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EX-32.2 - EXHIBIT 32.2 - Federal Home Loan Bank of Des Moinesexhibit322september302010.htm
EX-31.1 - EXHIBIT 31.1 - Federal Home Loan Bank of Des Moinesexhibit311september302010.htm
EX-31.2 - EXHIBIT 31.2 - Federal Home Loan Bank of Des Moinesexhibit312september302010.htm
EX-32.1 - EXHIBIT 32.1 - Federal Home Loan Bank of Des Moinesexhibit321september302010.htm
 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
 
 
x
 
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
 
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
Commission File Number: 000-51999
 
 
FEDERAL HOME LOAN BANK OF DES MOINES
(Exact name of registrant as specified in its charter)
Federally chartered corporation
(State or other jurisdiction of incorporation or organization) 
 
42-6000149
(I.R.S. employer identification number)
 
 
 
Skywalk Level
801 Walnut Street, Suite 200
Des Moines, IA
(Address of principal executive offices) 
 
 
 
50309
(Zip code)
 
Registrant's telephone number, including area code: (515) 281-1000
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
o Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
 
Accelerated filer o
 
Non-accelerated filer x
 
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes x No
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
 
 
Shares outstanding as of
 
 
October 31, 2010
Class B Stock, par value $100
 
22,485,725
 
 
 
 
 
 

Table of Contents
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


PART I—FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF CONDITION
(In thousands, except shares)
(Unaudited)
 
September 30,
2010
 
December 31,
2009
ASSETS
 
 
 
Cash and due from banks
$
106,400
 
 
$
298,841
 
Interest-bearing deposits
11,051
 
 
10,570
 
Securities purchased under agreements to resell
2,250,000
 
 
 
Federal funds sold
2,036,000
 
 
3,133,000
 
Investments
 
 
 
Trading securities (Note 3)
1,496,680
 
 
4,434,522
 
Available-for-sale securities (Note 4)
6,549,195
 
 
7,737,413
 
Held-to-maturity securities (estimated fair value of $8,148,383 and $5,535,975 at September 30, 2010 and December 31, 2009) (Note 5)
7,897,150
 
 
5,474,664
 
Advances (Note 7)
32,014,188
 
 
35,720,398
 
Mortgage loans held for portfolio, net of allowance for credit losses on mortgage loans of $6,800 and $1,887 at September 30, 2010 and December 31, 2009 (Note 8)
7,548,744
 
 
7,716,549
 
Accrued interest receivable
88,752
 
 
81,703
 
Premises, software, and equipment, net
9,185
 
 
9,062
 
Derivative assets (Note 9)
8,571
 
 
11,012
 
Other assets
52,423
 
 
28,939
 
Total assets
$
60,068,339
 
 
$
64,656,673
 
 
 
 
 
LIABILITIES AND CAPITAL
 
 
 
LIABILITIES
 
 
 
Deposits
 
 
 
Interest-bearing
$
1,379,237
 
 
$
1,144,225
 
Non-interest-bearing demand
124,580
 
 
80,966
 
Total deposits
1,503,817
 
 
1,225,191
 
Consolidated obligations (Note 10)
 
 
 
Discount notes
7,470,727
 
 
9,417,182
 
Bonds (includes $1,510,607 and $5,997,867 at fair value under the fair value option at September 30, 2010 and December 31, 2009)
47,518,521
 
 
50,494,474
 
Total consolidated obligations
54,989,248
 
 
59,911,656
 
Mandatorily redeemable capital stock (Note 11)
4,697
 
 
8,346
 
Accrued interest payable
234,898
 
 
243,693
 
Affordable Housing Program (AHP) Payable
41,204
 
 
40,479
 
Payable to REFCORP
9,907
 
 
10,124
 
Derivative liabilities (Note 9)
271,722
 
 
280,384
 
Other liabilities
40,857
 
 
26,245
 
Total liabilities
57,096,350
 
 
61,746,118
 
 
 
 
 
Commitments and contingencies (Note 14)
 
 
 
 
 
 
 
CAPITAL (Note 11)
 
 
 
Capital stock - Class B putable ($100 par value) authorized, issued, and outstanding 22,962,260 and 24,604,186 shares at September 30, 2010 and December 31, 2009
2,296,226
 
 
2,460,419
 
Retained earnings
529,213
 
 
484,071
 
Accumulated other comprehensive income (loss)
 
 
 
Net unrealized gain (loss) on available-for-sale securities (Note 4)
147,812
 
 
(32,533
)
Pension and postretirement benefits
(1,262
)
 
(1,402
)
Total capital
2,971,989
 
 
2,910,555
 
Total liabilities and capital
$
60,068,339
 
 
$
64,656,673
 
 
The accompanying notes are an integral part of these financial statements.

3


FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF INCOME
(In thousands)
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2010
 
2009
 
2010
 
2009
INTEREST INCOME
 
 
 
 
 
 
 
Advances
$
98,989
 
 
$
148,880
 
 
$
307,543
 
 
$
535,131
 
Advance prepayment fees, net
133,521
 
 
3,471
 
 
152,435
 
 
6,719
 
Interest-bearing deposits
111
 
 
108
 
 
254
 
 
339
 
Securities purchased under agreements to resell
913
 
 
466
 
 
1,493
 
 
1,625
 
Federal funds sold
542
 
 
2,449
 
 
3,845
 
 
15,645
 
Investments
 
 
 
 
 
 
 
Trading securities
7,648
 
 
14,667
 
 
33,320
 
 
49,936
 
Available-for-sale securities
24,225
 
 
17,960
 
 
74,102
 
 
40,119
 
Held-to-maturity securities
62,110
 
 
42,541
 
 
166,598
 
 
133,868
 
Mortgage loans
88,997
 
 
95,057
 
 
272,567
 
 
348,972
 
Total interest income
417,056
 
 
325,599
 
 
1,012,157
 
 
1,132,354
 
 
 
 
 
 
 
 
 
INTEREST EXPENSE
 
 
 
 
 
 
 
Consolidated obligations
 
 
 
 
 
 
 
Discount notes
2,667
 
 
18,829
 
 
7,221
 
 
126,539
 
Bonds
210,138
 
 
247,929
 
 
675,300
 
 
873,024
 
Deposits
350
 
 
582
 
 
873
 
 
2,050
 
Borrowings from other FHLBanks
 
 
 
 
2
 
 
21
 
Mandatorily redeemable capital stock
32
 
 
117
 
 
106
 
 
199
 
Total interest expense
213,187
 
 
267,457
 
 
683,502
 
 
1,001,833
 
 
 
 
 
 
 
 
 
NET INTEREST INCOME
203,869
 
 
58,142
 
 
328,655
 
 
130,521
 
Provision for credit losses on mortgage loans held for portfolio
1,695
 
 
91
 
 
5,647
 
 
341
 
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES
202,174
 
 
58,051
 
 
323,008
 
 
130,180
 
 
 
 
 
 
 
 
 
OTHER (LOSS) INCOME
 
 
 
 
 
 
 
Service fees
380
 
 
416
 
 
1,238
 
 
1,647
 
Net gain (loss) on trading securities
7,925
 
 
(1,697
)
 
61,557
 
 
52,056
 
Net gain (loss) on sale of available-for-sale securities
 
 
31,059
 
 
 
 
(11,710
)
Net gain (loss) on bonds held at fair value
3,027
 
 
(3,165
)
 
1,882
 
 
(15,392
)
Net gain on loans held for sale
 
 
 
 
 
 
1,342
 
Net (loss) gain on derivatives and hedging activities
(23,562
)
 
1,881
 
 
(112,792
)
 
98,297
 
Loss on extinguishment of debt
(127,308
)
 
(28,567
)
 
(131,335
)
 
(80,925
)
Other, net
2,941
 
 
1,551
 
 
7,733
 
 
3,896
 
Total other (loss) income
(136,597
)
 
1,478
 
 
(171,717
)
 
49,211
 
 
 
 
 
 
 
 
 
OTHER EXPENSE
 
 
 
 
 
 
 
Compensation and benefits
7,386
 
 
6,874
 
 
22,678
 
 
21,053
 
Operating
3,197
 
 
3,410
 
 
11,969
 
 
11,512
 
Federal Housing Finance Agency
637
 
 
551
 
 
1,994
 
 
1,694
 
Office of Finance
414
 
 
468
 
 
1,456
 
 
1,576
 
Total other expense
11,634
 
 
11,303
 
 
38,097
 
 
35,835
 
 
 
 
 
 
 
 
 
INCOME BEFORE ASSESSMENTS
53,943
 
 
48,226
 
 
113,194
 
 
143,556
 
 
 
 
 
 
 
 
 
AHP
4,406
 
 
3,948
 
 
9,251
 
 
11,739
 
REFCORP
9,908
 
 
8,856
 
 
20,789
 
 
26,364
 
Total assessments
14,314
 
 
12,804
 
 
30,040
 
 
38,103
 
 
 
 
 
 
 
 
 
NET INCOME
$
39,629
 
 
$
35,422
 
 
$
83,154
 
 
$
105,453
 
 
The accompanying notes are an integral part of these financial statements.

4


FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENT OF CHANGES IN CAPITAL
(In thousands)
(Unaudited)
 
 
Capital Stock
Class B (putable)
 
 
 
Accumulated
Other
 
 
 
Shares
 
Par Value
 
Retained Earnings
 
Comprehensive
Income
 
Total
Capital
 
 
 
 
 
 
 
 
 
 
BALANCE DECEMBER 31, 2009
24,604
 
 
$
2,460,419
 
 
$
484,071
 
 
$
(33,935
)
 
$
2,910,555
 
Proceeds from issuance of capital stock
3,633
 
 
363,246
 
 
 
 
 
 
363,246
 
Repurchase/redemption of capital stock
(5,234
)
 
(523,356
)
 
 
 
 
 
(523,356
)
Net shares reclassified to mandatorily redeemable capital stock
(41
)
 
(4,083
)
 
 
 
 
 
(4,083
)
Comprehensive income:
 
 
 
 
 
 
 
 
 
 
Net income
 
 
 
 
83,154
 
 
 
 
83,154
 
Other comprehensive income:
 
 
 
 
 
 
 
 
 
 
Net unrealized gain on available-for-sale securities
 
 
 
 
 
 
180,345
 
 
180,345
 
Pension and postretirement benefits
 
 
 
 
 
 
140
 
 
140
 
Total comprehensive income
 
 
 
 
 
 
 
 
263,639
 
Cash dividends on capital stock (2.00% annualized)
 
 
 
 
(38,012
)
 
 
 
(38,012
)
BALANCE SEPTEMBER 30, 2010
22,962
 
 
$
2,296,226
 
 
$
529,213
 
 
$
146,550
 
 
$
2,971,989
 
 
The accompanying notes are an integral part of these financial statements.

5


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

6


FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Nine Months Ended September 30,
 
2010
 
2009
OPERATING ACTIVITIES
 
 
 
Net income
$
83,154
 
 
$
105,453
 
 
 
 
 
Adjustments to reconcile net income to net cash provided by operating activities
 
 
 
Depreciation and amortization:
 
 
 
Net premiums, discounts, and basis adjustments on investments, advances, mortgage loans, and consolidated obligations
29,097
 
 
(33,799
)
Concessions on consolidated obligations
7,407
 
 
3,395
 
Premises, software, and equipment
1,383
 
 
996
 
Other
(26
)
 
279
 
Provision for credit losses on mortgage loans held for portfolio
5,647
 
 
341
 
Loss on extinguishment of debt
131,335
 
 
80,925
 
Net gain on trading securities
(61,557
)
 
(52,056
)
Net loss on sale of available-for-sale securities
 
 
11,710
 
Net gain on loans held for sale
 
 
(1,342
)
Net change in fair value on bonds held at fair value
(1,882
)
 
15,392
 
Net change in fair value on derivatives and hedging activities
(24,198
)
 
(84,618
)
Net realized loss on disposal of premises, software, and equipment
557
 
 
4
 
Net gain on real estate owned
(3,172
)
 
 
Net change in:
 
 
 
Accrued interest receivable
(7,067
)
 
8,398
 
Accrued interest on derivatives
(15,323
)
 
16,033
 
Other assets
1,228
 
 
443
 
Accrued interest payable
(9,165
)
 
(27,694
)
AHP Payable and discount on AHP advances
712
 
 
692
 
Payable to REFCORP
(217
)
 
8,878
 
Other liabilities
3,587
 
 
(2,997
)
 
 
 
 
Total adjustments
58,346
 
 
(55,020
)
 
 
 
 
Net cash provided by operating activities
141,500
 
 
50,433
 
 
The accompanying notes are an integral part of these financial statements.

7


FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF CASH FLOWS (continued from previous page)
(In thousands)
(Unaudited)
 
Nine Months Ended September 30,
 
2010
 
2009
INVESTING ACTIVITIES
 
 
 
Net change in:
 
 
 
Interest-bearing deposits
(125,781
)
 
171,967
 
Securities purchased under agreements to resell
(2,250,000
)
 
 
Federal funds sold
1,097,000
 
 
(1,060,000
)
Trading securities:
 
 
 
Proceeds from sales
2,999,401
 
 
754,626
 
Purchases
 
 
(3,844,300
)
Available-for-sale securities:
 
 
 
Proceeds from sales and maturities
1,589,609
 
 
3,270,871
 
Purchases
(189,880
)
 
(4,638,468
)
Held-to-maturity securities:
 
 
 
Net (increase) decrease in short-term
(335,000
)
 
384,933
 
Proceeds from maturities
1,819,314
 
 
1,082,735
 
Purchases
(3,904,199
)
 
(1,249,913
)
Advances to members:
 
 
 
Principal collected
30,921,415
 
 
35,776,149
 
Originated
(26,859,854
)
 
(30,551,036
)
Mortgage loans held for portfolio:
 
 
 
Principal collected
1,061,580
 
 
1,943,767
 
Originated or purchased
(920,359
)
 
(1,368,885
)
Mortgage loans held for sale:
 
 
 
  Principal collected
 
 
128,045
 
  Proceeds from sales
 
 
2,123,595
 
Proceeds from sales of foreclosed assets
17,183
 
 
11,452
 
Additions to premises, software, and equipment
(2,073
)
 
(1,717
)
Proceeds from sale of premises, software, and equipment
10
 
 
185
 
Net cash provided by investing activities
4,918,366
 
 
2,934,006
 
 
 
 
 
FINANCING ACTIVITIES
 
 
 
Net change in:
 
 
 
Deposits
337,399
 
 
(276,045
)
Net proceeds (payments) on derivative contracts with financing elements
20,725
 
 
(7,787
)
Net proceeds from issuance of consolidated obligations:
 
 
 
Discount notes
247,309,644
 
 
607,196,488
 
Bonds
31,276,702
 
 
20,766,716
 
Payments for maturing, transferring and retiring consolidated obligations:
 
 
 
Discount notes
(249,251,189
)
 
(614,333,936
)
Bonds
(34,739,734
)
 
(16,495,849
)
Proceeds from issuance of capital stock
363,246
 
 
189,804
 
Payments for repurchase of mandatorily redeemable capital stock
(7,732
)
 
(9,976
)
Payments for repurchase/redemption of capital stock
(523,356
)
 
(2,285
)
Cash dividends paid
(38,012
)
 
(29,040
)
Net cash used in financing activities
(5,252,307
)
 
(3,001,910
)
 
 
 
 
Net decrease in cash and due from banks
(192,441
)
 
(17,471
)
Cash and due from banks at beginning of the period
298,841
 
 
44,368
 
Cash and due from banks at end of the period
$
106,400
 
 
$
26,897
 
 
 
 
 
Supplemental disclosures
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
1,366,257
 
 
$
1,552,789
 
AHP
$
8,526
 
 
$
11,135
 
REFCORP
$
21,006
 
 
$
17,486
 
Unpaid principal balance transferred from mortgage loans held for portfolio to real estate owned
$
21,323
 
 
$
11,896
 
The accompanying notes are an integral part of these financial statements.

8


FEDERAL HOME LOAN BANK OF DES MOINES
 
CONDENSED NOTES TO THE FINANCIAL STATEMENTS (UNAUDITED)
 
Background Information
 
The Federal Home Loan Bank of Des Moines (the Bank) is a federally chartered corporation organized on October 31, 1932, that is exempt from all federal, state, and local taxation except real property taxes and is one of 12 district Federal Home Loan Banks (FHLBanks). The FHLBanks were created under the authority of the Federal Home Loan Bank Act of 1932 (FHLBank Act), which was amended by the Housing and Economic Recovery Act of 2008. The FHLBanks are regulated by the Federal Housing Finance Agency (Finance Agency), whose mission is to provide effective supervision, regulation, and housing mission oversight of the FHLBanks to promote their safety and soundness, support housing and finance and affordable housing, and support a stable and liquid mortgage market. The Finance Agency establishes policies and regulations governing the operations of the FHLBanks. Each FHLBank operates as a separate entity with its own management, employees, and board of directors.
 
The FHLBanks serve the public by enhancing the availability of funds for residential mortgages and targeted community development. The Bank provides a readily available, low cost source of funds to its member institutions and eligible housing associates in Iowa, Minnesota, Missouri, North Dakota, and South Dakota. Commercial banks, savings institutions, credit unions, insurance companies, and community development financial institutions may apply for membership. State and local housing associates that meet certain statutory criteria may also borrow from the Bank; while eligible to borrow, housing associates are not members of the Bank and, as such, are not permitted to hold capital stock.
 
The Bank is a cooperative. This means the Bank is owned by its customers, whom the Bank calls members. As a condition of membership in the Bank, all members must purchase and maintain membership capital stock based on a percentage of their total assets as of the preceding December 31st. Each member is also required to purchase and maintain activity-based capital stock to support certain business activities with the Bank.
 
The Bank's current members own nearly all of the outstanding capital stock of the Bank. Former members own the remaining capital stock to support business transactions still carried on the Bank's Statements of Condition. All stockholders, including current members and former members, may receive dividends on their investment to the extent declared by the Bank's Board of Directors.
 
Note 1—Basis of Presentation
 
The accompanying unaudited financial statements of the Bank for the three and nine months ended September 30, 2010 have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information. Accordingly, they do not include all of the information required by GAAP for full year information and should be read in conjunction with the audited financial statements for the year ended December 31, 2009, which are contained in the Bank's annual report on Form 10-K filed with the Securities and Exchange Commission on March 18, 2010 (2009 Form 10-K).
 
