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EX-32.2 - EX-32.2 - Federal Home Loan Bank of Pittsburghfhlbpitex322q32010.htm
EX-32.1 - EX-32.1 - Federal Home Loan Bank of Pittsburghfhlbpitex321q32010.htm
EX-31.2 - EX-31.2 - Federal Home Loan Bank of Pittsburghfhlbpitex312q32010.htm
EX-31.1 - EX-31.1 - Federal Home Loan Bank of Pittsburghfhlbpitex311q32010.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
R
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 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.  S Yes  £ 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).  £ Yes £ 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):
 
£ Large accelerated filer
£ Accelerated filer
S Non-accelerated filer
£ Smaller reporting company  
 
 
(Do not check if smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). £ Yes  S No
 
There were 39,652,707 shares of common stock with a par value of $100 per share outstanding at October 29, 2010.
 

FEDERAL HOME LOAN BANK OF PITTSBURGH
 
TABLE OF CONTENTS
 
Part I - FINANCIAL INFORMATION
 
    Item 1: Financial Statements (unaudited)
 
    Notes to Financial Statements (unaudited)
 
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations
 
Risk Management
 
Item 3: Quantitative and Qualitative Disclosures about Market Risk
 
Item 4: Controls and Procedures
 
Part II - OTHER INFORMATION
 
Item 1: Legal Proceedings
 
Item 1A: Risk Factors
 
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
 
Item 3: Defaults upon Senior Securities
 
Item 4: (Removed and Reserved)
 
Item 5: Other Information
 
Item 6: Exhibits
 
Signature
 
 
 
 
 
 
 
 
 
 
 
 
 
 

i.

PART I – FINANCIAL INFORMATION
 
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
This Executive Summary should be read in conjunction with the Bank’s unaudited financial statements and footnotes to the financial statements in this quarterly report filed on the Form 10-Q as well as the Bank’s 2009 Annual Report filed on Form 10-K.
 
Executive Summary
 
Overview. The Bank's financial condition and results of operation are influenced by the interest rate environment, global and national economies, local economies within its three-state district, and the conditions in the financial, housing and credit markets.
 
The interest rate environment significantly impacts the Bank's profitability as 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. A portion of the Bank's advances have been hedged with interest-rate exchange agreements in which 3-month LIBOR is received. Short term interest rates also directly affect the Bank through earnings on invested capital. Finally, the Bank has a large percentage of mortgage-related assets on the balance sheet thus making it sensitive to mortgage rates. This interest rate environment impact has been negative as evidenced by the average 10-year Treasury yield declining 70 basis points in the third quarter 2010 from second quarter 2010, 3-month LIBOR decreasing 5 basis points in the same comparison and the continued low overnight Federal Funds rate. Generally, due to the Bank's cooperative structure, the Bank earns relatively narrow net spreads between yield on assets and the cost of corresponding liabilities.
 
The Bank expects its ability to have significant earnings on short term investments will be limited as the Federal Open Market Committee (FOMC) has indicated that they will maintain the target range for the Federal funds rate at 0.00 percent to 0.25 percent. It also anticipates that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the Federal funds rate for an extended period.
 
The following table presents key market interest rates for the periods indicated (obtained from Bloomberg L.P.).
 
 
3rd 
Quarter
2010 Average
2nd 
Quarter
2010 Average
3rd Quarter
2009
 Average
Average Year-to-Date
2010
Average Year-to-Date
2009
3rd 
Quarter
2010
Ended
2nd 
Quarter
2010
Ended
3rd Quarter
2009
 Ended
 
 
 
 
 
 
 
 
 
Target overnight Federal
 funds rate
0.25
%
0.25
%
0.25
%
0.25
%
0.25
%
0.25
%
0.25
%
0.25
%
3-month LIBOR(1)
0.39
%
0.44
%
0.41
%
0.36
%
0.83
%
0.29
%
0.53
%
0.29
%
2-yr U.S. Treasury
0.53
%
0.86
%
1.01
%
0.76
%
0.97
%
0.43
%
0.61
%
0.95
%
5-yr. U.S. Treasury
1.54
%
2.24
%
2.45
%
2.06
%
2.15
%
1.27
%
1.78
%
2.32
%
10-yr. U.S. Treasury
2.77
%
3.47
%
3.50
%
3.31
%
3.17
%
2.51
%
2.93
%
3.31
%
15-yr. mortgage current
 coupon(2)
2.75
%
3.40
%
3.82
%
3.23
%
3.80
%
2.66
%
3.00
%
3.57
%
30-yr. mortgage current
 coupon(2)
3.54
%
4.23
%
4.50
%
4.05
%
4.31
%
3.41
%
3.76
%
4.26
%
Notes:
(1)LIBOR - London Interbank Offered Rate
(2)Simple average of Fannie Mae and Freddie Mac MBS current coupon rates.
 
Business spending on equipment and software has continued to rise, though less rapidly than earlier in the year. Financial institution lending continues to be weak and small businesses remain reluctant to add to payrolls due to concerns about the strength of the economic recovery. Commercial real estate activity has also been restrained by high vacancy rates, low property prices, and strained credit conditions. The financial markets have reflected this uncertainty, as both equity and fixed income markets have experienced volatility. The sovereign debt crisis in Europe sparked a flight to quality during the second quarter, as investors questioned the stability of the European Union. This trend continued into third quarter 2010.
 

1

Although housing starts hit a five-month high in September 2010, overall housing starts and existing home sales continue to run at low levels, due in part to the expiration of the U.S. tax credits offered to home buyers. This temporary program, as well as others, served to support the housing market and stabilize prices in the first half of 2010, yet concern remains due to a large inventory of distressed or vacant existing houses and by the difficulties of many builders in obtaining credit. Delinquency and foreclosure rates continue to run at high levels. Jobless claims remain high and unemployment has stalled at just under 10 percent for the last nine months. As a result, consumer confidence is lacking and many individuals were unable to take advantage of the historically low mortgage rates that have been available.
 
The labor market has been hit particularly hard by the recession. Private sector job growth has remained weak. It is likely that it will take a significant amount of time to restore the nearly 8.5 million jobs that were lost during the recession and unemployment is expected to remain high into at least 2011.
 
The Bank's members' demand for advances has continued to decline based on the factors described above. Additionally, members have deposit levels that permit them to use that funding for the loan demand that they have, which also decreases demand for Bank advances. As an example of the volatility in advance demand, during the height of the credit crisis in September 2008 when the FHLBanks continued to provide funding to its members, the Bank's advances were $72 billion. However, now that the credit crisis has eased and the members have excess deposits, the demand for advances has declined to $31.6 billion at September 30, 2010.
 
Results of Operations. The overall economic conditions discussed above have significantly impacted the Bank in terms of advance volume and credit losses on its private label mortgage-backed securities (MBS). Those items are discussed below along with other items which significantly impacted the Bank.
 
During the three months ended September 30, 2010, the Bank recorded net income of $45.1 million. For the nine months ended September 30, 2010, the Bank recorded a net loss of $13.2 million.
 
The third quarter and year-to-date September 2010 results were impacted by other-than-temporary impairment (OTTI) credit losses taken on the Bank's private label MBS portfolio. The Bank recorded $7.0 million and $145.3 million of OTTI credit losses during the third quarter and first nine months of 2010, respectively.
 
Deterioration in the mortgage market started in the subprime sector and then moved into the Alt-A sector, which includes borrowers who have characteristics of both subprime and prime borrowers. The Bank was not significantly impacted by the deterioration in the subprime market, as there was very little subprime private-label MBS in its portfolio. As the deterioration moved in into the Alt-A sector, the Bank experienced more significant OTTI credit charges. The Bank has experienced Alt-A OTTI credit charges life-to-date of $173.6 million. The majority of the Bank's private label MBS portfolio is prime. Deterioration in the investment portfolio has now moved into the prime sector. These borrowers are not only under stress from the global economic forces noted above, but some of them may also be making strategic default decisions. Strategic default occurs when borrowers who can afford to make their mortgage payments choose not to because their home value is “underwater” with respect to the mortgage loan balance outstanding. High levels of inventories of unsold properties further pressure housing prices. The Bank has experienced prime OTTI credit charges life to date of $203.0 million.
 
The OTTI credit losses reflect the impact of projected credit losses on loan collateral underlying certain private label MBS in the Bank's portfolio. The credit loss is the difference between the amortized cost and the present value of the estimated cash flows the Bank expects to realize on the investments over their life. The modeling of credit losses on private label MBS is relatively new to the financial industry and continues to evolve. The FHLBank System works to ensure consistency in the determination and measurement of OTTI for investment securities among the FHLBanks. All FHLBanks use the same systems and key modeling assumptions for purposes of cash flow analyses for measurement of OTTI. The creation of a System-wide OTTI Governance Committee, which is responsible for reviewing and approving key modeling assumptions, ensures consistent application of assumptions across all FHLBanks. These assumptions are for the life of the underlying loan collateral and are adjusted quarterly based on actual performance and future expectations. These assumptions include: (1) default frequency, which is based on who will default and is affected by local and national economic conditions; (2) loss severities, which reflects the expected severity of the loss incurred upon selling the home which varies by geographic location and servicer foreclosure practices; (3) changes in housing prices in varying regions of the country; and (4) prepayment assumptions on the underlying collateral.
 
The second quarter 2010 process resulted in more pessimistic input assumptions due to current and forecasted economic trends affecting the collateral of the private label MBS, including high unemployment, pressured housing prices, limited refinancing opportunities and the increase in current and projected future defaults. A large portion of the Bank's private label MBS portfolio is in the 2006 and 2007 vintages, which have experienced the greatest performance deterioration and price decline. The third quarter 2010 assumptions were consistent with the second quarter and there was not significant further deterioration in the

2

performance of the underlying loan collateral on the securities. Therefore, OTTI credit losses had a less dramatic impact on the Bank's financial results.
 
Many factors could influence the future modeling assumptions including economic, financial market and housing conditions. In addition, the recent decision by certain financial institutions to temporarily halt foreclosures until certain legal issues surrounding the foreclosure process are resolved is another factor that may affect future assumptions and results. Certain institutions recently announced that they have restarted foreclosure proceedings. If performance of the underlying loan collateral deteriorates further and/or the Bank's modeling assumptions become more pessimistic, the Bank could experience further losses on the portfolio. At the present time, the Bank cannot estimate the future amount of any additional OTTI charges.
 
Net interest income was $50.6 million and $168.7 million for the third quarter and first nine months of 2010, respectively, declining from the corresponding prior year periods. These decreases were primarily due to the decline in both interest rates and volumes or size of the balance sheet. The net interest margin for the nine months ended September 30, 2010, however, did improve 3 basis points to 37 basis points, due primarily to improved funding costs versus yields earned on interest-earning assets.
 
Financial Condition. Advances. The Bank's advance portfolio declined 23.3 percent from December 31, 2009 to September 30, 2010. Demand for advances has decreased as members have reduced their balance sheets and experienced high levels of retail deposits relative to historical levels. Although the advance portfolio has declined, its average life has been extended as certain members have replaced their short-term advances with long-term advances; this is evidenced in the swing of short-term advance balances from year-end. At September 30, 2010, only 38.6 percent of the par value of loans in the portfolio had a remaining maturity of one year or less, compared to 47.7 percent at December 31, 2009. A large portion of these types of short-term advances have historically been rolled over upon maturity.
 
