementary Financial Data, all in the Bank’s 2009 Annual Report filed on Form 10-K.
 
Forward-Looking Information
 
Statements contained in the quarterly report on this Form 10-Q, including statements describing the objectives, projections, estimates, or predictions of the future of the Bank, may be “forward-looking statements.” These statements may use forward-looking terms, such as “anticipates,” “believes,” “could,” “estimates,” “may,” “should,” “will,” or their negatives or other variations on these terms. The Bank cautions that by their nature, forward-looking statements involve risk or uncertainty and that actual results could differ materially from those expressed or implied in these forward-looking statements or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. These forward-looking statements involve risks and uncertainties including, but not limited to, the following: economic and market conditions, including, but not limited to, real estate, credit and mortgage markets; volatility of market prices, rates, and indices; political, legislative, regulatory, litigation, or judicial events or actions; changes in the Bank’s capital structure; changes in the Bank’s capital requirements; membership changes; changes in the demand by Bank members for Bank advances; an increase in advances’ prepayments; competitive forces, including the availability of other sources of funding for Bank members; changes in investor demand for consolidated obligations and/or the terms of interest rate exchange agreements and similar agreements; the ability of the Bank to introduce new products and services to meet market demand and to manage successfully the risks associated with new products and services; the ability of each of the other FHLBanks to repay the principal and interest on consolidated obligations for which it is the primary obligor and with respect to which the Bank has joint and several liability; and timing and volume of market activity. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Bank’s unaudited interim financial statements and notes and Risk Factors included in Part II, Item 1A of the quarterly report filed on this Form 10-Q, as well as Risk Factors in Item 1A of the Bank’s 2009 Annual Report filed on Form 10-K.
 
Earnings Performance
 
The following is Management’s Discussion and Analysis of the Bank’s earnings performance for the three months ended March 31, 2010 compared to the three months ended March 31, 2009. This discussion should be read in conjunction with the unaudited interim financial statements and notes included in the quarterly report filed on this Form 10-Q as well as the audited financial statements and analysis for the year ended December 31, 2009, included in the Bank’s 2009 Annual Report filed on Form 10-K.
 
Summary of Financial Results
 
Net Income and Return on Equity. For the first quarter of 2010, the Bank’s net income totaled $9.9 million, an increase of $33.5 million from the first quarter 2009 loss of $23.6 million. This increase was primarily due to a $35.3 million reserve recorded in the first quarter of 2009 related to the collectibility of the LBSF receivable, as well as higher net interest income and slightly lower net OTTI losses. First quarter 2010 results also reflect slightly higher operating expenses from the prior year. Net OTTI losses for the three months ended March 31, 2010 and 2009 were $27.6 million and $30.5 million, respectively. Details of the Statement of Operations are presented more fully below. The Bank’s return on average equity was 1.07% in the first quarter of 2010, compared to (2.30)% in the same year-ago period.


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Adjusted Earnings. As presented above, adjusted earnings for first quarter 2010 and 2009 exclude the impact of the LBSF contingency reserve, net OTTI losses and related assessments. For the first quarter of 2010, the Bank’s adjusted earnings totaled $30.1 million, a decrease of $0.9 million over the first quarter 2009 adjusted earnings. An increase in net interest income as well as a benefit for credit losses in the current year quarter were offset by losses on derivatives and hedging activities and higher other expense. The Bank’s adjusted return on average equity was 3.25% in first quarter 2010, compared to 3.02% in first quarter 2009. The decrease in average capital, due to higher noncredit OTTI losses in AOCI, more than offset the decrease in adjusted earnings in the quarter-over-quarter comparison, resulting in an increase in the overall return.
 
Dividend. On December 23, 2008, the Bank announced its voluntary decision to temporarily suspend payment of dividends until further notice. Therefore, there were no dividends declared or paid in the first quarters of 2010 and 2009. Retained earnings were $398.9 million as of March 31, 2010, compared to $389.0 million at December 31, 2009. See additional discussion regarding dividends and retained earnings levels in the Financial Condition section of this Item 2. Management’s Discussion and Analysis in the quarterly report filed on this Form 10-Q.


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Net Interest Income
 
The following table summarizes the rate of interest income or interest expense, the average balance for each of the primary balance sheet classifications and the net interest margin for the three months ended March 31, 2010 and 2009.
 
Average Balances and Interest Yields/Rates Paid
 
                                                   
      Three Months Ended March 31,
      2010   2009
              Avg.
          Avg.
          Interest
  Yield/
      Interest
  Yield/
      Average
  Income/
  Rate
  Average
  Income/
  Rate
(dollars in millions)     Balance(1)   Expense   (%)   Balance(1)   Expense   (%)
Assets
                                                 
Federal funds sold (2)
    $ 4,722.1     $ 1.3       0.11     $ 13.9     $ -       0.12  
Interest-bearing deposits
      514.8       0.2       0.13       9,637.9       5.8       0.24  
Investment securities (3)
      13,661.8       106.5       3.16       15,050.2       153.4       4.13  
Advances(4)
      40,143.2       74.3       0.75       56,450.5       241.7       1.74  
Mortgage loans held for portfolio(5)
      5,070.4       63.7       5.10       6,084.9       76.9       5.12  
                                                   
Total interest-earning assets
      64,112.3       246.0       1.55       87,237.4       477.8       2.22  
Allowance for credit losses
      (12.0 )                     (14.0 )                
Other assets(5)(6)
      (131.4 )                     558.8                  
                                                   
Total assets
    $ 63,968.9                     $ 87,782.2                  
                                                   
                                                   
Liabilities and capital
                                                 
Deposits
    $ 1,363.5     $ 0.2       0.06     $ 1,745.0     $ 0.4       0.10  
Consolidated obligation discount notes
      9,921.5       2.6       0.11       17,867.4       24.8       0.56  
Consolidated obligation bonds(7)
      47,326.6       184.2       1.58       61,659.5       396.2       2.61  
Other borrowings
      11.0       -       0.55       6.2       -       1.15  
                                                   
Total interest-bearing liabilities
      58,622.6       187.0       1.29       81,278.1       421.4       2.10  
Other liabilities
      1,583.5                       2,342.0                  
Total capital
      3,762.8                       4,162.1                  
                                                   
Total liabilities and capital
    $ 63,968.9                     $ 87,782.2                  
                                                   
                                                   
Net interest spread
                      0.26                       0.12  
Impact of noninterest-bearing funds
                      0.11                       0.14  
                                                   
Net interest income/net interest margin
            $ 59.0       0.37             $ 56.4       0.26  
                                                   
Notes:
 
(1) Average balances of deposits (assets and liabilities) include cash collateral received from/paid to counterparties which are reflected in the Statement of Condition as derivative assets/liabilities.
(2) The average balance of Federal funds sold, related interest income and average yield calculations may include loans to other FHLBanks.
(3) Investment securities include trading, held-to-maturity and available-for-sale securities. The average balances of held-to-maturity and available-for-sale securities are reflected at amortized cost; therefore, the resulting yields do not give effect to changes in fair value or the noncredit component of a previously recognized OTTI reflected in AOCI.
(4) Average balances reflect noninterest-earning hedge accounting adjustments of $1.5 billion and $2.2 billion in 2010 and 2009, respectively.
(5) Nonaccrual mortgage loans are included in average balances in determining the average rate. BOB loans are reflected in other assets.
(6) The noncredit portion of OTTI losses on investment securities is reflected in other assets for purposes of the average balance sheet presentation.
(7) Average balances reflect noninterest-bearing hedge accounting adjustments of $310 million and $508 million in 2010 and 2009, respectively


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Net interest income increased $2.6 million, or 4.6%, to $59.0 million for first quarter 2010, compared with the same year-ago period. The improvement in net interest income was driven by favorable funding costs. Rates paid on interest-bearing liabilities fell 81 basis points while yields on interest-earning assets fell 67 basis points in the year-over-year comparison. Total average interest-earning assets for first quarter 2010 were $64.1 billion, a decrease of $23.1 billion, or 26.5%, from the same year-ago period. The majority of the decline in interest-earning assets was attributed to lower demand for advances, which declined $16.3 billion, or 28.9%, as members de-levered, increased deposits and utilized government programs aimed at improving liquidity. In addition, in response to the Bank’s temporary suspension of dividends and repurchase of excess capital stock, many of the Bank’s members may have reacted by limiting the use of the Bank’s advance products. The current economic conditions also decreased the Bank’s members’ need for funding from the Bank. For first quarter 2010, interest-bearing deposits decreased $9.1 billion from first quarter 2009, primarily due to a shift to investments in Federal funds sold. The first quarter 2009 interest bearing deposit balance was higher than normal because the Bank had shifted balances from Federal funds sold into higher-yielding interest-bearing Federal Reserve Bank (FRB) accounts. However, beginning in July 2009, the FRBs stopped paying interest on the excess balances it holds on the Bank’s behalf; consequently, the Bank shifted its investments back to Federal funds sold. During the second half of 2009 the Bank reduced its concentration in Federal funds sold due to the unattractive yields. This portfolio subsequently declined to $4.7 billion for the three months ended March 31, 2010. The Bank also experienced a reduction in its level of MBS and mortgage loans due primarily to paydowns. Additional details and analysis regarding the shift in the mix of these categories is included in the “Rate/Volume Analysis” discussion below.
 
The net interest margin improved 11 basis points to 37 basis points, compared to 26 basis points a year ago. Favorable funding costs, partially offset by lower yields on the investment of interest-free funds (capital), contributed to the improvement. The impact of favorable funding was evident within both the advance and investment securities portfolios, as the improvement in cost of funds, combined with the use of some short-term debt greatly improved spreads. Partially offsetting this improvement was a lower yield on interest-free funds (capital) typically invested in short-term assets.
 
Rate/Volume Analysis. Changes in both volume and interest rates influence changes in net interest income and net interest margin. The following table summarizes changes in interest income and interest expense between first quarter 2010 and first quarter 2009.
 
                           
      2010 Compared to 2009
      Increase (Decrease) in Interest
      Income/Expense Due to Changes in:
(in millions)     Volume   Rate   Total
Federal funds sold
    $ 1.3     $ -     $ 1.3  
Interest-bearing deposits
      (3.8 )     (1.8 )     (5.6 )
Investment securities
      (13.2 )     (33.7 )     (46.9 )
Advances
      (56.4 )     (111.0 )     (167.4 )
Mortgage loans held for portfolio
      (12.8 )     (0.4 )     (13.2 )
                           
Total interest-earning assets
    $ (84.9 )   $ (146.9 )   $ (231.8 )
                           
Interest-bearing deposits
    $ (0.1 )   $ (0.1 )   $ (0.2 )
Consolidated obligation discount notes
      (7.9 )     (14.3 )     (22.2 )
Consolidated obligation bonds
      (78.6 )     (133.4 )     (212.0 )
                           
Total interest-bearing liabilities
    $ (86.6 )   $ (147.8 )   $ (234.4 )
                           
Total increase (decrease) in net interest income
    $ 1.7     $ 0.9     $ 2.6  
                           
                           
 
Net interest income increased $2.6 million from first quarter 2009 to first quarter 2010. Total interest income decreased $231.8 million year-over-year. This decline included a decrease of $146.9 million due to rate and $84.9 million due to volume, driven primarily by the advances portfolio and, to a lesser extent, the investment securities portfolio, as discussed below. Total interest expense decreased $234.4 million in the same comparison,


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including a rate impact of $147.8 million and a volume impact of $86.6 million, both due to the consolidated obligation bonds and discount notes portfolios, discussed in more detail below.
 
For first quarter 2010, average Federal funds sold increased $4.7 billion from $13.9 million in first quarter 2009. In the first quarter 2009, the Bank utilized an interest-bearing deposit account with the FRBs due to favorable rates paid on these balances. These balances were reinvested in Federal funds sold once the FRBs stopped paying interest on these deposits. Related interest income increased $1.3 million, nearly entirely due to the higher balances. For first quarter 2010, average interest-bearing deposits decreased $9.1 billion, partially due to the shift to Federal funds sold noted above. Related interest income decreased $5.6 million due to the lower balances and the relatively low yields on short-term investments.
 
The decrease in yields on both Federal funds sold and interest-bearing deposits quarter-over-quarter reflects the significant downward change in overall short-term rates. These decreases are evidenced in the interest rate trend presentation in the “Current Financial and Mortgage Market Events and Trends” discussion earlier in this Item 2. Management’s Discussion and Analysis.
 
The average investment securities portfolio balance for first quarter 2010 decreased $1.4 billion, or 9.2%, from first quarter 2009. Correspondingly, the interest income on this portfolio decreased $46.9 million, driven primarily by a 97 basis point decline in the yield, and secondarily by the volume decrease.
 
The investment securities portfolio includes trading, available-for-sale and held-to-maturity securities. The decrease in investments from first quarter 2009 to first quarter 2010 was due to declining certificates of deposit balances and run-off of the MBS portfolio as well as credit-related OTTI recorded on certain private label MBS. The Bank has been cautious toward investments linked to the U.S. housing market, including MBS, and has not purchased any MBS in the first three months of 2010, and only purchased U.S. agency and GSE MBS in 2009.
 