In the opinion of management, the unaudited financial information is complete and reflects all adjustments, consisting of normal recurring adjustments, for a fair statement of results for the interim periods. The presentation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year ending December 31, 2010.
 
Descriptions of the Bank's significant accounting policies are included in “Note 1 — Summary of Significant Accounting Policies” of the Bank's 2009 Form 10-K.
 
Reclassifications
 
During the third quarter of 2010, the Bank changed its calculation of adjusted net interest income for segment reporting and renamed this measure core net interest income. Prior period amounts were reclassified to be consistent with the presentation for the three and nine months ended September 30, 2010. Refer to "Note 12 - Segment Information" for further information.
 

9


During the fourth quarter of 2009, the Bank classified all proceeds from sales of foreclosed assets as investing activities in the Statements of Cash Flows. Prior period amounts were reclassified to be consistent with the presentation for the nine months ended September 30, 2010.
 
Note 2—Recently Issued and Adopted Accounting Standards & Interpretations
 
Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. On July 21, 2010, the Financial Accounting Standards Board (FASB) issued amended guidance to enhance financial statement disclosures about an entity's allowance for credit losses and the credit quality of its financing receivables. The amended guidance requires all public and nonpublic entities with financing receivables, including loans, lease receivables, and other long-term receivables, to provide disclosures that facilitate a financial statement user's evaluation of the following: (i) the nature of credit risk inherent in the entity's portfolio of financing receivables, (ii) how that risk is analyzed and assessed in arriving at the allowance for credit losses, and (iii) the changes and reasons for those changes in its allowance for credit losses. Both new and existing disclosures must be disaggregated by portfolio segment or class of financing receivable. A portfolio segment is defined as the level at which an entity develops and documents a systematic method for determining its allowance for credit losses. Short-term accounts receivable, receivables measured at fair value or at the lower of cost or fair value, and debt securities are exempt from this amended guidance. For public entities, the required disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010 (December 31, 2010 for the Bank). The required disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010 (January 1, 2011 for the Bank). The Bank's adoption of this amended guidance will likely result in increased interim and annual financial statement disclosures, but will not impact the Bank's financial condition, results of operations, or cash flows.
  
Scope Exception Related to Embedded Credit Derivatives. On March 5, 2010, the FASB issued amended guidance to clarify that the only type of embedded credit derivative feature related to the transfer of credit risk that is exempt from derivative bifurcation requirements is one that is in the form of subordination of one financial instrument to another. As a result, entities that have contracts containing an embedded credit derivative feature in a form other than such subordination will need to assess those embedded credit derivatives to determine if bifurcation and separate accounting as a derivative is required. This amended guidance became effective as of July 1, 2010 for the Bank. The Bank's adoption of this amended guidance did not impact its financial condition, results of operations, or cash flows.
 
Fair Value Measurements and Disclosures - Improving Disclosures about Fair Value Measurements. On January 21, 2010, the FASB issued amended guidance for fair value measurements and disclosures. The update requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. Furthermore, the update requires a reporting entity to present separately information about purchases, sales, issuances, and settlements in the reconciliation for fair value measurements using significant unobservable inputs; clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value; and amends guidance on employers' disclosures about postretirement benefit plan assets to require that disclosures be provided by classes of assets instead of by major categories of assets. The amended guidance became effective for interim and annual reporting periods beginning after December 15, 2009 (January 1, 2010 for the Bank), except for the disclosures about purchases, sales, issuances, and settlements in the reconciliation for fair value measurements using significant unobservable inputs. Those disclosures are effective for fiscal years beginning after December 15, 2010 (January 1, 2011 for the Bank), and for interim periods within those fiscal years. In the period of initial adoption, entities are not required to provide the amended disclosures for any previous periods presented for comparative purposes. The Bank adopted this amended guidance effective January 1, 2010, with the exception of disclosures about purchases, sales, issuances, and settlements in the reconciliation for fair value measurements using significant unobservable inputs. The Bank's adoption of this amended guidance resulted in increased interim and annual financial statement disclosures but did not impact the Bank's financial condition, results of operations, or cash flows.
 

10


Accounting for the Consolidation of Variable Interest Entities. On June 12, 2009, the FASB issued guidance to improve financial reporting by enterprises involved with variable interest entities (VIEs) and to provide more relevant and reliable information to users of financial statements. This guidance amends the manner in which entities evaluate whether consolidation is required for VIEs. An entity must first perform a qualitative analysis in determining whether it must consolidate a VIE, and if the qualitative analysis is not determinative, the entity must perform a quantitative analysis. The guidance also requires an entity to continually evaluate VIEs for consolidation, rather than making such an assessment based upon the occurrence of triggering events. Additionally, the guidance requires enhanced disclosures about how an entity's involvement with a VIE affects its financial statements and its exposure to risks.
 
The Bank's investments in VIEs may include, but are not limited to, senior interests in private-label mortgage-backed securities (MBS) and Mortgage Partnership Finance (MPF) shared funding securities (Mortgage Partnership Finance and MPF are registered trademarks of the FHLBank of Chicago). The Bank does not have the power to significantly affect the economic performance of any of its investments in VIEs since it does not act as a key decision-maker and does not have the unilateral ability to replace a key decision-maker. Additionally, since the Bank holds a senior interest, rather than residual interest, in its investments in VIEs, it does not have either the obligation to absorb losses of, or the right to receive benefits from, any of its investments in VIEs that could potentially be significant to the VIEs. Furthermore, the Bank does not design, sponsor, transfer, service, or provide credit or liquidity support in any of its investments in VIEs. The Bank's maximum loss exposure for these investments is limited to the carrying value.
 
This guidance became effective as of January 1, 2010 for the Bank. The Bank evaluated its investments in VIEs and determined that consolidation accounting is not required under the new accounting guidance since the Bank is not the primary beneficiary as described above. Therefore, the Bank's adoption of this guidance did not impact its financial condition, results of operations, or cash flows.    
 
Accounting for Transfers of Financial Assets. On June 12, 2009, the FASB issued guidance intended to improve the relevance, representational faithfulness, and comparability of the information a reporting entity provides in its financial reports about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor's continuing involvement in transferred financial assets. Key provisions of the guidance include: (i) the removal of the concept of qualifying special purpose entities; (ii) the introduction of the concept of a participating interest, in circumstances in which a portion of a financial asset has been transferred; and (iii) the requirement that in order to qualify for sale accounting, the transferor must evaluate whether it maintains effective control over transferred financial assets either directly or indirectly. The guidance also requires enhanced disclosures about transfers of financial assets and a transferor's continuing involvement in transferred financial assets. This guidance became effective as of January 1, 2010 for the Bank. The adoption of this guidance did not impact the Bank's financial condition, results of operations, or cash flows.    
 

11


Note 3—Trading Securities
 
Major Security Types. Trading securities were as follows (dollars in thousands):
 
 
September 30,
2010
 
December 31,
2009
TLGP1
$
1,216,305
 
 
$
3,692,984
 
Taxable municipal bonds2
280,375
 
 
741,538
 
Total
$
1,496,680
 
 
$
4,434,522
 
 
1 
 
Temporary Liquidity Guarantee Program (TLGP) securities represented corporate debentures of the issuing party that are backed by the full faith and credit of the U.S. Government.
 
 
 
2 
 
Taxable municipal bonds represented investments in U.S. Government subsidized Build America Bonds.
 
The following table summarizes net gain (loss) on trading securities (dollars in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2010
 
2009
 
2010
 
2009
Realized gain on sale of trading securities
$
4,882
 
 
$
3,038
 
 
$
28,586
 
 
$
3,626
 
Holding gain (loss) on trading securities
3,043
 
 
(4,735
)
 
32,971
 
 
48,430
 
Net gain (loss) on trading securities
$
7,925
 
 
$
(1,697
)
 
$
61,557
 
 
$
52,056
 
 
 

12


Note 4—Available-for-Sale Securities
 
Major Security Types. Available-for-sale securities at September 30, 2010 were as follows (dollars in thousands):
 
 
 
 
 
 
Amounts Recorded in
Accumulated Other
Comprehensive Income
 
 
 
Amortized
Cost
 
Hedging
Adjustments
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
 
Fair Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
TLGP1
$
563,688
 
 
$
1,277
 
 
$
2,086
 
 
$
 
 
$
567,051
 
Taxable municipal bonds2
28,077
 
 
(61
)
 
78
 
 
3
 
 
28,091
 
Other U.S. obligations3
79,752
 
 
 
 
3,235
 
 
 
 
82,987
 
Government-sponsored enterprise obligations4
489,431
 
 
17,761
 
 
40,312
 
 
 
 
547,504
 
Total non-mortgage-backed securities
1,160,948
 
 
18,977
 
 
45,711
 
 
3
 
 
1,225,633
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
Government-sponsored enterprise5
5,221,458
 
 
 
 
105,369
 
 
3,265
 
 
5,323,562
 
 
 
 
 
 
 
 
 
 
 
Total
$
6,382,406
 
 
$
18,977
 
 
$
151,080
 
 
$
3,268
 
 
$
6,549,195
 
 
 
Available-for-sale securities at December 31, 2009 were as follows (dollars in thousands):
 
 
 
 
 
 
Amounts Recorded in
Accumulated Other
Comprehensive Loss
 
 
 
Amortized
Cost
 
Hedging
Adjustments
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
 
Fair Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
TLGP1
$
563,688
 
 
$
41
 
 
$
2,028
 
 
$
 
 
$
565,757
 
Government-sponsored enterprise obligations4
491,136
 
 
(1,847
)
 
5,793
 
 
1,798
 
 
493,284
 
Total non-mortgage-backed securities
1,054,824
 
 
(1,806
)
 
7,821
 
 
1,798
 
 
1,059,041
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
Government-sponsored enterprise5
6,716,928
 
 
 
 
10,514
 
 
49,070
 
 
6,678,372
 
 
 
 
 
 
 
 
 
 
 
Total
$
7,771,752
 
 
$
(1,806
)
 
$
18,335
 
 
$
50,868
 
 
$
7,737,413
 
 
1 
 
TLGP securities represented corporate debentures of the issuing party that are backed by the full faith and credit of the U.S. Government.
 
 
 
2 
 
Taxable municipal bonds represented investments in U.S. Government subsidized Build America Bonds and State of Iowa IJOBS Program Special Obligations.
 
 
 
3 
 
Other U.S. obligations represented Export-Import Bank bonds.
 
 
 
4 
 
Government-sponsored enterprise (GSE) obligations represented Tennessee Valley Authority (TVA) and Federal Farm Credit Bank (FFCB) bonds.
 
 
 
5 
 
GSE MBS represented Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) securities.
    

13


The following table summarizes the available-for-sale securities with unrealized losses at September 30, 2010. The unrealized losses are aggregated by major security type and the length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands):
 
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Taxable municipal bonds
$
11,101
 
 
$
64
 
 
$
 
 
$
 
 
$
11,101
 
 
$
64
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
 Government-sponsored enterprise
 
 
 
 
548,212
 
 
3,265
 
 
548,212
 
 
3,265
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
11,101
 
 
$
64
 
 
$
548,212
 
 
$
3,265
 
 
$
559,313
 
 
$
3,329
 
 
The following table summarizes the available-for-sale securities with unrealized losses at December 31, 2009. The unrealized losses are aggregated by major security type and the length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands):
 
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Government-sponsored enterprise obligations
$
143,278
 
 
$
1,798
 
 
$
 
 
$
 
 
$
143,278
 
 
$
1,798
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Government-sponsored enterprise
2,784,687
 
 
14,134
 
 
2,932,739
 
 
34,936
 
 
5,717,426
 
 
49,070
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
2,927,965
 
 
$
15,932
 
 
$
2,932,739
 
 
$
34,936
 
 
$
5,860,704
 
 
$
50,868
 
 
Redemption Terms. The following table summarizes the amortized cost and fair value of available-for-sale securities categorized by contractual maturity (dollars in thousands). Expected maturities of some securities and MBS may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.
 
 
 
September 30, 2010
 
December 31, 2009
Year of Maturity
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
 
 
 
 
 
 
 
 
Due after one year through five years
 
$
586,471
 
 
$
591,781
 
 
$
573,425
 
 
$
575,703
 
Due after five years through ten years
 
445,736
 
 
497,654
 
 
456,150
 
 
458,139
 
Due after ten years
 
128,741
 
 
136,198
 
 
25,249
 
 
25,199
 
 
 
1,160,948
 
 
1,225,633
 
 
1,054,824
 
 
1,059,041
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
5,221,458
 
 
5,323,562
 
 
6,716,928
 
 
6,678,372
 
 
 
 
 
 
 
 
 
 
Total
 
$
6,382,406
 
 
$
6,549,195
 
 
$
7,771,752
 
 
$
7,737,413
 
 
At September 30, 2010 and December 31, 2009, the amortized cost of the Bank's MBS classified as available-for-sale included net discounts of $0.7 million and $1.6 million.
 

14


Sales. During the three months ended September 30, 2010, the Bank did not sell any available-for-sale securities. During the nine months ended September 30, 2010, the Bank sold an available-for-sale security at par of $91.0 million and therefore recognized no gain or loss on the sale. During the three months ended September 30, 2009, the Bank received $1.9 billion in proceeds from the sale of of available-for-sale securities and recognized gross gains of $31.3 million and gross losses of $0.2 million in other (loss) income. During the nine months ended September 30, 2009, the Bank received $2.7 billion in proceeds from the sale of of available-for-sale securities and recognized gross gains of $31.3 million and gross losses of $43.0 million in other (loss) income.
 
Note 5—Held-to-Maturity Securities
 
Major Security Types. Held-to-maturity securities at September 30, 2010 were as follows (dollars in thousands):
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
Negotiable certificates of deposit
$
335,000
 
 
$
 
 
$
34
 
 
$
334,966
 
Government-sponsored enterprise obligations1
311,903
 
 
49,718
 
 
 
 
361,621
 
State or local housing agency obligations2
110,311
 
 
4,869
 
 
 
 
115,180
 
TLGP3
1,250
 
 
39
 
 
 
 
1,289
 
Other4
3,779
 
 
 
 
 
 
3,779
 
Total non-mortgage-backed securities
762,243
 
 
54,626
 
 
34
 
 
816,835
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
 
Government-sponsored enterprise5
7,036,318
 
 
203,644
 
 
1,919
 
 
7,238,043
 
U.S. government agency-guaranteed6
36,197
 
 
170
 
 
1
 
 
36,366
 
MPF shared funding
28,609
 
 
130
 
 
310
 
 
28,429
 
Other7
33,783
 
 
 
 
5,073
 
 
28,710
 
Total mortgage-backed securities
7,134,907
 
 
203,944
 
 
7,303
 
 
7,331,548
 
 
 
 
 
 
 
 
 
Total
$
7,897,150
 
 
$
258,570
 
 
$
7,337
 
 
$
8,148,383
 
 
    

15


Held-to-maturity securities at December 31, 2009 were as follows (dollars in thousands):
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
Negotiable certificates of deposit
$
450,000
 
 
$
659
 
 
$
 
 
$
450,659
 
Government-sponsored enterprise obligations1
312,962
 
 
233
 
 
5,851
 
 
307,344
 
State or local housing agency obligations2
123,608
 
 
486
 
 
424
 
 
123,670
 
TLGP3
1,250
 
 
29
 
 
 
 
1,279
 
Other4
6,742
 
 
94
 
 
 
 
6,836
 
Total non-mortgage-backed securities
894,562
 
 
1,501
 
 
6,275
 
 
889,788
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
 
Government-sponsored enterprise5
4,468,928
 
 
88,482
 
 
14,942
 
 
4,542,468
 
U.S. government agency-guaranteed6
42,620
 
 
36
 
 
142
 
 
42,514
 
MPF shared funding
33,202
 
 
247
 
 
405
 
 
33,044
 
Other7
35,352
 
 
 
 
7,191
 
 
28,161
 
Total mortgage-backed securities
4,580,102
 
 
88,765
 
 
22,680
 
 
4,646,187
 
 
 
 
 
 
 
 
 
Total
$
5,474,664
 
 
$
90,266
 
 
$
28,955
 
 
$
5,535,975
 
 
1 
 
GSE obligations represented TVA and FFCB bonds.
 
 
 
2 
 
State or local housing agency obligations represented Housing Finance Authority (HFA) bonds that were purchased by the Bank from housing associates in the Bank's district.
 
 
 
3 
 
TLGP securities represented corporate debentures issued by the Bank's members that are backed by the full faith and credit of the U.S. Government.
 
 
 
4 
 
Other non-MBS investments represented investments in municipal bonds and Small Business Investment Company.
 
 
 
5 
 
GSE MBS represented Fannie Mae and Freddie Mac securities.
 
 
 
6 
 
U.S. government agency-guaranteed MBS represented Government National Mortgage Association securities and Small Business Administration (SBA) Pool Certificates. SBA Pool Certificates represent undivided interests in pools of the guaranteed portions of SBA loans. The SBA's guarantee of the Pool Certificates is backed by the full faith and credit of the U.S. Government.
 
 
 
7 
 
Other MBS investments represented private-label MBS.
 

16


The following table summarizes the held-to-maturity securities with unrealized losses at September 30, 2010. The unrealized losses are aggregated by major security type and the length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands):
 
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Negotiable certificates of deposit
$
334,966
 
 
$
34
 
 
$
 
 
$
 
 
$
334,966
 
 
$
34
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Government-sponsored enterprise
2,015
 
 
1
 
 
426,552
 
 
1,918
 
 
428,567
 
 
1,919
 
U.S. government agency-guaranteed
 
 
 
 
882
 
 
1
 
 
882
 
 
1
 
MPF shared funding
 
 
 
 
1,488
 
 
310
 
 
1,488
 
 
310
 
Other
 
 
 
 
28,710
 
 
5,073
 
 
28,710
 
 
5,073
 
Total mortgage-backed securities
2,015
 
 
1
 
 
457,632
 
 
7,302
 
 
459,647
 
 
7,303
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
336,981
 
 
$
35
 
 
$
457,632
 
 
$
7,302
 
 
$
794,613
 
 
$
7,337
 
 
The following table summarizes the held-to-maturity securities with unrealized losses at December 31, 2009. The unrealized losses are aggregated by major security type and the length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands):
 
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Government-sponsored enterprise obligations
$
280,715
 
 
$
5,851
 
 
$
 
 
$
 
 
$
280,715
 
 
$
5,851
 
State or local housing agency obligations
33,171
 
 
424
 
 
 
 
 
 
33,171
 
 
424
 
Total non-mortgage-backed securities
313,886
 
 
6,275
 
 
 
 
 
 
313,886
 
 
6,275
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Government-sponsored enterprise
365,866
 
 
1,017
 
 
1,898,140
 
 
13,925
 
 
2,264,006
 
 
14,942
 
U.S. government agency-guaranteed
 
 
 
 
37,246
 
 
142
 
 
37,246
 
 
142
 
MPF shared funding
 
 
 
 
1,564
 
 
405
 
 
1,564
 
 
405
 
Other
 
 
 
 
28,161
 
 
7,191
 
 
28,161
 
 
7,191
 
Total mortgage-backed securities
365,866
 
 
1,017
 
 
1,965,111
 
 
21,663
 
 
2,330,977
 
 
22,680
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
679,752
 
 
$
7,292
 
 
$
1,965,111
 
 
$
21,663
 
 
$
2,644,863
 
 
$
28,955
 
 
    

17


Redemption Terms. The following table summarizes the amortized cost and fair value of held-to-maturity securities by contractual maturity (dollars in thousands). Expected maturities of some securities and MBS may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.
 