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) member reaction to the Bank's voluntary decision to temporarily suspend dividend payments and excess capital stock repurchases; (4) the Bank's liquidity position and how management chooses to fund the Bank; (5) current, as well as future, credit market conditions; (6) housing market trends; and (7) the shape of the yield curve. In the current market environment, the Bank believes that there may be an increased probability of extensions in maturities of members' advances as well as higher levels of advance prepayment activity.
 
During the first nine months of 2010, 127 Federal Deposit Insurance Corporation (FDIC)-insured institutions have failed, None of the FHLBanks have incurred any losses on advances outstanding to these institutions. Additionally, none of the failed institutions during 2010 was a member of the Bank.
 
Investments. At September 30, 2010, the Bank held $18.3 billion of total investment securities, including trading, available-for-sale and held-to-maturity securities as well as interest-bearing deposits and Federal funds sold. This total included $4.9 billion of private label MBS, of which $2.2 billion was "investment grade" and $2.7 billion was "below investment grade." The majority of the deterioration between "investment grade" and "below investment grade" occurred in the first nine months of 2009. However, since then there has been stabilization between "investment grade" and "below investment grade." There has been continued deterioration in the below investment grade category area; specifically, there has been a significant increase in bonds being downgraded from CCC to CC. On a positive note, the Bank has continued to see some improvement in the fair value, or price, of its private label MBS portfolio since the low point at the end of 2008. However, prices can appreciate or depreciate for many reasons; the Bank is unable to predict where prices on these investments may go in the future. The overall balance of the par value of the private label MBS continues to decline, primarily due to paydowns.
 
Consolidated Obligations of the FHLBanks. The Bank's ability to operate its business, meet its obligations and generate net interest income depends primarily on the ability to issue large amounts of various debt structures at attractive rates. During the first quarter of 2010, the Bank experienced an increase in its cost of funds, with rates hitting a peak at the end of March. This increase occurred in conjunction with the announcement from Fannie Mae and Freddie Mac of plans to purchase 120 days plus delinquent mortgage loans, which would require both to issue additional debt to raise funds for these purchases. Following the spike, debt costs were relatively stable until late May, when costs fell due to the impact of the European debt crisis and investors' desire for more stable, high-quality investments.
 
FHLBank System outstanding debt balances continued to contract during the third quarter of 2010, although month-over-month, the pace of decline slowed. Consolidated obligations outstanding fell slightly more than $40 billion during third quarter 2010, driven by a decline of approximately $43 billion in consolidated obligation bonds, partially offset by an increase of approximately $3 billion in consolidated discount notes. The decline in consolidated bonds outstanding may be attributed in part to significant consolidated bond redemptions during the third quarter of 2010; consolidated bond maturities were $56 billion and consolidated bond calls were $103 billion during the current quarter.

3

 
The Bank's total consolidated obligations declined $10.7 billion, or 18.0 percent, since year-end 2009. Discount notes increased $2.0 billion, or 20.0 percent, from December 31, 2009 to September 30, 2010 and accounted for 25.2 percent and 17.2 percent of the Bank's total consolidated obligations at September 30, 2010 and December 31, 2009, respectively. Total bonds decreased $12.7 billion, or 25.9 percent, from December 31, 2009 to September 30, 2010, and comprised a smaller percentage of the total debt portfolio, decreasing from 82.8 percent at December 31, 2009 to 74.8 percent at September 30, 2010.
 
Capital Position and Regulatory Requirements. Retained earnings at September 30, 2010 were $375.8 million, down $13.2 million from year-end 2009 due to the year-to-date 2010 net loss. Accumulated other comprehensive income (loss) (AOCI) related to the noncredit portion of OTTI losses on available-for-sale securities improved from $(691.5) million at December 31, 2009 to $(257.4) million at September 30, 2010 due to paydowns in the private label MBS portfolio, certain OTTI noncredit losses being reclassified as credit losses, and price appreciation.
 
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. This plan has been accepted by the Finance Agency and the Bank was deemed "adequately capitalized" as of June 30, 2010. In its determination, the Finance Agency expressed concerns regarding the Bank's capital position and earnings prospects. The Finance Agency believes that the Bank's retained earnings levels are insufficient and the poor quality of its private label MBS portfolio has created uncertainties about its ability to maintain sufficient capital. The Finance Agency continues to monitor the Bank's capital adequacy. As provided for under the Finance Agency's final rule on FHLBank capital classification and critical capital levels, the Director of the Finance Agency has discretion to reclassify the Bank's capital classification even if the Bank meets or exceeds the regulatory requirements established. As of the date of this filing, the Bank has not received final notice from the Finance Agency regarding its capital classification for the quarter ended September 30, 2010. The Bank exceeded its risk-based, total and leverage capital requirements at September 30, 2010.
 
Effective July 1, 2010, changes to the Bank's Capital Plan were implemented. The amended Capital Plan replaced the unused borrowing capacity membership stock purchase requirement with an annual Membership Asset Value (MAV) stock purchase requirement. This calculation is not affected by the amount the member borrows from the Bank. All members will be required to fully transition to the amended Capital Plan by the first MAV re-calculation date of April 10, 2011.
 
Beginning in first quarter 2010, the Bank began measuring capital adequacy with a key risk indicator - Market Value of Equity to Par Value of Common Stock (MV/CS). This metric provides a current assessment of the fair value of the Bank's assets less liabilities on a liquidation basis compared to the par value of the capital stock. The term liquidation basis is used because this calculation assumes no intangibles or going-concern value. An initial floor of 85 percent was established by the Board of Directors, representing the estimated level from which the MV/CS would recover to par through the retention of earnings over the 5-year redemption period of the Bank's capital stock. When MV/CS is below the established floor, excess capital repurchases and dividend payouts are required to be restricted.
 
Because the MV/CS ratio was above 85 percent at September 30, 2010, the Bank performed additional analysis of the adequacy of retained earnings taking into consideration the impact of excess capital stock repurchases and/or dividend payouts. As a result of this analysis, the Bank repurchased approximately $200 million in excess capital stock on October 29, 2010. The amount of excess capital stock repurchased from any member was the lesser of 5 percent of the member's total capital stock outstanding or its excess capital stock outstanding through October 28, 2010. Decisions regarding any future repurchases of excess capital stock will be made on a quarterly basis. The Bank will continue to monitor the condition of its private label MBS portfolio, its overall financial performance and retained earnings, developments in the mortgage and credit markets and other relevant information as the basis for determining the status of dividends and excess capital stock repurchases in future quarters.
 
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 2009 or in the first nine months of 2010. Retained earnings were $375.8 million as of September 30, 2010, compared to $389.0 million at December 31, 2009.
 

4

Financial Highlights
 
The Statement of Operations data for the three and nine months ended September 30, 2010 and the Condensed Statement of Condition data as of September 30, 2010 are unaudited and were derived from the financial statements included in the quarterly report filed on this Form 10-Q. The Statement of Operations and Condensed Statement of Condition data for all other interim quarterly periods, as well as the Statement of Operations data for the nine months ended September 30, 2009, is unaudited and was derived from the applicable quarterly reports filed on 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.
Statement of Operations
 
 
For the Three Months Ended
 
(in millions, except per share data)
September 30,
2010
June 30,
2010
March 31, 2010
December 31,
2009
September 30, 2009
Net interest income before provision (benefit)
 for credit losses
$
50.6
 
$
59.1
 
$
59.0
 
$
64.2
 
$
67.5
 
Provision (benefit) for credit losses
(1.3
)
(1.3
)
(0.1
)
(5.5
)
1.4
 
Other income (loss):
 
 
 
 
 
 Net OTTI losses(1)
(7.0
)
(110.7
)
(27.6
)
(65.4
)
(93.3
)
 Net gains (losses) on derivatives and
 hedging activities
4.9
 
(8.0
)
(4.6
)
 
5.3
(4.5
)
 Net realized gains (losses) on available-
   for-sale securities
8.4
 
(0.1
)
 
(2.2
)
 
 Net realized gains on held-to-maturity
 securities
 
 
 
1.8
 
 
 All other income
2.7
 
1.8
 
2.7
 
2.9
 
4.5
 
Total other income (loss)
9.0
 
(117.0
)
(29.5
)
(57.6
)
(93.3
)
Other expense
15.8
 
15.1
 
16.2
 
17.6
 
16.2
 
Income (loss) before assessments
45.1
 
(71.7
)
13.4
 
(5.5
)
(43.4
)
Assessments (2)
 
(3.5
)
3.5
 
 
(3.0
)
Net income (loss)
$
45.1
 
$
(68.2
)
$
9.9
 
$
(5.5
)
$
(40.4
)
Earnings (loss) per share(3)
$
1.11
 
$
(1.70
)
$
0.25
 
$
(0.14
)
$
(1.01
)
Dividends(4)
 
 
 
 
 
Return on average equity
4.39
%
(7.01
)%
1.07
%
(0.61
)%
(4.39
)%
Return on average assets
0.31
%
(0.45
)%
0.06
%
(0.03
)%
(0.23
)%
Net interest margin(5)
0.35
%
0.39
 %
0.37
%
0.38
 %
0.38
 %
Regulatory capital ratio (6)
8.27
%
7.22
 %
7.57
%
6.76
 %
6.64
 %
Total capital ratio (at period-end)(7)
7.73
%
6.54
 %
6.54
%
5.69
 %
5.36
 %
Total average equity to average assets
7.01
%
6.38
 %
5.88
%
5.45
 %
5.17
 %
Notes:
(1)Represents the credit-related portion of OTTI losses on private label MBS portfolio.
(2)Includes REFCORP and Affordable Housing Programs (AHP) assessments
(3) Earnings (loss) per share calculated based on net income (loss).
(4)The Bank has temporarily suspended dividend payments, effective December 2008.
(5)Net interest margin is net interest income before provision (benefit) for credit losses as a percentage of average interest-earning assets.
(6)Regulatory capital ratio is the sum 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.
(7)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.
 

5

 
 
For the Nine Months Ended
 
(in millions, except per share data)
September 30,
2010
September 30, 2009
Net interest income before provision (benefit)
 for credit losses
$
168.7
 
$
199.8
 
Provision (benefit) for credit losses
(2.7
)
2.9
 
Other income (loss):
 
 
 Net OTTI losses(1)
(145.3
)
(163.1
)
 Net gains (losses) on derivatives and
 hedging activities
(7.7
)
 
6.7
 Net realized gains on available-for-sale securities
8.3
 
 
 Contingency reserve
 
(35.3
)
 All other income
7.2
 
9.6
 
Total other losses
(137.5
)
(182.1
)
Other expense
47.1
 
46.7
 
Income (loss) before assessments
(13.2
)
(31.9
)
Assessments (2)
 
-
 
Net loss
$
(13.2
)
$
(31.9
)
Loss per share(3)
$
(0.33
)
$
(0.80
)
 
Dividends(4)
 
 
Return on average equity
(0.45
)%
(1.09
)%
Return on average assets
(0.03
)%
(0.05
)%
Net interest margin(5)
0.37
 %
0.34
 %
Regulatory capital ratio(6)
8.27
 %
6.64
 %
Total capital ratio (at period-end)(7)
7.73
 %
5.36
 %
Total average equity to average assets
6.41
 %
4.92
 %
Notes:
(1)Represents the credit-related portion of OTTI losses on private label MBS portfolio.
(2)Includes REFCORP and AHP assessments
(3)Earnings (loss) per share calculated based on net income (loss).
(4)The Bank has temporarily suspended dividend payments, effective December 2008.
(5)Net interest margin is net interest income before provision (benefit) for credit losses as a percentage of average interest-earning assets.
(6)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.
(7)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.
 