The average advances portfolio decreased $16.3 billion, or 28.9%, from first quarter 2009 to first quarter 2010. This decline in volume, coupled with a 99 basis point decrease in the yield, resulted in a $167.4 million decline in interest income year-over-year. Advance demand began to decline in the fourth quarter of 2008 and continued through 2009 and into the first quarter of 2010, as members grew core deposits and gained access to additional liquidity from the Federal Reserve and other government programs that became available in the second half of 2008. The interest income on this portfolio was significantly impacted by the decline in short-term rates, as presented in the interest rate trend presentation in the “Current Financial and Mortgage Market Events and Trends” discussion earlier in this Item 2. Management’s Discussion and Analysis. Average 3-month LIBOR declined 98 basis points in the quarter-over-quarter comparison. Specific mix changes within the portfolio are discussed more fully below under “Average Advances Portfolio Detail.”
 
The mortgage loans held for portfolio balance declined $1.0 billion, or 16.7%, from first quarter 2009 to first quarter 2010. The related interest income on this portfolio declined $13.2 million in the same period. The quarter-over-quarter decrease was due to the continued runoff of the existing portfolio, which more than offset the new portfolio activity. The decrease in interest income was due primarily to lower average portfolio balances as the yields on the portfolio only declined 2 basis points.
 
Interest-bearing deposits decreased $381.5 million, or 21.9%, from first quarter 2009 to first quarter 2010. Interest expense on interest-bearing deposits decreased $0.2 million quarter-over-quarter, driven by a 4 basis point decline in rates paid. Average interest-bearing deposit balances fluctuate periodically and are driven by member activity.
 
The consolidated obligations portfolio balance decreased $22.3 billion from first quarter 2009 to first quarter 2010. Discount notes accounted for $8.0 billion of the decline, while average bonds fell by $14.3 billion quarter over quarter. The decline in discount notes was consistent with the decline in short-term advance demand from members as noted above. Interest expense on discount notes decreased $22.2 million from the prior year quarter. The decrease was partially attributable to the volume decline and partially due to the 45 basis point declines in rates paid


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quarter-over-quarter. The decline in rates paid was consistent with the general decline in short-term rates as previously mentioned. Interest expense on bonds decreased $212.0 million from first quarter 2009 to first quarter 2010. This was due in part to the 103 basis points decrease in rates paid on bonds, as well as the volume decline.
 
A portion of the bond portfolio is swapped to 3-month LIBOR; therefore, as the LIBOR rate (decreases) increases, interest expense on swapped bonds, including the impact of swaps, (decreases) increases. Market conditions continued to impact spreads on the Bank’s consolidated obligations. Bond spreads were volatile in the beginning of 2009 and the Bank experienced some obstacles in attempting to issue longer-term debt as investors had been reluctant to buy longer-term GSE obligations. However, investor demand for shorter-term GSE debt grew stronger during 2009 and the Bank continued to be able to issue discount notes and term bonds at attractive rates as needed into 2010. See details regarding the impact of swaps on the quarterly rates paid in the “Net Interest Income Derivatives Effects” discussion below.
 
For additional information, see the “Liquidity and Funding Risk” discussion in Risk Management in this Item 2. Management’s Discussion and Analysis in the quarterly report filed on this Form 10-Q.
 
Average Advances Portfolio Detail
 
                   
      Average Balances
      Three Months Ended March 31,
(in millions)    
                    Product     2010   2009
Repo
    $ 19,112.2     $ 28,556.4  
Term Loans
      12,847.2       14,541.8  
Convertible Select
      6,596.3       7,385.8  
Hedge Select
      50.0       150.0  
Returnable
      25.8       3,551.7  
                   
Total par value
    $ 38,631.5     $ 54,185.7  
                   
                   
 
The par value of the Bank’s average advance portfolio decreased 28.7% from first quarter 2009 to first quarter 2010. The most significant percentage decrease in the comparison was in the Returnable product, which declined $3.5 billion, or 99.3%. The most significant dollar decrease was in the Repo product, which declined $9.4 billion, or 33.1% year-over-year.
 
The decrease in average balances for the Repo product reflected the impact of members’ access to additional liquidity from government programs as well as members’ reactions to the Bank’s pricing of short-term advance products. Members have also taken other actions during the credit crisis, such as raising core deposits and reducing the size of their balance sheets. In addition, many of the Bank’s members may have reacted to the Bank’s temporary actions of not paying dividends and not repurchasing excess capital stock by limiting their use of the Bank’s advance products. The current economic recession has reduced the Bank’s members’ need for funding from the Bank as well. The majority of the decline was driven by decreases in average advances of the Bank’s larger borrowers, with five banks reducing their total average advances outstanding by $10.0 billion. The decline in Returnable product balances was due to one of the Bank’s largest borrowers exercising their option to return their advances. To a much lesser extent, the decrease in interest rates also contributed to the decline in the Returnable product balances.
 
As of March 31, 2010, 48.4% of the par value of loans in the portfolio had a remaining maturity of one year or less, compared to 47.7% at December 31, 2009. Details of the portfolio components are included in Note 7 to the unaudited financial statements in the quarterly report filed on this Form 10-Q.
 
The ability to grow the advance portfolio may be affected by, among other things, the following: (1) the liquidity demands of the Bank’s borrowers; (2) the composition of the Bank’s membership itself; (3) the Bank’s liquidity position and how management chooses to fund the Bank; (4) current, as well as future, credit market conditions; (5) member reaction to the Bank’s voluntary decision to temporarily suspend dividend payments and


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excess capital stock repurchases until further notice; (6) actions of the U.S. government; (7) housing market trends; and (8) the shape of the yield curve.
 
Beginning in 2008 and continuing through 2009, the Federal Reserve took a series of unprecedented actions that made it more attractive for eligible financial institutions to borrow directly from the FRBs, creating increased competition for the Bank. See the “Legislative and Regulatory Actions” discussion in Item 7. Management’s Discussion and Analysis in the Bank’s 2009 Annual Report filed on Form 10-K for additional information regarding these government actions.
 
The Bank accepts various forms of collateral including, but not limited to, AAA-rated investment securities and residential mortgage loans. In light of recent market conditions, the Bank recognizes that there is the potential for an increase in the credit risk of the advance portfolio. However, the Bank continues to monitor its collateral position and the related policies and procedures, to help ensure adequate collateral coverage. The Bank believes it was fully secured as of March 31, 2010. For more information on collateral, see the “Loan Products” discussion in “Overview” and the Credit and Counterparty Risk discussion in “Risk Management” in this Item 2. Management’s Discussion and Analysis, both in the quarterly report filed on this Form 10-Q.


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Net Interest Income Derivative Effects. The following tables separately quantify the effects of the Bank’s derivative activities on its interest income and interest expense for the three months ended March 31, 2010 and 2009. Derivative and hedging activities are discussed below in the “Other Income (Loss)” section.
 
                                                           
              Avg.
      Avg.
       
Three Months Ended
        Interest Inc./
  Yield/
  Interest Inc./
  Yield/
      Incr./
March 31, 2010
    Average
  Exp. with
  Rate
  Exp. without
  Rate
  Impact of
  (Decr.)
(dollars in millions)     Balance   Derivatives   (%)   Derivatives   (%)   Derivatives(1)   (%)
Assets
                                                         
Advances
    $ 40,143.2     $ 74.3       0.75     $ 323.0       3.26     $ (248.7 )     (2.51 )
Mortgage loans held for portfolio
      5,070.4       63.7       5.10       64.4       5.15       (0.7 )     (0.05 )
All other interest-earning assets
      18,898.7       108.0       2.32       108.0       2.32       -       -  
                                                           
Total interest-earning
assets
    $ 64,112.3     $ 246.0       1.55     $ 495.4       3.12     $ (249.4 )     (1.57 )
                                                           
                                                           
Liabilities and capital
                                                         
Consolidated obligation
bonds
    $ 47,326.6     $ 184.2       1.58     $ 305.7       2.62     $ (121.5 )     (1.04 )
All other interest-bearing liabilities
      11,296.0       2.8       0.10       2.8       0.10       -       -  
                                                           
Total interest-bearing
liabilities
    $ 58,622.6     $ 187.0       1.29     $ 308.5       2.13     $ (121.5 )     (0.84 )
                                                           
Net interest income/net
interest spread
            $ 59.0       0.26     $ 186.9       0.99     $ (127.9 )     (0.73 )
                                                           
                                                           
 
                                                           
              Avg.
      Avg.
       
Three Months Ended
        Interest Inc./
  Yield/
  Interest Inc./
  Yield/
      Incr./
March 31, 2009
    Average
  Exp. with
  Rate
  Exp. without
  Rate
  Impact of
  (Decr.)
(dollars in millions)     Balance   Derivatives   (%)   Derivatives   (%)   Derivatives(1)   (%)
Assets
                                                         
Advances
    $ 56,450.5     $ 241.7       1.74     $ 499.1       3.59     $ (257.4 )     (1.85 )
Mortgage loans held for portfolio
      6,084.9       76.9       5.12       77.7       5.18       (0.8 )     (0.06 )
All other interest-earning
assets
      24,702.0       159.2       2.61       159.2       2.61       -       -  
                                                           
Total interest-earning
assets
    $ 87,237.4     $ 477.8       2.22     $ 736.0       3.42     $ (258.2 )     (1.20 )
                                                           
                                                           
Liabilities and capital
                                                         
Consolidated obligation
bonds
    $ 61,659.5     $ 396.2       2.61     $ 500.7       3.29     $ (104.5 )     (0.68 )
All other interest-bearing liabilities
      19,618.6       25.2       0.52       25.2       0.52       -       -  
                                                           
Total interest-bearing
liabilities
    $ 81,278.1     $ 421.4       2.10     $ 525.9       2.62     $ (104.5 )     (0.52 )
                                                           
Net interest income/net
interest spread
            $ 56.4       0.12     $ 210.1       0.80     $ (153.7 )     (0.68 )
                                                           
                                                           
Note:
 
(1) Impact of Derivatives includes net interest settlements and amortization of basis adjustments resulting from previously terminated hedging relationships.


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The Bank uses derivatives to hedge the fair market value changes attributable to the change in the LIBOR benchmark interest rate. The Bank generally uses interest rate swaps to hedge a portion of advances and consolidated obligations which convert the interest rates on those instruments from a fixed rate to a LIBOR-based variable rate. The purpose of this strategy is to protect the interest rate spread. Using derivatives to convert interest rates from fixed to variable can increase or decrease net interest income. The variances in the advances and consolidated obligation derivative impacts from period to period are driven by the change in the average LIBOR-based variable rate, the timing of interest rate resets and the average hedged portfolio balances outstanding during any given period.
 
For first quarter 2010, the impact of derivatives decreased net interest income by $127.9 million and reduced the net interest spread 73 basis points. Average 3-month LIBOR for first quarter 2010 fell 98 basis points year-over-year and the impact of declining rates on existing derivative contracts continued to negatively impact net interest income. For first quarter 2009, the impact of derivatives decreased net interest income by $153.7 million and reduced net interest spread 68 basis points.
 
The mortgage loans held for portfolio derivative impact for the periods presented was affected by the amortization of basis adjustments resulting from hedges of commitments to purchase mortgage loans through the MPF program.
 
Other Income (Loss)
 
                           
      Three Months Ended March 31,    
(in millions)     2010   2009   % Change
Services fees
    $ 0.6     $ 0.6       -  
Net gains (losses) on trading securities
      (0.3 )     -       n/m  
Net gains (losses) on derivatives and hedging
activities
      (4.6 )     (1.2 )     283.3  
Net OTTI losses
      (27.6 )     (30.5 )     9.5  
Contingency reserve
      -       (35.3 )     n/m  
Other income, net
      2.4       2.0       20.0  
                           
Total other income (loss)
    $ (29.5 )   $ (64.4 )     54.2  
                           
                           
n/m = not meaningful
 
The Bank recorded total other losses of $29.5 million for first quarter 2010 compared to total other losses of $64.4 million for first quarter 2009. Losses on derivative and hedging activities were $4.6 million for first quarter 2010 compared to losses of $1.2 million for first quarter 2009. Net OTTI losses reflect the credit loss portion of OTTI charges taken on the private label MBS portfolio. The $35.3 million contingency reserve represents the establishment of a contingency reserve for the Bank’s LBSF receivable in first quarter 2009. There has been no change in the reserve in 2010.
 
See additional discussion on OTTI charges in the “Credit and Counterparty Risk – Investments” discussion in Risk Management, both in this Item 2. Management’s Discussion and Analysis in the quarterly report filed on this Form 10-Q. The activity related to net gains on derivatives and hedging activities is discussed in more detail below.


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Derivatives and Hedging Activities. The following table details the net gains and losses on derivatives and hedging activities, including hedge ineffectiveness.
 