 
 
September 30, 2010
 
December 31, 2009
Year of Maturity
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
 
 
 
 
 
 
 
 
Due in one year or less
 
$
335,000
 
 
$
334,966
 
 
$
452,989
 
 
$
453,742
 
Due after one year through five years
 
1,250
 
 
1,289
 
 
1,250
 
 
1,279
 
Due after five years through ten years
 
1,920
 
 
1,932
 
 
2,600
 
 
2,614
 
Due after ten years
 
424,073
 
 
478,648
 
 
437,723
 
 
432,153
 
 
 
762,243
 
 
816,835
 
 
894,562
 
 
889,788
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
7,134,907
 
 
7,331,548
 
 
4,580,102
 
 
4,646,187
 
 
 
 
 
 
 
 
 
 
Total
 
$
7,897,150
 
 
$
8,148,383
 
 
$
5,474,664
 
 
$
5,535,975
 
 
At September 30, 2010 and December 31, 2009, the amortized cost of the Bank's MBS classified as held-to-maturity included net discounts of $9.5 million and $17.4 million.
 
Note 6—Other-Than-Temporary Impairment
 
The Bank evaluates its individual available-for-sale and held-to-maturity securities in an unrealized loss position for other-than-temporary impairment (OTTI) on at least a quarterly basis. As part of its OTTI evaluation, the Bank considers its intent to sell each debt security and whether it is more likely than not that it will be required to sell the security before its anticipated recovery. If either of these conditions is met, the Bank will recognize an OTTI charge to earnings equal to the entire difference between the security's amortized cost basis and its fair value at the balance sheet date. For securities in an unrealized loss position that meet neither of these conditions, the Bank performs an analysis to determine if any of these securities are other-than-temporarily impaired.
 
For its agency and GSE MBS in an unrealized loss position, the Bank determined that the strength of the issuers' guarantees through direct obligations or support from the U.S. Government was sufficient to protect the Bank from losses based on current expectations. For its taxable municipal bonds and negotiable certificates of deposit in an unrealized loss position, the Bank determined that the creditworthiness of the issuers' was sufficient to protect the Bank from losses based on current expectations. For its MPF shared funding securities in an unrealized loss position, the Bank determined that credit enhancements resulting from subordination were sufficient to protect the Bank from losses based on current expectations. As a result, the Bank determined that, at September 30, 2010, all gross unrealized losses on its agency and GSE MBS, taxable municipal bonds, negotiable certificates of deposit, and MPF shared funding securities are temporary. Furthermore, the declines in market value of these securities are not attributable to credit quality. The Bank does not intend to sell these securities, and it is not more likely than not that the Bank will be required to sell these securities before recovery of their amortized cost bases. As a result, the Bank does not consider any of these securities to be other-than-temporarily impaired at September 30, 2010.
 

18


For its private-label MBS, the Bank performs cash flow analyses to determine whether the entire amortized cost bases of these securities are expected to be recovered. In 2009, the FHLBanks formed an OTTI Governance Committee, comprised of representation from all 12 FHLBanks, which is responsible for reviewing and approving the key modeling assumptions, inputs, and methodologies to be used by the FHLBanks to generate cash flow projections used in analyzing credit losses and determining OTTI for private-label MBS. In accordance with this methodology, the Bank may engage another designated FHLBank to perform the cash flow analyses underlying its OTTI determination. In order to promote consistency in the application of the assumptions, inputs, and implementation of the OTTI methodology, the FHLBanks established control procedures whereby the FHLBanks performing the cash flow analyses select a sample group of private-label MBS and each perform cash flow analyses on all such test MBS, using the assumptions approved by the OTTI Governance Committee. These FHLBanks exchange and discuss the results and make any adjustments necessary to achieve consistency among their respective cash flow models.
 
Utilizing this methodology, the Bank is responsible for making its own determination of impairment, which includes determining the reasonableness of assumptions, inputs, and methodologies used. At September 30, 2010, the Bank obtained cash flow analyses from its designated FHLBanks for all five of its private-label MBS. The cash flow analyses use two third-party models. The first third-party model considers borrower characteristics and the particular attributes of the loans underlying the Bank's securities, in conjunction with assumptions about future changes in home prices and interest rates, to project prepayments, defaults, and loss severities. A significant input to the first model is the forecast of future housing price changes for the relevant states and core based statistical areas (CBSAs), which is based upon an assessment of the individual housing markets. CBSA refers collectively to metropolitan and micropolitan statistical areas as defined by the U.S. Office of Management and Budget; as currently defined, a CBSA must contain at least one urban area with a population of 10,000 or more people. The Bank's housing price forecast as of September 30, 2010 assumed CBSA level current-to-trough home price declines ranging from 0 to 10 percent over the 3 to 9 month period beginning July 1, 2010. Thereafter, home prices are projected to remain flat in the first year, and to increase 1 percent in the second year, 3 percent in the third year, 4 percent in the fourth year, 5 percent in the fifth year, 6 percent in the sixth year, and 4 percent in each subsequent year.
 
The month-by-month projections of future loan performance derived from the first model, which reflect projected prepayments, defaults, and loss severities, are then input into a second model that allocates the projected loan level cash flows and losses to the various security classes in the securitization structure in accordance with its prescribed cash flow and loss allocation rules. The scenario of cash flows determined based on the model approach described above reflects a best estimate scenario and includes a base case current-to-trough housing price forecast and a base case housing price recovery path described in the prior paragraph. If this estimate results in a present value of expected cash flows that is less than the amortized cost basis of the security (that is, a credit loss exists), an OTTI is considered to have occurred. If there is no credit loss and the Bank does not intend to sell or it is not more likely than not it will be required to sell, any impairment is considered temporary.
 
At September 30, 2010, the Bank's private-label MBS cash flow analyses did not project any credit losses. Even under an adverse scenario that delays recovery of the housing price index, no credit losses were projected. The Bank does not intend to sell these securities and it is not more likely than not that the Bank will be required to sell these securities before recovery of their amortized cost bases. As a result, the Bank does not consider any of these securities to be other-than-temporarily impaired at September 30, 2010.
 
The Bank did not consider any of its investments to be other-than-temporarily impaired at December 31, 2009.
 

19


Note 7—Advances
 
Redemption Terms. The following table summarizes the Bank's advances outstanding by year of maturity (dollars in thousands):
 
 
 
September 30, 2010
 
December 31, 2009
Year of Maturity
 
Amount
 
Weighted
Average
Interest
Rate %
 
Amount
 
Weighted
Average
Interest
Rate %
 
 
 
 
 
 
 
 
 
Overdrawn demand deposit accounts
 
$
170
 
 
 
$
90
 
 
Due in one year or less
 
7,942,326
 
 
2.02
 
7,810,541
 
 
2.56
Due after one year through two years
 
3,650,215
 
 
2.51
 
4,802,348
 
 
2.71
Due after two years through three years
 
6,159,283
 
 
1.65
 
6,080,490
 
 
1.71
Due after three years through four years
 
1,298,802
 
 
2.88
 
4,938,047
 
 
1.86
Due after four years through five years
 
2,056,268
 
 
1.92
 
990,975
 
 
3.34
Thereafter
 
9,863,804
 
 
2.98
 
10,409,938
 
 
3.45
 
 
 
 
 
 
 
 
 
Total par value
 
30,970,868
 
 
2.34
 
35,032,429
 
 
2.62
 
 
 
 
 
 
 
 
 
Discounts on AHP advances
 
(1
)
 
 
 
(14
)
 
 
Premiums
 
254
 
 
 
 
308
 
 
 
Discounts
 
(3
)
 
 
 
(4
)
 
 
Fair value hedging adjustments
 
 
 
 
 
 
 
 
Cumulative fair value gain on existing hedges
 
949,953
 
 
 
 
590,243
 
 
 
Basis adjustments from terminated hedges
 
93,117
 
 
 
 
97,436
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
$
32,014,188
 
 
 
 
$
35,720,398
 
 
 
 
The Bank offers advances to members that may be prepaid on pertinent dates (call dates) without incurring prepayment or termination fees (callable advances). At September 30, 2010 and December 31, 2009, the Bank had callable advances outstanding totaling $6.6 billion. The Bank also offers putable advances. With a putable advance, the Bank has the right to terminate the advance at predetermined exercise dates, which the Bank typically would exercise when interest rates increase, and the borrower may then apply for a new advance at the prevailing market rate. At September 30, 2010 and December 31, 2009, the Bank had putable advances outstanding totaling $5.5 billion and $7.1 billion.
 
Prepayment Fees. Other advances may only be prepaid by paying a fee to the Bank (prepayment fee) that makes the Bank financially indifferent to the prepayment of the advance. These prepayment fees are net of hedging fair value adjustments and are recorded as a component of "Advance prepayment fees, net" in the Statements of Income. The following table summarizes the Bank's advance prepayment fees, net (dollars in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2010
 
2009
 
2010
 
2009
Gross prepayment fees
$
171,868
 
 
$
3,471
 
 
$
190,782
 
 
$
6,719
 
Hedging fair value adjustments
(38,347
)
 
 
 
(38,347
)
 
 
Advance prepayment fees, net
$
133,521
 
 
$
3,471
 
 
$
152,435
 
 
$
6,719
 
 
 

20


Interest Rate Payment Terms. The following table summarizes the Bank's advances by interest rate payment type (dollars in thousands):
 
 
September 30,
2010
 
December 31,
2009
Par amount of advances
 
 
 
Fixed rate
$
21,357,763
 
 
$
24,601,644
 
Variable rate
9,613,105
 
 
10,430,785
 
Total
$
30,970,868
 
 
$
35,032,429
 
 
 
Note 8—Mortgage Loans Held for Portfolio
 
The MPF program involves investment by the Bank in mortgage loans that are held for portfolio which are either funded by the Bank through, or purchased from, participating financial institutions (PFIs). MPF loans may also be participations in pools of eligible mortgage loans purchased from other FHLBanks. The Bank's PFIs originate, service, and credit enhance mortgage loans that are sold to the Bank. PFIs participating in the servicing release program do not service the loans owned by the Bank. The servicing on these loans is sold concurrently by the PFI to a designated mortgage service provider.
 
Mortgage loans with a contractual maturity of 15 years or less are classified as medium-term, and all other mortgage loans are classified as long-term. The following table presents information on the Bank's mortgage loans held for portfolio (dollars in thousands):
 
 
September 30,
2010
 
December 31,
2009
Real Estate:
 
 
 
Fixed rate, medium-term single family mortgages
$
1,822,520
 
 
$
1,908,191
 
Fixed rate, long-term single family mortgages
5,709,018
 
 
5,804,567
 
 
 
 
 
Total unpaid principal balance
7,531,538
 
 
7,712,758
 
 
 
 
 
Premiums
58,019
 
 
53,007
 
Discounts
(44,491
)
 
(52,165
)
Basis adjustments from mortgage delivery commitments
10,478
 
 
4,836
 
Allowance for credit losses
(6,800
)
 
(1,887
)
 
 
 
 
Total mortgage loans held for portfolio, net
$
7,548,744
 
 
$
7,716,549
 
 
 
The following table details the unpaid principal balance of the Bank's mortgage loans held for portfolio (dollars in thousands):
 
 
September 30,
2010
 
December 31,
2009
Conventional loans
$
7,160,924
 
 
$
7,333,496
 
Government-insured loans
370,614
 
 
379,262
 
Total unpaid principal balance
$
7,531,538
 
 
$
7,712,758
 
    

21


The Bank's management of credit risk in the MPF program involves several layers of legal loss protection that are defined in agreements among the Bank and its participating PFIs. For the Bank's conventional MPF loans, the availability of loss protection may differ slightly among MPF products. The Bank's loss protection consists of the following loss layers, in order of priority:
 
•    
Homeowner Equity.
 
•    
Primary Mortgage Insurance (PMI). PMI is on all loans with homeowner equity of less than 20 percent of the original purchase price or appraised value.
 
•    
First Loss Account. The first loss account specifies the Bank's potential loss exposure under each master commitment prior to the PFI's credit enhancement obligation. If the Bank experiences losses in a master commitment, these losses will either be (i) recovered through the recapture of performance based credit enhancement fees from the PFI or (ii) absorbed by the Bank. The first loss account balance for all master commitments is a memorandum account and was $121.4 million and $116.4 million at September 30, 2010 and December 31, 2009.
 
•    
Credit Enhancement Obligation of PFI. PFIs have a credit enhancement obligation to absorb losses in excess of the first loss account in order to limit the Bank's loss exposure to that of an investor in an MBS that is rated the equivalent of AA by a nationally recognized statistical rating organization. PFIs are required to either collateralize their credit enhancement obligation with the Bank or to purchase supplemental mortgage insurance (SMI) from mortgage insurers. All of the Bank's SMI providers have had their external ratings for claims-paying ability or insurer financial strength downgraded below AA. Ratings downgrades imply an increased risk that these SMI providers will be unable to fulfill their obligations to reimburse the Bank for claims under insurance policies.
 
The Bank utilizes an allowance for credit losses to reserve for estimated losses after considering the recapture of performance based credit enhancement fees from the PFI. Credit enhancement fees available to recapture losses consist of accrued credit enhancement fees to be paid to the PFIs and projected credit enhancement fees to be paid to the PFIs over the next twelve months less any losses incurred or expected to be incurred. These estimated credit enhancement fees are calculated at a master commitment level and are only available to the specified master commitment.
 
The allowance for credit losses on mortgage loans was as follows (dollars in thousands):
 
 
September 30, 2010
 
December 31, 2009
 
 
 
 
Balance, beginning of year
$
1,887
 
 
$
500
 
Charge-offs
(734
)
 
(88
)
Provision for credit losses
5,647
 
 
1,475
 
Balance, end of period
$
6,800
 
 
$
1,887
 
 
The Bank estimates its allowance for credit losses based upon both quantitative and qualitative factors that may vary based upon the MPF product. Quantitative factors include, but are not limited to, a rolling twelve-month average of (i) loan delinquencies, (ii) loans migrating to real estate owned, and (iii) actual historical losses, as well as credit enhancement fees available to recapture estimated losses assuming a declining portfolio balance adjusted for prepayments. Qualitative factors include, but are not limited to, management judgment and experience and changes in national and local economic trends.
 
During the nine months ended September 30, 2010, the Bank recorded a provision for credit losses of $5.6 million, bringing its allowance for credit losses to $6.8 million at September 30, 2010. The provision recorded was due to estimated losses in the Bank's mortgage portfolio increasing as a result of increased delinquency and loss severity and management's expectation that loans migrating to real estate owned will likely increase. The Bank allocates available credit enhancement fees to recapture estimated losses. As charge-off activity has increased, estimated available credit enhancement fees decreased to $4.3 million at September 30, 2010 from $6.9 million at December 31, 2009.
 

22


During 2009, as a result of increased delinquency and loss severity and decreased estimated credit enhancement fees available to recapture losses, the Bank increased its provision by $1.5 million, resulting in an allowance for credit losses of $1.9 million at December 31, 2009.
 
At September 30, 2010 and December 31, 2009, the Bank had $108.7 million and $102.0 million of nonaccrual loans. At September 30, 2010 and December 31, 2009, the Bank had $17.8 million and $12.2 million of real estate owned recorded as a component of “Other assets” in the Statements of Condition.
 
Note 9—Derivatives and Hedging Activities
 
Nature of Business Activity
 
The Bank enters into derivatives to manage the interest rate risk exposures inherent in otherwise unhedged assets and funding positions and to achieve its risk management objectives. The Bank's Enterprise Risk Management Policy prohibits trading in or the speculative use of these derivative instruments and limits credit risk arising from these instruments. Derivatives are an integral part of the Bank's financial management strategy. The most common ways in which the Bank uses derivatives are to:
 
•    
reduce funding costs by combining a derivative with a consolidated obligation, as the cost of a combined funding structure can be lower than the cost of a comparable consolidated obligation;
•    
reduce the interest rate sensitivity and repricing gaps of assets and liabilities;
•    
preserve a favorable interest rate spread between the yield of an asset (i.e., an advance) and the cost of the related liability (i.e., the consolidated obligation used to fund the advance). Without the use of derivatives, this interest rate spread could be reduced or eliminated when a change in the interest rate on the advance does not match a change in the interest rate on the consolidated obligation;
•    
mitigate the adverse earnings effects of the shortening or extension of certain assets (i.e., advances or mortgage assets) and liabilities; and
•    
manage embedded options in assets and liabilities.
 
Types of Derivatives
 
The Bank can use the following instruments to manage its exposure to interest rate risks inherent in its normal course of business:
 
•    
interest rate swaps;
•    
options;
•    
swaptions;
•    
interest rate caps or floors; and
•    
future/forward contracts.
 
Application of Derivatives
 
Derivative financial instruments are used by the Bank in two ways:
 
•    
a hedge of the fair value of a recognized asset or liability or an unrecognized firm commitment (a fair value hedge); or
•    
a non-qualifying hedge of an asset, liability, or firm commitment (an economic hedge) for asset-liability management purposes.
     
The Bank uses derivatives when they are considered to be a cost-effective alternative to achieve the Bank's financial and risk management objectives. The Bank reevaluates its hedging strategies from time to time and may change the hedging techniques it uses or adopt new hedging strategies.
 