 

6

Condensed Statement of Condition
 
 
(in millions)
September 30, 2010
June 30,
 2010
March 31, 2010
December 31,
2009
September 30, 2009
Cash and due from banks
$
161.5
 
$
79.9
 
$
251.6
 
$
1,418.8
 
$
373.3
 
Investments(1)
18,298.7
 
19,246.0
 
16,241.0
 
17,173.5
 
19,039.9
 
Advances
31,594.9
 
36,058.4
 
36,823.8
 
41,177.3
 
41,363.4
 
Mortgage loans held for portfolio, net(2)
4,740.8
 
4,895.7
 
4,991.2
 
5,162.8
 
5,339.1
 
Prepaid REFCORP assessment
39.6
 
39.6
 
37.2
 
39.6
 
39.6
 
Total assets
55,139.5
 
60,629.7
 
58,656.0
 
65,290.9
 
66,510.5
 
Consolidated obligations, net:
 
 
 
 
 
 Discount notes
12,251.9
 
12,118.1
 
9,990.4
 
10,208.9
 
11,462.5
 
 Bonds
36,401.2
 
42,325.8
 
42,477.1
 
49,103.9
 
49,022.3
 
Total consolidated obligations, net(3)
48,653.1
 
54,443.9
 
52,467.5
 
59,312.8
 
60,484.8
 
Deposits and other borrowings
1,164.3
 
1,146.5
 
1,418.4
 
1,284.3
 
1,023.8
 
Mandatorily redeemable capital stock
36.0
 
36.3
 
8.3
 
8.3
 
8.2
 
AHP payable
15.1
 
17.2
 
22.1
 
24.5
 
28.0
 
REFCORP payable
-
 
-
 
-
 
-
 
-
 
Capital stock - putable
4,146.8
 
4,012.2
 
4,035.1
 
4,018.0
 
4,013.1
 
Retained earnings
375.8
 
330.7
 
398.9
 
389.0
 
394.5
 
AOCI
(258.9
)
(375.0
)
(596.0
)
(693.9
)
(845.2
)
Total capital
4,263.7
 
3,967.9
 
3,838.0
 
3,713.1
 
3,562.4
 
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 $3.2 million, $2.9 million, $2.9 million, $2.7 million, and $7.5 million at September 30, 2010, June 30, 2010, March 31, 2010, December 31, 2009 and September 30, 2009, respectively.
(3)Aggregate FHLBank System-wide consolidated obligations (at par) were $806.0 billion, $846.5 billion, $870.9 billion, $930.6 billion, and $1.0 trillion at September 30, 2010, June 30, 2010, March 31, 2010, December 31, 2009 and September 30, 2009, respectively.
 
Core Earnings. Because of the nature of (1) OTTI charges, (2) the gains (losses) on sales of OTTI securities and (3) the contingency reserve and gains on derivatives and hedging activities resulting from the Lehman-related activities as described below, the Bank believes that adjusting net income for these items and evaluating results as adjusted (which the Bank defines as "core earnings") is important in order to understand how the Bank is performing with respect to its primary business operations and to provide meaningful comparisons to prior periods. Core earnings are considered to be a non-GAAP measurement. Results based on this definition of core earnings are presented below.
 
On September 15, 2008, Lehman Brothers Holding, Inc. (Lehman) filed for bankruptcy. At that time, Lehman's subsidiary, Lehman Brothers Special Financing, Inc. (LBSF) was the Bank's largest derivatives counterparty. Lehman was a guarantor under the Bank's agreement with LBSF such that Lehman's bankruptcy filing triggered an event of default. 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. The Bank sent a final settlement notice to LBSF and demanded return of the balance of posted Bank collateral of approximately $41.5 million.
 
The Bank has 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 September 30, 2010. As of September 30, 2010 the Bank maintained a $35.3 million reserve, established in the first quarter of 2009, on the $41.5 million receivable noted above.
 
 
See Item 3. Legal Proceedings in the Bank's 2009 Annual Report filed on Form 10-K and Part II. Item 1 of this quarterly report on Form 10-Q for additional information concerning the proceedings discussed above.
 

7

Statement of Operations
Reconciliation of GAAP Earnings to Non-GAAP Core Earnings
 
 
For the Three Months Ended September 30, 2010
 
(in millions)
GAAP
Earnings
Private Label MBS-OTTI Activity
Non-GAAP Core
Earnings
Net interest income before benefit for credit losses
$
50.6
 
$
 
$
50.6
 
Benefit for credit losses
(1.3
)
 
(1.3
)
Other income (loss):
 
 
 
 Net OTTI losses
(7.0
)
7.0
 
 
 Net gains on derivatives and hedging activities
4.9
 
 
4.9
 
 Net realized gains on available-for-sale securities
8.4
 
(8.4
)
 
 All other income
2.7
 
 
2.7
 
Total other income (loss)
9.0
 
(1.4
)
7.6
 
Other expense
15.8
 
 
15.8
 
Income (loss) before assessments
45.1
 
(1.4
)
43.7
 
Assessments (1)
 
11.6
 
11.6
 
Net income (loss)
$
45.1
 
$
(13.0
)
$
32.1
 
Earnings (loss) per share
$
1.11
 
$
(0.32
)
$
0.79
 
 
 
 
 
Return on average equity
4.39
%
(1.26
)%
3.13
%
Return on average assets
0.31
%
(0.09
)%
0.22
%
 
 
For the Three Months Ended September 30, 2009
 
(in millions)
GAAP
Earnings
Private Label MBS-OTTI Activity
Non-GAAP Core
Earnings
Net interest income before provision for credit
 losses
$
67.5
 
$
 
$
67.5
 
Provision for credit losses
1.4
 
 
1.4
 
Other income (loss):
 
 
 
 Net OTTI losses
(93.3
)
93.3
 
 
 Net losses on derivatives and hedging activities
(4.5
)
 
(4.5
)
 All other income
4.5
 
 
4.5
 
Total other income (loss)
(93.3
)
93.3
 
 
Other expense
16.2
 
 
16.2
 
Income before assessments
(43.4
)
93.3
 
49.9
 
Assessments (1)
(3.0
)
16.2
 
13.2
 
Net income (loss)
$
(40.4
)
$
77.1
 
$
36.7
 
Earnings (loss) per share
$
(1.01
)
$
1.93
 
$
0.92
 
 
 
 
 
Return on average equity
(4.39
)%
8.38
%
3.99
%
Return on average assets
(0.23
)%
0.44
%
0.21
%
 
 
 

8

 
For the Nine Months Ended September 30, 2010
 
(in millions)
GAAP
Earnings
Private Label MBS-OTTI Activity
Non-GAAP Core
Earnings
Net interest income before benefit for credit losses
$
168.7
 
$
 
$
168.7
 
Benefit for credit losses
(2.7
)
 
(2.7
)
Other income (loss):
 
 
 
 Net OTTI losses
(145.3
)
145.3
 
 
 Net losses on derivatives and hedging activities
(7.7
)
 
(7.7
)
 Net realized gains on available-for-sale securities
8.3
 
(8.3
)
 
 All other income
7.2
 
 
7.2
 
Total other income (loss)
(137.5
)
137.0
 
(0.5
)
Other expense
47.1
 
 
47.1
 
Income (loss) before assessments
(13.2
)
137.0
 
123.8
 
Assessments(1)
 
32.8
 
32.8
 
Net income (loss)
$
(13.2
)
$
104.2
 
$
91.0
 
Earnings (loss) per share
$
(0.33
)
$
2.59
 
$
2.26
 
 
 
 
 
Return on average equity
(0.45
)%
3.56
%
3.11
%
Return on average assets
(0.03
)%
0.23
%
0.20
%
 
For the Nine Months Ended September 30, 2009
 
(in millions)
GAAP
Earnings
Lehman
Impact
Private Label MBS-OTTI Activity
Non-GAAP Core
Earnings
Net interest income before provision for credit
 losses
$
199.8
 
$
 
$
 
$
199.8
 
Provision for credit losses
2.9
 
 
 
2.9
 
Other income (loss):
 
 
 
 
 Net OTTI losses
(163.1
)
 
163.1
 
 
 Net gains on derivatives and hedging
 activities
6.7
 
 
 
6.7
 
 Contingency reserve
(35.3
)
35.3
 
 
 
 All other income
9.6
 
 
 
9.6
 
Total other income (loss)
(182.1
)
35.3
 
163.1
 
16.3
 
Other expense
46.7
 
 
 
46.7
 
Income before assessments
(31.9
)
35.3
 
163.1
 
166.5
 
Assessments (1)
 
7.8
 
36.3
 
44.1
 
Net income
$
(31.9
)
$
27.5
 
$
126.8
 
$
122.4
 
Earnings (loss) per share
$
(0.80
)
$
0.69
 
$
3.17
 
$
3.06
 
 
 
 
 
 
Return on average equity
(1.09
)%
0.94
%
4.35
%
4.20
%
Return on average assets
(0.05
)%
0.05
%
0.21
%
0.21
%
Note:
(1) Assessments (including REFCORP and AHP assessments) on the Lehman impact, OTTI charges and realized gains on OTTI available-for-sale securities were prorated based on the required adjusted earnings assessment expense to take into account the impact of the three and nine months ended September 30, 2010 and 2009 GAAP net losses.
 
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

9

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 assumptions used in the quarterly OTTI process; 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; applicable Bank policy requirements for retained earnings and the ratio of the market value of equity to par value of capital stock; the Bank's ability to maintain adequate capital levels (including meeting applicable regulatory capital requirements); business and capital plan adjustments and amendments; and timing and volume of market activity. This Management's Discussion and Analysis 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.
 

10

Earnings Performance
 
The following is Management's Discussion and Analysis of the Bank's earnings performance for the three and nine months ended September 30, 2010 compared to the three and nine months ended September 30, 2009. This discussion should be read in conjunction with the unaudited interim financial statements and notes included in this quarterly report filed on the 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 third quarter of 2010, the Bank recorded net income of $45.1 million, compared to a net loss of $40.4 million in third quarter 2009. This improvement in results was driven by lower OTTI credit losses on the Bank's private label MBS portfolio. OTTI credit losses were $7.0 million for third quarter 2010, compared to $93.3 million for third quarter 2009. For the nine months ended September 30, 2010, the Bank recorded a net loss of $13.2 million, compared to a net loss of $31.9 million for the same prior year period primarily due to lower net OTTI credit losses year-over-year. Details of the Statement of Operations, including the impact of net interest income and derivatives and hedging activities on the results of operations, are presented more fully below.
 