                   
      For the Three Months Ended
      March 31, 2010
  March 31, 2009
(in millions)     Gain (Loss)   Gain (Loss)
Derivatives and hedged items in hedge
accounting relationships
                 
Advances
    $ (1.7 )   $ (19.2 )
Consolidated obligations
      0.9       17.4  
                   
Total net loss related to fair value
hedge ineffectiveness
      (0.8 )     (1.8 )
                   
Derivatives not designated as hedging
instruments under hedge accounting
                 
Economic hedges
      (4.5 )     (1.4 )
Mortgage delivery commitments
      0.4       1.9  
Other
      0.3       0.1  
                   
Total net gain (loss) related to derivatives not
designated as hedging instruments under
hedge accounting
      (3.8 )     0.6  
                   
Net losses on derivatives and hedging
activities
    $ (4.6 )   $ (1.2 )
                   
                   
 
Fair Value Hedges.  The Bank uses fair value hedge accounting treatment for certain of its advances and consolidated obligation bonds using interest rate swaps. The interest rate swaps convert fixed-rate instruments to a variable-rate (i.e., LIBOR) or provide offset to options embedded within variable-rate instruments. For the first quarter of 2010, total ineffectiveness related to these fair value hedges resulted in a loss of $0.8 million compared to a loss of $1.8 million in the first quarter of 2009. During the same period, the overall notional amount decreased from $57.6 billion at March 31, 2009 to $42.8 billion at March 31, 2010. Fair value hedge ineffectiveness represents the difference between the change in the fair value of the derivative compared to the change in the fair value of the underlying asset/liability hedged. Fair value hedge ineffectiveness is generated by movement in the benchmark interest rate being hedged and by other structural characteristics of the transaction involved. For example, the presence of an upfront fee associated with a structured debt hedge will introduce valuation differences between the hedge and hedged item that will fluctuate through time.
 
Economic Hedges.  For economic hedges, the Bank includes the net interest income and the changes in the fair value of the hedges in net gain (loss) on derivatives and hedging activities. Total amounts recorded for economic hedges were a loss of $4.5 million in first quarter 2010 compared to a loss of $1.4 million in first quarter 2009. The majority of the first quarter 2010 loss was comprised of losses on the Bank’s interest rate caps. The overall notional amount of economic hedges increased from $0.8 billion at March 31, 2009 to $1.5 billion at March 31, 2010. The notional amount of the Bank’s interest rate caps was $1.4 billion at March 31, 2010. The Bank did not have any interest rate caps at March 31, 2009.
 
Mortgage Delivery Commitments.  Certain mortgage purchase commitments are considered derivatives. When the mortgage purchase commitment derivative settles, the current market value of the commitment is included with the basis of the mortgage loan and amortized accordingly. Total gains relating to mortgage delivery commitments for the first quarter of 2010 were $0.4 million compared to total gains of $1.9 million for the first quarter of 2009. Total notional of the Bank’s mortgage delivery commitments decreased from $31.7 million at March 31, 2009 to $16.7 million at March 31, 2010.


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Other Expense
 
                           
      Three Months Ended
   
      March 31,    
(in millions)     2010   2009   % Change
Operating - salaries and benefits
    $ 8.9     $ 8.2       8.5  
Operating - occupancy
      0.7       0.6       16.7  
Operating - other
      4.9       4.9       -  
Finance Agency
      1.0       0.8       25.0  
Office of Finance
      0.7       0.7       -  
                           
Total other expenses
    $ 16.2     $ 15.2       6.6  
                           
                           
 
For first quarter 2010, other expense totaled $16.2 million compared to $15.2 million for the same prior year period, an increase of $1.0 million, or 6.6%, driven by higher salaries and benefits expense. The combined operating expenses of the Finance Agency and the OF increased 13.3% quarter-over-quarter, driven by an increase in Finance Agency expenses. The Bank expects this trend to continue through 2010. The increase in salaries and benefits expense was primarily driven by severance costs in first quarter 2010.
 
Collectively, the twelve FHLBanks are responsible for the operating expenses of the Finance Agency and the OF. These payments, allocated among the FHLBanks according to a cost-sharing formula, are reported as other expense on the Bank’s Statement of Operations.
 
Affordable Housing Program (AHP) and Resolution Funding Corp. (REFCORP) Assessments
 
                             
      Three Months Ended March 31,      
(in millions)     2010   2009     % Change
Affordable Housing Program (AHP)
    $ 1.1     $  -         n/m  
REFCORP
      2.4       -         n/m  
                             
Total assessments
    $ 3.5     $ -         n/m  
                             
                             
n/m = not meaningful
 
Assessment Calculations.  Although the FHLBanks are not subject to federal or state income taxes, the combined financial obligations of making payments to REFCORP (20%) and AHP contributions (10%) equate to a proportion of the Bank’s net income comparable to that paid in income tax by fully taxable entities. Inasmuch as both the REFCORP and AHP payments are each separately subtracted from earnings prior to the assessment of each, the combined effective rate is less than the simple sum of both (i.e., less than 30%). In passing the Financial Services Modernization Act of 1999, Congress established a fixed 20% annual REFCORP payment rate beginning in 2000 for each FHLBank. The fixed percentage replaced a fixed-dollar annual payment of $300 million which had previously been divided among the twelve FHLBanks through a complex allocation formula. The law also calls for an adjustment to be made to the total number of REFCORP payments due in future years so that, on a present value basis, the combined REFCORP payments of all twelve FHLBanks are equal in amount to what had been required under the previous calculation method. The FHLBanks’ aggregate payments through the first quarter of 2010 exceeded the scheduled payments, effectively accelerating payment of the REFCORP obligation and shortening its remaining term to a final payment during the second quarter of 2012. This date assumes that the FHLBanks pay exactly $300 million annually until 2012. The cumulative amount to be paid to REFCORP by the FHLBank is not determinable at this time due to the interrelationships of the future earnings of all FHLBanks and interest rates. In addition, the FHLBanks must set aside for the AHP annually on a combined basis, the greater of an aggregate of $100 million or 10 percent of current year’s net earnings (income before interest expense related to mandatorily redeemable capital stock but after the assessment for REFCORP). The AHP, mandated by statute, is the largest and primary public policy program among the FHLBanks. The AHP funds, which are offered on a competitive basis,


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provide grants and below-market loans for both rental and owner-occupied housing for households at 80% or less of the area median income.
 
Application of the REFCORP percentage rate as applied to earnings during first quarter 2010 resulted in expenses for the Bank of $2.4 million. Due to the pre-assessment loss incurred in the first quarter 2009, the Bank did not incur REFCORP or AHP expense for the period.
 
The Bank currently has a prepaid REFCORP assessment balance of $37.2 million as of March 31, 2010. This prepaid REFCORP assessment balance was the result of the Bank overpaying its 2008 REFCORP assessment as a result of the loss recognized in fourth quarter 2008. As instructed by the U.S. Treasury, the Bank is using its overpayment as a credit against future REFCORP assessments (to the extent the Bank has positive net income in the future) over an indefinite period of time. This overpayment is recorded as a prepaid asset by the Bank and reported as “prepaid REFCORP assessment” on the Statement of Condition. Over time, as the Bank uses this credit against its future REFCORP assessments, the prepaid asset will be reduced until it has been exhausted. If any amount of the prepaid asset still remains at the time that the REFCORP obligation for the FHLBank System as a whole is fully satisfied, REFCORP, in consultation with the U.S. Treasury, will implement a procedure so that the Bank would be able to collect on its remaining prepaid asset.
 
Financial Condition
 
The following is Management’s Discussion and Analysis of the Bank’s financial condition at March 31, 2010 compared to December 31, 2009. This should be read in conjunction with the Bank’s unaudited interim financial statements and notes in this report and the audited financial statements in the Bank’s 2009 Annual Report filed on Form 10-K.
 
Asset Composition.  As a result of declining loan demand by members, the Bank’s total assets decreased $6.6 billion, or 10.1%, to $58.7 billion at March 31, 2010, down from $65.3 billion at December 31, 2009. Advances decreased $4.4 billion while total investment securities decline $2.0 billion. These decreases were partially offset by a $1.1 billion increase in Federal funds sold.
 
Total housing finance-related assets, which include MPF Program loans, advances, MBS and other mission-related investments, decreased $5.0 billion, or 8.9%, to $50.9 billion at March 31, 2010, down from $55.9 billion at December 31, 2009. Total housing finance-related assets accounted for 86.8% of assets as of March 31, 2010 and 85.7% of assets as of December 31, 2009.
 
Advances.  At March 31, 2010, total advances reflected balances of $36.8 billion to 218 borrowing members, compared to $41.2 billion at year-end 2009 to 222 borrowing members, representing a 10.6% decrease in the portfolio balance. A significant concentration of the loans continued to be generated from the Bank’s five largest borrowers, generally reflecting the asset concentration mix of the Bank’s membership base. Total loans outstanding to the Bank’s five largest members were $21.9 billion and $25.4 billion at March 31, 2010 and December 31, 2009, respectively. The decrease in advance balances reflected the impact of members’ access to additional liquidity from government programs and members’ reactions to the Bank’s pricing of short-term advance products. Members have also taken other actions during the credit crisis, such as raising core deposits and reducing the size of their balance sheets. In addition, many of the Bank’s members may have reacted to the Bank’s temporary actions of not paying dividends and not repurchasing excess capital stock by limiting their use of the Bank’s advance products.


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The following table provides a distribution of the number of members, categorized by individual member asset size, that had an outstanding average balance during the three months ended March 31, 2010 and the year ended December 31, 2009.
 
                   
Member Asset Size     2010   2009
Less than $100 million
      35       40  
Between $100 million and $500 million
      120       135  
Between $500 million and $1 billion
      40       39  
Between $1 billion and $5 billion
      30       30  
Greater than $5 billion
      15       16  
                   
Total borrowing members during the year
      240       260  
                   
                   
Total membership
      318       316  
Percent of members borrowing during the period
      75.5 %     82.3 %
Total borrowing members with outstanding loan balances at period-end
      218       222  
Percent of member borrowing at period-end
      68.6 %     70.3 %
                   
 
As of March 31, 2010, the par value of the RepoPlus products decreased $4.0 billion, or 20.0%, to $16.1 billion, compared to $20.1 billion at December 31, 2009. These products represented 45.4% and 50.6% of the par value of the Bank’s total advances portfolio at March 31, 2010 and December 31, 2009, respectively. The Bank’s shorter-term advances decreased as a result of members having less need for liquidity from the Bank as they have taken other actions during the credit crisis, such as raising core deposits, reducing their balance sheets, and identifying alternative sources of funds. The short-term portion of the advances portfolio is volatile; as market conditions change rapidly, the short-term nature of these lending products could materially impact the Bank’s outstanding loan balance. See Item 1. Business in the Bank’s 2009 Annual Report filed on Form 10-K for details regarding the Bank’s various loan products.
 
The Bank’s longer-term advances, referred to as Term Advances, remained flat at $12.8 billion at both March 31, 2010, and December 31, 2009. These balances represented 36.3% and 32.2% of the Bank’s advance portfolio at March 31, 2010 and December 31, 2009, respectively. A number of the Bank’s members have a high percentage of long-term mortgage assets on their balance sheets and these members generally fund these assets through these longer-term borrowings with the Bank to mitigate interest rate risk. Certain members also prefer Term Advances given the current interest rate environment. Meeting the needs of such members has been, and will continue to be, an important part of the Bank’s advances business.
 
As of March 31, 2010, the Bank’s longer-term option embedded advances decreased $338.7 million to $6.5 billion, down from $6.8 billion as of December 31, 2009. These products represented 18.3% and 17.2% of the Bank’s advances portfolio on March 31, 2010 and December 31, 2009, respectively.
 
Mortgage Loans Held for Portfolio.  Net mortgage loans held for portfolio decreased 3.3% to $5.0 billion as of March 31, 2010 compared to $5.2 billion at December 31, 2009. This decrease was primarily due to the continued runoff of the existing portfolio, which more than offset the new portfolio purchase activity.


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Loan Portfolio Analysis.  The Bank’s outstanding loans, nonaccrual loans and loans 90 days or more past due and accruing interest are presented in the following table.
 
                   
      March 31,
  December 31,
(in millions)     2010   2009
Advances(1)
    $ 36,823.8     $ 41,177.3  
Mortgage loans held for portfolio, net(2)
      4,991.2       5,162.8  
Nonaccrual mortgage loans, net(3)
      77.6       71.2  
Mortgage loans past due 90 days or
more and still accruing interest(4)
      14.3       16.5  
Banking on Business (BOB) loans, net(5)
      11.5       11.8  
                   
Notes:
 
(1) There are no advances which are past due or on nonaccrual status.
(2) All of the real estate mortgages held in portfolio by the Bank are fixed-rate. Balances are reflected net of allowance for credit losses.
(3) All nonaccrual mortgage loans are reported net of interest applied to principal.
(4) Government-insured or -guaranteed loans (e.g., FHA, VA, HUD or RHS) continue to accrue interest after becoming 90 days or more delinquent.
(5) Due to the nature of the program, all BOB loans are considered nonaccrual loans. Balances are reflected net of allowance for credit losses.
 
The Bank has experienced an increase in its nonaccrual mortgage loans held for portfolio. Nonaccrual mortgage loans increased approximately $6.4 million, or 9.0%, from December 31, 2009 to March 31, 2010. This increase was driven by the general economic conditions. The decrease in mortgage loans past due 90 days or more and still accruing from December 31, 2009 to March 31, 2010 occurred as a result of the Bank permitting PFI’s to repurchase loans that met certain pre-established criteria (i.e., government-guaranteed loans) at the time of the sale of the loans to the Bank. The Bank increased its allowance for loan losses, from $2.7 million at December 31, 2009 to $2.9 million at March 31, 2010, an increase of 7.1%.
 
Interest-Bearing Deposits and Federal Funds Sold.  At March 31, 2010, these short-term investments totaled $4.1 billion, a net increase of $1.1 billion, or 36.7%, from December 31, 2009. These combined balances have continued to grow over the last two years, reflecting the Bank’s strategy to maintain its short-term liquidity position in part to be able to meet members’ loan demand and regulatory liquidity requirements.
 