23


Types of Hedged Items
 
The Bank documents at inception all relationships between derivatives designated as hedging instruments and hedged items, its risk management objectives and strategies for undertaking various hedge transactions, and its method of assessing effectiveness. This process includes linking all derivatives that are designated as fair value hedges to (i) assets and liabilities in the Statements of Condition, or (ii) firm commitments. The Bank also formally assesses (both at the hedge's inception and at least monthly) whether the derivatives it uses in hedging transactions have been effective in offsetting changes in the fair value of hedged items and whether those derivatives may be expected to remain effective in future periods. The Bank uses regression analyses to assess hedge effectiveness prospectively and retrospectively. The types of hedged items are:
 
•    
advances;
•    
investments;
•    
mortgage loans; and
•    
consolidated obligations.
 
Managing Credit Risk on Derivatives
 
The Bank is subject to credit risk due to nonperformance by counterparties to the derivative contracts. The degree of counterparty credit risk depends on the extent to which collateral agreements are included in such contracts to mitigate the risk. The Bank manages counterparty credit risk through credit analyses, collateral requirements, and adherence to the requirements set forth in Bank policies and regulations.
 
The notional amount of derivatives reflects the volume of the Bank's hedges, but it does not measure the credit exposure of the Bank because there is no principal at risk. The Bank requires collateral agreements on all derivative contracts that establish collateral delivery thresholds. The maximum credit risk is the estimated cost of replacing derivative instruments that have a net positive market value, assuming the counterparty defaults and the related collateral, if any, is of no value to the Bank. In determining maximum credit risk, the Bank considers accrued interest receivables and payables, the legal right to offset derivative assets and liabilities by counterparty, and cash collateral held.
 
At September 30, 2010, the Bank held cash collateral plus accrued interest for derivative credit risk of $61.5 million, which reduced its total derivative credit risk exposure of $70.1 million to $8.6 million as reflected in "Derivative assets" in the Statements of Condition. At December 31, 2009, the Bank held cash collateral plus accrued interest for derivative credit risk of $2.8 million, which reduced its total derivative credit risk exposure of $13.8 million to $11.0 million.
 
The valuation of derivative assets and liabilities must reflect the value of the instrument including the values associated with counterparty risk and the Bank's own credit standing. The Bank has collateral agreements with all its derivative counterparties that take into account both the Bank's and the counterparty's credit ratings. As a result of these practices and agreements, the Bank has concluded that the impact of the credit differential between the Bank and its derivative counterparties was sufficiently mitigated to an immaterial level and no further adjustments for credit were deemed necessary to the recorded fair values of "Derivative assets" and "Derivative liabilities" in the Statements of Condition at September 30, 2010.
 
Some of the Bank's derivative contracts contain provisions that require the Bank to post additional collateral with its counterparties if there is deterioration in the Bank's credit rating. If the Bank's credit rating is lowered by a major credit rating agency, the Bank may be required to deliver additional collateral on derivative instruments in net liability positions. The aggregate fair value of all derivative instruments with credit-risk related contingent features that were in a net liability position at September 30, 2010 was $453.0 million, for which the Bank has posted cash collateral of $181.3 million in the normal course of business. If the Bank's credit rating had been lowered one notch (i.e., from its current rating of AAA to AA), the Bank would have been required to deliver up to an additional $218.2 million of collateral to its derivative counterparties at September 30, 2010. However, the Bank's credit rating did not change during the nine months ended September 30, 2010.
 

24


Financial Statement Effect and Additional Financial Information
 
The following table summarizes the Bank's fair value of derivative instruments, without the effect of netting arrangements or collateral at September 30, 2010 (dollars in thousands). For purposes of this disclosure, the derivative values include fair value of derivatives and related accrued interest.
 
Fair Value of Derivative Instruments
 
Notional
Amount
 
Derivative
Assets
 
Derivative
 Liabilities
 
 
 
 
 
 
 
Derivatives designated as hedging instruments
 
 
 
 
 
 
Interest rate swaps
 
$
33,075,757
 
 
$
598,733
 
 
$
1,036,478
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments
 
 
 
 
 
 
Interest rate swaps
 
2,968,885
 
 
19,242
 
 
45,181
 
Interest rate caps and floors
 
9,490,000
 
 
80,715
 
 
 
Forward settlement agreements (TBAs)
 
254,500
 
 
97
 
 
675
 
Mortgage delivery commitments
 
255,061
 
 
685
 
 
84
 
Total derivatives not designated as hedging instruments
 
12,968,446
 
 
100,739
 
 
45,940
 
 
 
 
 
 
 
 
Total derivatives and related accrued interest before netting and collateral adjustments
 
$
46,044,203
 
 
699,472
 
 
1,082,418
 
 
 
 
 
 
 
 
Netting adjustments1
 
 
 
(629,370
)
 
(629,370
)
Cash collateral and related accrued interest2
 
 
 
(61,531
)
 
(181,326
)
Total netting adjustments and cash collateral
 
 
 
(690,901
)
 
(810,696
)
 
 
 
 
 
 
 
Derivative assets and liabilities
 
 
 
$
8,571
 
 
$
271,722
 
 
1 
 
Amounts represent the effect of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions by counterparty.
 
 
 
2 
 
Amounts exclude $9.1 million of excess cash collateral held by the Bank at September 30, 2010, which is recorded as a deposit liability in the Statements of Condition.
 
 

25


The following table summarizes the Bank's fair value of derivative instruments, without the effect of netting arrangements or collateral at December 31, 2009 (dollars in thousands). For purposes of this disclosure, the derivative values include fair value of derivatives and related accrued interest.
 
Fair Value of Derivative Instruments
 
Notional
Amount
 
Derivative
Assets
 
Derivative
 Liabilities
 
 
 
 
 
 
 
Derivatives designated as hedging instruments
 
 
 
 
 
 
Interest rate swaps
 
$
34,196,552
 
 
$
284,759
 
 
$
685,933
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments
 
 
 
 
 
 
Interest rate swaps
 
9,407,539
 
 
41,976
 
 
14,783
 
Interest rate caps
 
3,240,000
 
 
51,312
 
 
 
Forward settlement agreements (TBAs)
 
27,500
 
 
322
 
 
1
 
Mortgage delivery commitments
 
26,712
 
 
2
 
 
283
 
Total derivatives not designated as hedging instruments
 
12,701,751
 
 
93,612
 
 
15,067
 
 
 
 
 
 
 
 
Total derivatives and related accrued interest before netting and collateral adjustments
 
$
46,898,303
 
 
378,371
 
 
701,000
 
 
 
 
 
 
 
 
Netting adjustments1
 
 
 
(364,609
)
 
(364,609
)
Cash collateral and related accrued interest
 
 
 
(2,750
)
 
(56,007
)
Total netting adjustments and cash collateral
 
 
 
(367,359
)
 
(420,616
)
 
 
 
 
 
 
 
Derivative assets and liabilities
 
 
 
$
11,012
 
 
$
280,384
 
 
1 
 
Amounts represent the effect of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions by counterparty.
    
The following table summarizes the components of “Net (loss) gain on derivatives and hedging activities” as presented in the Statements of Income for the three and nine months ended September 30, 2010 and 2009 (dollars in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2010
 
2009
 
2010
 
2009
Derivatives and hedged items in fair value hedging relationships
 
 
 
 
 
 
 
Interest rate swaps
$
(11,480
)
 
$
8,935
 
 
$
(8,174
)
 
$
95,403
 
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
Interest rate swaps
(14,950
)
 
(8,697
)
 
(66,386
)
 
(5,864
)
Interest rate caps and floors
3,228
 
 
1,804
 
 
(37,182
)
 
10,930
 
Forward settlement agreements (TBAs)
(4,076
)
 
(1,037
)
 
(9,187
)
 
1,721
 
Mortgage delivery commitments
3,716
 
 
876
 
 
8,137
 
 
(3,893
)
 
(12,082
)
 
(7,054
)
 
(104,618
)
 
2,894
 
 
 
 
 
 
 
 
 
Net (loss) gain on derivatives and hedging activities
$
(23,562
)
 
$
1,881
 
 
$
(112,792
)
 
$
98,297
 

26


The following tables summarize, by type of hedged item, the (loss) gain on derivatives and the related hedged items in fair value hedging relationships and the impact of those derivatives on the Bank's net interest income for the three and nine months ended September 30, 2010 and 2009 (dollars in thousands):
 
 
 
Three Months Ended September 30, 2010
Hedged Item Type
 
(Loss) Gain on
Derivatives
 
Gain (Loss) on
Hedged Item
 
Net Fair Value
Hedge
Ineffectiveness
 
Effect on
Net Interest
Income1
 
 
 
 
 
 
 
 
 
Advances
 
$
(138,467
)
 
$
140,049
 
 
$
1,582
 
 
$
(93,504
)
Investments
 
(6,897
)
 
6,945
 
 
48
 
 
(1,580
)
Bonds
 
216,059
 
 
(229,169
)
 
(13,110
)
 
83,015
 
Total
 
$
70,695
 
 
$
(82,175
)
 
$
(11,480
)
 
$
(12,069
)
 
 
 
Three Months Ended September 30, 2009
Hedged Item Type
 
(Loss) Gain on
Derivatives
 
Gain (Loss) on
Hedged Item
 
Net Fair Value
Hedge
Ineffectiveness
 
Effect on
Net Interest
Income1
 
 
 
 
 
 
 
 
 
Advances
 
$
(107,096
)
 
$
107,986
 
 
$
890
 
 
$
(102,274
)
Investments
 
22,063
 
 
(14,210
)
 
7,853
 
 
(7,654
)
Bonds
 
28,077
 
 
(27,885
)
 
192
 
 
71,266
 
Total
 
$
(56,956
)
 
$
65,891
 
 
$
8,935
 
 
$
(38,662
)
 
 
 
 
Nine Months Ended September 30, 2010
Hedged Item Type
 
(Loss) Gain on
Derivatives
 
Gain (Loss) on
Hedged Item
 
Net Fair Value
Hedge
Ineffectiveness
 
Effect on
Net Interest
Income1
 
 
 
 
 
 
 
 
 
Advances
 
$
(387,671
)
 
$
390,386
 
 
$
2,715
 
 
$
(302,228
)
Investments
 
(20,889
)
 
20,783
 
 
(106
)
 
(4,939
)
Bonds
 
385,997
 
 
(396,780
)
 
(10,783
)
 
257,271
 
Total
 
$
(22,563
)
 
$
14,389
 
 
$
(8,174
)
 
$
(49,896
)
 
 
 
 
Nine Months Ended September 30, 2009
Hedged Item Type
 
Gain (Loss) on
Derivatives
 
(Loss) Gain on
Hedged Item
 
Net Fair Value
Hedge
Ineffectiveness
 
Effect on
Net Interest
Income1
 
 
 
 
 
 
 
 
 
Advances
 
$
328,517
 
 
$
(325,470
)
 
$
3,047
 
 
$
(254,880
)
Investments
 
79,720
 
 
2,699
 
 
82,419
 
 
(10,030
)
Bonds
 
(137,653
)
 
147,590
 
 
9,937
 
 
181,062
 
Total
 
$
270,584
 
 
$
(175,181
)
 
$
95,403
 
 
$
(83,848
)
 
1 
 
The net interest on derivatives in fair value hedge relationships is presented in the interest income/expense line item of the respective hedged item.
 

27


Note 10—Consolidated Obligations
 
Consolidated obligations are the joint and several obligations of the FHLBanks and consist of bonds and discount notes. The FHLBanks issue consolidated obligations through the Office of Finance as their agent. Bonds are typically issued to raise intermediate- and long-term funds for the FHLBanks and are not subject to any statutory or regulatory limits on maturity. Discount notes are typically issued to raise short-term funds of one year or less. Discount notes sell at less than their face amount and are redeemed at par value when they mature. The par amounts of the outstanding consolidated obligations of the 12 FHLBanks were approximately $805.9 billion and $930.5 billion at September 30, 2010 and December 31, 2009.
 
Bonds. The following table summarizes the Bank's bonds outstanding by year of maturity (dollars in thousands):
 
 
September 30, 2010
 
December 31, 2009
Year of Maturity
Amount
 
Weighted
Average
Interest
Rate %
 
Amount
 
Weighted
Average
Interest
Rate %
 
 
 
 
 
 
 
 
Due in one year or less
$
17,921,150
 
 
1.40
 
$
23,040,050
 
 
1.43
Due after one year through two years
8,372,350
 
 
1.80
 
9,089,100
 
 
2.45
Due after two years through three years
6,965,320
 
 
2.32
 
5,337,250
 
 
2.79
Due after three years through four years
2,515,465
 
 
2.55
 
2,522,835
 
 
3.73
Due after four years through five years
2,392,235
 
 
2.93
 
1,421,710
 
 
3.66
Thereafter
7,197,640
 
 
4.74
 
6,961,565
 
 
5.04
Index amortizing notes
1,632,889
 
 
5.12
 
1,950,088
 
 
5.12
 
 
 
 
 
 
 
 
Total par value
46,997,049
 
 
2.39
 
50,322,598
 
 
2.58
 
 
 
 
 
 
 
 
Premiums
43,879
 
 
 
 
49,514
 
 
 
Discounts
(33,053
)
 
 
 
(34,785
)
 
 
Fair value hedging adjustments
 
 
 
 
 
 
 
Cumulative fair value loss on existing hedges
506,463
 
 
 
 
148,954
 
 
 
Basis adjustments from terminated and ineffective hedges
(1,424
)
 
 
 
326
 
 
 
Fair value option adjustments
 
 
 
 
 
 
 
  Cumulative fair value loss
2,512
 
 
 
 
4,394
 
 
 
  Accrued interest payable
3,095
 
 
 
 
3,473
 
 
 
 
 
 
 
 
 
 
 
Total
$
47,518,521
 
 
 
 
$
50,494,474
 
 
 
 
The following table summarizes the Bank's total bonds outstanding (dollars in thousands):
 
 
September 30,
2010
 
December 31,
2009
Par amount of bonds
 
 
 
Noncallable or nonputable
$
32,853,049
 
 
$
44,380,598
 
Callable
14,144,000
 
 
5,942,000
 
Total par value
$
46,997,049
 
 
$
50,322,598
 
 
    

28


Interest Rate Payment Terms. The following table summarizes the Bank's bonds by interest rate payment type (dollars in thousands):
 
 
September 30,
2010
 
December 31,
2009
Par amount of bonds
 
 
 
Fixed rate
$
41,025,049
 
 
$
41,360,598
 
Simple variable rate
5,000,000
 
 
7,540,000
 
    Step-up
972,000
 
 
1,422,000
 
Total par value
$
46,997,049
 
 
$
50,322,598
 
 
Extinguishment of Debt. During the three and nine months ended September 30, 2010, the Bank extinguished bonds with a total par value of $1.0 billion and $1.1 billion and recognized losses of $127.3 million and $131.3 million in other (loss) income. During the three and nine months ended September 30, 2009, the Bank extinguished bonds with a total par value of $266.8 million and $853.3 million and recognized losses of $28.5 million and $80.9 million in other (loss) income.
 
Discount Notes. The following table summarizes the Bank's discount notes (dollars in thousands):
 
 
September 30, 2010
 
December 31, 2009
 
Amount
 
Weighted
Average
Interest
Rate %
 
Amount
 
Weighted
Average
Interest
Rate %
Par value
$
7,471,332
 
 
0.13
 
$
9,418,870
 
 
0.13
Discounts
(605
)
 
 
 
(1,688
)
 
 
Total
$
7,470,727
 
 
 
 
$
9,417,182
 
 
 
 
Note 11—Capital
 
The Bank is subject to three regulatory capital requirements. First, the Finance Agency requires that the Bank maintain at all times permanent capital greater than or equal to the sum of its credit, market, and operations risk capital requirements, all calculated in accordance with Finance Agency regulations. Only permanent capital, defined as Class B capital stock and retained earnings, can satisfy this risk based capital requirement. Second, the Finance Agency requires a minimum four percent capital-to-asset ratio, which is defined as total capital divided by total assets. Third, the Finance Agency imposes a five percent minimum leverage ratio, which is defined as the sum of permanent capital weighted 1.5 times and nonpermanent capital weighted 1.0 times divided by total assets. At September 30, 2010 and December 31, 2009, the Bank did not have any nonpermanent capital. For purposes of compliance with the regulatory minimum capital-to-asset and leverage ratios, capital includes all capital stock, including mandatorily redeemable capital stock, plus retained earnings. If the Bank's capital falls below the required levels, the Finance Agency has authority to take actions necessary to return it to safe and sound business operations within the regulatory minimum ratios.

29


The following table shows the Bank's compliance with the Finance Agency's three regulatory capital requirements (dollars in thousands):
 
 
September 30, 2010
 
December 31, 2009
 
Required
 
Actual
 
Required
 
Actual
Regulatory capital requirements
 
 
 
 
 
 
 
Risk based capital
$
519,594
 
 
$
2,830,136
 
 
$
826,709
 
 
$
2,952,836
 
Total capital-to-asset ratio
4.00
%
 
4.71
%
 
4.00
%
 
4.57
%
Total regulatory capital
$
2,402,734
 
 
$
2,830,136
 
 
$
2,586,267
 
 
$
2,952,836
 
Leverage ratio
5.00
%
 
7.07
%
 
5.00
%
 
6.85
%
Leverage capital
$
3,003,417
 
 
$
4,245,204
 
 
$
3,232,834
 
 
$
4,429,254
 
 
The Bank issues a single class of capital stock (Class B capital stock). The Bank's Class B capital stock has a par value of $100 per share, and all shares are purchased, repurchased, redeemed, or transferred only at par value. The Bank has two subclasses of Class B capital stock: membership capital stock and activity-based capital stock.
 
Each member is required to maintain a certain minimum capital stock investment in the Bank. The minimum investment requirements are designed so that the Bank remains adequately capitalized as member activity changes. To ensure the Bank remains adequately capitalized within ranges established in the Capital Plan, these requirements may be adjusted upward or downward by the Bank's Board of Directors.
 
Capital stock owned by members in excess of their minimum investment requirements is known as excess capital stock. The Bank had excess capital stock (including excess mandatorily redeemable capital stock) of $60.5 million and $61.8 million at September 30, 2010 and December 31, 2009.
 