Core Earnings. As presented above, core earnings for the three and nine months ended September 30, 2010 and 2009 exclude the impact of the LBSF contingency reserve, OTTI charges, gains (losses) on sales of OTTI securities and related assessments, as applicable. For third quarter 2010, the Bank's core earnings totaled $32.1 million, a decrease of $4.6 million over third quarter 2009 core earnings. This decrease was driven by lower net interest income in the current quarter. The Bank's return on average equity on core earnings was 3.13 percent in third quarter 2010, compared to 3.99 percent in third quarter 2009.
 
For the nine months ended September 30, 2010, the Bank's core earnings totaled $91.0 million, a decrease of $31.4 million over the same prior year core earnings. This decline was driven primarily by lower net interest income due to declining interest rates and lower volume of interest-earning assets as well as losses on derivatives and hedging activities in the current period. The Bank's return on average equity on core earnings was 3.11 percent for year-to-date September 2010, compared to 4.20 percent for year-to-date September 2009.
 

11

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 and nine months ended September 30, 2010 and 2009.
 
Average Balances and Interest Yields/Rates Paid
 
 
Three Months Ended September 30,
 
2010
2009
 
 
(dollars in millions)
 
Average
Balance
Interest
Income/
Expense
Avg.
Yield/
Rate
(%)
 
Average
Balance
Interest
Income/
Expense
Avg.
Yield/
Rate
(%)
Assets
 
 
 
 
 
 
Federal funds sold (1)
$
4,467.3
 
$
2.0
 
0.18
%
$
5,714.0
 
$
1.8
 
0.13
%
Interest-bearing deposits (2)
451.5
 
0.2
 
0.19
%
671.5
 
0.3
 
0.17
%
Investment securities (3)
14,022.5
 
96.4
 
2.73
%
16,289.4
 
128.0
 
3.12
%
Advances(4) 
33,891.9
 
86.5
 
1.01
%
42,501.9
 
115.8
 
1.08
%
Mortgage loans held for portfolio(5)
4,835.0
 
60.2
 
4.94
%
5,471.2
 
67.6
 
4.90
%
Total interest-earning assets
57,668.2
 
245.3
 
1.69
%
70,648.0
 
313.5
 
1.76
%
Allowance for credit losses
(10.3
)
 
 
(16.0
)
 
 
Other assets(5)(6)
496.5
 
 
 
(127.3
)
 
 
Total assets
$
58,154.4
 
 
 
$
70,504.7
 
 
 
Liabilities and capital
 
 
 
 
 
 
Deposits (2)
$
1,263.7
 
$
0.3
 
0.08
%
$
1,799.0
 
$
0.3
 
0.07
%
Consolidated obligation discount notes
12,239.5
 
5.9
 
0.19
%
11,814.8
 
5.3
 
0.18
%
Consolidated obligation bonds(7)
38,722.1
 
188.5
 
1.93
%
51,393.0
 
240.3
 
1.86
%
Other borrowings
35.7
 
 
0.14
%
8.2
 
0.1
 
0.77
%
Total interest-bearing
 liabilities
52,261.0
 
194.7
 
1.48
%
65,015.0
 
246.0
 
1.50
%
Other liabilities
1,819.0
 
 
 
1,842.7
 
 
 
Total capital
4,074.4
 
 
 
3,647.0
 
 
 
Total liabilities and capital
$
58,154.4
 
 
 
$
70,504.7
 
 
 
Net interest spread
 
 
0.21
%
 
 
0.26
%
Impact of noninterest-bearing funds
 
 
0.14
%
 
 
0.12
%
Net interest income/net interest margin
 
$
50.6
 
0.35
%
 
$
67.5
 
0.38
%
Notes:
(1)The average balance of Federal funds sold, related interest income and average yield calculations may include loans to other FHLBanks.
(2)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.
(3)Investment securities include trading, available-for-sale and held-to-maturity securities. The average balances of available-for-sale and held-to-maturity 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 $1.7 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 $421.7 million and $385.2 million in 2010 and 2009, respectively.
 

12

Net interest income declined quarter-over-quarter primarily due to the decline in interest rates. The overall yield on interest-earning assets declined more than the overall cost of funds, resulting in a compression of net interest spread and lower net interest income. In addition, average interest-earning assets declined 18.4 percent driven primarily by the lower demand for advances. Demand for advances has decreased as members have reduced their balance sheets and experienced high levels of retail deposits relative to historical levels. The Bank also experienced a reduction in its level of higher-yield 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 declined compared to the prior year quarter as yields on interest-earning assets declined more than the cost of funds.
 

13

 
 
Nine Months Ended September 30,
 
2010
2009
 
 
(dollars in millions)
 
Average
Balance
Interest
Income/
Expense
Avg.
Yield/
Rate
(%)
 
Average
Balance
Interest
Income/
Expense
Avg.
Yield/
Rate
(%)
Assets
 
 
 
 
 
 
Federal funds sold (1)
$
4,670.2
 
$
5.3
 
0.15
%
$
1,968.3
 
$
1.9
 
0.13
%
Interest-bearing deposits(2) 
466.1
 
0.6
 
0.17
%
6,087.1
 
11.1
 
0.24
%
Investment securities (3)
13,807.4
 
303.9
 
2.94
%
15,856.4
 
424.7
 
3.58
%
Advances(4) 
37,025.4
 
240.8
 
0.87
%
49,350.6
 
527.4
 
1.43
%
Mortgage loans held for portfolio(5)
4,949.5
 
186.2
 
5.03
%
5,779.9
 
214.8
 
4.97
%
Total interest-earning assets
60,918.6
 
736.8
 
1.62
%
79,042.3
 
1,179.9
 
2.00
%
Allowance for credit losses
(11.4
)
 
 
(15.1
)
 
 
Other assets(5)(6)
155.3
 
 
 
227.4
 
 
 
Total assets
$
61,062.5
 
 
 
$
79,254.6
 
 
 
Liabilities and capital
 
 
 
 
 
 
Deposits (2)
$
1,283.2
 
$
0.7
 
0.07
%
$
1,792.4
 
$
1.1
 
0.08
%
Consolidated obligation discount notes
11,258.4
 
13.6
 
0.16
%
15,158.5
 
38.9
 
0.34
%
Consolidated obligation bonds(7)
42,909.2
 
553.8
 
1.73
%
56,288.4
 
940.0
 
2.23
%
Other borrowings
30.4
 
 
0.23
%
7.6
 
0.1
 
0.88
%
Total interest-bearing liabilities
55,481.2
 
568.1
 
1.37
%
73,246.9
 
980.1
 
1.79
%
Other liabilities
1,668.0
 
 
 
2,111.8
 
 
 
Total capital
3,913.3
 
 
 
3,895.9
 
 
 
Total liabilities and capital
$
61,062.5
 
 
 
$
79,254.6
 
 
 
Net interest spread
 
 
0.25
%
 
 
0.21
%
Impact of noninterest-bearing funds
 
 
0.12
%
 
 
0.13
%
Net interest income/net interest margin
 
$
168.7
 
0.37
%
 
$
199.8
 
0.34
%
Notes:
(1)The average balance of Federal funds sold, related interest income and average yield calculations may include loans to other FHLBanks.
(2)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.
(3)Investment securities include trading, available-for-sale and held-to-maturity securities. The average balances of available-for-sale and held-to-maturity 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 $1.4 billion and $1.9 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 $338.4 million and $450.7 million in 2010 and 2009, respectively.
 
Net interest income declined $31.1 million year-over-year due to both the decline in interest rates as well as the decrease in interest-earning assets. Average interest-earning assets declined 22.9 percent driven primarily by the lower demand for advances. Interest-bearing deposits decreased year-over-year primarily due to a shift into investments in Federal funds sold. The higher interest-bearing deposit balance in 2009 was due to the Bank's shift in balances from Federal funds sold into higher-yielding interest-bearing Federal Reserve Bank (FRB) accounts. However, beginning in July 2009, the FRB stopped paying interest on the excess balances it held on the Bank's behalf; consequently, the Bank shifted its investments back to Federal funds sold. Additional details and analysis regarding the shift in the mix of these categories is included in the “Rate/Volume Analysis” discussion below.

14

 
The net interest margin improved year-over-year as the yield on interest-earning assets declined less than the cost of funds.
 
Average Advances Portfolio Detail
 
(in millions)
Three Months Ended
September 30,
Nine Months Ended
September 30,
Product
2010
2009
2010
2009
Repo
$
12,913.3
 
$
19,927.2
 
$
16,108.4
 
$
23,914.8
 
Term Loans
13,255.8
 
12,978.8
 
13,001.9
 
13,677.3
 
Convertible Select
5,994.0
 
7,173.9
 
6,306.6
 
7,290.7
 
Hedge Select
50.0
 
120.4
 
50.0
 
127.7
 
Returnable
22.0
 
612.3
 
25.5
 
2,352.1
 
Total par value
$
32,235.1
 
$
40,812.6
 
$
35,492.4
 
$
47,362.6
 
 
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 2010 and 2009.
 
 
Increase (Decrease) in Interest Income/Expense Due to Changes
 in Rate/Volume
 
Three Months Ended September 30
Nine Months Ended September 30
(in millions)
Volume
Rate
Total
Volume
Rate
Total
Federal funds sold
$
(0.5
)
$
0.7
 
$
0.2
 
$
3.0
 
$
0.4
 
$
3.4
 
Interest-bearing deposits
(0.1
)
 
(0.1
)
(7.9
)
(2.6
)
(10.5
)
Investment securities
(16.7
)
(14.9
)
(31.6
)
(50.8
)
(70.0
)
(120.8
)
Advances
(22.3
)
(7.0
)
(29.3
)
(111.6
)
(175.0
)
(286.6
)
Mortgage loans held for portfolio
(7.9
)
0.5
 
(7.4
)
(31.2
)
2.6
 
(28.6
)
 Total interest-earning assets
$
(47.5
)
$
(20.7
)
$
(68.2
)
$
(198.5
)
$
(244.6
)
$
(443.1
)
 
 
 
 
 
 
 
Interest-bearing deposits
$
(0.1
)
$
0.1
 
$
 
$
(0.3
)
$
(0.1
)
$
(0.4
)
Consolidated obligation discount notes
0.2
 
0.4
 
0.6
 
(8.3
)
(17.0
)
(25.3
)
Consolidated obligation bonds
(61.3
)
9.5
 
(51.8
)
(197.5
)
(188.7
)
(386.2
)
Other borrowings
 
(0.1
)
(0.1
)
0.1
 
(0.2
)
(0.1
)
 Total interest-bearing liabilities
$
(61.2
)
$
9.9
 
$
(51.3
)
$
(206.0
)
$
(206.0
)
$
(412.0
)
 
 
 
 
 
 
 
Total increase (decrease) in net interest
 income
$
13.7
 
$
(30.6
)
$
(16.9
)
$
7.5
 
$
(38.6
)
$
(31.1
)
 
The average balance sheet has shrunk considerably in both the quarter-over-quarter and year-over-year comparisons. Interest income and interest expense have likewise decreased in the comparisons driven by both rate and volume declines.
 
Quarter-over-quarter, the decline in interest income was primarily volume-driven related to the advances portfolio and the investment securities portfolio. The mortgage loans held for portfolio experienced a slight increase in rate-related interest income, due to an uptick in yields, although overall still reported a decrease in interest income due to lower volume. Year-over-year, the decline in interest income was primarily rate-driven, as a result of declines in rates on the advances and investment portfolios. The decline in interest expense quarter-over-quarter was volume driven related to consolidated obligation bonds. In the year-over-year comparison the decline in interest expense was equally due to volume and rates, primarily on consolidated obligation bonds.
 