Investment Securities.  The $2.0 billion, or 14.3%, decrease in investment securities from December 31, 2009 to March 31, 2010, was primarily due to a decrease in the certificates of deposit in the held-to-maturity portfolio as well as MBS paydowns. The decrease in certificates of deposit was driven by narrowing spreads. The Bank has not invested in any private label MBS since late 2007. Available-for-sale MBS paydowns were offset by an increase in the fair value of the investments during first quarter 2010. In addition, during 2009 the Bank did offset some of the MBS portfolio run-off with the purchase of U.S. agency MBS.


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The following tables summarize key investment securities portfolio statistics.
 
                 
    March 31,
  December 31,
(in millions)   2010   2009
Trading securities:
               
Mutual funds offsetting deferred compensation
  $ 6.6     $ 6.7  
U.S. Treasury bills
    1,029.7       1,029.5  
TLGP investments
    250.0       250.0  
                 
Total trading securities
  $ 1,286.3     $ 1,286.2  
                 
                 
Available-for-sale securities:
               
Mutual funds offsetting supplemental retirement plan
  $ 2.0     $ 2.0  
MBS
    2,367.0       2,395.3  
                 
Total available-for-sale securities
  $ 2,369.0     $ 2,397.3  
                 
                 
Held-to-maturity securities:
               
Certificates of deposit
  $ 1,650.0       3,100.0  
State or local agency obligations
    608.7       608.4  
U.S. government-sponsored enterprises
    71.4       176.7  
MBS
    6,149.4       6,597.3  
                 
Total held-to-maturity securities
    8,479.5       10,482.4  
                 
Total investment securities
  $ 12,134.8     $ 14,165.9  
                 
                 
 
The following table presents the maturity and yield characteristics for the investment securities portfolio as of March 31, 2010.
 
                 
(dollars in millions)   Book Value   Yield
Trading securities:
               
Mutual funds offsetting deferred compensation
  $ 6.6       n/a  
U.S. Treasury bills
    1,029.7       0.34 %
TLGP investments
    250.0       0.22  
                 
Total trading securities
  $ 1,286.3       0.32  
                 
                 
Available-for-sale securities:
               
Mutual funds offsetting supplemental retirement plan
  $ 2.0       n/a  
MBS
    2,367.0       5.38  
                 
Total available-for-sale securities
  $ 2,369.0       5.38  
                 
                 
Held-to-maturity securities:
               
Certificates of deposit
  $ 1,650.0       0.26  
State or local agency obligations:
               
Within one year
    55.7       5.85  
After one but within five years
    78.0       5.75  
After five years but within ten years
    11.8       0.38  
After ten years
    463.2       2.73  
                 
Total state or local agency obligations
    608.7       3.36  
                 
U.S. government-sponsored enterprises:
               
After five years but within ten years
    71.4       4.05  
                 
Total U.S. government-sponsored enterprises
    71.4       4.05  
                 
MBS
    6,149.4       3.26  
                 
Total held-to-maturity securities
  $ 8,479.5       2.69  
                 
                 
n/a – not applicable


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As of March 31, 2010, the Bank held securities from the following issuers with a book value greater than 10% of Bank total capital.
 
                 
    Total
  Total
(in millions)   Book Value   Fair Value
Government National Mortgage Association
  $ 1,670.4     $ 1,674.3  
J.P. Morgan Mortgage Trust
    1,248.8       1,217.4  
U.S. Treasury
    1,029.7       1,029.7  
Federal Home Loan Mortgage Corp. 
    900.9       939.5  
Wells Fargo Mortgage Backed Securities Trust
    748.4       712.4  
Structured Adjustable Rate Mortgage Loan Trust
    442.0       424.6  
Pennsylvania Housing Finance Agency
    401.0       391.7  
                 
Total
  $ 6,441.2     $ 6,389.6  
                 
                 
 
During the third quarter of 2009, Taylor, Bean & Whitaker (TBW), a servicer on one of the Bank’s private label MBS filed for bankruptcy. There is now a replacement servicer on this security. The replacement servicer has provided monthly remittances related to 2010 activity. However, certain months in 2009 are continuing to be reconciled by the replacement servicer.
 
For additional information on the credit risk of the investment portfolio, see “Credit and Counterparty Risk-Investments” discussion in the Risk Management section of this Item 2. Management’s Discussion and Analysis in the quarterly report filed on this Form 10-Q.
 
Deposits.  At March 31, 2010, time deposits in denominations of $100 thousand or more totaled $5.0 million. The table below presents the maturities for time deposits in denominations of $100 thousand or more:
 
                                                   
            Over 3
    Over 6
           
            Months but
    Months but
           
 (in millions)
    3 Months
    Within
    Within
           
 By Remaining Maturity at March 31, 2010     or Less     6 Months     12 Months     Thereafter     Total
 Time certificates of deposit ($100,000 or more)
    $  4.5       $  -       $  0.5       $  -       $  5.0  
                                                   
                                                   
 
Commitment and Off-balance Sheet Items.  At March 31, 2010, the Bank was obligated to fund approximately $158.0 million in additional advances, $16.7 million of mortgage loans and $8.0 billion in outstanding standby letters of credit, and to issue $995.0 million in consolidated obligations. The Bank does not consolidate any off-balance sheet special purpose entities or other off-balance sheet conduits.
 
Retained Earnings.  The Finance Agency has issued regulatory guidance to the FHLBanks relating to capital management and retained earnings. The guidance directs each FHLBank to assess, at least annually, the adequacy of its retained earnings with consideration given to future possible financial and economic scenarios. The guidance also outlines the considerations that each FHLBank should undertake in assessing the adequacy of its retained earnings. In accordance with the Finance Agency’s RBC regulations, when the Bank’s market value of equity to book value of equity falls below 85%, the Bank is required to provide for additional market RBC. In response to recent regulatory guidance, management has revised its Asset Classification Policy. This change may result in certain MBS being assigned a higher level of credit risk for reasons beyond a credit rating below investment grade. Management’s assessment as of March 31, 2010 indicated that this new guidance did not have a material impact with respect to required retained earnings levels. This assessment will be performed on an ongoing basis, so the impact on future periods could prove to be material.


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On December 23, 2008, in an effort to build retained earnings, the Bank announced its voluntary decision to temporarily suspend dividend payments until further notice.
 
                 
    Three Months Ended March 31,
(in millions)   2010   2009
Balance, beginning of the period
  $ 389.0     $ 170.5  
Cumulative effect of adoption of the amended OTTI guidance
    -       255.9  
Net income (loss)
    9.9       (23.6 )
                 
Balance, end of the period
  $ 398.9     $ 402.8  
                 
                 
 
At March 31, 2010, retained earnings were $398.9 million, an increase of $9.9 million, or 2.5%, from December 31, 2009. This increase reflects the Bank’s first quarter 2010 net income. At March 31, 2009, retained earnings were $402.8 million, representing an increase of $232.3 million, or 136.2%, from December 31, 2008. The Bank adopted the amended OTTI guidance effective January 1, 2009. This adoption resulted in a $255.9 million increase in retained earnings due to the cumulative effect adjustment recorded as of January 1, 2009. This cumulative effect adjustment did not impact the Bank’s REFCORP or AHP assessment expenses or liabilities, as these assessments are based on GAAP net income. Excluding the cumulative effect adjustment, retained earnings fell $23.6 million from prior year-end driven by the Bank’s first quarter 2009 net loss. Additional information regarding the amended OTTI guidance is available in the Critical Accounting Policies and Note 3 to the audited financial statements, both in the Bank’s 2009 Annual Report filed on Form 10-K. Further details of the components of required RBC are presented in the “Capital Resources” discussion in Management’s Discussion and Analysis in the quarterly report filed on this Form 10-Q. See Note 19 to the audited financial statements in the Bank’s 2009 Annual Report filed on Form 10-K for further discussion of risk-based capital and the Bank’s policy on capital stock requirements.
 
Capital Resources
 
The following is Management’s Discussion and Analysis of the Bank’s capital resources as of March 31, 2010, which should be read in conjunction with the unaudited interim financial conditions and notes included in the quarterly report filed on this Form 10-Q and the audited financial statements in the Bank’s 2009 Annual Report filed on Form 10-K.
 
Risk-Based Capital (RBC)
 
The Finance Agency’s RBC regulations require the Bank to maintain sufficient permanent capital, defined as retained earnings plus capital stock, to meet its combined credit risk, market risk and operational risk. Each of these components is computed as specified in regulations and directives issued by the Finance Agency.
 
                         
    March 31,
  December 31,
  December 31,
(in millions)   2010   2009   2008
Permanent capital:
                       
Capital stock(1)
  $ 4,043.4     $ 4,026.3     $ 3,986.4  
Retained earnings
    398.9       389.0       170.5  
                         
Total permanent capital
  $ 4,442.3     $ 4,415.3     $ 4,156.9  
                         
                         
                         
RBC requirement:
                       
Credit risk capital
  $ 909.2     $ 943.7     $ 278.7  
Market risk capital
    1,042.7       1,230.8       2,739.1  
Operations risk capital
    585.5       652.4       905.3  
                         
Total RBC requirement
  $ 2,537.4     $ 2,826.9     $ 3,923.1  
                         
                         
Note:
 
(1) Capital stock includes mandatorily redeemable capital stock


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The Bank held excess permanent capital over RBC requirements of $1.9 billion, $1.6 billion and $233.8 million at March 31, 2010, December 31, 2009 and December 31, 2008, respectively.
 
Capital and Leverage Ratios
 
In addition to the requirements for RBC, the Finance Agency has mandated maintenance of certain capital and leverage ratios. The Bank must maintain total regulatory capital and leverage ratios of at least 4.0% and 5.0% of total assets, respectively. Management has an ongoing program to measure and monitor compliance with the ratio requirements. As a matter of policy, the Board has established an operating range for capitalization that calls for the capital ratio to be maintained between 4.08% and 5.0%. To enhance overall returns, it has been the Bank’s practice to utilize leverage within this operating range when market conditions permit, while maintaining compliance with statutory, regulatory and Bank policy limits.
 
                         
    March 31,
  December 31,
  December 31,
(dollars in millions)   2010   2009   2008
Capital Ratio
                       
Minimum capital (4.0% of total assets)
  $ 2,346.2     $ 2,611.6     $ 3,632.2  
Actual capital (permanent capital plus loan loss reserves)
    4,442.3       4,415.4       4,170.9  
Total assets
    58,656.0       65,290.9       90,805.9  
Capital ratio (actual capital as a percent of total assets)
    7.6 %     6.8 %     4.6 %
                         
Leverage Ratio
                       
Minimum leverage capital (5.0% of total assets)
  $ 2,932.8     $ 3,264.5     $ 4,540.3  
Leverage capital (permanent capital multiplied by a 1.5 weighting factor plus loan loss reserves)
    6,663.4       6,623.1       6,249.3  
Leverage ratio (leverage capital as a percent of total assets)
    11.4 %     10.1 %     6.9 %
 
Management reviews, on a routine basis, projections of capital leverage that incorporate anticipated changes in assets, liabilities, and capital stock levels as a tool to manage overall balance sheet leverage within the Board’s operating ranges. In connection with this review, when management believes that adjustments to the current member stock purchase requirements within the ranges established in the capital plan are warranted, a recommendation is presented for Board consideration. The member stock purchase requirements have been adjusted several times since the implementation of the capital plan in December 2002. The current percentages are 4.75%, 0.75% and 4.0% of member loans outstanding, unused borrowing capacity and AMA activity, respectively.
 
The Bank has initiated the process of amending its capital plan. The goal of this capital plan amendment is to provide members with a more stable membership capital stock calculation that would replace the Unused Borrowing Capacity calculation. Additionally, the proposed amendment would expand the AMA stock purchase requirement range and prospectively establish a capital stock purchase requirement for letters of credit. As required by Finance Agency regulation and the terms of the capital plan, any amendment must be approved by the Finance Agency prior to becoming effective.
 
On November 10, 2008, the Bank first changed its excess capital stock repurchase practice, stating that the Bank would no longer make excess capital stock repurchases at a member’s request and noting that the previous practice of repurchasing excess capital stock from all members on a periodic basis was revised. Subsequently, as announced on December 23, 2008, the Bank temporarily suspended excess capital stock repurchases on a voluntary basis until further notice. At March 31, 2010 and December 31, 2009, excess capital stock totaled $1.3 billion and $1.2 billion, respectively. The Bank’s prior practice was to promptly repurchase the excess capital stock of its members upon their request (except with respect to directors’ institutions during standard blackout periods). As long as it is not repurchasing excess capital stock, the Bank’s capital and leverage ratios may continue to increase outside of normal ranges as evidenced by the increases from December 31, 2008 through March 31, 2010. This may continue to result in lower earnings per share and return on capital.


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Critical Accounting Policies
 
The Bank’s financial statements are prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP). Application of these principles requires management to make estimates, assumptions or judgments that affect the amounts reported in the financial statements and accompanying notes. The use of estimates, assumptions and judgments is necessary when financial assets and liabilities are required to be recorded at, or adjusted to reflect, fair value. Assets and liabilities carried at fair value inherently result in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices when available. When quoted market prices are not available, fair values may be obtained from third-party sources or are estimated in good faith by management, primarily through the use of internal cash flow and other financial modeling techniques.
 