Under the Bank's Capital Plan, the Bank, at its discretion and upon 15 days' written notice, may repurchase excess membership capital stock. If a member's membership capital stock balance exceeds an operational threshold set forth in the Capital Plan, the Bank may repurchase the amount of excess capital stock necessary to make the member's membership capital stock balance equal to the operational threshold. Additionally, if a member's activity-based capital stock balance exceeds an operational threshold set forth in the Capital Plan, the Bank may repurchase the amount of excess capital stock necessary to make the member's activity-based capital stock balance equal to the operational threshold.
 
Mandatorily Redeemable Capital Stock. The following table summarizes the Bank's mandatorily redeemable capital stock activity (dollars in thousands):
 
September 30,
2010
 
December 31,
2009
 
 
 
 
Balance, beginning of year
$
8,346
 
 
$
10,907
 
Mandatorily redeemable capital stock issued
 
 
7
 
Capital stock subject to mandatory redemption reclassified from capital stock
4,083
 
 
19,170
 
Redemption of mandatorily redeemable capital stock
(7,732
)
 
(21,738
)
Balance, end of period
$
4,697
 
 
$
8,346
 
 

30


Note 12—Segment Information
 
The Bank has identified two primary operating segments based on its products and services as well as its method of internal reporting: Member Finance and Mortgage Finance.
 
The Member Finance segment includes advances, investments (excluding MBS, HFA investments, and SBA investments), and the funding and hedging instruments related to those assets. Member deposits are also included in this segment. Net interest income for the Member Finance segment is derived primarily from the difference, or spread, between the yield on the assets in this segment and the cost of the member deposit and funding related to those assets.
 
The Mortgage Finance segment includes mortgage loans purchased through the MPF program, MBS, HFA investments, and SBA investments, and the funding and hedging instruments related to those assets. Net interest income for the Mortgage Finance segment is derived primarily from the difference, or spread, between the yield on the assets in this segment and the cost of the funding related to those assets.
 
Capital is allocated to the Member Finance and Mortgage Finance segments based on each segment's amount of capital stock, retained earnings, and accumulated other comprehensive income (loss).
 
The Bank reports performance of the segments based on adjusted net interest income. During the third quarter of 2010, the Bank changed its calculation of adjusted net interest income and renamed this measure core net interest income. Prior period amounts were reclassified to be consistent with the presentation for the three and nine months ended September 30, 2010.
 
For core net interest income, the Bank includes the following:
 
•    
Interest income and interest expense associated with economic hedges recorded as a component of “Net (loss) gain on derivatives and hedging activities” in other (loss) income in the Statements of Income.
 
For core net interest income, the Bank excludes the following:
 
•    
Advance prepayment fees, net of hedging fair value adjustments recorded as a component of "Advance prepayment fees, net" in the Statements of Income.
 
•    
Hedging fair value adjustments on called and extinguished debt.
 
 
 
 

31


The following table summarizes the Bank's financial performance by operating segment for the three months ended September 30, 2010 and 2009 (dollars in thousands).
 
 
Member
Finance
 
Mortgage
Finance
 
Total
Three months ended September 30, 2010
 
 
 
 
 
Core net interest income before the provision for credit losses
$
27,092
 
 
$
41,426
 
 
$
68,518
 
Provision for credit losses on mortgage loans
 
 
1,695
 
 
1,695
 
Core net interest income
$
27,092
 
 
$
39,731
 
 
$
66,823
 
 
 
 
 
 
 
Average assets for the period
$
39,338,399
 
 
$
20,584,774
 
 
$
59,923,173
 
Total assets at period end
$
39,950,815
 
 
$
20,117,524
 
 
$
60,068,339
 
 
 
 
 
 
 
Three months ended September 30, 2009
 
 
 
 
 
Core net interest income before the provision for credit losses
$
42,306
 
 
$
15,150
 
 
$
57,456
 
Provision for credit losses on mortgage loans
 
 
91
 
 
91
 
Core net interest income
$
42,306
 
 
$
15,059
 
 
$
57,365
 
 
 
 
 
 
 
Average assets for the period
$
50,834,791
 
 
$
17,047,675
 
 
$
67,882,466
 
Total assets at period end
$
48,155,207
 
 
$
17,270,772
 
 
$
65,425,979
 
 
The following table summarizes the Bank's financial performance by operating segment for the nine months ended September 30, 2010 and 2009 (dollars in thousands).
 
 
Member
Finance
 
Mortgage
Finance
 
Total
Nine months ended September 30, 2010
 
 
 
 
 
Core net interest income before the provision for credit losses
$
95,241
 
 
$
86,571
 
 
$
181,812
 
Provision for credit losses on mortgage loans
 
 
5,647
 
 
5,647
 
Core net interest income
$
95,241
 
 
$
80,924
 
 
$
176,165
 
 
 
 
 
 
 
Average assets for the period
$
42,448,221
 
 
$
20,598,997
 
 
$
63,047,218
 
Total assets at period end
$
39,950,815
 
 
$
20,117,524
 
 
$
60,068,339
 
 
 
 
 
 
 
Nine months ended September 30, 2009
 
 
 
 
 
Core net interest income before the provision for credit losses
$
86,145
 
 
$
57,615
 
 
$
143,760
 
Provision for credit losses on mortgage loans
 
 
341
 
 
341
 
Core net interest income
$
86,145
 
 
$
57,274
 
 
$
143,419
 
 
 
 
 
 
 
Average assets for the period
$
52,508,125
 
 
$
18,941,228
 
 
$
71,449,353
 
Total assets at period end
$
48,155,207
 
 
$
17,270,772
 
 
$
65,425,979
 
 

32


The following table reconciles the Bank's financial performance by operating segment to total income before assessments (dollars in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2010
 
2009
 
2010
 
2009
Core net interest income
$
66,823
 
 
$
57,365
 
 
$
176,165
 
 
$
143,419
 
Net interest income on economic hedges
(2,692
)
 
(1,532
)
 
(6,390
)
 
(6,173
)
Advance prepayment fees, net
133,521
 
 
3,471
 
 
152,435
 
 
6,719
 
Hedging fair value adjustments
4,522
 
 
(1,253
)
 
798
 
 
(13,785
)
Net interest income after mortgage loan credit loss provision
202,174
 
 
58,051
 
 
323,008
 
 
130,180
 
 
 
 
 
 
 
 
 
Other (loss) income
(136,597
)
 
1,478
 
 
(171,717
)
 
49,211
 
Other expense
11,634
 
 
11,303
 
 
38,097
 
 
35,835
 
 
 
 
 
 
 
 
 
Income before assessments
$
53,943
 
 
$
48,226
 
 
$
113,194
 
 
$
143,556
 

33


Note 13—Fair Value
 
Fair value amounts are determined by the Bank using available market information and the Bank's best judgment of appropriate valuation methods.
 
The following table summarizes the carrying values and fair values of the Bank's financial instruments (dollars in thousands). These fair values do not represent an estimate of the overall market value of the Bank as a going concern, which would take into account future business opportunities and the net profitability of assets versus liabilities.
 
FAIR VALUE SUMMARY TABLE
 
 
 
September 30, 2010
 
December 31, 2009
Financial Instruments
 
Carrying
Value
 
  Fair
Value
 
Carrying
Value
 
 Fair
Value
Assets
 
 
 
 
 
 
 
 
Cash and due from banks
 
$
106,400
 
 
$
106,400
 
 
$
298,841
 
 
$
298,841
 
Interest-bearing deposits
 
11,051
 
 
10,969
 
 
10,570
 
 
10,346
 
Securities purchased under agreements to resell
 
2,250,000
 
 
2,250,000
 
 
 
 
 
Federal funds sold
 
2,036,000
 
 
2,036,000
 
 
3,133,000
 
 
3,133,000
 
Trading securities
 
1,496,680
 
 
1,496,680
 
 
4,434,522
 
 
4,434,522
 
Available-for-sale securities
 
6,549,195
 
 
6,549,195
 
 
7,737,413
 
 
7,737,413
 
Held-to-maturity securities
 
7,897,150
 
 
8,148,383
 
 
5,474,664
 
 
5,535,975
 
Advances
 
32,014,188
 
 
32,317,291
 
 
35,720,398
 
 
35,978,355
 
Mortgage loans held for portfolio, net
 
7,548,744
 
 
7,984,119
 
 
7,716,549
 
 
7,996,456
 
Accrued interest receivable
 
88,752
 
 
88,752
 
 
81,703
 
 
81,703
 
Derivative assets
 
8,571
 
 
8,571
 
 
11,012
 
 
11,012
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
Deposits
 
(1,503,817
)
 
(1,503,814
)
 
(1,225,191
)
 
(1,224,975
)
Consolidated obligations
 
 
 
 
 
 
 
 
Discount notes
 
(7,470,727
)
 
(7,470,648
)
 
(9,417,182
)
 
(9,417,818
)
        Bonds1
 
(47,518,521
)
 
(48,971,556
)
 
(50,494,474
)
 
(51,544,919
)
Total consolidated obligations
 
(54,989,248
)
 
(56,442,204
)
 
(59,911,656
)
 
(60,962,737
)
 
 
 
 
 
 
 
 
 
Mandatorily redeemable capital stock
 
(4,697
)
 
(4,697
)
 
(8,346
)
 
(8,346
)
Accrued interest payable
 
(234,898
)
 
(234,898
)
 
(243,693
)
 
(243,693
)
Derivative liabilities
 
(271,722
)
 
(271,722
)
 
(280,384
)
 
(280,384
)
 
 
 
 
 
 
 
 
 
Other
 
 
 
 
 
 
 
 
Commitments to extend credit for mortgage loans
 
(2,227
)
 
(2,270
)
 
 
 
 
Standby letters of credit
 
(1,420
)
 
(1,420
)
 
(1,443
)
 
(1,443
)
Standby bond purchase agreements
 
 
 
3,654
 
 
 
 
6,477
 
 
1 
Includes $1.5 billion and $6.0 billion at fair value under the fair value option at September 30, 2010 and December 31, 2009.
 
Valuation Techniques and Significant Inputs
 
Cash and Due from Banks and Securities Purchased under Agreements to Resell. The fair value approximates the recorded book balance.
 
Interest-Bearing Deposits. For interest-bearing deposits with less than three months to maturity, the fair value approximates the recorded book balance. For interest-bearing deposits with more than three months to maturity, the fair value is determined by calculating the present value of the expected future cash flows and reducing the amount for accrued interest receivable.
 

34


Federal Funds Sold. For overnight and term Federal funds sold with less than three months to maturity, the fair value approximates the recorded book balance. For term Federal funds sold with more than three months to maturity, the fair value is determined by calculating the present value of the expected future cash flows. The discount rates used in these calculations are the rates for Federal funds with similar terms.
 
Investment Securities. The Bank's valuation technique incorporates prices from up to four designated third-party pricing vendors, when available. These pricing vendors use methods that generally employ market indicators, including but not limited to, benchmark yields, recent trades, dealer estimates, valuation models, benchmarking of like securities, sector groupings, and/or matrix pricing. The Bank establishes a price for each of its investment securities using a formula that is based upon the number of prices received. If four prices are received, the average of the middle two prices is used; if three prices are received, the middle price is used; if two prices are received, the average of the two prices is used; and if one price is received, it is used subject to some type of validation as described below. The computed prices are tested for reasonableness using specified tolerance thresholds. Prices within the established thresholds are generally accepted unless strong evidence suggests that using the formula-driven price would not be appropriate. Preliminary estimated fair values that are outside the tolerance thresholds, or that management believes may not be appropriate based on all available information (including those limited instances in which only one price is received), are subject to further analysis including, but not limited to, a comparison to the prices for similar securities and/or to non-binding dealer estimates or use of an internal model that is deemed most appropriate after consideration of all relevant facts and circumstances that a market participant would consider. The relative proximity of the prices received supports the Bank's conclusion that the final computed prices are reasonable estimates of fair value. At September 30, 2010, substantially all of the Bank's investment securities were priced using this valuation technique. In limited instances, when no prices are available from the four designated pricing services, the Bank obtains prices from dealers.
 
Advances. The fair value of advances is determined by calculating the present value of the expected future cash flows and reducing the amount for accrued interest receivable. The Bank uses the following inputs for measuring the fair value of advances:
 
•    
CO Curve. A market-observable curve constructed by the Office of Finance that represents the FHLBanks' cost of funds and is used to price advances.
•    
Spread assumption.
•    
Volatility assumption. Market-based expectations of future interest rate volatility implied from current market prices for similar options.
 
The discount rates used in these calculations are the replacement advance rates for advances with similar terms. In accordance with Bank policy and Finance Agency regulations, advances generally require a prepayment fee sufficient to make the Bank financially indifferent to a borrower's decision to prepay the advances. Therefore, the fair value of advances does not assume prepayment risk.
 
Mortgage Loans Held for Portfolio. The fair value of mortgage loans held for portfolio are determined based on quoted market prices of similar mortgage loans available in the market or modeled prices, if available. The modeled prices start with prices for new MBS issued by GSEs or similar new mortgage loans. Prices are then adjusted for differences in coupon, average loan rate, seasoning and cash flow remittance between the Bank’s mortgage loans and the MBS or mortgage loans. The prices of the referenced MBS and the mortgage loans are highly dependent upon the underlying prepayment assumptions priced in the secondary market. Changes in the prepayment rates often have a material effect on the fair value estimates. These underlying prepayment assumptions are susceptible to material changes in the near term because they are made at a specific point in time.
 
Real Estate Owned. The fair value of real estate owned is estimated using a current property value from the MPF Servicer or a broker price opinion adjusted for estimated selling costs.
 
Accrued Interest Receivable and Payable. The fair value approximates the recorded book balance.
 
Derivative Assets and Liabilities. The fair value of derivatives is generally determined using discounted cash flow analyses and comparisons to similar instruments. The discounted cash flow model utilizes market observable inputs (inputs that are actively quoted and can be validated to external sources). Inputs by class of derivative are as follows:
 

35


Interest Related Derivatives
 
•    
LIBOR Swap Curve.
•    
Volatility assumption. Market-based expectations of future interest rate volatility implied from current market prices for similar options.
•    
In limited instances, fair value estimates for interest-rate related derivatives (i.e. floors) are obtained from dealers and are corroborated by the Bank using a pricing model and observable market data.
 
Forward Settlement Agreements (TBAs)
 
•    
TBA securities prices. Market-based prices of TBAs are determined by coupon class and expected term until settlement.
 
Mortgage Delivery Commitments
 
•    
TBA securities prices. Prices are then adjusted for differences in coupon, average loan rate, and seasoning.
 
Deposits. For deposits with three months or less to maturity, the fair value approximates the recorded book balance. For deposits with more than three months to maturity, the fair value is determined by calculating the present value of the expected future cash flows and reducing this amount by accrued interest payable. The discount rates used in these calculations are the cost of deposits with similar terms.
 
Consolidated Obligations. The fair value of consolidated obligations is determined by calculating the present value of the expected future cash flows and reducing the amount for accrued interest payable. The Bank uses the following inputs for measuring the fair value of consolidated obligations:
 
•    
CO Curve.
•    
Volatility assumption. Market-based expectations of future interest rate volatility implied from current market prices for similar options.
 
The discount rates used in these calculations are for consolidated obligations with similar terms. The CO Curve is constructed by the Office of Finance using the Treasury Curve as a base curve which is then adjusted by adding indicative spreads obtained largely from market observable sources. These market indications are generally derived from pricing indications from dealers, historical pricing relationships, market color such as recent GSE trades, and secondary market activity.
 
Adjustments may be necessary to reflect the FHLBanks' credit quality when valuing consolidated obligations measured at fair value. Due to the joint and several liability of consolidated obligations, the Bank monitors its own creditworthiness and the creditworthiness of the other FHLBanks to determine whether any credit adjustments for credit risk are necessary in its fair value measurement of consolidated obligations.
 
Mandatorily Redeemable Capital Stock. The fair value of capital stock subject to mandatory redemption is generally reported at par value. Fair value also includes an estimated dividend earned at the time of reclassification from equity to a liability (if applicable), until such amount is paid. Capital stock can only be acquired by members at par value and redeemed at par value. Capital stock is not publicly traded and no market mechanism exists for the exchange of stock outside the cooperative structure.
 
Commitments to Extend Credit for Mortgage Loans. The fair value of commitments to extend credit for mortgage loans is determined by using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. The fair value also takes into account the difference between current and committed interest rates.
 
Standby Letters of Credit. The fair value of standby letters of credit is based on either (i) the fees currently charged for similar agreements or (ii) the estimated cost to terminate the agreement or otherwise settle the obligation with the counterparty.
 
Standby Bond Purchase Agreements. The fair value of standby bond purchase agreements is calculated using the present value of the expected future fees related to the agreements. The discount rates used in the calculations are based on municipal spreads over the Treasury Curve, which are comparable to discount rates used to value the underlying bonds. Upon purchase of any bonds under these agreements, the Bank estimates fair value using the "Investment Securities" fair value methodology.

36


Fair Value Hierarchy
 
The Bank records trading investments, available-for-sale investments, derivative assets, certain real estate owned, derivative liabilities, and certain bonds, for which the fair value option has been elected, at fair value in the Statements of Condition. The fair value hierarchy is used to prioritize the fair value methodologies and valuation techniques as well as the inputs to valuation techniques used to measure fair value for assets and liabilities carried at fair value. The inputs are evaluated and an overall level for the fair value measurement is determined. This overall level is an indication of market observability of the fair value measurement for the asset or liability.
 
Outlined below is the application of the fair value hierarchy to the Bank's assets and liabilities that are carried at fair value in the Statements of Condition on a recurring or nonrecurring basis.
 
Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. An active market for the asset or liability is a market in which the transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. The Bank carries certain derivative contracts (i.e. forward settlement agreements) that are highly liquid and actively traded in over-the-counter markets at Level 1 fair value on a recurring basis.
 
Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. The Bank carries its investment securities, certain derivative contracts and certain bonds recorded at fair value under the fair value option at Level 2 fair value on a recurring basis.
 
Level 3 - inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs are supported by little or no market activity or by the entity's own assumptions. The Bank carries certain real estate owned at Level 3 fair value on a nonrecurring basis.
 
The Bank utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. On a quarterly basis, the Bank reviews the fair value hierarchy classifications. Changes in the observability of the valuation attributes may result in a reclassification to the hierarchy level for certain assets or liabilities. At September 30, 2010, the Bank had made no reclassifications to its fair value hierarchy.
 