For third quarter 2010, average Federal funds sold balances decreased from the prior year quarter. Related interest income on Federal funds sold increased due to the higher average yield in the current quarter more than offsetting the lower volumes. For third quarter 2010, average interest-bearing deposits decreased while related interest income on interest-bearing deposits also decreased due to the lower balances which offset the slight increase in yield.

15

 
For the nine months ended September 30, 2010, average Federal funds sold balances increased from the same prior year period. For the first half of 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 in July 2009. For year-to-date September 2010, average interest-bearing deposit balances decreased primarily due to the shift to Federal funds sold noted above for the first half of 2009.
 
The investment securities portfolio includes trading, available-for-sale and held-to-maturity securities. The decrease in investments quarter-over-quarter and year-over-year 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 decrease in interest income in both comparisons was driven by both rate and volume.The Bank has not purchased any private label MBS since late 2007, purchasing only agency and GSE MBS since 2008, including $1.7 billion in the first nine months of 2010.
 
The average advances portfolio decreased from third quarter 2009 to third quarter 2010. This decline in volume, along with a smaller decline in the yield, caused the decrease in interest income quarter-over-quarter. For the nine months ended September 30, 2010, the average advances portfolio decreased from the same prior year period. This decline in volume, coupled with a decrease in the yield, resulted in a significant decline in interest income year-over-year.
 
Advance demand began to decline in the fourth quarter of 2008, continued through 2009 and into the first nine months of 2010, as members grew core deposits and gained access to additional liquidity from the Federal Reserve and other government programs that initially became available in the second half of 2008. These programs ended in first quarter 2010. The interest income on this portfolio, particularly in the year-over-year comparison, was significantly impacted by the decline in short-term rates. Average 3-month LIBOR declined 2 basis points and 47 basis points in the quarter-over-quarter and year-over-year comparisons, respectively.
 
As presented in the Average Advances Portfolio Detail table, the decrease in average balances for the Repo product reflected the impact of members' high level of retail deposits as well as members' reactions to the Bank's increased pricing of short-term advance products. In addition to raising core deposits, members have also reduced the size of their balance sheets during the credit crisis. 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 recession has reduced the Bank's members' need for funding from the Bank as well. While balances in all advance products declined, the majority of the decline was driven by decreases in average advances in the Repo product related to the Bank's larger borrowers, with five banks reducing their total average advances outstanding by $8.8 billion year-over-year. The decline in Returnable product balances was due to one of the Bank's largest borrowers exercising their option to return their advances.
 
The mortgage loans held for portfolio balance declined from third quarter 2009 to third quarter 2010 as well as in the year-over-year comparison. In both comparisons, the related interest income on the portfolio declined. The decrease in the portfolio balance for both comparisons was due to the continued runoff of the existing portfolio, which more than offset new portfolio activity. The decrease in interest income was due to the lower average portfolio balances more than offsetting the yield increase. The yield increase in both comparisons was impacted by lower amortization of basis adjustments in 2010 compared to 2009, as seen in the “Net Interest Income Derivative Effects” table below.
 
Mortgage loans contributed approximately 25.3 percent and 18.2 percent of total interest income for the first nine months of 2010 and 2009, respectively. While interest income on mortgage loans dropped 13.3 percent in the year-over-year comparison, the Bank's total interest income decreased 37.6 percent. Total interest income decreased more rapidly than interest income on mortgage loans held for portfolio because the higher-yielding mortgage loan portfolio comprised a larger percentage of the balance sheet in the first nine months of 2010 than it did in the first nine months of 2009.
 
The consolidated obligations portfolio balance decreased from third quarter 2009 to third quarter 2010. A decrease in bonds drove the decline. Interest expense on discount notes increased from the prior year quarter, partially attributable to the volume increase and partially due to the slight increase in rates paid quarter-over-quarter. Interest expense on bonds decreased from third quarter 2009 to third quarter 2010. The large decline in volume more than offset an increase in rates paid on bonds.
 
For the nine months ended September 30, 2010, the consolidated obligations portfolio balance decreased from the same prior year period. The decline in discount notes was consistent with the decline in short-term advance demand from members during the same period as previously discussed. Interest expense on discount notes decreased from prior year-to-date September. The decrease was driven primarily by a decline in rates paid year-over-year as well as volume decline. The decline in rates paid was consistent with the general decline in short-term rates. Interest expense on bonds decreased year-over-year, due in part to the decrease in rates paid on bonds, as well as the volume decline.

16

 
A portion of the bond portfolio is currently swapped to 3-month LIBOR; therefore, as the LIBOR rate (decreases) increases, interest expense on swapped bonds, including the impact of swaps, (decreases) increases. See details regarding the impact of swaps on the quarterly rates paid in the “Net Interest Income Derivatives Effects” discussion below.
 
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 has continued to be able to issue discount notes and term bonds at attractive rates as needed into 2010. As a result of the European debt crisis, investors have had more interest in GSE debt, which has aided the Bank in obtaining favorable rates on debt issuance.
 
For additional information, see the “Liquidity and Funding Risk” discussion in Risk Management in this Item 2. Management's Discussion and Analysis in this quarterly report filed on the Form 10-Q.
 
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 and nine months ended September 30, 2010 and 2009. Derivative and hedging activities are discussed below.
 
Three Months Ended September 30, 2010
 
(dollars in millions)
 
Average Balance
Interest Inc./
 Exp. with Derivatives
Avg.
Yield/
Rate
(%)
Interest Inc./ Exp. without
Derivatives
Avg.
Yield/
Rate
(%)
 
Impact of
Derivatives(1)
Incr./
(Decr.)
(%)
Assets:
 
 
 
 
 
 
 
Advances
$
33,891.9
 
$
86.5
 
1.01
%
$
276.5
 
3.24
%
$
(190.0
)
(2.23
)%
Mortgage loans held for
 portfolio
4,835.0
 
60.2
 
4.94
%
61.1
 
5.01
%
(0.9
)
(0.07
)%
All other interest-earning
 assets
18,941.3
 
98.6
 
2.07
%
98.6
 
2.07
%
 
 %
Total interest-earning
 assets
$
57,668.2
 
$
245.3
 
1.69
%
$
436.2
 
3.00
%
$
(190.9
)
(1.31
)%
Liabilities and capital:
 
 
 
 
 
 
 
Consolidated obligation
 bonds
$
38,722.1
 
$
188.5
 
1.93
%
$
272.7
 
2.79
%
$
(84.2
)
(0.86
)%
All other interest-bearing
 liabilities
13,538.9
 
6.2
 
0.18
%
6.2
 
0.18
%
 
 %
Total interest-bearing
 liabilities
$
52,261.0
 
$
194.7
 
1.48
%
$
278.9
 
2.12
%
$
(84.2
)
(0.64
)%
Net interest income/net
 interest spread
 
$
50.6
 
0.21
%
$
157.3
 
0.88
%
$
(106.7
)
(0.67
)%
Note:
(1)Impact of Derivatives includes net interest settlements and amortization of basis adjustments resulting from previously terminated hedging relationships.
 

17

Three Months Ended
September 30, 2009
 
(dollars in millions)
 
Average Balance
Interest Inc./
 Exp. with Derivatives
Avg.
Yield/
Rate
(%)
Interest Inc./ Exp. without
Derivatives
Avg.
Yield/
Rate
(%)
 
Impact of
Derivatives(1)
Incr./
(Decr.)
(%)
Assets:
 
 
 
 
 
 
 
Advances
$
42,501.9
 
$
115.8
 
1.08
%
$
396.7
 
3.70
%
$
(280.9
)
(2.62
)%
Mortgage loans held for
 portfolio
5,471.2
 
67.6
 
4.90
%
68.7
 
4.99
%
(1.1
)
(0.09
)%
All other interest-earning
 assets
22,674.9
 
130.1
 
2.28
%
130.1
 
2.28
%
 
 %
Total interest-earning
 assets
$
70,648.0
 
$
313.5
 
1.76
%
$
595.5
 
3.34
%
$
(282.0
)
(1.58
)%
Liabilities and capital:
 
 
 
 
 
 
 
Consolidated obligation
 Bonds
$
51,393.0
 
$
240.3
 
1.86
%
$
352.5
 
2.72
%
$
(112.2
)
(0.86
)%
All other interest-bearing
 Liabilities
13,622.0
 
5.7
 
0.16
%
5.7
 
0.16
%
 
 %
Total interest-bearing
 Liabilities
$
65,015.0
 
$
246.0
 
1.50
%
$
358.2
 
2.19
%
$
(112.2
)
(0.69
)%
Net interest income/net
 interest spread
 
$
67.5
 
0.26
%
$
237.3
 
1.15
%
$
(169.8
)
(0.89
)%
Note:
(1)Impact of Derivatives includes net interest settlements and amortization of basis adjustments resulting from previously terminated hedging relationships.
 
Nine Months Ended September 30, 2010
 
(dollars in millions)
 
Average Balance
Interest Inc./
 Exp. with Derivatives
Avg.
Yield/
Rate
(%)
Interest Inc./ Exp. without
Derivatives
Avg.
Yield/
Rate
(%)
 
Impact of
Derivatives(1)
Incr./
(Decr.)
(%)
Assets:
 
 
 
 
 
 
 
Advances
$
37,025.4
 
$
240.8
 
0.87
%
$
900.6
 
3.25
%
$
(659.8
)
(2.38
)%
Mortgage loans held for
 portfolio
4,949.5
 
186.2
 
5.03
%
188.5
 
5.09
%
(2.3
)
(0.06
)%
All other interest-earning
 assets
18,943.7
 
309.8
 
2.19
%
309.8
 
2.19
%
 
 %
Total interest-earning
 assets
$
60,918.6
 
$
736.8
 
1.62
%
$
1,398.9
 
3.07
%
$
(662.1
)
(1.45
)%
Liabilities and capital:
 
 
 
 
 
 
 
Consolidated obligation
 bonds
$
42,909.2
 
$
553.8
 
1.73
%
$
870.4
 
2.71
%
$
(316.6
)
(0.98
)%
All other interest-bearing
 liabilities
12,572.0
 
14.3
 
0.15
%
14.3
 
0.15
%
 
 %
Total interest-bearing
 liabilities
$
55,481.2
 
$
568.1
 
1.37
%
$
884.7
 
2.13
%
$
(316.6
)
(0.76
)%
Net interest income/net
 interest spread
 
$
168.7
 
0.25
%
$
514.2
 
0.94
%
$
(345.5
)
(0.69
)%
Note:
(1)Impact of Derivatives includes net interest settlements and amortization of basis adjustments resulting from previously terminated hedging relationships.
 