The most significant accounting policies followed by the Bank are presented in Note 2 to the audited financial statements in the Bank’s 2009 Annual Report filed on Form 10-K. These policies, along with the disclosures presented in the other notes to the financial statements and in this Form 10-Q, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Management views critical accounting policies to be those which are highly dependent on subjective or complex judgments, estimates or assumptions, and those for which changes in those estimates or assumptions could have a significant impact on the financial statements.
 
The following critical accounting policies are discussed in more detail under this same heading in the Bank’s 2009 Annual Report filed on Form 10-K:
  •     Other-Than-Temporary Impairment Assessments for Investment Securities*
  •     Fair Value Calculations and Methodologies
  •     Accounting for Derivatives
  •     Advances and Related Allowance for Credit Losses
  •     Guarantees and Consolidated Obligations
  •     Accounting for Premiums and Discounts on Mortgage Loans and MBS
  •     Allowance for Credit Losses on Banking on Business Loans
  •     Allowance for Credit Losses on Mortgage Loans Held for Portfolio
  •     Future REFCORP Payments
 
*The critical accounting policies in the Bank’s 2009 Annual Report filed on Form 10-K includes discussion regarding the impact of the amended OTTI guidance issued by the FASB during April 2009 and adopted by the Bank effective January 1, 2009. The Bank’s adoption of the amended OTTI guidance required a cumulative effect adjustment as of January 1, 2009 which increased the Bank’s retained earnings by $255.9 million, with an offsetting decrease in AOCI.
 
The Bank did not implement any material changes to its accounting policies or estimates, nor did the Bank implement any new accounting policies that had a material impact on the Bank’s Statement of Operations and Statement of Condition for the three months ended March 31, 2010.
 
Recently Issued Accounting Standards and Interpretations. See Note 2 to the unaudited financial statements in Item 1. Financial Statements and Supplementary Financial Data in the quarterly report filed on this Form 10-Q for a discussion of recent accounting pronouncements that are relevant to the Bank’s businesses.
 
Legislative and Regulatory Developments
 
Final Rule Regarding Restructuring the Office of Finance (OF). On August 4, 2009, the Finance Agency issued a proposed rule regarding the restructuring of the board of directors of the OF. On May 3, 2010 the Finance Agency issued a final regulation restructuring the board of directors of the OF. The regulation will become effective on June 2, 2010. Among other things, the final regulation: (1) increases the size of the board such that it will be comprised of the twelve FHLBank presidents and five independent directors; (2) creates an audit committee; (3) provides for the creation of other committees; (4) sets a method for electing independent directors along with setting qualifications for these directors; and (5) provides that the method of funding the OF and allocating its expenses among the FHLBanks shall be as determined by policies adopted by the board of directors. The newly-


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created audit committee will be comprised solely of the five independent directors and will be charged with oversight of greater consistency in accounting policies and procedures among the FHLBanks related to the combined financial reports published by the OF.
 
Final Regulation on FHLBank Directors’ Eligibility, Elections, Compensation and Expenses. On April 5, 2010, the Finance Agency issued a final regulation on FHLBank director elections, compensation and expenses. Regarding elections, the final regulation changes the process by which FHLBank directors are chosen after a directorship is re-designated to a new state prior to the end of the term as a result of the annual designation of FHLBank directorships. Specifically, the re-designation causes the original directorship to terminate at the end of the next calendar year and creates a new directorship that will be filled by an election of the applicable members. Regarding compensation, the final regulation, among other things: (1) allows FHLBanks to pay directors reasonable compensation and reimburse necessary expenses; (2) requires FHLBanks to adopt a written compensation and reimbursement of expenses plan; (3) prescribes certain related reporting requirements; and (4) prohibits payments to FHLBank directors who regularly fail to attend board or committee meetings.
 
Final Regulation on the Reporting of Fraudulent Financial Instruments and Loans. On January 26, 2010 the Finance Agency issued a final regulation regarding reporting of fraudulent financial instruments and loans. The final regulation largely incorporates the terms of the proposed regulation issued June 17, 2009, requiring Fannie Mae, Freddie Mac, and the FHLBanks to report to the Finance Agency any such entity’s sale or purchase of fraudulent financial assets and loans. The final regulation imposes requirements on the timeframe, format, document retention, and nondisclosure obligations for the Bank reporting fraud or possible fraud to the Finance Agency. Under the final regulation, fraud and potential fraud are defined broadly, potentially creating significant reporting obligations. The final regulation states that the Finance Agency will issue additional guidance establishing the specific reporting requirements for the FHLBanks. It is expected that this guidance will be issued by the end of April 2010. The Bank will be in a position to assess the significance of the reporting obligations once the Finance Agency has promulgated the additional guidance and specific requirements.
 
Finance Agency Examiner Guidance—Framework for Adversely Classifying Investment Securities and Supplemental Framework for Identifying Special Mention and Adversely Classifying Private-Label Mortgage-Backed Securities. On January 7, 2010 the Finance Agency issued guidance adopting the federal banking regulators’ Uniform Agreement on Classification of Assets and Appraisal of Securities Held by Banks and Thrifts (Interagency Agreement). The Interagency Agreement establishes standards for adversely classifying investment securities. In addition, the Examiner Guidance bulletin states that the Finance Agency is supplementing the Interagency Agreement with additional factors for adversely classifying private label MBS. The level and severity of adversely classified private label MBS is to be considered by the FHLBanks when establishing retained earnings targets and considered as an element of performance-based compensation for executive management. This change may result in certain MBS being assigned a higher level of credit risk for reasons beyond a credit rating below investment grade. Management’s assessment as of March 31, 2010 indicated that this new guidance did not have a material impact with respect to required retained earnings levels. This assessment will be performed on an ongoing basis, so the impact on future periods could prove to be significant.
 
Finance Agency Advisory Bulletin on Application of Guidance on Nontraditional and Subprime Residential Mortgage Loans. On April 6, 2010, the Finance Agency issued an advisory bulletin to provide clarification to the FHLBanks on whether certain nontraditional and subprime loans pledged to the FHLBanks by their members or private label MBS backed by such loans may be considered eligible collateral or whether such assets are required to be treated as ineligible collateral for advances. This Advisory Bulletin may have significant implications on the Bank’s acceptance of private label MBS and nontraditional residential mortgages as advance collateral. The Bank is completing a preliminary impact analysis on its members.
 
Finance Agency Proposed Rule Regarding FHLBank Investments. On May 4, 2010, the Finance Agency issued a notice of proposed rule regarding FHLBank investments. Among other things the proposed rule would (1) move the existing Finance Board investment regulations from 12 C.F.R. Part 956 to 12 C.F.R. Part 1267 and (2) incorporate the regulation the current limitations on the level of an FHLBank’s MBS investments that are applicable as a matter of Finance Agency financial management policy and order (including without limitation the provision limiting the level of an FHLBank’s MBS investments to no more than 300% of an FHLBank’s capital).


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The proposal also requests comment on whether additional limitations on an FHLBank’s MBS investments, including its private label MBS investments, should be adopted as part of a final regulation and whether with respect to private label MBS investments limitations should be based on an FHLBank’s level of retained earnings. Comments on the proposed rule are due on July 6, 2010.
 
Money Market Fund Reform. On March 4, 2010, the SEC published a final rule, amending the rules governing money market funds under the Investment Company Act. These amendments will result in tightened liquidity requirements, such as: maintaining certain financial instruments for short-term liquidity; reducing the maximum weighted-average maturity of portfolio holdings and improving the quality of portfolio holdings. The final rule includes overnight FHLBank consolidated discount notes in the definition of “daily liquid assets” and “weekly liquid assets” and will encompass FHLBank consolidated discount notes with remaining maturities of up to 60 days in the definition of “weekly liquid assets.” These provisions reflect changes to the SEC’s proposed rule that would have excluded certain FHLBank consolidated discount notes, other than overnight FHLBank consolidated discount notes, from the definition of both “daily liquid assets” and “weekly liquid assets.” The final rule’s requirements become effective on May 5, 2010 unless another compliance date is specified for a requirement (e.g., daily and weekly liquidity requirements become effective on May 28, 2010). The Bank expects this final rule will increase demand for discount notes with maturities of up to 60 days, which may benefit the Bank in terms of an increase in the market for discount notes.
 
Federal Reserve Board GSE Debt and MBS Purchase Initiatives. On November 25, 2008, the Federal Reserve announced an initiative for the FRBNY to purchase up to $100 billion of the debt of Freddie Mac, Fannie Mae, and the FHLBanks. On March 18, 2009, the Federal Reserve committed to purchase up to an additional $100 billion of such debt. On November 4, 2009, the Federal Reserve announced that it will cease purchasing such debt when the aggregated purchases reach $175 billion. The Federal Reserve completed these purchases in March 2010; however the Bank’s funding costs were not materially impacted.
 
Federal Reserve Board Term Deposit Program. On December 28, 2009, the Federal Reserve announced a proposal to offer a term deposit program for certain eligible Federal Reserve member institutions. On May 3, 2010 the Federal Reserve announced that it had approved a final regulation establishing the Federal Reserve term deposit program. The FHLBanks are not eligible to participate in this program. The program will enable eligible institutions to deposit funds with the Federal Reserve outside of the Federal Reserve program, earn interest on the funds, and pledge such deposits as collateral for loans from the Federal Reserve.
 
FDIC Regulation on Deposit Insurance Assessments. On April 13, 2010 the FDIC approved a proposed rule to revise the deposit insurance assessment system for large institutions which pose unique and concentrated risks to the deposit insurance fund. An ability to withstand funding-related stress score would be calculated with the ratio of secured liabilities to total domestic deposits receiving a 50% risk weight when calculating an institution’s loss severity score. The FDIC would continue to allow for adjustments as a result of secured liabilities and the proposal would extend the adjustment for brokered deposits to all large institutions. On February 27, 2009, the FDIC issued a final regulation on increases in deposit insurance premium assessments to restore the Deposit Insurance Fund. The final regulation is effective April 1, 2009. The assessments adopted by the FDIC are higher for institutions that use secured liabilities in excess of 25 percent of deposits. Secured liabilities are defined to include FHLBank advances. These rules may tend to decrease demand for advances from Bank members affected due to the increase in the effective all-in cost from the increased premium assessments.
 
FDIC Transaction Account Guarantee Program. On August 26, 2009, the FDIC approved the extension of its guarantee for noninterest bearing transaction accounts through June 30, 2010 for those participating institutions that do not opt-out of the program. On April 13, 2010 the FDIC extended the transaction account guarantee program through December 31, 2010. Under the FDIC’s interim final rule the FDIC has the authority to further extend the program through December 31, 2011.
 
Federal Banking Regulators Interagency Guidance on Correspondent Concentration Risks. On April 30, 2010, the FDIC, Federal Reserve, Office of the Comptroller of the Currency, and Office of Thrift Supervision (the Agencies) issued final guidance on correspondent concentration risks, which is effective upon issuance. The guidance provides that the stated levels of credit and funding exposures are not firm limits but that relationships within the levels set forth in the guidance warrant robust risk management. The guidance provides that the Agencies


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generally consider credit exposures arising from direct and indirect obligations in an amount equal to or greater than 25 percent of total capital as concentrations. Depending on its size and characteristics, a concentration of credit for a financial institution may represent a funding exposure to the correspondent. However, the guidance does not establish a funding concentration threshold. The guidance provides that the percentage of liabilities or other measurements that may constitute a concentration of funding is likely to vary depending on the type and maturity of the funding, and the structure of the recipient’s sources of funds. Since it is unclear whether member advances from an FHLBank may constitute a concentration subject to the guidance and, if so, what the implication for such a member would be, the Bank cannot predict what impact the guidance may have.
 
Helping Families Save Their Homes Act of 2009 and Other Mortgage Modification Legislation. On May 20, 2009, the Helping Families Save Their Home Act of 2009 was enacted to encourage loan modifications in order to prevent mortgage foreclosures and to support the federal deposit insurance system. One provision in the act provides a safe harbor from liability for mortgage servicers who modify the terms of a mortgage consistent with certain qualified loan modification plans. At this time it is uncertain what effect the provisions regarding loan modifications will have on the value of the Bank’s mortgage asset portfolio, the mortgage loan collateral pledged by members to secure their loans to members from the Bank or the value of the Bank’s MBS. As mortgage servicers modify mortgages under the various government incentive programs and otherwise, the value of the Bank’s MBS and mortgage loans held for investment and mortgage assets pledged as collateral for member advances may be reduced. At this point, legislation to allow bankruptcy cramdowns on mortgages secured by owner-occupied homes has been defeated in the U.S. Senate; however, similar legislation could be re-introduced. With this potential change in the law, the risk of losses on mortgages due to borrower bankruptcy filings could become material. The previously proposed legislation permitted a bankruptcy judge, in specified circumstances, to reduce the mortgage amount to today’s market value of the property, reduce the interest rate paid by the debtor, and/or extend the repayment period. In the event that this legislation would again be proposed, passed and applied to existing mortgage debt (including residential MBS), the Bank could face increased risk of credit losses on its private label MBS that include bankruptcy carve-out provisions and allocate bankruptcy losses over a specified dollar amount on a pro-rata basis across all classes of a security. As of March 31, 2010, the Bank had 69 private label MBS with a par value of $3.6 billion that include bankruptcy carve-out language that could be affected by cramdown legislation. The effect on the Bank will depend on the actual version of the legislation that would be passed (if any) and whether mortgages held by the Bank, either within the MPF Program or as collateral for MBS held by the Bank, would be subject to bankruptcy proceedings under the new legislation. Other Bankruptcy Reform Act Amendments also continue to be discussed.
 