37


Fair Value on a Recurring Basis
 
The following table summarizes, for each hierarchy level, the Bank's assets and liabilities that are measured at fair value in the Statements of Condition at September 30, 2010 (dollars in thousands):
 
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustment1
 
Total
Assets
 
 
 
 
 
 
 
 
 
Trading securities
 
 
 
 
 
 
 
 
 
TLGP
$
 
 
$
1,216,305
 
 
$
 
 
$
 
 
$
1,216,305
 
Taxable municipal bonds
 
 
280,375
 
 
 
 
 
 
280,375
 
Available-for-sale securities
 
 
 
 
 
 
 
 
 
TLGP
 
 
567,051
 
 
 
 
 
 
567,051
 
Taxable municipal bonds
 
 
28,091
 
 
 
 
 
 
28,091
 
Other U.S. obligations
 
 
82,987
 
 
 
 
 
 
82,987
 
Government-sponsored enterprise obligations
 
 
547,504
 
 
 
 
 
 
547,504
 
Government-sponsored enterprise MBS
 
 
5,323,562
 
 
 
 
 
 
5,323,562
 
Derivative assets
 
 
 
 
 
 
 
 
 
Interest rate related
 
 
698,690
 
 
 
 
(690,901
)
 
7,789
 
Forward settlement agreements (TBAs)
97
 
 
 
 
 
 
 
 
97
 
Mortgage delivery commitments
 
 
685
 
 
 
 
 
 
685
 
 
 
 
 
 
 
 
 
 
 
Total assets at fair value
$
97
 
 
$
8,745,250
 
 
$
 
 
$
(690,901
)
 
$
8,054,446
 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
Bonds2
$
 
 
$
(1,510,607
)
 
$
 
 
$
 
 
$
(1,510,607
)
Derivative liabilities
 
 
 
 
 
 
 
 
 
Interest rate related
 
 
(1,081,659
)
 
 
 
810,696
 
 
(270,963
)
Forward settlement agreements (TBAs)
(675
)
 
 
 
 
 
 
 
(675
)
Mortgage delivery commitments
 
 
(84
)
 
 
 
 
 
(84
)
 
 
 
 
 
 
 
 
 
 
Total liabilities at fair value
$
(675
)
 
$
(2,592,350
)
 
$
 
 
$
810,696
 
 
$
(1,782,329
)
 
1 
 
Amounts represent the effect of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions and also cash collateral and the related accrued interest held or placed with the same counterparties.
 
 
 
2 
 
Represents bonds recorded under the fair value option.
 
    

38


The following table summarizes, for each hierarchy level, the Banks' assets and liabilities that are measured at fair value in the Statements of Condition at December 31, 2009 (dollars in thousands):
 
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustment1
 
Total
Assets
 
 
 
 
 
 
 
 
 
Trading securities
 
 
 
 
 
 
 
 
 
TLGP
$
 
 
$
3,692,984
 
 
$
 
 
$
 
 
$
3,692,984
 
Taxable municipal bonds
 
 
741,538
 
 
 
 
 
 
741,538
 
Available-for-sale securities
 
 
 
 
 
 
 
 
 
TLGP
 
 
565,757
 
 
 
 
 
 
565,757
 
Government-sponsored enterprise
 
 
7,171,656
 
 
 
 
 
 
7,171,656
 
Derivative assets
322
 
 
378,049
 
 
 
 
(367,359
)
 
11,012
 
 
 
 
 
 
 
 
 
 
 
Total assets at fair value
$
322
 
 
$
12,549,984
 
 
$
 
 
$
(367,359
)
 
$
12,182,947
 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
Bonds2
$
 
 
$
(5,997,867
)
 
$
 
 
$
 
 
$
(5,997,867
)
Derivative liabilities
(1
)
 
(700,999
)
 
 
 
420,616
 
 
(280,384
)
 
 
 
 
 
 
 
 
 
 
Total liabilities at fair value
$
(1
)
 
$
(6,698,866
)
 
$
 
 
$
420,616
 
 
$
(6,278,251
)
 
1 
 
Amounts represent the effect of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions and also cash collateral and the related accrued interest held or placed with the same counterparties.
 
 
 
2 
 
Represents bonds recorded under the fair value option
 
Fair Value on a Nonrecurring Basis
 
The Bank measures certain real estate owned at Level 3 fair value on a nonrecurring basis. These assets are not measured at fair value on an ongoing basis, but are subject to fair value adjustments in certain circumstances. Fair value adjustments on real estate owned are recorded as either a component of "Other, net” in the Statements of Income or “Other assets” in the Statements of Condition if there are available credit enhancement fees to recapture the estimated losses. At September 30, 2010, the fair value of real estate owned in which a fair value adjustment was recorded during the three months ended September 30, 2010 was approximately $76,000.
 
Fair Value Option
 
The fair value option provides an irrevocable option to elect fair value as an alternative measurement for selected assets, liabilities, unrecognized firm commitments, and written loan commitments not previously carried at fair value. It requires entities to display the fair value of those assets and liabilities for which the entity has chosen to use fair value on the face of the Statements of Condition. Fair value is used for both the initial and subsequent measurement of the designated assets, liabilities, and commitments, with the changes in fair value recognized in net income.
 
During the three and nine months ended September 30, 2010 and 2009, the Bank elected to record certain bonds that did not qualify for hedge accounting at fair value under the fair value option. In most instances, the Bank executed economic derivatives in order to achieve some offset to the mark-to-market on the fair value option bonds.
 

39


The following table summarizes the activity related to bonds in which the fair value option has been elected (dollars in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2010
 
2009
 
2010
 
2009
 
 
 
 
 
 
 
 
Balance, beginning of period
$
(4,181,915
)
 
$
(4,305,524
)
 
$
(5,997,867
)
 
$
 
New bonds elected for fair value option
 
 
 
 
(3,300,000
)
 
(4,290,000
)
Maturities and terminations
2,665,000
 
 
 
 
7,785,000
 
 
 
Net gain (loss) on bonds held at fair value
3,027
 
 
(3,165
)
 
1,882
 
 
(15,392
)
Change in accrued interest
3,281
 
 
188
 
 
378
 
 
(3,109
)
Balance, end of period
$
(1,510,607
)
 
$
(4,308,501
)
 
$
(1,510,607
)
 
$
(4,308,501
)
 
For bonds recorded under the fair value option, the related contractual interest expense is recorded as part of net interest income in the Statements of Income. The remaining changes are recorded as “Net gain (loss) on bonds held at fair value” in the Statements of Income. At September 30, 2010 and December 31, 2009, the Bank determined no credit risk adjustments for nonperformance were necessary to the bonds recorded under the fair value option. Concessions paid on bonds under the fair value option are expensed as incurred and recorded in “Other expense” in the Statements of Income.
 
The following table summarizes the difference between the fair value and the remaining contractual principal balance outstanding of bonds for which the fair value option has been elected (dollars in thousands):
 
 
September 30,
2010
 
December 31,
2009
Principal balance
$
1,505,000
 
 
$
5,990,000
 
Fair value
1,510,607
 
 
5,997,867
 
Fair value over principal balance
$
5,607
 
 
$
7,867
 
 
Note 14—Commitments and Contingencies
 
Joint and Several Liability. The 12 FHLBanks have joint and several liability for all consolidated obligations issued. Accordingly, should one or more of the FHLBanks be unable to repay its participation in the consolidated obligations, each of the other FHLBanks could be called upon by the Finance Agency to repay all or part of such obligations. No FHLBank has ever been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank. The par amounts of the outstanding consolidated obligations issued on behalf of other FHLBanks for which the Bank is jointly and severally liable were approximately $751.5 billion and $870.8 billion at September 30, 2010 and December 31, 2009.
 
Unsettled Consolidated Obligations. The par value of bonds that had traded but not yet settled at September 30, 2010 and December 31, 2009 was $1.0 billion and $0.2 billion. The par value of discount notes that had traded but not yet settled at September 30, 2010 was $1.5 billion. The Bank had no unsettled discount notes at December 31, 2009.
 

40


Commitments to Extend Credit. Standby letters of credit are executed with members for a fee. A standby letter of credit is typically a short-term financing arrangement between the Bank and a member. If the Bank is required to make payment for a beneficiary's draw, the payment is withdrawn from the member's demand account. Any resulting overdraft is converted into a collateralized advance to the member. Outstanding standby letters of credit were as follows (dollars in millions):
 
 
September 30,
2010
 
December 31,
2009
Expire within one year
$
4,424,191
 
 
$
3,331,151
 
Expire after one year
107,327
 
 
171,326
 
Total
$
4,531,518
 
 
$
3,502,477
 
 
 
 
 
Original terms (minimum)
4 days
 
5 days
Original terms (maximum)
13 years
 
13 years
Final expiration year
2020
 
2020
 
At September 30, 2010, $1.0 billion of standby letters of credit were purchased from the FHLBank of Pittsburgh under a Master Participation Agreement (MPA). Refer to "Note 16 - Activities with Other FHLBanks" for additional information on the MPA. Unearned fees for standby letters of credit are recorded in “Other liabilities” in the Statements of Condition and amounted to $1.4 million at September 30, 2010 and December 31, 2009. Based on management's credit analyses and collateral requirements, the Bank does not deem it necessary to have any provision for credit losses on these standby letters of credit. The estimated fair value of standby letters of credit at September 30, 2010 and December 31, 2009 is reported in “Note 13 — Fair Value.”
 
At September 30, 2010, the Bank had committed to fund $17.5 million of additional advances. The Bank had no commitments to fund additional advances at December 31, 2009.
 
Commitments to Fund or Purchase Mortgage Loans. Commitments that unconditionally obligate the Bank to fund or purchase mortgage loans from members in the MPF program totaled $257.3 million and $26.7 million at September 30, 2010 and December 31, 2009. Commitments are generally for periods not to exceed 45 business days. Commitments that obligate the Bank to purchase closed mortgage loans from its members are considered derivatives, and their estimated fair value at September 30, 2010 and December 31, 2009 is reported in “Note 9 — Derivatives and Hedging Activities” as mortgage delivery commitments. Commitments that obligate the Bank to table fund mortgage loans are not considered derivatives, and their estimated fair value at September 30, 2010 and December 31, 2009 is reported in “Note 13 — Fair Value” as commitments to extend credit for mortgage loans.
 
Standby Bond Purchase Agreements. At September 30, 2010 and December 31, 2009, the Bank had 24 standby bond purchase agreements with housing associates within its district whereby the Bank would be required to purchase bonds under circumstances defined in each agreement. The Bank would hold investments in the bonds until the designated remarketing agent could find a suitable investor or the housing associate repurchases the bonds according to a schedule established by the standby bond purchase agreement. At September 30, 2010 and December 31, 2009, the 24 outstanding standby bond purchase agreements totaled $684.8 million and $711.1 million and expire seven years after execution, with a final expiration in 2016. The Bank received fees for the guarantees that amounted to $0.4 million and $0.3 million for the three months ended September 30, 2010 and 2009 and $1.3 million and $0.7 million for the nine months ended September 30, 2010 and 2009. At September 30, 2010, the Bank had not been required to purchase any bonds under the executed standby bond purchase agreements. The estimated fair value of standby bond purchase agreements at September 30, 2010 and December 31, 2009 is reported in “Note 13 — Fair Value.”
 
Other Commitments. On June 1, 2010, the Bank entered into an agreement with the Missouri Housing Development Commission to purchase up to $75.0 million of taxable single family mortgage revenue bonds. The agreement expires on January 20, 2011. As of September 30, 2010, the Bank had not purchased any mortgage revenue bonds under this agreement.
 
As discussed in “Note 8 - Mortgage Loans Held for Portfolio”, the first loss account specifies the Bank's potential loss exposure under each master commitment after homeowner equity and PMI but prior to the PFI's credit enhancement obligation. The first loss account balance for all master commitments is a memorandum account and was $121.4 million and $116.4 million at September 30, 2010 and December 31, 2009.
 

41


In conjunction with its sale of certain mortgage loans to Fannie Mae through the FHLBank of Chicago in 2009, the Bank entered into an agreement with the FHLBank of Chicago on June 11, 2009 to indemnify the FHLBank of Chicago for potential losses on mortgage loans remaining in four master commitments from which the mortgage loans were sold. The Bank agreed to indemnify the FHLBank of Chicago for any losses not otherwise recovered through credit enhancement fees, subject to an indemnification cap of $2.1 million by December 31, 2010, $1.2 million by December 31, 2012, $0.8 million by December 31, 2015, and $0.3 million by December 31, 2020. At September 30, 2010, the FHLBank of Chicago had not informed the Bank of any losses that would not otherwise be recovered through credit enhancement fees.
 
Legal Proceedings. The Bank is not currently aware of any material pending legal proceedings other than ordinary routine litigation incidental to the business, to which the Bank is a party or of which any of its property is the subject.
 
Note 15—Activities with Stockholders and Housing Associates
 
Under the Bank's Capital Plan, voting rights conferred upon the Bank's members are for the election of member directors and independent directors. Member directorships are allocated to the five states in the Bank's district and a member is entitled to nominate and vote for candidates for the state in which the member's principal place of business is located. A member is entitled to cast, for each applicable member directorship, one vote for each share of capital stock that the member is required to hold, subject to a statutory limitation. Under this limitation, the total number of votes that a member may cast is limited to the average number of shares of the Bank's capital stock that were required to be held by all members in that state as of the record date for voting. The independent directors are nominated by the Bank's Board of Directors after consultation with the FHLBank's Affordable Housing Advisory Council, and then voted upon by all members within the Bank's five-state district. Non-member stockholders are not entitled to cast votes for the election of directors. At September 30, 2010 and December 31, 2009, no member owned more than 10 percent of the voting interests of the Bank due to statutory limits on members' voting rights as mentioned above.
 
Transactions with Stockholders. The Bank is a cooperative, which means that current members own nearly all of the outstanding capital stock of the Bank and may receive dividends on their investment. Former members own the remaining capital stock to support business transactions still carried in the Bank's Statements of Condition. All advances are issued to members and eligible housing associates and all mortgage loans held for portfolio are purchased from members. The Bank also maintains demand deposit accounts for members primarily to facilitate settlement activities that are directly related to advances and mortgage loan purchases. The Bank may not invest in any equity securities issued by its stockholders. The Bank extends credit to members in the ordinary course of business on substantially the same terms, including interest rates and collateral that must be pledged to us, as those prevailing at the time for comparable transactions with other members unless otherwise discussed. These extensions of credit do not involve more than the normal risk of collectibility and do not present other unfavorable features.
 
    

42


The following table summarizes transactions with members and their affiliates, former members and their affiliates, and eligible housing associates (dollars in thousands):
 
 
September 30,
2010
 
December 31,
2009
Assets
 
 
 
Cash
$
66,375
 
 
$
1,470
 
Interest-bearing deposits1
10,880
 
 
10,406
 
Federal funds sold
176,000
 
 
340,000
 
Trading securities2
130,611
 
 
130,819
 
Held-to-maturity securities2
446,561
 
 
124,858
 
Advances
32,014,188
 
 
35,720,398
 
Accrued interest receivable
5,762
 
 
6,675
 
Derivative assets
1,816
 
 
6,216
 
Other assets
263
 
 
389
 
 
 
 
 
Total
$
32,852,456
 
 
$
36,341,231
 
 
 
 
 
Liabilities
 
 
 
Deposits
$
1,376,284
 
 
$
1,147,469
 
Mandatorily redeemable capital stock
4,697
 
 
8,346
 
Accrued interest payable
101
 
 
118
 
Derivative liabilities
44,152
 
 
27,631
 
Other liabilities
1,761
 
 
1,894
 
 
 
 
 
Total
$
1,426,995
 
 
$
1,185,458
 
 
 
 
 
Capital
 
 
 
Capital stock — Class B putable
$
2,296,226
 
 
$
2,460,419
 
 
 
 
 
Notional amount of derivatives
$
6,544,265
 
 
$
5,255,246
 
Notional amount of standby letters of credit
$
3,531,518
 
 
$
3,502,477
 
Notional amount of standby bond purchase agreements
$
684,800
 
 
$
711,135
 
 
1 
 
Interest-bearing deposits consist of non-negotiable certificates of deposit purchased by the Bank from its members.
 
 
 
2 
 
Trading securities and held-to-maturity securities consist of negotiable certificates of deposit, state or local housing agency obligations, and TLGP debt investments purchased by the Bank from its members or eligible housing associates.
    
 
Transactions with Directors' Financial Institutions. In the normal course of business, the Bank extends credit to its members whose directors and officers serve as Bank directors (Directors' Financial Institutions). Finance Agency regulations require that transactions with Directors' Financial Institutions be subject to the same eligibility and credit criteria, as well as the same terms and conditions, as all other transactions. At September 30, 2010 and December 31, 2009, advances outstanding to Directors' Financial Institutions were $609.6 million and $684.4 million, respectively, representing 2.0 percent of the Bank's total advances outstanding for both periods. During the three months ended September 30, 2010 and 2009, mortgage loans originated by the Directors' Financial Institutions were $3.8 million and $13.8 million, respectively. During the nine months ended September 30, 2010 and 2009, mortgage loans originated by the Directors' Financial Institutions were $9.7 million and $38.8 million, respectively. At September 30, 2010 and December 31, 2009, capital stock outstanding to the Directors' Financial Institutions was $42.0 million and $44.4 million, representing 1.8 percent of the Bank's total capital stock outstanding for both periods. The Bank did not have any investment or derivative transactions with Directors' Financial Institutions during the three and nine months ended September 30, 2010 and 2009.
 
    

43


Business Concentrations. The Bank has business concentrations with stockholders whose capital stock outstanding is in excess of 10 percent of the Bank's total capital stock outstanding.
 
Capital Stock — The following tables summarize members and their affiliates holding 10 percent or more of outstanding capital stock (including stock classified as mandatorily redeemable) (shares in thousands):
 
 
 
 
 
 
 
Shares at
 
Percent of
Name
 
City
 
State
 
September 30,
2010
 
Total Capital
Stock
 
 
 
 
 
 
 
 
 
Transamerica Life Insurance Company1
 
Cedar Rapids
 
IA
 
2,347
 
 
10.2
%
Monumental Life Insurance Company1
 
Cedar Rapids
 
IA
 
278
 
 
1.2
 
 
 
 
 
 
 
2,625
 
 
11.4
%
 
 
 
 
 
 
 
Shares at
 
Percent of
Name
 
City
 
State
 
December 31,
2009
 
Total Capital
Stock
 
 
 
 
 
 
 
 
 
Superior Guaranty Insurance Company2
 
Minneapolis
 
MN
 
2,693
 
 
10.9
%
Transamerica Life Insurance Company1
 
Cedar Rapids
 
IA
 
2,525
 
 
10.2
 
Wells Fargo Bank, N.A.2
 
Sioux Falls
 
SD
 
412
 
 
1.7
 
Monumental Life Insurance Company1
 
Cedar Rapids
 
IA
 
278
 
 
1.1
 
 
 
 
 
 
 
5,908
 
 
23.9
%
 
1 
 
Monumental Life Insurance Company is an affiliate of Transamerica Life Insurance Company.
 