 

18

Nine Months Ended
September 30, 2009
 
(dollars in millions)
 
Average Balance
Interest Inc./
 Exp. with Derivatives
Avg.
Yield/
Rate
(%)
Interest Inc./ Exp. without
Derivatives
Avg.
Yield/
Rate
(%)
 
Impact of
Derivatives(1)
Incr./
(Decr.)
(%)
Assets:
 
 
 
 
 
 
 
Advances
$
49,350.6
 
$
527.4
 
1.43
%
$
1,352.2
 
3.66
%
$
(824.8
)
(2.23
)%
Mortgage loans held for
 portfolio
5,779.9
 
214.8
 
4.97
%
218.2
 
5.05
%
(3.4
)
(0.08
)%
All other interest-earning
 assets
23,911.8
 
437.7
 
2.45
%
437.7
 
2.45
%
 
 %
Total interest-earning
 assets
$
79,042.3
 
$
1,179.9
 
2.00
%
$
2,008.1
 
3.40
%
$
(828.2
)
(1.40
)%
Liabilities and capital:
 
 
 
 
 
 
 
Consolidated obligation
 bonds
$
56,288.4
 
$
940.0
 
2.23
%
$
1,255.0
 
2.98
%
$
(315.0
)
(0.75
)%
All other interest-bearing
 liabilities
16,958.5
 
40.1
 
0.32
%
40.1
 
0.32
%
 
 %
Total interest-bearing
 liabilities
$
73,246.9
 
$
980.1
 
1.79
%
$
1,295.1
 
2.36
%
$
(315.0
)
(0.57
)%
Net interest income/net
 interest spread
 
$
199.8
 
0.21
%
$
713.0
 
1.04
%
$
(513.2
)
(0.83
)%
Note:
(1)Impact of Derivatives includes net interest settlements and amortization of basis adjustments resulting from previously terminated hedging relationships.
 
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.
 
The impact of derivatives reduced both net interest income and net interest spread for third quarter 2010 and 2009. The impact to net interest income was less in 2010 compared to 2009 primarily due to the lower overall volume of hedged instruments year-over-year. Average 3-month LIBOR was relatively flat, declining only 2 basis points in the quarter-over-quarter comparison.
 
The impact of derivatives reduced both net interest income and net interest spread for the nine months ended September 30, 2010 and 2009. The impact to net interest income was less in 2010 compared to 2009 primarily due to the lower overall volume of hedged instruments year-over-year. This volume effect more than offset the impact from the 47 basis point decrease of average 3-month LIBOR.
 
The mortgage loans held for portfolio derivative impact for all periods presented was affected by the amortization of basis adjustments resulting from hedges of commitments to purchase mortgage loans through the MPF program.
 
The Bank uses many different funding and hedging strategies, one of which involves closely match-funding bullet advances with bullet debt and is designed in part to (1) avoid the use of derivatives where prudent, (2) restrain growth in the size of the Bank's derivatives portfolio, and (3) reduce the Bank's reliance on short-term funding.
 
In addition, the Bank has initiated a program to lower derivative counterparty credit exposure by reducing the number of derivatives outstanding without materially impacting the Bank's risk or earnings profiles. The initial phase of this program focused on bullet advances with balances between $5 and $10 million and involved the simultaneous termination of swaps hedging advances and swaps hedging comparable maturity bullet debt. Basis adjustments (BAs) that are created as a result of the discontinuation of fair value hedge accounting upon termination of the swaps are accreted or amortized over the remaining lives of the advances or debt. This strategy will result in additional accretion and amortization of BAs which will be reflected in the Statement of Operations within net interest income. If there are significant prepayments of debt that have associated BAs, there will be an acceleration of the amortization of the related BA, which may or may not be offset by prepayment fees. If a significant number of instruments prepay, this will result in volatility within interest income in the Statement of Operations.

19

 
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
September 30,
For the Nine Months Ended
September 30,
(in millions)
2010
2009
2010
2009
Derivatives and hedged items in hedge
 accounting relationships:
 
 
 
 
 Advances
$
3.9
 
$
(8.9
)
$
(3.9
)
$
(18.1
)
 Consolidated obligations
0.4
 
4.6
 
(0.5
)
24.1
 
Total net gains (losses) related to fair value
 hedge ineffectiveness
4.3
 
(4.3
)
(4.4
)
6.0
 
Derivatives not designated as hedging
 instruments under hedge accounting:
 
 
 
 
 Economic hedges
(0.8
)
(1.8
)
(6.8
)
(4.3
)
 Mortgage delivery commitments
1.2
 
1.4
 
2.9
 
4.4
 
 Other
0.2
 
0.2
 
0.6
 
0.6
 
Total net gains (losses) related to derivatives not designated as hedging instruments under
hedge accounting
0.6
 
(0.2
)
(3.3
)
0.7
 
Net gains (losses) on derivatives and hedging activities
$
4.9
 
$
(4.5
)
$
(7.7
)
$
6.7
 
 
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 third quarter of 2010, total ineffectiveness related to these fair value hedges resulted in a gain of $4.3 million compared to a loss of $4.3 million in the third quarter of 2009. For the nine months ended September 30, 2010, total ineffectiveness resulted in a loss of $4.4 million compared to a gain of $6.0 million for the same prior year period. The overall notional amount decreased from $50.6 billion at September 30, 2009 to $29.1 billion at September 30, 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, which generally reverses over the life of hedge relationships, 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 $0.8 million in third quarter 2010 compared to a loss of $1.8 million in third quarter 2009. For the nine months ended September 30, 2010, the Bank recorded net losses on economic hedges of $6.8 million, compared to losses of $4.3 million for the same prior year period. The majority of the losses in 2010 were comprised of losses on the Bank's interest rate caps. The overall notional amount of economic hedges increased from $1.2 billion at September 30, 2009 to $1.7 billion at September 30, 2010. The notional amount of the Bank's interest rate caps was $1.6 billion at September 30, 2010 compared to $0.7 billion at September 30, 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 third quarter 2010 were $1.2 million compared to total gains of $1.4 million for third quarter 2009. For the nine months ended September 30, 2010, total gains on mortgage delivery commitments were $2.9 million compared to gains of $4.4 million for the same prior year period. The total notional amount of the Bank's mortgage delivery commitments increased from $12.7 million at September 30, 2009 to $33.3 million million at September 30, 2010.
 

20

Affordable Housing Program (AHP) and Resolution Funding Corp. (REFCORP) Assessments
 
Although the FHLBanks are not subject to federal or state income taxes, the combined financial obligations of making payments to REFCORP (20 percent) and AHP contributions (10 percent) equate to a proportion of the Bank's net income comparable to that paid in income tax by fully taxable entities. The FHLBanks' aggregate actual payments through the third 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 first 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.
 
Financial Condition
 
The following is Management's Discussion and Analysis of the Bank's financial condition at September 30, 2010 compared to December 31, 2009. This should be read in conjunction with the Bank's unaudited interim financial statements and notes in this quarterly report filed on the Form 10-Q and the audited financial statements in the Bank's 2009 Annual Report filed on Form 10-K.
 
Assets
 
As a result of declining loan demand by members, the Bank's total assets decreased from December 31, 2009 to September 30, 2010. The decrease in advances was partially offset by an increase in Federal funds sold and investment securities. Total housing finance-related assets, which include MPF Program loans, advances, MBS and other mission-related investments, decreased as of September 30, 2010 as well.
 
Advances and Mortgage Loans Held for Portfolio. At September 30, 2010, the Bank had advances to 206 borrowing members, compared to 222 borrowing members at December 31, 2009. A significant concentration of the advances continued to be generated from the Bank's five largest borrowers, generally reflecting the asset concentration mix of the Bank's membership base. Total advances outstanding to the Bank's five largest members decreased as of September 30, 2010 compared to December 31, 2009, reflecting a stronger deposit market and limited growth in member lending. 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 following table provides a distribution of the number of members, categorized by individual member asset size, that had an outstanding average balance during the nine months ended September 30, 2010 and the year ended December 31, 2009.
 
Member Asset Size
2010
2009
Less than $100 million
33
 
40
 
Between $100 million and $500 million
122
 
135
 
Between $500 million and $1 billion
44
 
39
 
Between $1 billion and $5 billion
29
 
30
 
Greater than $5 billion
15
 
16
 
Total borrowing members during the year
243
 
260
 
Total membership
314
 
316
 
Percent of members borrowing during the period
77.4
%
82.3
%
Total borrowing members with outstanding loan balances at period-end
206
 
222
 
Percent of members borrowing at period-end
65.6
%
70.3
%
 
During the first nine months of 2010, changes in the Bank's membership resulted in a net decrease of two members. This activity included one out-of-district merger, one completed withdrawal from membership and two members merged within the Bank's district. These reductions were offset by the addition of two new members.
 
See the “Credit and Counterparty Risk - Total Credit Products and Collateral” discussion in the Risk Management section of this Item 2. Management's Discussion and Analysis in this quarterly report filed on the 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 September 30, 2010.
 

21

The Bank's net mortgage loans held for portfolio under the MPF Program decreased from December 31, 2009 to September 30, 2010, driven primarily by the continued runoff of the existing portfolio, which more than offset new portfolio purchase activity.
 
The Bank currently has a loan modification plan in place for participating PFIs under the MPF Program. As of September 30, 2010, there had been a few requests for loan modifications. There were five loans with total unpaid principal balance of $1.0 million in the 90-day trial period as of September 30, 2010. In addition, there were two loans which had been modified and completed the 90-day trial period with a total unpaid principal balance of $383 thousand as of September 30, 2010.
 
The Bank's outstanding advances, nonaccrual mortgage loans, mortgage loans 90 days or more delinquent and accruing interest, troubled debt restructurings and Banking on Business (BOB) loans are presented in the following table.
 
(in millions)
September 30,
2010
December 31,
2009
Advances(1)
$
31,594.9
 
$
41,177.3
 
Mortgage loans held for portfolio, net(2)
4,740.8
 
5,162.8
 
Nonaccrual mortgage loans, net(3)
74.5
 
71.2
 
Mortgage loans 90 days or more delinquent and still accruing interest(4)
10.4
 
16.5
 
Troubled debt restructurings - mortgage loans (5)
0.4
 
 
BOB loans, net(6)
14.9
 
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)Only government-insured or -guaranteed loans (e.g., FHA, VA, HUD or RHS) continue to accrue interest after becoming 90 days or more delinquent.
(5)Troubled debt restructurings includes mortgage loan balances related to loan modifications under the Bank's current MPF Program. The balance at September 30, 2010 was $383 thousand, representing two loans. There were no balances at December 31, 2009.
(6)Due to the nature of the program, all BOB loans are considered nonaccrual loans. Balances are reflected net of allowance for credit losses.
 
Delinquencies in the Bank's portfolio remain markedly below national delinquency rates for prime mortgage loans. Details of delinquencies in the Bank's conventional mortgage loan portfolio are presented in the table below.
 
 
(dollars in millions)
 
September 30,
2010
December 31, 2009
30-59 days delinquent and not in foreclosure
 
$
67.7
 
$
69.7
 
60-89 days delinquent and not in foreclosure
 
16.9
 
21.5
 
90 days or more delinquent and not in foreclosure
 
22.6
 
31.5
 
In process of foreclosure(1)
 
47.7
 
34.2
 
Real estate owned (REO) inventory
 
12.3
 
11.1
 
Serious delinquency rate(2)
 
1.6
%
1.4
%
Notes:
(1) Includes loans where the decision of foreclosure or similar alternative such as pursuit of deed-in-lieu has been reported.
(2) Sum of 90 days or more delinquent and not in foreclosure plus in process of foreclosure, as a percent of total conventional loan principal balance.
 