House and Senate Financial Reform Legislation. On December 11, 2009, the U.S. House of Representatives passed the Wall Street Reform and Consumer Protection Act (the Reform Act), which, if passed by the U.S. Senate and signed into law by the president, would, among other things: (1) create a consumer financial protection agency; (2) create an inter-agency oversight council that will identify and regulate systemically-important financial institutions; (3) regulate the over-the-counter derivatives market; (4) reform the credit rating agencies; (5) provide shareholders with an advisory vote on the compensation practices of the entity in which they invest including for executive compensation and golden parachutes; and (6) create a federal insurance office that will monitor the insurance industry.
 
The Senate version of financial regulatory reform legislation, the Restoring American Financial Stability Act (Financial Stability Act), passed the Senate banking committee on March 22, 2010 and is undergoing Senate floor action. The Financial Stability Act, would, among other things: (1) create a consumer financial protection bureau, housed within the Federal Reserve; (2) create an inter-agency oversight council that will identify and regulate systemically-important financial institutions; (3) attempt to end “too big to fail” by creating a new way to liquidate failed financial firms, imposing new capital and leverage requirements, updating the Federal Reserve’s authority to allow system-wide support and establishing rigorous standards and supervision to protect the economy; (4) establish a new system of regulation for over the counter derivatives; (5) streamline bank supervision; (6) provide shareholders with a say on pay and corporate affairs with a nonbinding vote on executive compensation; (7) require the largest financial firms to separate their investment banking and proprietary trading from their commercial banking activities; (8) provide for rules for transparency and accountability for credit rating agencies; and (9) strengthen regulatory oversight and empower regulators to aggressively pursue financial fraud, conflicts of interest and manipulation of the financial system. Depending on whether the House or


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Senate version, or similar legislation, is signed into law and the final content of any such legislation, the Bank’s business, operations, funding costs, rights, obligations, and/or the manner in which the Bank carries out its mission may be impacted. For example, regulations on the over-the-counter derivatives market that may be issued under final legislation could impact the Bank’s ability to and increase the costs to hedge its interest-rate risk exposure from advances, achieve the Bank’s risk management objectives, and act as an intermediary between its members and counterparties. Limitations on the level of lending an FHLBank could engage in with its members could have a significant impact on the FHLBanks. Any proprietary trading limits that do not treat FHLBank System debt in the same manner as Fannie Mae and Freddie Mac debt would also have an impact on the FHLBanks.
 
Depending on whether the House or Senate version, or similar legislation is signed into law and on the final content of any such legislation, the Bank’s business, operations, funding costs, rights, obligations, and/or the manner in which the Bank carries out its mission may be impacted. For example, regulations on the over-the-counter derivatives market that may be issued under the Reform Act could impact the Bank’s ability to hedge its interest-rate risk exposure from advances, achieve the Bank’s risk management objectives, and act as an intermediary between its members and counterparties. Limitations on the level of lending an FHLBank could engage in with its members could have a significant impact on the FHLBanks. However, the Bank cannot predict whether any such legislation will be enacted and what the content of any such legislation or regulations issued under any such legislation would be and so cannot predict what impact the Reform Act or similar legislation may have on the Bank.
 
GSE Reform and Additional Financial Regulatory Reform. On April 14, 2010, the U.S. Treasury released for a 60-day public comment period questions regarding how the future U.S. housing finance system should be structured and the role of the GSEs in housing. The GSE and housing finance system reform process are in their initial stages. In January 2010, the U.S. Treasury announced a proposal to impose a 15 basis point financial responsibility fee that financial firms with assets of greater than $50 billion would pay on their covered liabilities. In the event that covered liabilities are defined to include FHLBank advances to members, the fee could impact member borrowing by affected firms.
 
U.S. Treasury Department’s Financial Stability Plan. On March 23, 2009, in accordance with the U.S. Treasury’s announced Financial Stability Plan’s initiative to purchase illiquid assets, the U.S. Treasury announced the Public-Private Investment Program (PPIP), which is a program designed to attract private investors to purchase certain real estate loans and illiquid MBS (originally AAA-rated) owned by financial institutions using up to $100 billion in TARP capital funds. These funds could be levered with debt funding also provided by the U.S. Treasury to expand the capacity of the program. On July 8, 2009, the U.S. Treasury announced that it had selected the initial nine PPIP fund managers to purchase legacy securities including commercial and residential MBS originally issued prior to 2009 that were originally rated AAA by two or more NRSROs. On September 30, 2009, the Treasury Department announced the initial closings of two Public Private Investment Funds established under PPIP to purchase legacy securities. Through March 31, 2010 the market value of the PPIP residential MBS transactions executed was $8.8 billion. The PPIP’s activities in purchasing such residential MBS could affect the values of residential MBS. On September 18, 2009, the Treasury Department ended its temporary program to sustain money market funds at stable net asset values.
 
Risk Management
 
Ongoing concerns over the impact of residential mortgage lending practices, including failure to adhere to sound underwriting standards, precipitated a sharp deterioration in the subprime- and Alt-A-related mortgage markets, as well as the broader mortgage and credit markets, beginning in 2008 and continuing through the first quarter of 2010. In particular, the market for MBS experienced high levels of volatility and uncertainty, reduced demand and lack of liquidity, resulting in credit spreads widening significantly. This deterioration in the housing market was evidenced by growing delinquency and foreclosure rates on subprime, Alt-A and prime mortgages. Given the uncertainty in the mortgage markets, MBS continue to be subject to various rating agency downgrades. Central banks, including the Federal Reserve and the European Central Bank, have sought to prevent a serious and extended economic downturn resulting from these and other market difficulties by making significant interest rate reductions and taking other actions to free up credit.


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The Bank is heavily dependent on the residential mortgage market through the collateral securing member loans and holdings of mortgage-related assets. The Bank’s member collateral policies, practices and secured status are discussed in more detail below as well as in Item 1. Business in the Bank’s 2009 Annual Report filed on Form 10-K. Additionally, the Bank has outstanding credit exposures related to the MPF Program and investments in private label MBS, which are affected by the mortgage market deterioration. All of these risk exposures are continually monitored and are discussed in more detail in the following sections.
 
For further information regarding the financial and residential markets in first quarter 2010, see the “Current Financial and Mortgage Markets and Trends” discussion in the Overview section of this Item 2. Management’s Discussion and Analysis in the quarterly report filed on this Form 10-Q.
 
Risk Governance
 
The Bank’s lending, investment and funding activities and use of derivative hedging instruments expose the Bank to a number of risks that include market and interest rate risk, credit and counterparty risk, liquidity and funding risk, and operating and business risk, among others, including those described in Item 1A. Risk Factors in the Bank’s 2009 Annual Report filed on Form 10-K.
 
During first quarter 2010, the Board, with the support of management, conducted an evaluation of the Bank’s risk appetite. This included updates/changes to the Board level risk metrics being used to monitor the Bank’s risk position. Information regarding the new and/or revised metrics is included in each relevant discussion in more detail below.
 
Capital Adequacy Measures. During 2008 and 2009, the Bank’s overarching capital adequacy metric was the Projected Capital Stock Price (PCSP). The PCSP was calculated using risk components for interest rates, spread, credit, operating and accounting risk. The sum of these components represented an estimate of projected capital stock price variability and was used in evaluating the adequacy of retained earnings and developing dividend payout recommendations to the Board. The Board had established a PCSP floor of 85% and a target of 95%. The difference between the actual PCSP and the floor or target, if any, represented a range of additional retained earnings that, in the absence of a reduction in the aforementioned risk components, would need to be accumulated over time to restore the PCSP and retained earnings to an adequate level.
 
Mortgage spreads, particularly spreads on private label MBS, expanded to historically wide levels over the last two years, reflecting increased credit risk and an illiquid market environment. In response to these unprecedented market developments, management developed an Alternative Risk Profile to exclude the effects of further increases in certain mortgage-related asset credit spreads to better reflect the underlying interest rate risk and accommodate prudent management of the Bank’s balance sheet.
 
The following table presents the Bank’s PCSP calculation under the provisions of the Risk Governance Policy through December 31, 2009. Under both the Actual and Alternative Risk Profile calculations, the Bank was out of compliance with the PCSP limits for all periods presented.
 
                                         
      Projected Capital Stock Price (PCSP)
      Actual     Alternative Risk Profile     Floor     Target
December 31, 2009
      34.1 %       68.4 %       85 %       95 %
                                         
September 30, 2009
      25.5 %       67.8 %       85 %       95 %
                                         
June 30, 2009
      21.2 %       71.6 %       85 %       95 %
                                         
March 31, 2009
      11.6 %       73.2 %       85 %       95 %
                                         
December 31, 2008
      9.9 %       74.2 %       85 %       95 %
                                         
 
As a part of the risk appetite evaluation previously mentioned, the Board and management reviewed the PCSP calculation. Given the uncertainty in the credit markets, reflected in current market values, the PCSP calculation became less meaningful in terms of assessing Bank risk. As a result, the Bank transitioned from using the PCSP metric and replaced it with a new key risk indicator – Market Value of Equity to Par Value of Capital Stock


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(MV/CS) – for first quarter 2010. This risk metric provides a current assessment of the liquidation value of the balance sheet and measures the Bank’s current ability to honor the par put redemption feature of its capital stock.
 
An initial floor of 85% was established for MV/CS. The floor represents the estimated level from which the MV/CS would recover to par, through the retention of retained earnings, over the five-year par put redemption period of the Bank’s capital stock. MV/CS will be measured against the floor monthly. When MV/CS is below the established floor, excess capital stock repurchases and dividend payouts will be restricted. When MV/CS is above the established floor, additional analysis of the adequacy of retained earnings will be performed, taking into consideration the impact of excess capital stock repurchases and/or dividend payouts.
 
The following table presents the MV/CS calculations for March 31, 2010, as well as the four quarters of 2009, which were calculated for comparison purposes.
 
           
      MV/CS
March 31, 2010
      80.7 %
           
December 31, 2009
      74.4 %
           
September 30, 2009
      66.6 %
           
June 30, 2009
      48.5 %
           
March 31, 2009
      29.3 %
           
 
During first quarter 2010, the change in the MV/CS was primarily due to narrower mortgage spreads, principal paydowns on private label MBS and lower longer term interest rates and volatility.
 
Qualitative Disclosures Regarding Market Risk
 
Managing Market and Interest Rate Risk. The Bank’s market and interest rate risk management objective is to protect member/shareholder and bondholder value consistent with the Bank’s housing mission and safe and sound operations in all interest-rate environments. Management believes that a disciplined approach to market and interest rate risk management is essential to maintaining a strong and durable capital base and uninterrupted access to the capital markets.
 
Market risk is defined as the risk of loss arising from adverse changes in market rates and prices and other relevant market rate or price changes, such as basis changes. Generally, the Bank manages basis risk through asset selection and pricing. The unprecedented private label mortgage credit spreads have significantly reduced the Bank’s net market value.
 
Interest rate risk is the risk that relative and absolute changes in prevailing market interest rates may adversely affect an institution’s financial performance or condition. Interest rate risk arises from a variety of sources, including repricing risk, yield curve risk and options risk. The Bank invests in mortgage assets, such as MPF Program mortgage loans and MBS, which together represent the primary source of option risk. As of March 31, 2010, mortgage assets totaled 23.0% of the Bank’s balance sheet. Management reviews the estimated market risk of the entire portfolio of mortgage assets and related funding and hedges on a monthly basis to assess the need for rebalancing strategies. These rebalancing strategies may include entering into new funding and hedging transactions, forgoing or modifying certain funding or hedging transactions normally executed with new mortgage purchases, or terminating certain funding and hedging transactions for the mortgage asset portfolio.
 
Earnings-at-Risk. The Bank employs an Earnings-at-Risk framework for certain mark-to-market positions, including economic hedges. This framework establishes a forward-looking, scenario-based exposure limit based on parallel rate shocks that would apply to any existing or proposed transaction that is marked to market through the income statement without an offsetting mark arising from a qualifying hedge relationship. Beginning in the fourth quarter of 2009, the rate shocks used to measure the Earnings-at-Risk Board-level metric were expanded to include flattening and steepening scenarios.
 
In February 2010, the Board updated the daily exposure limit to $2.4 million, compared to the previous limit of $2.5 million. The Bank’s Asset and Liability Committee (ALCO) has a more restrictive daily exposure operating guideline of $2.0 million. Throughout the first quarter of 2010, the daily forward-looking exposure was below the


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operating guidelines of $2.0 million and at March 31, 2010 measured $472 thousand. The Bank’s Capital Markets and Corporate Risk Management departments also monitor actual profit/loss change on a daily, monthly cumulative, and quarterly cumulative basis.
 