 
 
2 
 
Superior Guaranty Insurance Company (Superior) is an affiliate of Wells Fargo Bank, N.A (Wells Fargo).
 
Advances — The following table summarizes advances outstanding with stockholders and their affiliates whose capital stock outstanding is in excess of 10 percent of the Bank's total capital stock outstanding (dollars in thousands):
 
                    Stockholder
 
September 30,
2010
 
December 31,
2009
 
 
 
 
 
Transamerica Life Insurance Company
 
$
5,050,000
 
 
$
5,450,000
 
Superior Guaranty Insurance Company
 
*
 
 
1,625,000
 
Wells Fargo Bank, N.A.
 
*
 
 
700,000
 
Monumental Life Insurance Company
 
400,000
 
 
400,000
 
 
 
$
5,450,000
 
 
$
8,175,000
 
 
* 
 
Stockholder did not have capital stock outstanding in excess of 10 percent of the Bank's total capital stock outstanding at the stated period end.
 
During the nine months ended September 30, 2010, the Bank did not originate any advances to stockholders or their affiliates whose capital stock outstanding was in excess of 10 percent of the Bank's total capital stock outstanding at September 30, 2010. Interest income earned on advances with stockholders and their affiliates whose capital stock outstanding was in excess of 10 percent of the Bank's total capital stock outstanding at September 30, 2010 amounted to $6.0 million and $15.9 million during the three and nine months ended September 30, 2010.
 
Mortgage Loans — At September 30, 2010 and December 31, 2009, 51 and 57 percent of the Bank's mortgage loans outstanding were purchased from Superior.
 
    

44


Other — The Bank has a 20 year lease with an affiliate of Wells Fargo for space in a building for the Bank's headquarters that commenced on January 2, 2007. Rental expense for the three months ended September 30, 2010 and 2009 amounted to $0.2 million. Rental expense for the nine months ended September 30, 2010 and 2009 amounted to $0.7 million. Future minimum rentals to the Wells Fargo affiliate are as follows (dollars in thousands):
 
Year
 
Amount
Due in one year or less
 
$
869
 
Due after one year through two years
 
869
 
Due after two years through three years
 
869
 
Due after three years through four years
 
869
 
Due after four years through five years
 
869
 
Thereafter
 
10,646
 
 
 
 
Total
 
$
14,991
 
 
Note 16—Activities with Other FHLBanks
 
Investments in Consolidated Obligations. The Bank may invest in other FHLBank consolidated obligations, for which the other FHLBanks are the primary obligor, for liquidity purposes. If made, these investments in other FHLBank consolidated obligations would be purchased in the secondary market from third parties and would be accounted for as available-for-sale securities. The Bank did not have any investments in other FHLBank consolidated obligations at September 30, 2010 and December 31, 2009.
 
Investments in MPF Shared Funding Certificates. The Bank purchased MPF shared funding certificates from the FHLBank of Chicago. See "Note 5 — Held to Maturity Securities" for balances at September 30, 2010 and December 31, 2009.
 
Advances and Standby Letters of Credit. On August 19, 2010, the Bank entered into a MPA with the FHLBank of Pittsburgh allowing either FHLBank to (i) sell a participating interest in an existing advance to the other FHLBank, (ii) fund a new advance on a participating basis to the other FHLBank, or (iii) sell a participating interest in a standby letter of credit, each drawing thereunder, and the related reimbursement obligations to the other FHLBank. As of September 30, 2010, the FHLBank of Pittsburgh sold $1.0 billion of participating interests in standby letters of credit, each drawing thereunder, and the related reimbursement obligations to the Bank.
 
MPF Mortgage Loans. The Bank pays a service fee to the FHLBank of Chicago for its participation in the MPF program. This service fee expense is recorded as an offset to other (loss) income. For the three months ended September 30, 2010 and 2009, the Bank recorded $0.4 million and $0.3 million in service fee expense to the FHLBank of Chicago. For the nine months ended September 30, 2010 and 2009, the Bank recorded $1.2 million and $1.0 million in service fee expense to the FHLBank of Chicago.
 
Overnight Funds. The Bank may borrow or lend unsecured overnight funds from or to other FHLBanks. All such transactions are at current market rates. The following table summarizes loan activity from other FHLBanks during the nine months ended September 30, 2010 and 2009 (dollars in thousands):
Other FHLBank
 
Beginning
Balance
 
Borrowings
 
Principal
Payment
 
Ending
Balance
 
 
 
 
 
 
 
 
 
September 30, 2010
 
 
 
 
 
 
 
 
Chicago
 
$
 
 
$
500,000
 
 
$
(500,000
)
 
$
 
Cincinnati
 
 
 
25,000
 
 
(25,000
)
 
 
 
 
$
 
 
$
525,000
 
 
$
(525,000
)
 
$
 
 
 
 
 
 
 
 
 
 
September 30, 2009
 
 
 
 
 
 
 
 
San Francisco
 
$
 
 
$
6,104,000
 
 
$
(6,104,000
)
 
$
 
 
    

45


The following table summarizes loan activity to other FHLBanks during the nine months ended September 30, 2010 (dollars in thousands).
Other FHLBank
 
Beginning
Balance
 
Advances
 
Principal
Payment Received
 
Ending
Balance
 
 
 
 
 
 
 
 
 
September 30, 2010
 
 
 
 
 
 
 
 
Chicago
 
$
 
 
$
5,000
 
 
$
(5,000
)
 
$
 
 
The Bank did not make any loans to other FHLBanks during the nine months ended September 30, 2009.
 
Debt Transfers. Occasionally, the Bank transfers debt that it no longer needs to other FHLBanks. These transfers are accounted for in the same manner as debt extinguishments. In connection with these transactions, the assuming FHLBanks become the primary obligors for the transferred debt. During the nine months ended September 30, 2010, the Bank transferred $140.0 million, $100.0 million, and $193.9 million of par value bonds to the FHLBanks of Atlanta, Boston, and New York, respectively. The aggregate net losses realized on these debt transfers totaled $54.1 million. During the nine months ended September 30, 2009, the Bank transferred $375.0 million of par value bonds to the FHLBank of Atlanta. The aggregate net losses on these debt transfers totaled $23.1 million.

46


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Our Management's Discussion and Analysis (MD&A) of Financial Condition and Results of Operations should be read in conjunction with our financial statements and condensed notes at the beginning of this Form 10-Q and in conjunction with our MD&A and annual report on Form 10-K for the fiscal year ended December 31, 2009, filed with the Securities and Exchange Commission (SEC) on March 18, 2010 (2009 Form 10-K). Our MD&A is designed to provide information that will help the reader develop a better understanding of our financial statements, key financial statement changes from quarter to quarter, and the primary factors driving those changes. Our MD&A is organized as follows:
 
 

47


Forward-Looking Information
 
Statements contained in this report, including statements describing the objectives, projections, estimates, or future predictions in our operations, may be forward-looking statements. These statements may be identified by the use of forward-looking terminology, such as believes, projects, expects, anticipates, estimates, intends, strategy, plan, could, should, may, and will or their negatives or other variations on these terms. By their nature, forward-looking statements involve risk or uncertainty, and actual results could differ materially from those expressed or implied or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. These risks and uncertainties include, but are not limited to, the following:
 
•    
Economic and market conditions, including changes to conditions in the mortgage, housing and capital markets;
•    
Demand for our advances;
•    
Timing and volume of market activity;
•    
The volume of eligible mortgage loans originated and sold to us by participating members through the Mortgage Partnership Finance (MPF) program (Mortgage Partnership Finance and MPF are registered trademarks of the FHLBank of Chicago);
•    
Volatility of market prices, rates, and indices that could affect the value of financial instruments or our ability to liquidate collateral expediently in the event of a default by an obligor;
•    
Political events, including legislative, regulatory, judicial, or other developments that affect us, our members, our counterparties, and/or our investors in the consolidated obligations of the 12 Federal Home Loan Banks (FHLBanks);
•    
Changes in the terms and investor demand for derivatives and similar instruments;
•    
Changes in the relative attractiveness of consolidated obligations as compared to other investment opportunities explicitly guaranteed by the U.S. Government;
•    
Risks related to the other 11 FHLBanks that could trigger our joint and several liability for debt issued by the other 11 FHLBanks;
•    
Member failures or other member changes, including changes resulting from mergers or changes in the principal place of business of members; and
    
Effects of derivative accounting treatment, other-than-temporary impairment (OTTI) accounting treatment and other accounting rule requirements.
 
There can be no assurance that unanticipated risks will not materially and adversely affect our results of operations. For additional information regarding these and other risks and uncertainties that could cause our actual results to differ materially from the expectations reflected in our forward-looking statements, see “Item 1A. Risk Factors” in our 2009 Form 10-K. You are cautioned not to place undue reliance on any forward-looking statements made by us or on our behalf. Forward-looking statements are made as of the date of this report. We undertake no obligation to update or revise any forward-looking statement.
 
Executive Overview
 
Our Bank is a member-owned cooperative serving shareholder members in a five-state region (Iowa, Minnesota, Missouri, North Dakota, and South Dakota). Our mission is to provide funding and liquidity for our members and eligible housing associates by providing a stable source of short- and long-term funding through advances, standby letters of credit, mortgage purchases, and targeted housing and economic development activities. Our member institutions may include commercial banks, savings institutions, credit unions, insurance companies, and community development financial institutions.
 
For the three and nine months ended September 30, 2010, we recorded net income of $39.7 million and $83.2 million compared to $35.5 million and $105.5 million for the same periods in 2009. Net income increased $4.2 million during the three months ended September 30, 2010 and decreased $22.3 million during the nine months ended September 30, 2010 when compared to the same periods in 2009. The changes in net income between the periods were primarily due to increased net interest income, losses on the extinguishment of debt, and derivatives and hedging activities.
 

48


During the three and nine months ended September 30, 2010, our earnings calculated in accordance with accounting principles generally accepted in the United States of America (GAAP) were primarily impacted by advance prepayment fees, debt extinguishments, and derivatives and hedging activities. Advance prepayment fees, net of hedging fair value adjustments positively impacted GAAP net interest income and amounted to $133.5 million and $152.4 million during the three and nine months ended September 30, 2010 compared to $3.5 million and $6.7 million for the same periods in 2009. The majority of these prepayment fees were due to one member prepaying approximately $1.1 billion of fixed rate advances during the third quarter of 2010. The prepayment fees represent forgone interest payments on the prepaid advances and make us financially indifferent to the prepayment of the advances. We utilized the prepayment fees to extinguish certain bonds that were funding the prepaid advances. We extinguished bonds with a total par value of $1.0 billion and $1.1 billion during the three and nine months ended September 30, 2010 and recorded losses of $127.3 million and $131.3 million. These losses are reflected through “Loss on extinguishment of debt” in the Statements of Income. The prepaid fixed rate advances were replaced with callable variable rate advances and therefore did not impact our total advance balance at September 30, 2010.
 
We utilized derivative instruments to manage our interest rate exposure and prepayment risk during the three and nine months ended September 30, 2010. Because derivative accounting rules affect the timing and recognition of income or expense, we may be subject to income statement volatility from quarter to quarter. We recorded losses on derivatives and hedging activities of $23.6 million and $112.8 million during the three and nine months ended September 30, 2010 compared to gains of $1.9 million and $98.3 million during the same periods in 2009. The losses in 2010 were primarily attributable to our economic derivatives, including interest rate caps and floors. We recorded losses on our economic derivatives of $12.1 million and $104.6 million during the three and nine months ended September 30, 2010 compared to losses of $7.0 million and gains of $2.9 million for the same periods in 2009. In addition, during the three and nine months ended September 30, 2009, we sold available-for-sale securities and terminated the associated interest rate swaps, resulting in net gains on the derivative termination of $6.8 million and $82.6 million recorded through "Net (loss) gain on derivatives and hedging activities." For additional discussion on our derivatives and hedging activities, refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations - Hedging Activities.”
 
As net income results can be impacted by transactions that are considered to be unpredictable or the result of mark-to-market activity driven by market volatility, management utilizes a measure of core earnings to evaluate financial performance. Our measure of core earnings adjusts net income and net interest income calculated in accordance with GAAP. Specifically, our core earnings excludes the impacts of (i) market volatility relating to derivative and hedging activities and instruments held at fair value (i.e. certain bonds and trading securities), (ii) realized gains (losses) on sales of securities, and (iii) other unpredictable transactions, including advance prepayments and debt extinguishments. Management believes by excluding these items, because we are primarily a "hold-to-maturity" investor, core earnings provides a more meaningful period-to-period comparison of our operating results.
 
The resulting non-GAAP measure, referred to as our core earnings, reflects both core net interest income and core net income. Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. While this non-GAAP measure can be used to assist in understanding the components of our earnings, it should not be considered a substitute for results reported under GAAP.
 

49


The following table summarizes the reconciliation between GAAP net interest income and core net interest income:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2010
 
2009
 
2010
 
2009
Net interest income after provision for credit losses (GAAP)
$
202.2
 
 
$
58.1
 
 
$
323.0
 
 
$
130.2
 
Excludes:
 
 
 
 
 
 
 
Advance prepayment fees, net
133.5
 
 
3.5
 
 
152.4
 
 
6.7
 
Hedging fair value adjustments
4.5
 
 
(1.3
)
 
0.8
 
 
(13.7
)
Total core net interest income adjustments
138.0
 
 
2.2
 
 
153.2
 
 
(7.0
)
Includes items reclassified from other (loss) income:
 
 
 
 
 
 
 
Net interest income on economic hedges
2.7
 
 
1.5
 
 
6.4
 
 
6.2
 
Core net interest income
$
66.9
 
 
$
57.4
 
 
$
176.2
 
 
$
143.4
 
 
The following table summarizes the reconciliation between GAAP net income and core net income:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2010
 
2009
 
2010
 
2009
Net income before assessments (GAAP)
$
54.0
 
 
$
48.3
 
 
$
113.2
 
 
$
143.6
 
Excludes:
 
 
 
 
 
 
 
Core net interest income adjustments (per table above)
138.0
 
 
2.2
 
 
153.2
 
 
(7.0
)
Net (loss) gain on derivatives and hedging activities
(23.6
)
 
1.9
 
 
(112.8
)
 
98.3
 
Loss on extinguishment of debt
(127.3
)
 
(28.5
)
 
(131.3
)
 
(80.9
)
Net gain (loss) on bonds held at fair value
3.1
 
 
(3.2
)
 
1.9
 
 
(15.4
)
Net gain (loss) on trading securities
8.0
 
 
(1.7
)
 
61.6
 
 
52.1
 
Net gain (loss) on sale of available-for-sale securities
 
 
31.1
 
 
 
 
(11.7
)
Net gains on loans held for sale
 
 
 
 
 
 
1.3
 
Includes:
 
 
 
 
 
 
 
Net interest income on economic hedges
2.7
 
 
1.5
 
 
6.4
 
 
6.2
 
Core net income before assessments
$
58.5
 
 
$
48.0
 
 
$
147.0
 
 
$
113.1
 
 
Our core net income before assessments was $58.5 million and $147.0 million during the three and nine months ended September 30, 2010 compared to $48.0 million and $113.1 million for the same periods in 2009. The increase in our core net income during the three and nine months ended September 30, 2010 was primarily due to increased core net interest income. During the three and nine months ended September 30, 2010, our core net interest income increased $9.5 million and $32.8 million when compared to the same periods in 2009 due primarily to an improvement in our funding costs as a result of the low interest rate environment. In addition, our investment interest income increased due to an increase in government-sponsored enterprise (GSE) mortgage-backed securities (MBS).
 
As a result of the low interest rate environment throughout 2010, our funding costs decreased $53.9 million and $317.0 million during the three and nine months ended September 30, 2010 when compared to the same periods in 2009. As rates declined during the third quarter of 2010, we called existing debt and issued new lower costing callable debt in order to reduce our funding costs and protect ourselves against potential future mortgage prepayments. During the three and nine months ended September 30, 2010, we called $10.3 billion and $15.9 billion of par value debt compared to $0.5 billion and $2.5 billion for the same periods in 2009.
 
 

50


In addition, our investment interest income increased due to the purchase of $2.5 billion of GSE MBS during the first quarter of 2010. Interest income on our MBS amounted to $75.3 million and $207.2 million during the three and nine months ended September 30, 2010 compared to $48.3 million and $152.2 million for the same periods in 2009.
 
For additional discussion on items impacting our GAAP earnings, refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations.”
 
Conditions in the Financial Markets
 
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009 AND DECEMBER 31, 2009
 
Interest Rates
 
The following table shows information on key average market interest rates for the three and nine months ended September 30, 2010 and 2009 and key market interest rates at December 31, 2009:
 
 
Third Quarter
2010
3-Month
Average
 
Third Quarter
2009
3-Month
Average
 
Third Quarter
2010
9-Month
Average
 
Third Quarter
2009
9-Month
Average
 
December 31,
2009
Ending Rate
 
 
 
 
 
 
 
 
 
 
Federal funds target1
0.19
%
 
0.15
%
 
0.17
%
 
0.17
%
 
0.05
%
Three-month LIBOR1
0.38
 
 
0.41
 
 
0.36
 
 
0.83
 
 
0.25
 
2-year U.S. Treasury1
0.53
 
 
1.01
 
 
0.76
 
 
0.97
 
 
1.14
 
10-year U.S. Treasury1
2.77
 
 
3.50
 
 
3.31
 
 
3.17
 
 
3.84
 
30-year residential mortgage note1
4.45
 
 
5.17
 
 
4.79
 
 
5.08
 
 
5.14
 
1 
 
Source is Bloomberg.
    
Concern over the relative strength of the economy contributed to lower interest rates during the third quarter of 2010. Three-month LIBOR and U.S. Treasury yields decreased due to concerns about the economy and the possibility of the Federal Reserve increasing the money supply. Mortgage rates decreased in line with the decrease in U.S. Treasury yields as investors sought high-quality, liquid assets. As U.S. financial institutions continued to de-lever and maintain excess balance sheet liquidity, short-term money market investments maintained low yields during the third quarter of 2010.
 