The Bank has experienced an increase in its nonaccrual mortgage loans held for portfolio, driven by general economic conditions. The Bank permits PFI's to repurchase loans that meet certain pre-established criteria (i.e., government-guaranteed loans) at the time of the sale of the loans to the Bank. The decrease in mortgage loans which were 90 days or more delinquent and still accruing interest from December 31, 2009 to September 30, 2010 reflects these repurchases, totaling $17.8 million, offset by net activity related to loans moving into the 90 days or more delinquent category.
 
The amount of foregone interest income on the Bank's nonaccrual mortgage loans and troubled debt restructurings was $71 thousand and $49 thousand for the three months ended September 30, 2010 and 2009, respectively. For the nine months ended September 30, 2010 and 2009, respectively, the amounts were $259 thousand and $138 thousand. These amounts include activity related to loan modifications under the Bank's MPF Program for 2010.
 

22

The Bank increased its allowance for loan losses on mortgage loans held for portfolio, from December 31, 2009 to September 30, 2010, due to deterioration in the portfolio related to higher delinquencies. The Bank experienced minimal net charge-offs during the nine months ended September 30, 2010 and 2009.
 
Investments. At September 30, 2010, the Bank's total interest-bearing deposits and Federal funds sold increased from December 31, 2009, 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.
 
The increase in investment securities from December 31, 2009 to September 30, 2010 was due to purchases of agency and GSE MBS. This activity was offset by MBS paydowns during the first nine months of 2010. The Bank has not purchased any private label MBS since late 2007. Available-for-sale MBS paydowns were partially offset by an increase in the fair value of certain available-for-sale investments as well as the transfers of seven OTTI held-to-maturity securities to available-for-sale during the first nine months of 2010.
 
The following tables summarize key investment securities portfolio statistics.
 
(in millions)
September 30,
2010
December 31,
2009
Trading securities:
 
 
 Mutual funds offsetting deferred compensation
$
6.4
 
$
6.7
 
 U.S. Treasury bills
879.8
 
1,029.5
 
 TLGP investments
250.0
 
250.0
 
Total trading securities
$
1,136.2
 
$
1,286.2
 
Available-for-sale securities:
 
 
 Mutual funds partially securing supplemental retirement plan
$
2.0
 
$
2.0
 
 Private label MBS
2,372.3
 
2,395.3
 
Total available-for-sale securities
$
2,374.3
 
$
2,397.3
 
Held-to-maturity securities:
 
 
 Certificates of deposit
$
3,050.0
 
$
3,100.0
 
 State or local agency obligations
521.6
 
608.4
 
 U.S. government-sponsored enterprises
561.4
 
176.7
 
 Agency and GSE MBS
4,304.0
 
3,067.9
 
 Private label MBS
2,529.8
 
3,529.4
 
Total held-to-maturity securities
10,966.8
 
10,482.4
 
Total investment securities
$
14,477.3
 
$
14,165.9
 
 

23

The following table presents the maturity and yield characteristics for the investment securities portfolio as of September 30, 2010.
 
(dollars in millions)
Book Value
Yield %
Trading securities:
 
 
 Mutual funds offsetting deferred compensation
$
6.4
 
n/a
 
 U.S. Treasury bills
879.8
 
0.16
%
 TLGP investments
250.0
 
0.26
%
Total trading securities
$
1,136.2
 
0.18
%
Available-for-sale securities:
 
 
 Mutual funds partially securing supplemental retirement plan
$
2.0
 
n/a
 
 Private label MBS
2,372.3
 
5.66
%
Total available-for-sale securities
$
2,374.3
 
5.65
%
Held-to-maturity securities:
 
 
 Certificates of deposit
$
3,050.0
 
0.41
%
 State or local agency obligations:
 
 
 Within one year
71.8
 
5.89
%
 After one but within five years
5.7
 
4.21
%
 After five years but within ten years
10.1
 
0.41
%
 After ten years
434.0
 
2.64
%
 Total state or local agency obligations
$
521.6
 
3.07
%
 U.S. government-sponsored enterprises:
 
 
 After one year but within five years
500.0
 
0.54
%
 After five years but within ten years
61.4
 
4.05
%
 Total U.S. government-sponsored enterprises
561.4
 
0.92
%
 Agency and GSE MBS
4,304.0
 
1.64
%
 Private label MBS
2,529.8
 
4.00
%
Total held-to-maturity securities
$
10,966.8
 
1.88
%
n/a - not applicable
 
As of September 30, 2010, the Bank held securities from the following issuers with a book value greater than 10 percent of Bank total capital.
 
 
Total
Book Value
Total
Fair Value
(in millions)
Government National Mortgage Association
$
2,374.0
 
$
2,384.5
 
Federal National Mortgage Association
1,290.6
 
1,303.4
 
Federal Home Loan Mortgage Corp
1,200.7
 
1,244.2
 
J.P. Morgan Mortgage Trust
1,010.0
 
998.0
 
U.S. Treasury
879.8
 
879.8
 
Wells Fargo Mortgage Backed Securities Trust
644.6
 
630.7
 
Structured Adjustable Rate Mortgage Loan Trust
427.4
 
417.2
 
Total
$
7,827.1
 
$
7,857.8
 
 
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, final remittances related to certain months in 2009, which had various reconciliation items because of issues with the original servicer, have not yet been determined 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 this quarterly report filed on the Form 10-Q.

24

 
Liabilities and Capital
 
Deposits. At September 30, 2010, time deposits in denominations of $100 thousand or more totaled $500 thousand, all of which had a maturity of three to six months.
 
Consolidated Obligations. The Bank's total consolidated obligations decreased from December 31, 2009 to September 30, 2010 due to lower demand for advances. Consolidated obligation bonds decreased from year-end, due in part to significant bond maturities and calls; conversely, consolidated obligation discount notes increased in the comparison to fund the Bank's investment opportunities. See the Executive Summary discussion and the “Liquidity and Funding Risk” discussion in the Risk Management section, both in this Item 2. Management's Discussion and Analysis in this quarterly report filed on the Form 10-Q, for further information regarding consolidated obligations and related liquidity risk.
 
Commitments and Off-Balance Sheet Items. At September 30, 2010, the Bank was obligated to fund approximately $311.9 million in additional advances, $33.3 million of mortgage loans and $9.5 billion in outstanding standby letters of credit, and to issue $432.0 million in consolidated obligations. The Bank does not consolidate any off-balance sheet special purpose entities or other off-balance sheet conduits.
 
Capital and 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 response to additional regulatory guidance issued earlier this year, 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 September 30, 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.
 
The following table presents a rollforward of retained earnings for the nine months ended September 30, 2010 and 2009.
 
Nine Months Ended September 30,
(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 loss
(13.2
)
(31.9
)
Balance, end of the period
$
375.8
 
$
394.5
 
 
 
 

25

Capital Resources
 
The following is Management's Discussion and Analysis of the Bank's capital resources as of September 30, 2010, which should be read in conjunction with the unaudited interim financial conditions and notes included in this quarterly report filed on the 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.
 
 
(in millions)
September 30,
2010
June 30,
2010
March 31,
2010
December 31,
2009
Permanent capital:
 
 
 
 
 Capital stock (1)
$
4,182.8
 
$
4,048.5
 
$
4,043.4
 
$
4,026.3
 
 Retained earnings
375.8
 
330.7
 
398.9
 
389.0
 
Total permanent capital
$
4,558.6
 
$
4,379.2
 
$
4,442.3
 
$
4,415.3
 
 
 
 
 
 
RBC requirement:
 
 
 
 
 Credit risk capital
$
836.3
 
$
932.5
 
$
909.2
 
$
943.7
 
 Market risk capital
578.7
 
649.3
 
1,042.7
 
1,230.8
 
 Operations risk capital
424.5
 
474.6
 
585.5
 
652.4
 
Total RBC requirement
$
1,839.5
 
$
2,056.4
 
$
2,537.4
 
$
2,826.9
 
Excess permanent capital over RBC
    requirements
$
2,719.1
 
$
2,322.8
 
$
1,904.9
 
$
1,588.4
 
Note:
 
 
 
 
(1)Capital stock includes mandatorily redeemable capital stock.
 
The excess permanent capital over the RBC requirement has continued to increase since December 31, 2009. These increases were driven primarily by lower market risk capital requirements due to narrowing mortgage credit spreads, which are consistent with the increase in fair values of the Bank's private label MBS portfolio. 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 percent, the Bank is required to provide for additional market RBC. Details regarding the determination of the three components of risk-based capital are available in the Capital Resources discussion in Item 7. Management's Discussion and Analysis in the Bank's 2009 Annual Report filed on Form 10-K.
 
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 percent and 5.0 percent 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 percent and 5.0 percent. 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. The Bank exceeded all regulatory capital requirements at September 30, 2010.
 

26

 
(dollars in millions)
September 30,
2010
June 30,
 2010
March 31,
 2010
December 31, 2009
Capital Ratio
 
 
 
 
Minimum capital (4.0% of total assets)
$
2,205.6
 
$
2,425.2
 
$
2,346.2
 
$
2,611.6
 
Regulatory capital (permanent capital plus off-balance
   sheet credit reserves)
4,559.0
 
4,379.3
 
4,442.3
 
4,415.4
 
Total assets
55,139.5
 
60,629.7
 
58,656.0
 
65,290.9
 
Capital ratio (regulatory capital as a percent of total
   assets)
8.3
%
7.2
%
7.6
%
6.8
%
 
 
 
 
 
Leverage Ratio
 
 
 
 
Minimum leverage capital (5.0% of total assets)
$
2,757.0
 
$
3,031.5
 
$
2,932.8
 
$
3,264.5
 
Leverage capital (permanent capital multiplied by a 1.5
   weighting factor plus off-balance sheet credit reserves)
6,838.2
 
6,568.9
 
6,663.4
 
6,623.1
 
Leverage ratio (leverage capital as a percent of total
    assets)
12.4
%
10.8
%
11.4
%
10.1
%
 
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.
 
As discussed in the Executive Summary in this Item 2. Management's Discussion and Analysis, the Bank implemented modifications to its Capital Plan. The amended Capital Plan replaced the unused borrowing capacity membership stock purchase requirement, which was calculated quarterly and when a member borrowed from the Bank, with an annual Membership Asset Value stock purchase requirement based on the member's prior December 31 call report data. This calculation is not affected by the amount the member borrows from the Bank. Membership assets include, but are not limited to, the following: U.S. Treasury securities; U.S. agency securities; U.S. agency MBS; nonagency MBS; 1-4 family residential first mortgage loans; multi-family mortgage loans; 1-4 family residential second mortgage loans; home equity lines of credit; and commercial real estate loans. A factor is applied to each membership asset category and the resulting Membership Asset Value is determined by summing the products of the membership asset categories and the respective factor. The Membership Asset Value capital stock requirement range is from 0.05-1.00 percent. All members will be required to fully transition to the amended Capital Plan by the first Membership Asset Value re-calculation date of April 10, 2011. The range of the capital stock requirement on advances was expanded from 4.50-6.00 percent to 3.00-6.00 percent. The initial capital stock requirement under the amended Capital Plan for advances was lowered from 4.75 percent to 4.60 percent. The range of the capital stock requirement on AMA loans (i.e., MPF loans) sold to the Bank and put on its balance sheet was expanded from 0.00-4.00 percent to 0.00-6.00 percent. The amended Capital Plan also introduced a new capital stock requirement on letters of credit. See the amended Capital Plan filed as Exhibit 4.1.1 to the Second Quarter 2010 quarterly report filed on Form 10-Q on August 9, 2010.
 