Quantitative Disclosures Regarding Market Risk
 
The Bank’s Market Risk Model. Significant resources, both in analytical computer models and staff, are devoted to assuring that the level of interest rate risk in the balance sheet is accurately measured, thus allowing management to monitor the risk against policy and regulatory limits. The Bank uses an externally developed market risk model to evaluate its financial position. Management regularly reviews the major assumptions and methodologies used in the model, as well as available upgrades to the model. One of the most critical market-based model assumptions relates to the prepayment of principal on mortgage-related instruments, which was upgraded in 2009 and the first quarter of 2010 to more accurately reflect expected prepayment behavior.
 
In recognition of the importance of the accuracy and reliability of the valuation of financial instruments, management engages in an ongoing internal review of model valuations for various instruments. These valuations are evaluated on a quarterly basis to confirm the reasonableness of the valuations. The Bank regularly validates the models used to generate fair values. The verification and validation procedures depend on the nature of the instrument and valuation methodology being reviewed and may include comparisons with observed trades or other sources and independent verification of key model inputs. Results of the quarterly verification process, as well as any changes in valuation methodologies, are reported to ALCO, which is responsible for reviewing and approving the approaches used in the valuation to ensure that they are well controlled and effective, and result in reasonable fair values.
 
The duration of equity, return volatility and market value of equity volatility metrics were historically the direct primary metrics used by the Bank to manage its interest rate risk exposure. As discussed above, in first quarter 2010 the Bank re-evaluated its risk appetite, which included review and, when necessary, revisions and/or replacements of the primary market risk metrics. As a result, the return volatility metric was renamed as the Earned Dividend Spread (EDS) Floor and a new key risk indicator, EDS Volatility, was established. The Bank’s asset/liability management policies specify acceptable ranges for duration of equity, EDS Floor and EDS Volatility, and the Bank’s exposures are measured and managed against these limits. These metrics are described in more detail below.
 
Duration of Equity. One key risk metric used by the Bank, and which is commonly used throughout the financial services industry, is duration. Duration is a measure of the sensitivity of a financial instrument’s value, or the value of a portfolio of instruments, to a parallel shift in interest rates. Duration (typically measured in months or years) is commonly used by investors throughout the fixed income securities market as a measure of financial instrument price sensitivity. Longer duration instruments generally exhibit greater price sensitivity to changes in market interest rates than shorter duration instruments. For example, the value of an instrument with a duration of five years is expected to change by approximately 5% in response to a one percentage point change in interest rates. Duration of equity, an extension of this conceptual framework, is a measure designed to capture the potential for the market value of the Bank’s equity base to change with movements in market interest rates. Higher duration numbers, whether positive or negative, indicate a greater potential exposure of market value of equity in response to changing interest rates.
 
The Bank’s asset/liability management policy approved by the Board calls for duration of equity to be maintained within a + 4.5 year range in the base case. In addition, the duration of equity exposure limit in an instantaneous parallel interest rate shock of + 200 basis points is + 7 years. Management analyzes the duration of equity exposure against this policy limit on a daily basis and continually evaluates its market risk management strategies. In connection with the Alternative Risk Profile discussed above, management requested and was initially approved to use the alternate calculation of duration of equity for monitoring against established limits in 2008. This approval was extended for 2009 through December 31, 2010.


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The following table presents the Bank’s duration of equity exposure in accordance with the actual and Alternative Risk Profile duration of equity calculation by quarter.
 
                               
      Base
    Up 100
    Up 200
(in years)     Case     basis points     basis points
Alternative duration of equity
                             
                               
March 31, 2010
      1.8         3.8         4.5  
                               
December 31, 2009
      1.1         2.4         2.9  
                               
September 30, 2009
      0.2         2.2         2.8  
                               
June 30, 2009
      2.3         3.2         3.3  
                               
March 31, 2009
      (2.7 )       0.2         1.1  
                               
                               
                               
Actual duration of equity
                             
                               
March 31, 2010
      7.7         7.0         6.0  
                               
December 31, 2009
      11.6         7.5         4.7  
                               
September 30, 2009
      15.3         10.5         6.2  
                               
June 30, 2009
      22.1         11.7         6.2  
                               
March 31, 2009
      13.9         2.2         (2.2 )
                               
Note: Given the low level of interest rates, an instantaneous parallel interest rate shock of “down 200 basis points” and “down 100 basis points” cannot be meaningfully measured for these periods and therefore is not presented.
 
Private label MBS spreads widened significantly throughout 2008, causing a substantial decline in the market value of equity. The Bank’s low market value of equity has the effect of amplifying the actual reported duration of equity metric, As a result, the Bank was substantially out of compliance with the actual reported duration of equity throughout 2009 and the first quarter of 2010. However, under the Alternative Risk Profile, the Bank was in compliance with the duration of equity policy metric for all periods presented.
 
During first quarter 2010, increases in the Alternative duration of equity were primarily a result of prepayment model changes made during the quarter, which more accurately reflect actual prepayment levels and the impact of fixed rate debt calls. The resulting extension in duration was partially offset by the impact of lower longer term interest rates as well as fixed rate debt issued during the quarter.
 
The Bank continues to monitor the mortgage and related fixed income markets and the impact that changes in the market may have on duration of equity and other market risk measures and may take actions to reduce market risk exposures as needed. Management believes that the Bank’s current market risk profile is reasonable given these market conditions.
 
Earned Dividend Spread (EDS). The Bank’s asset/liability management policy previously specified a Return Volatility metric, which is based on an earned dividend spread (EDS). EDS is defined as the Bank’s return on average capital stock in excess of the average return of an established benchmark market index, the 3-month LIBOR in the Bank’s case, for the period measured. EDS measures the Bank’s forecasted level of earned dividend spread in response to shifts in interest rates and reflects the Bank’s ability to provide a minimum return on investment to its members in the short term compared to the benchmark. Consistent with the Return Volatility metric, EDS is measured over both a rolling forward one to 12 month time period (Year 1) and a 13 to 24 month time period (Year 2), for selected interest rate scenarios.
 
As previously discussed, during first quarter 2010 the Board and management re-evaluated the Bank’s risk appetite and the related risk metrics used to manage the Bank’s risk, including the Return Volatility metric. As a result, the Return Volatility metric was renamed the EDS Floor. In addition, a new key risk indicator, EDS Volatility, was established. The EDS Floor represents the minimum acceptable return under the selected interest rate scenarios, for both Year 1 and Year 2. For both Years 1 and 2, the EDS Floor is 3-month LIBOR plus 15 basis points. EDS Volatility is a measure of the variability of the Bank’s EDS in response to shifts in interest rates, specifically the change in EDS for a given time period and interest rate scenario compared to the current base forecasted EDS. EDS Volatility is also measured for both Year 1 and Year 2 and reflects the Bank’s ability to provide


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a somewhat stable EDS in the short-term. As a new measure, a limit on EDS Volatility has been established initially for Year 1; a limit for Year 2 will be evaluated in the future. Both the EDS Floor and EDS Volatility will be assessed on a monthly basis.
 
The following table presents the Bank’s EDS and EDS Volatility for the first quarter of 2010 as well as the four quarters of 2009. These metrics are presented as spreads over 3-month LIBOR. The steeper and flatter yield curve shift scenarios shown below are represented by appropriate increases and decreases in short-term and long-term interest rates using the three-year point on the yield curve as the pivot point. Given the current low rate environment, management replaced the “down 200 basis points parallel” rate scenario during the fourth quarter of 2009 with an additional non-parallel rate scenario that reflects a decline in longer term rates. The Bank was in compliance with the EDS Floor and EDS Volatility limit across all selected interest rate shock scenarios as of March 31, 2010.
 
                                                                                           
      Earned Dividend Spread
      Yield Curve Shifts (1)
      (expressed in basis points)
      Down 100 bps
                                         
      Longer Term Rate
                Forward
                Up 200 bps Parallel
      Shock     100 bps Steeper     Rates     100 bps Flatter     Shock
      EDS     Volatility     EDS     Volatility     EDS     EDS     Volatility     EDS     Volatility
Year 1 Return Volatility
                                                                                         
                                                                                           
March 31, 2010
      199         (37 )       254         18         236         221         (15 )       223         (13 )
                                                                                           
December 31, 2009
      187         (61 )       256         8         248         208         (40 )       211         (37 )
                                                                                           
September 30, 2009
      (2 )       (2 )       235         11         224         160         (64 )       146         (78 )
                                                                                           
June 30, 2009
      (2 )       (2 )       284         81         203         128         (75 )       87         (116 )
                                                                                           
March 31, 2009
      (2 )       (2 )       235         87         148         63         (85 )       79         (69 )
                                                                                           
                                                                                           
                                                                                           
Year 2 Return Volatility
                                                                                         
                                                                                           
March 31, 2010
      134         (71 )       227         22         205         186         (19 )       169         (36 )
                                                                                           
December 31, 2009
      137         (76 )       220         7         213         179         (34 )       160         (53 )
                                                                                           
September 30, 2009
      (2 )       (2 )       192         9         183         139         (44 )       135         (48 )
                                                                                           
June 30, 2009
      (2 )       (2 )       216         37         179         121         (58 )       103         (76 )
                                                                                           
March 31, 2009
      (2 )       (2 )       235         74         161         104         (57 )       99         (62 )
                                                                                           
Notes:
 
(1) Based on forecasted adjusted earnings, which exclude future potential OTTI charges which could be material, so that earnings  movement related to interest rate changes can be isolated.
(2) As noted above, previously the Bank utilized the “down 200 basis points” scenario for measuring compliance; however, due to  the low level of interest rates, an instantaneous parallel interest rate shock of that magnitude could not be meaningfully  measured for those periods presented above. Beginning in fourth quarter 2009, the Bank replaced that scenario with a  “down 100 basis points longer term rate shock” scenario, as presented above. This new scenario was not applicable  for periods prior to December 31, 2009, and therefore, those periods are not presented in the table.
 
During the first quarter of 2010, the primary cause for the decline in base case EDS (forward rates) was lower projected advance borrowings, down approximately $6 billion and $11 billion, respectively, for Year 1 and Year 2 relative to the forecasted levels during the fourth quarter of 2009. Lower forward rates and significantly slower mortgage prepayment projections from the prepayment model change noted above tempered this effect. The reduction in EDS volatility across the rate scenarios was primarily the result of less projected sensitivity of mortgage prepayments to rate changes and issuance of fixed-rate debt during the current quarter to reduce exposure to rising interest rates.
 
Credit and Counterparty Risk
 
Credit risk is the risk that the market value of an obligation will decline as a result of deterioration in the obligor’s creditworthiness. Credit risk arises when Bank funds are extended, committed, invested or otherwise exposed through actual or implied contractual agreements. The Bank faces credit risk on member and housing associate loans, letters of credit, and other credit product exposure; investments; mortgage loans; Banking On Business loans; and derivatives. The financial condition of Bank members and all investment, mortgage loan and


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derivative counterparties is monitored to ensure that the Bank’s financial exposure to each member/counterparty is in compliance with the Bank’s credit policies and Finance Agency regulations. Unsecured credit exposure to any counterparty is generally limited by the credit quality and capital level of the counterparty and by the capital level of the Bank. Financial monitoring reports evaluating each member/counterparty’s financial condition are produced and reviewed by the Bank’s Credit Risk Management department on an annual basis or more often if circumstances warrant. In general, credit risk is measured through consideration of the probability of default, the exposure at the time of default and the loss-given default. The expected loss for a given credit is determined by the product of these three components. The Board has established appropriate policies and limits regarding counterparty and investment credit risk, asset classification and the allowance for credit losses.
 
Credit and Counterparty Risk – Total Credit Products and Collateral
 
Total Credit Products. The Bank manages the credit risk on a member’s exposure on Total Credit Products (TCP), which includes advances, letters of credit, advance commitments, MPF credit enhancement obligations and other credit product exposure by monitoring the financial condition of borrowers and by requiring all borrowers (and, where applicable in connection with member affiliate pledge arrangements approved by the Bank, their affiliates) to pledge sufficient eligible collateral for all member indebtedness. The Bank establishes a maximum borrowing capacity for each member based on collateral weightings applied to qualifying collateral as described in the Bank’s Member Products Policy. Details regarding this Policy are available in the “Loan Products” discussion in Item 1. Business in the Bank’s 2009 Annual Report filed on Form 10-K.
 
Management believes that it has adequate policies and procedures in place to effectively manage credit risk related to member loans and letters of credit. These credit and collateral policies balance the Bank’s dual goals of meeting members’ needs as a reliable source of liquidity and limiting credit loss by adjusting the credit and collateral terms in response to deterioration in creditworthiness. The Bank has never experienced a credit loss on an advance or letter of credit.
 
Advance Concentration Risk. The Bank’s advance portfolio is concentrated in commercial banks and thrift institutions. At March 31, 2010, the Bank had a concentration of advances to its ten largest borrowers totaling $25.4 billion, or 71.6%, of total advances outstanding. Average par balances to these borrowers for the three months ended March 31, 2010 were $28.0 billion, or 72.5%, of total average advances outstanding. During the first quarter of 2010, the maximum outstanding balance to any one borrower was $12.4 billion. The advances made by the Bank to these borrowers are secured by collateral with an estimated value, after collateral weightings, in excess of the book value of the advances. Therefore, the Bank does not presently expect to incur any losses on these advances. Because of the Bank’s advance concentrations, the Bank has implemented specific credit and collateral review procedures for these members. In addition, the Bank analyzes the implication for its financial management and profitability if it were to lose one or more of these members.


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The following table lists the Bank’s top ten borrowers as of March 31, 2010, and their respective December 31, 2009 advance balances and percentage of the total advance portfolio.
 
                                   
      March 31, 2010   December 31, 2009
      Loan
  Percent
  Loan
  Percent
 (balances at par; dollars in millions)     Balance   of total   Balance   of total
Sovereign Bank, PA
    $ 10,345.0       29.2     $ 11,595.0       29.2  
Ally Bank, UT(1)
      4,816.0       13.6       5,133.0       12.9  
PNC Bank, National Association, PA
      4,000.4       11.3       4,500.4       11.3  
ING Bank, FSB, DE(2)
      1,563.0       4.4       2,563.0       6.4  
Citizens Bank of Pennsylvania, PA
      1,130.0       3.2       1,605.0       4.1  
Northwest Savings Bank, PA
      780.7       2.2       782.2       2.0  
National Penn Bank, PA
      740.1       2.1       752.8       1.9  
First Commonwealth Bank
      738.1       2.1       286.9       0.7  
Susquehanna Bank, PA
      644.3       1.8       769.3       1.9  
Wilmington Savings Fund Society FSB, DE
      615.5       1.7       613.1       1.5  
                                   
        25,373.1       71.6       28,600.7       71.9  
Other borrowers
      10,049.8       28.4       11,155.3       28.1  
 
Total advances
    $ 35,422.9       100.0     $ 39,756.0       100.0  
                                   
                                   
Notes:
 
(1) Formerly known as GMAC Bank. For Bank membership purposes, principal place of business is Horsham, PA.
(2) This borrower had an officer or director who served on the Bank’s Board as of March 31, 2010.
 
Over the last 18 months, there were several actions taken by the U.S. Treasury, the Federal Reserve and the FDIC that were intended to stimulate the economy and reverse the illiquidity in the credit and housing markets. Additionally, the Federal Reserve took a series of unprecedented actions that made it more attractive for eligible financial institutions to borrow directly from the FRBs. The Federal Reserve also created the Commercial Paper Funding Facility to provide a liquidity backstop for U.S. issuers of commercial paper and the FDIC created its TLGP supporting unsecured debt. Lastly, the FDIC recently approved a regulation increasing the FDIC assessment on FDIC-insured financial institutions with outstanding FHLBank loans and other secured liabilities above a specified level. The Bank experienced an impact from these actions in the form of reduced borrowings and/or paydowns by some of its members, including several of its top ten borrowers, during 2009 and into 2010.
 
Letters of Credit. The following table presents the Bank’s total outstanding letters of credit as of March 31, 2010 and December 31, 2009. As noted below, the majority of the balance was due to public unit deposit letters of credit, which collateralize public unit deposits. The letter of credit product is collateralized under the same procedures and guidelines that apply to advances. There has never been a draw on these letters of credit.
 
                 
    March 31,
   
(dollars in millions)   2010   December 31, 2009
Letters of credit:
               
Public unit deposit
  $ 7,490.5     $ 8,220.0  
Tax exempt bonds
    392.6       392.6  
Other
    115.1       114.8  
                 
Total
  $ 7,998.2     $ 8,727.4  
                 
                 


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The following table presents letters of credit based on expiration terms.
 
                 
    March 31,
   
(dollars in millions)   2010   December 31, 2009
Expiration terms:
               
One year or less
  $ 6,885.1     $ 7,478.8  
After one year through five years
    1,113.1       1,248.6  
                 
Total
  $ 7,998.2     $ 8,727.4  
                 
                 
 
Collateral Policies and Practices. All members are required to maintain collateral to secure their TCP. TCP outstanding includes advances, letters of credit, advance commitments, MPF credit enhancement obligations and other obligations to the Bank. Collateral eligible to secure TCP includes: (1) one-to-four family and multifamily mortgage loans and securities representing an interest in such mortgages; (2) securities issued, insured or guaranteed by the U.S. government or any Federal agency; (3) cash or deposits held by the Bank; and (4) certain other collateral that is real estate-related, provided that the collateral has a readily ascertainable value and that the Bank can perfect a security interest in it. Residential mortgage loans are a significant form of collateral for TCP. The Bank perfects its security interest in loan collateral by completing a UCC-1 filing for each member and affiliate (where applicable) pledging loans and also depending on circumstances by taking possession directly or through a third party custodian. The Bank also requires each borrower and affiliate pledgor, where applicable, to execute an agreement that establishes the Bank’s security interest in all collateral pledged by the borrower or affiliate pledgor. Finally, as additional security for a member’s indebtedness, the Bank has a statutory and contractual lien on the member’s capital stock in the Bank.
 
The Bank provides members with two options regarding collateral agreements: a blanket collateral pledge agreement or a specific collateral pledge agreement. Under a blanket agreement, the Bank obtains a lien against all of the member’s unencumbered eligible collateral assets and most ineligible collateral assets, to secure the member’s obligations with the Bank. Under a specific agreement, the Bank obtains a lien against the specific eligible collateral assets of a member, to secure the member’s obligations with the Bank.
 
The Bank periodically reviews the collateral pledged by members or affiliates. This review process occurs quarterly, monthly or daily depending on the form of pledge and type of collateral. Additionally, the Bank conducts periodic collateral verification reviews to ensure the eligibility, adequacy and sufficiency of the collateral pledged. The Bank may, in its discretion, require the delivery of loan collateral at any time. The Bank reviews and assigns borrowing capacities to this collateral, taking into account the known credit attributes in assigning the appropriate secondary market discounts, and has determined that all member loans are fully collateralized. Other factors that the Bank may consider in assigning borrowing capacities to a member’s collateral include the pledging method for loans, data reporting frequency, collateral field review results, the member’s financial strength and condition, and the concentration of collateral type by member.
 
In 2009, the Bank revised its collateral policies, no longer accepting subprime mortgage loans as qualifying collateral. The Bank also revised the policy definition of subprime to be consistent with the definition specified by the Federal Financial Institutions Examination Council (FFIEC). The FFIEC definition was more stringent than the Bank’s original definition and resulted in more loans pledged/delivered as collateral being classified as subprime and, therefore, deemed ineligible. These changes did not cause any member to become collateral deficient. Under limited circumstances, the Bank still accepts nontraditional mortgage loans to be pledged as collateral. As of March 31, 2010, the Bank held security interests in both subprime and nontraditional residential mortgage loans pledged as collateral included under blanket-lien agreements. However, the amount of pledged subprime mortgage loan collateral was immaterial with respect to total pledged collateral at quarter-end. At March 31, 2010, less than 8.0% of the Bank’s total pledged collateral was nontraditional mortgage loans and was primarily attributed to a few larger borrowers. Given the higher inherent risk related to nontraditional mortgage loans, the Bank takes additional steps regarding the review and acceptance of these loans as collateral. Members are required to identify nontraditional mortgage loans; these loans are typically excluded as eligible collateral. However, members may request that nontraditional mortgage loan collateral be included as eligible collateral, subject to an on-site review of the loans, the member’s processes and procedures for originating and servicing the loans, the quality of loan data


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and a review of the member’s loan underwriting. The Bank requires specific loan level characteristic reporting on the loans and assigns more conservative collateral weightings to nontraditional mortgage loan collateral on a case-by-case basis. In addition, in October 2009, the Board implemented Bank-wide limits on subprime and nontraditional mortgage loan exposure, including collateral, as detailed in the “Risk Governance” discussion in the Risk Management section of Item 7. Management’s Discussion and Analysis in the Bank’s 2009 Annual Report filed on Form 10-K.
 
The Bank made several other changes to collateral practices and policies during 2009, including the following: (1) requiring securities to be delivered in order to be counted in the maximum borrowing capacity (MBC) calculation; (2) removing the ORERC cap on collateral weightings; (3) adjusting the total borrowing limit to be equal to the lower of MBC or 50% of a member’s total assets; and (4) making other collateral weighting changes. Details of the Bank’s current collateral weightings are presented in the Advance Products – Collateral discussion in Item 1. Business in the Bank’s 2009 Annual Report filed on Form 10-K.
 
Under implementation of the GLB Act, the Bank is allowed to expand eligible collateral for many of its members. Members that qualify as CFIs can pledge small-business, small-farm, and small-agribusiness loans as collateral for advances from the Bank. At March 31, 2010, advances to CFIs secured with both eligible standard and expanded collateral represented approximately $4.4 billion, or 12.3% of total par value of advances outstanding. Eligible expanded collateral represented 7.3% of total eligible collateral for these advances. However, these advances were collateralized by sufficient levels of non-CFI collateral. Beginning in July 2009, the Bank implemented the new CFI definition, as defined in the Housing Act.
 
As noted in Legislative and Regulatory Developments in this Item 2. Management’s Discussion and Analysis, the Finance Agency has issued an Advisory Bulletin providing guidance on nontraditional and subprime mortgage loans with respect to collateral. This Advisory Bulletin may have significant implications on the Bank’s acceptance of private label MBS and nontraditional residential mortgages as advance collateral. The Bank is completing a preliminary impact analysis on its members.
 
Collateral Agreements and Valuation. As discussed earlier, the Bank provides members with two options regarding collateral agreements: a blanket lien collateral pledge agreement and a specific collateral pledge agreement. Under a blanket lien agreement, the Bank obtains a lien against all of the member’s unencumbered eligible collateral assets and most ineligible collateral assets to secure the member’s obligations with the Bank. Under a specific collateral agreement, the Bank obtains a lien against a specific set of a member’s eligible collateral assets, to secure the member’s obligations with the Bank. The member provides a detailed listing, as an addendum to the agreement, identifying those assets pledged as collateral.


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Table of Contents

The following tables summarize total eligible collateral values, after collateral weighting, by type under both blanket lien and specific collateral pledge agreements as of March 31, 2010 and December 31, 2009. The Bank held collateral with an eligible collateral value in excess of the book value of the advances on a borrower-by-borrower basis at both March 31, 2010 and December 31, 2009. The amount of excess collateral by individual borrowers, however, varies significantly.
 
                                   
      March 31, 2010   December 31, 2009
(dollars in millions)
       
All member borrowers     Amount   Percent   Amount   Percent
One-to-four single family residential mortgage loans
    $ 62,259.1       50.3     $ 60,778.7       49.1  
High quality investment securities(1)
      4,631.3       3.7       3,574.4       2.9  
Other real-estate related collateral/community financial institution eligible collateral
      50,185.7       40.6       50,824.6       41.0  
Multi-family residential mortgage loans
      6,669.0       5.4       8,689.9       7.0  
                                   
Total eligible collateral value
    $ 123,745.1       100.0     $ 123,867.6       100.0  
                                   
                                   
Total TCP outstanding
    $ 43,579.1             $ 48,497.9          
Collateralization ratio (eligible collateral value to TCP outstanding)
      284.0 %             255.4 %        
                                   
 
                                   
      March 31, 2010   December 31, 2009
(dollars in millions)
       
Ten largest member borrowers     Amount   Percent   Amount   Percent
One-to-four single family residential mortgage loans
    $ 36,439.2       51.7     $ 34,410.8       48.9  
High quality investment securities(1)
      1,625.6       2.3       1,238.9       1.7  
Other real-estate related collateral
      27,114.6       38.5       27,417.5       39.0  
Multi-family residential mortgage loans
      5,281.6       7.5       7,288.8       10.4  
                                   
Total eligible collateral value
    $ 70,461.0       100.0     $ 70,356.0       100.0  
                                   
                                   
Total TCP outstanding
    $ 32,197.4             $ 36,356.4          
Collateralization ratio (eligible collateral value to TCP outstanding)
      218.8 %             193.5 %        
                                   
Note:
 
(1)High quality investment securities are defined as U.S. Treasury and U.S. agency securities, TLGP investments, GSE MBS and private label MBS with a credit rating of AA or higher. Effective July 20, 2009, the Bank required delivery of these securities. Upon delivery, these securities are valued daily and are subject to weekly ratings reviews.
 
The increases in the collateralization ratios during the first quarter of 2010, as shown above, were due primarily to the overall reductions in total TCP outstanding.
 
The following table provides information regarding TCP extended to member and nonmember borrowers with either a blanket lien or specific collateral pledge agreement, in listing-specific or full collateral delivery status as of March 31, 2010 and December 31, 2009, along with corresponding eligible collateral values.
 
                                                   
      March 31, 2010   December 31, 2009
      Number of
          Number of
       
      Eligible
      Collateral
  Eligible
      Collateral
(dollars in millions)     Borrowers   TCP   Held   Borrowers   TCP   Held
Listing-specific pledge-collateral
      9     $ 39.3     $ 46.8       8     $ 40.8     $ 63.7  
Full collateral delivery status
      65     $ 7,040.7     $ 9,480.3       56     $ 6,926.3     $ 9,077.3  
                                                   
                                                   
 
Of the nine eligible borrowers with listing-specific pledge-collateral agreements noted in the table above, two borrowers (one of which was a former member merged out of district with TCP still outstanding) had outstanding TCP at March 31, 2010. The TCP for these two borrowers, as noted above, totaled $39.3 million, less than 0.1% of the Bank’s total TCP, with related collateral of $46.8 million. Of the 65 eligible borrowers in full collateral delivery status noted in the table above, 45 had outstanding TCP at March 31, 2010. The TCP for these 45 borrowers, as noted above, totaled $7.0 billion, or 16.2% of the Bank’s total TCP, with $9.5 billion of related collateral. The Bank’s remaining 245 eligible borr