At September 30, 2010 and December 31, 2009, excess capital stock held by the Bank's stockholders totaled $2.0 billion and $1.2 billion, respectively. Under the updated Capital Plan, certain members did not have adequate capital stock. As noted above, these members have until April 2011 to fully transition to the new requirements.
 
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 previously discussed, the Bank had suspended excess capital stock repurchases on December 23, 2008. However, on October 29, 2010, the Bank repurchased approximately $200 million of excess capital stock. The amount of excess capital stock repurchased from any member was the lesser of 5 percent of the member's total capital stock outstanding or its excess capital stock outstanding through October 28, 2010. Decisions regarding any future repurchases of excess capital stock will be made on a quarterly basis. The Bank will continue to monitor the condition of its private label MBS portfolio, its overall financial performance and retained earnings, developments in the mortgage and credit markets and other relevant information as the basis for determining the status of dividends and excess capital stock repurchases in future quarters. As long as it is not repurchasing all excess capital stock in accordance with prior practices, the Bank's capital and leverage ratios may be outside of normal operating ranges as evidenced by their levels through September 30, 2010.
 

27

As previously mentioned, the Bank's capital stock is owned by its members. The concentration of the Bank's capital stock is presented in the table below.
 
 
(dollars in millions)
 
September 30,
2010
December 31,
2009
Commercial banks
 
$
2,273.7
 
$
2,151.7
 
Thrifts
 
1,792.1
 
1,797.6
 
Credit unions
 
57.6
 
57.0
 
Insurance companies
 
23.4
 
11.7
 
Total GAAP capital stock
 
4,146.8
 
4,018.0
 
Mandatorily redeemable capital stock
 
36.0
 
8.3
 
Total capital stock
 
$
4,182.8
 
$
4,026.3
 
 
The composition of the Bank's membership by institution type is presented in the table below.
 
 
 
September 30,
2010
December 31,
2009
Commercial banks
 
197
 
197
 
Thrifts
 
90
 
92
 
Credit unions
 
24
 
24
 
Insurance companies
 
3
 
3
 
Total
 
314
 
316
 
 
 
Critical Accounting Policies
 
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. In addition, the Bank's critical accounting policies are presented in Item 7. Management's Discussion and Analysis 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 quarter report filed on the 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 Bank did not implement any material changes to its critical 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 nine months ended September 30, 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 this quarterly report filed on the Form 10-Q for a discussion of recent accounting pronouncements that are relevant to the Bank's businesses.
 
The FASB has proposed Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities Exposure Draft (FI ED). Although only proposed at this time and not expected to be finalized until the first half of 2011, if approved the FI ED is expected to have a material impact on the Bank's Statements of Operations, Condition, and Changes in Capital. In addition, the FI ED, as proposed, is expected to significantly change the Bank's Critical Accounting Policies except for Guarantees and Consolidated Obligations and Future REFCORP Payments. At this time, the Bank is continuing to evaluate the FI ED and monitor its status.
 
 

28

Legislative and Regulatory Developments
 
Legislation
Dodd-Frank Wall Street Reform and Consumer Protection Act. The most important legislative development during the period covered by this report was the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) on July 21, 2010, which is discussed in greater detail below together with a presentation of certain regulatory actions resulting from the Dodd-Frank Act that may have an important impact on the Bank. Other important developments during the period covered by this report include certain Finance Agency regulatory actions, each discussed below.
 
The Dodd-Frank Act, among other things: (1) creates an Interagency oversight council (Oversight Council) that is charged with identifying and regulating systemically important financial institutions; (2) regulates the over-the-counter derivatives market; (3) imposes new executive compensation proxy and disclosure requirements; (4) establishes new requirements for MBS, including a risk-retention requirement; (5) reforms the credit rating agencies; (6) makes a number of changes to the federal deposit insurance system; and (7) creates a consumer financial protection agency. The FHLBanks' business operations, funding costs, rights, obligations, and/or the environment in which FHLBanks carry out their housing-finance mission are likely to be impacted by the Dodd-Frank Act, although in the absence of final regulations implementing the Dodd-Frank Act, the extent and nature of that impact cannot be forecasted.
 
Helping Families Save Their Homes Act of 2009 and Other Mortgage Modification Legislation. 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. 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. In the event that such legislation is enacted 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 September 30, 2010, the Bank had 68 private label MBS with a par value of $3.0 billion that include bankruptcy carve-out language that could be affected by any cramdown legislation.
 
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 September 30, 2009, the U.S. Treasury announced the initial closings of two Public-Private Investment Funds established under PPIP to purchase legacy securities. Through September 30, 2010, the market value of the PPIP residential MBS transactions executed was approximately $19.3 billion. The PPIP’s activities in purchasing such residential MBS could affect the values of residential MBS.
 
GSE Reform. The U.S. Treasury and the Department of Housing and Urban Development are developing recommendations regarding the future of the housing GSEs, including the FHLBanks. The Administration is expected to unveil its plan for GSE reform in January 2011.
 
Tax-Exempt Bonds Supported by FHLBank Letters of Credit. Legislation has been introduced that would allow an FHLBank on behalf of one or more members to issue letters of credit to support non-housing related tax-exempt state and local bond issuances issued after December 31, 2010. The Housing and Economic Recovery Act first allowed for this authority, provided that the bonds were issued between July 30, 2008 and December 31, 2010.
 
Regulations
Proposed Rule Commodity Futures Trading Commission (CFTC)-SEC - Definitions of Swap and Major Swap Participant. On August 20, 2010, the U.S. Commodities Futures Trading Commission (the CFTC) and the SEC jointly issued a proposed rule with a comment deadline that closed September 20, 2010 requesting comment on certain key terms necessary to regulate the use and clearing of derivatives as required by the Dodd-Frank Act. The definitions of those terms may adversely impact the Bank. As two examples, such key terms include, among others, “swap” and “major swap participant.” To the extent that the final regulation defines “swap” to include bona fide loans that include caps or floors or variable rate loans, such loans may be subject to exchange or clearinghouse requirements, which would likely increase the costs of such transactions and reduce the attractiveness of such

29

transactions to the Bank's members. If an FHLBank is defined to be a “major swap participant” it will be required to trade certain of its standardized derivatives transactions through an exchange and clear those transactions through a centralized clearing house, and it will be subject to additional swap-based capital and margin requirements. In either case, the Bank's ability to achieve its risk management objectives and act as an intermediary between its members and counterparties may be materially impacted by this regulation or other regulations implemented under the Dodd-Frank Act that regulate derivatives.
 
Proposed Rule CFTC - Eligible Investments for Derivatives Clearing Organizations. At its meeting on October 26, 2010, the CFTC approved a proposed rule which, among other changes, would eliminate the ability of futures commissions merchants and derivatives clearing organizations to invest customer funds in GSE securities that are not explicitly guaranteed by the US Government. Currently, GSE securities are eligible investments under CFTC regulations. If this change in eligible investments is adopted as proposed, it may affect the demand for FHLBank debt.
 
Proposed Rule CFTC - Reporting of Pre-Enactment Swaps. On October 14, 2010, the CFTC adopted an interim final temporary rule effective October 14, 2010 requiring all swaps entered into before July 21, 2010 and still outstanding to be reported. Such reports are to be made by the earlier of (1) 60 days of the registration and the commencement of operations of a swap data repository to receive and maintain the data and (2) the operative date of permanent rules that the CFTC/SEC adopt to replace these interim final rules. The interim final rule requires reporting by swap dealers and major swap participants. In those transactions in which only one counterparty is a swap dealer or major swap participant that party is required to report. With respect to other swaps, the parties to the swap are required to select who will report. Parties are also required to maintain data related to the terms of pre-enactment swaps in support of the reporting requirements. The SEC has adopted a similar interim final temporary rule regarding security-based swaps.
 
Proposed Rule CFTC - Process for Review of Swaps for Mandatory Clearing. On November 2, 2010 the CFTC issued a proposed rule to implement new statutory provisions enacted by the Dodd-Frank Act. These proposed rules apply to the review of swaps by the Commission to determine whether the swaps are required to be cleared. Comments are due on January 3, 2011.
 
Oversight Council Proposed Rule Regarding Authority to Supervise and Regulate Certain Non-Bank Financial Companies. On October 6, 2010, the Oversight Council issued a proposed rule with a comment deadline of November 5, 2010 that would give the Oversight Council the authority to require a nonbank financial company (a term to be defined by the Oversight Council) to be supervised by the Board of Governors of the Federal Reserve System (''Board of Governors'') and subject to certain prudential standards. The Oversight Council shall make this determination based on whether material financial distress at a given firm, or the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the firm, could pose a threat to the financial stability of the United States. To the extent that the FHLBanks are determined to be nonbank financial companies subject to the Oversight Council's regulatory requirements, the FHLBanks operations and business are likely to be impacted.
 
Oversight Council Request for Information on Implementing the Volcker Rule. On October 6, 2010, the Oversight Council issued a public request for information in connection with the Oversight Commission's study on implementing certain prohibitions on proprietary trading, which prohibitions are commonly referred to as the Volcker Rule. Institutions subject to the Volcker Rule may be subject to higher capital requirements and quantitative limits with regard to their proprietary trading. To the extent that the Volcker Rule is implemented in a way that subjects FHLBanks to it, the Bank may be subject to additional limitations on the composition of its investment portfolio beyond those to which it is already subject under existing Finance Agency regulations. These limitations could result in less profitable investment alternatives.
 
FDIC Proposed Rule on Restoring the Deposit Insurance Fund. In addition to requiring unlimited deposit insurance coverage for transaction accounts (see discussion below), the Dodd-Frank Act also makes a number of changes to the federal deposit insurance program. First, it requires the FDIC to base future assessments for deposit insurance on the amount of assets held by an institution instead of on the amount of deposits it holds. Second, it permanently increases deposit insurance coverage for insured banks, savings associations, and credit unions to $250,000. Third, it increases the minimum reserve ratio for the FDIC insurance fund to 1.35 percent, which the FDIC is required to meet by September 30, 2020. Fourth, it requires the FDIC to offset the effect of meeting this higher reserve ratio on insured depository institutions with total consolidated assets of less than $10 billion. On October 19, 2010, the FDIC adopted a new restoration plan in order to meet the statutorily required 1.35 percent reserve ratio for its insurance fund by September 30, 2020 and issued a proposed rule that, among other things, would set the long-term designated reserve ratio for the fund at 2.00 percent. These changes made by the Dodd-Frank Act may provide an incentive for some of the Bank's members to hold more deposits than other non-deposit liabilities.
 
FDIC Proposed Rule on Unlimited Deposit Insurance for Noninterest-Bearing Transaction Accounts. The Dodd-Frank Act requires the FDIC and the National Credit Union Administration to provide unlimited deposit insurance for noninterest-bearing transaction accounts. This requirement is in effect for FDIC-insured institutions from December 31, 2010 until January 1, 2013 and for insured credit unions from the effective date of the Dodd-Frank Act until January 1, 2013. On September 27, 2010, the