The Federal Open Market Committee (FOMC) maintained the targeted range for the Federal funds rate at 0.00 to 0.25 percent at its August and September 2010 meetings. At its September meeting, the FOMC stated the following regarding inflation: “Measures of inflation are currently at levels somewhat below those we determine to be consistent with our mandate to promote maximum employment and price stability. We will continue to monitor financial developments and the economic outlook and are prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with our mandate.”
 
All of the Federal Reserve's purchase programs for agency MBS and agency securities expired as of June 30, 2010. However, the Federal Reserve has initiated re-investment of security receipts into U.S. Treasury securities.
 
 
 

51


Funding Spreads
 
 
Third
  Quarter 2010
3-Month
Average
 
Third
 Quarter
2009
3-Month
Average
 
Third
  Quarter 2010
9-Month
Average
 
Third
  Quarter 2009
9-Month
Average
 
December 31,
2009
Ending Spread
FHLB spreads to LIBOR
 
 
 
 
 
 
 
 
 
(basis points)1
 
 
 
 
 
 
 
 
 
3-month
(17.6
)
 
(0.2
)
 
(16.5
)
 
(56.7
)
 
(12.1
)
2-year
(4.9
)
 
(13.3
)
 
(6.7
)
 
6.2
 
 
(10.2
)
5-year
5.4
 
 
9.2
 
 
6.9
 
 
32.9
 
 
(1.7
)
10-year
44.1
 
 
56.7
 
 
43.2
 
 
90.5
 
 
41.9
 
1 
 
Source is Office of Finance.
    
Our access to funding has been stable throughout the third quarter of 2010 as investors continue to seek high-quality assets. As rates continued to decline during the third quarter, callable funding became more attractive and, as a result, we increased our callable debt issuances. We continued to utilize discount notes to fund certain advances and term investments, as well as to provide overall liquidity.
 
Selected Financial Data
 
The following selected financial data should be read in conjunction with our financial statements and condensed notes at the beginning of this Form 10-Q and in conjunction with our 2009 Form 10-K. The Statements of Condition data at September 30, 2010 and Statements of Income data for the three months ended September 30, 2010 were derived from the unaudited financial statements and condensed notes at the beginning of this Form 10-Q. The Statements of Condition data at December 31, 2009 was derived from audited financial statements and notes not included in this report but filed in our 2009 Form 10-K. The Statements of Condition data at June 30, 2010, March 31, 2010, and September 30, 2009 and the Statements of Income data for the three months ended June 30, 2010, March 31, 2010, December 31, 2009, and September 30, 2009 were derived from unaudited financial statements and condensed notes not included in this report.     
 
In the opinion of management, the unaudited financial information is complete and reflects all adjustments, consisting of normal recurring adjustments, for a fair statement of results for the interim periods and is in conformity with GAAP. The Statements of Income data for the three months ended March 31, 2010, June 30, 2010, and September 30, 2010 are not necessarily indicative of the results that may be achieved for our full 2010 fiscal year.
 
Statements of Condition
September 30, 2010
 
June 30, 2010
 
March 31, 2010
 
December 31, 2009
 
September 30, 2009
(Dollars in millions)
 
 
 
 
 
 
 
 
 
Investments1
$
20,240
 
 
$
19,179
 
 
$
23,236
 
 
$
20,790
 
 
$
21,134
 
Advances
32,014
 
 
32,491
 
 
33,027
 
 
35,720
 
 
36,303
 
Mortgage loans held for portfolio, gross2
7,556
 
 
7,537
 
 
7,559
 
 
7,719
 
 
7,839
 
Total assets
60,068
 
 
59,442
 
 
64,623
 
 
64,657
 
 
65,426
 
Consolidated obligations
 
 
 
 
 
 
 
 
 
 
 
Discount notes
7,471
 
 
3,485
 
 
4,706
 
 
9,417
 
 
12,874
 
Bonds
47,518
 
 
51,075
 
 
53,623
 
 
50,495
 
 
46,918
 
Total consolidated obligations3
54,989
 
 
54,560
 
 
58,329
 
 
59,912
 
 
59,792
 
Mandatorily redeemable capital stock
5
 
 
7
 
 
7
 
 
8
 
 
18
 
Capital stock — Class B putable4
2,296
 
 
2,307
 
 
2,331
 
 
2,461
 
 
2,952
 
Retained earnings
529
 
 
501
 
 
500
 
 
484
 
 
458
 
Accumulated other comprehensive income (loss)
147
 
 
103
 
 
23
 
 
(34
)
 
(24
)
Total capital
2,972
 
 
2,911
 
 
2,854
 
 
2,911
 
 
3,386
 

52


 
For the Three Months Ended
Statements of Income
September 30, 2010
 
June 30, 2010
 
March 31, 2010
 
December 31, 2009
 
September 30, 2009
(Dollars in millions)
 
 
 
 
 
 
 
 
 
Net interest income5
$
203.8
 
 
$
72.4
 
 
$
52.4
 
 
$
66.9
 
 
$
58.1
 
Provision for credit losses on mortgage loans
1.6
 
 
3.9
 
 
0.1
 
 
1.2
 
 
*
 
Other (loss) income 6
(136.6
)
 
(37.6
)
 
2.5
 
 
6.6
 
 
1.5
 
Other expense
11.6
 
 
13.0
 
 
13.5
 
 
17.3
 
 
11.3
 
Net income
39.7
 
 
13.2
 
 
30.3
 
 
40.4
 
 
35.5
 
 
For the Three Months Ended
Selected Financial Ratios
September 30, 2010
 
June 30, 2010
 
March 31, 2010
 
December 31, 2009
 
September 30, 2009
 
 
 
 
 
 
 
 
 
 
Net interest margin7
1.35
%
 
0.46
%
 
0.32
%
 
0.39
%
 
0.34
%
Return on average equity
5.32
 
 
1.84
 
 
4.25
 
 
4.84
 
 
4.17
 
Return on average capital stock
6.87
 
 
2.28
 
 
5.11
 
 
5.61
 
 
4.78
 
Return on average assets
0.26
 
 
0.08
 
 
0.19
 
 
0.24
 
 
0.21
 
Average equity to average assets
4.93
 
 
4.56
 
 
4.38
 
 
4.89
 
 
4.96
 
Regulatory capital ratio8
4.71
 
 
4.74
 
 
4.39
 
 
4.57
 
 
5.24
 
Dividend payout ratio9
29.15
 
 
90.04
 
 
48.07
 
 
36.57
 
 
40.86
 
 
1 
 
Investments include: interest-bearing deposits, securities purchased under agreements to resell, Federal funds sold, trading securities, available-for-sale securities, and held-to-maturity securities.
 
 
 
2 
 
Represents the gross amount of mortgage loans held for portfolio prior to the allowance for credit losses. The allowance for credit losses was $6.8 million, $5.6 million, $1.9 million, $1.9 million, and $0.8 million at September 30, 2010, June 30, 2010, March 31, 2010, December 31, 2009, and September 30, 2009.
 
 
 
3 
 
The par amounts of the outstanding consolidated obligations for all 12 FHLBanks were $805.9 billion, $846.4 billion, $870.9 billion, $930.5 billion, and $973.6 billion at September 30, 2010, June 30, 2010, March 31, 2010, December 31, 2009, and September 30, 2009.
 
 
 
4 
 
Total capital stock includes excess capital stock of $60.5 million, $51.6 million, $52.9 million, $61.8 million, and $540.1 million at September 30, 2010, June 30, 2010, March 31, 2010, December 31, 2009, and September 30, 2009. During the fourth quarter of 2008, we suspended our normal practice of voluntarily repurchasing excess capital stock after careful consideration of the unstable market conditions at that time. Due to improved market conditions throughout 2009, we resumed our normal practice of voluntarily repurchasing excess capital stock on December 18, 2009.
 
 
 
5 
 
Net interest income is before provision for credit losses on mortgage loans.
 
 
 
6 
 
Other (loss) income includes, among other things, net (losses) gains on derivatives and hedging activities, net gains (losses) on bonds held at fair value, losses on the extinguishment of debt, and net gains (losses) on trading securities.
 
 
 
7 
 
Net interest margin is net interest income expressed as a percentage of average interest-earning assets.
 
 
 
8 
 
Regulatory capital ratio is period-end regulatory capital expressed as a percentage of period-end total assets.
 
 
 
9 
 
Dividend payout ratio is dividends declared and paid in the stated period expressed as a percentage of net income in the stated period.
 
 
 
* 
 
Amount is less than $0.1 million.
 

53


Results of Operations
 
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009
 
The following discussion highlights significant factors influencing our results of operations. Average balances are calculated on a daily weighted average basis. Amounts used to calculate percentage variances are based on numbers in thousands. Accordingly, recalculations may not produce the same results when the amounts are disclosed in millions.
 
Net Income
 
The following table presents comparative highlights of our net income for the three and nine months ended September 30, 2010 and 2009 (dollars in millions). These items are further described in the sections that follow.
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2010
 
2009
 
$ Change
 
% Change
 
2010
 
2009
 
$ Change
 
% Change
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
$
203.8
 
 
$
58.1
 
 
$
145.7
 
 
250.8
 %
 
$
328.6
 
 
$
130.5
 
 
$
198.1
 
 
151.8
 %
Provision for credit losses on mortgage loans
1.6
 
 
*
 
 
1.6
 
 
100.0
 
 
5.6
 
 
0.3
 
 
5.3
 
 
1,766.7
 
Other (loss) income
(136.6
)
 
1.5
 
 
(138.1
)
 
(9,206.7
)
 
(171.7
)
 
49.2
 
 
(220.9
)
 
(449.0
)
Other expense
11.6
 
 
11.3
 
 
0.3
 
 
2.7
 
 
38.1
 
 
35.8
 
 
2.3
 
 
6.4
 
Income before assessments
54.0
 
 
48.3
 
 
5.7
 
 
11.8
 
 
113.2
 
 
143.6
 
 
(30.4
)
 
(21.2
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Assessments
14.3
 
 
12.8
 
 
1.5
 
 
11.7
 
 
30.0
 
 
38.1
 
 
(8.1
)
 
(21.3
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
$
39.7
 
 
$
35.5
 
 
$
4.2
 
 
11.8
 %
 
$
83.2
 
 
$
105.5
 
 
$
(22.3
)
 
(21.1
)%
 
* 
 
Amount is less than $0.1 million.
 

54


Net Interest Income
 
Our net interest income is primarily impacted by changes in average asset and liability balances, and the related yields and costs, as well as returns on invested capital. Net interest income is managed within the context of tradeoff between market risk and return.
 
The following tables present average balances and rates of major interest rate sensitive asset and liability categories for the three and nine months ended September 30, 2010 and 2009. The tables also present the net interest spread between yield on total interest-earning assets and cost of total interest-bearing liabilities as well as the net interest margin (dollars in millions).
 
 
For the Three Months Ended
September 30, 2010
 
For the Three Months Ended
September 30, 2009
 
Average
Balance 1
 
Yield/Cost
 
Interest
Income/
Expense
 
Average
Balance 1
 
Yield/Cost
 
Interest
Income/
Expense
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
159
 
 
0.28
%
 
$
0.1
 
 
$
76
 
 
0.57
%
 
$
0.1
 
Securities purchased under agreements to resell
1,828
 
 
0.20
 
 
0.9
 
 
1,223
 
 
0.15
 
 
0.4
 
Federal funds sold
1,425
 
 
0.15
 
 
0.5
 
 
4,787
 
 
0.20
 
 
2.4
 
Short-term investments
203
 
 
0.28
 
 
0.2
 
 
511
 
 
0.47
 
 
0.7
 
Mortgage-backed securities2
12,832
 
 
2.33
 
 
75.3
 
 
9,027
 
 
2.12
 
 
48.3
 
  Other investments2
3,128
 
 
2.36
 
 
18.5
 
 
7,557
 
 
1.39
 
 
26.1
 
Advances3,4
32,306
 
 
2.86
 
 
232.5
 
 
36,578
 
 
1.65
 
 
152.4
 
Mortgage loans5
7,553
 
 
4.67
 
 
89.0
 
 
7,954
 
 
4.74
 
 
95.1
 
Total interest-earning assets
59,434
 
 
2.78
 
 
417.0
 
 
67,713
 
 
1.91
 
 
325.5
 
Noninterest-earning assets
489
 
 
 
 
 
 
169
 
 
 
 
 
Total assets
$
59,923
 
 
2.76
%
 
$
417.0
 
 
$
67,882
 
 
1.90
%
 
$
325.5
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
Deposits
$
1,457
 
 
0.10
%
 
$
0.4
 
 
$
1,320
 
 
0.17
%
 
$
0.6
 
Consolidated obligations
 
 
 
 
 
 
 
 
 
 
 
Discount notes
6,373
 
 
0.17
 
 
2.7
 
 
18,265
 
 
0.41
 
 
18.8
 
Bonds4
48,201
 
 
1.73
 
 
210.1
 
 
44,009
 
 
2.24
 
 
247.9
 
Other interest-bearing liabilities
6
 
 
2.03
 
 
*
 
 
17
 
 
2.68
 
 
0.1
 
Total interest-bearing liabilities
56,037
 
 
1.51
 
 
213.2
 
 
63,611
 
 
1.67
 
 
267.4
 
Noninterest-bearing liabilities
930
 
 
 
 
 
 
903
 
 
 
 
 
Total liabilities
56,967
 
 
1.48
 
 
213.2
 
 
64,514
 
 
1.64
 
 
267.4
 
Capital
2,956
 
 
 
 
 
 
3,368
 
 
 
 
 
Total liabilities and capital
$
59,923
 
 
1.41
%
 
$
213.2
 
 
$
67,882
 
 
1.56
%
 
$
267.4
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income and spread
 
 
1.27
%
 
$
203.8
 
 
 
 
0.24
%
 
$
58.1
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest margin6
 
 
1.35
%
 
 
 
 
 
0.34
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Average interest-earning assets to interest-bearing liabilities
 
 
106.06
%
 
 
 
 
 
106.45
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Composition of net interest income
 
 
 
 
 
 
 
 
 
 
 
Asset-liability spread
 
 
1.28
%
 
$
192.7
 
 
 
 
0.26
%
 
$
44.2
 
Earnings on capital
 
 
1.48
%
 
11.1
 
 
 
 
1.64
%
 
13.9
 
Net interest income
 
 
 
 
$
203.8
 
 
 
 
 
 
$
58.1
 
 
            

55


 
For the Nine Months Ended
 September 30, 2010
 
For the Nine Months Ended
 September 30, 2009
 
Average
Balance 1
 
Yield/Cost
 
Interest
Income/
Expense
 
Average
Balance 1
 
Yield/Cost
 
Interest
Income/
Expense
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
113
 
 
0.30
%
 
$
0.2
 
 
$
121
 
 
0.37
%
 
$
0.3
 
Securities purchased under agreements to resell
1,119
 
 
0.18
 
 
1.5
 
 
1,239
 
 
0.18
 
 
1.6
 
Federal funds sold
3,297
 
 
0.16
 
 
3.8
 
 
6,262
 
 
0.33
 
 
15.6
 
Short-term investments
505
 
 
0.44
 
 
1.7
 
 
713
 
 
0.51
 
 
2.7
 
Mortgage-backed securities2
12,878
 
 
2.15
 
 
207.2
 
 
9,239
 
 
2.20
 
 
152.2
 
    Other investments2
4,038
 
 
2.16
 
 
65.1
 
 
5,809
 
 
1.59
 
 
69.0
 
Advances3,4
33,146
 
 
1.86
 
 
460.0
 
 
38,258
 
 
1.89
 
 
541.9
 
Mortgage loans5
7,568
 
 
4.82
 
 
272.6
 
 
9,662
 
 
4.83
 
 
349.0
 
Total interest-earning assets
62,664
 
 
2.16
 
 
1,012.1
 
 
71,303
 
 
2.12
 
 
1,132.3
 
Noninterest-earning assets
383
 
 
 
 
 
 
146
 
 
 
 
 
Total assets
$
63,047
 
 
2.15
%
 
$
1,012.1
 
 
$
71,449
 
 
2.12
%
 
$
1,132.3
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
Deposits
$
1,356
 
 
0.09
%
 
$
0.9
 
 
$
1,291
 
 
0.21
%
 
$
2.1
 
Consolidated obligations
 
 
 
 
 
 
 
 
 
 
 
Discount notes
6,741
 
 
0.14
 
 
7.2
 
 
23,527
 
 
0.72
 
 
126.5
 
Bonds4
50,836
 
 
1.78
 
 
675.3
 
 
42,303
 
 
2.76
 
 
873.0
 
Other interest-bearing liabilities
9
 
 
1.61
 
 
0.1
 
 
45
 
 
0.65
 
 
0.2
 
Total interest-bearing liabilities
58,942
 
 
1.55
 
 
683.5
 
 
67,166
 
 
1.99
 
 
1,001.8
 
Noninterest-bearing liabilities
1,195
 
 
 
 
 
 
1,038
 
 
 
 
 
Total liabilities
60,137
 
 
1.52
 
 
683.5
 
 
68,204
 
 
1.96
 
 
1,001.8
 
Capital
2,910
 
 
 
 
 
 
3,245
 
 
 
 
 
Total liabilities and capital
$
63,047
 
 
1.45
%
 
$
683.5
 
 
$
71,449
 
 
1.87
%
 
$
1,001.8
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income and spread
 
 
0.61
%
 
$
328.6
 
 
 
 
0.13
%
 
$
130.5
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest margin6
 
 
0.70
%
 
 
 
 
 
0.25
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Average interest-earning assets to interest-bearing liabilities
 
 
106.32
%
 
 
 
 
 
106.16
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Composition of net interest income
 
 
 
 
 
 
 
 
 
 
 
Asset-liability spread
 
 
0.63
%
 
$
295.5
 
 
 
 
0.16
%
 
$
82.8
 
Earnings on capital
 
 
1.52
%
 
33.1
 
 
 
 
1.96
%
 
47.7
 
Net interest income
 
 
 
 
$
328.6
 
 
 
 
 
 
$
130.5
 
1 
 
Average balances do not reflect the effect of derivative master netting arrangements with counterparties.
 
 
 
2 
 
The average balance of available-for-sale securities is reflected at amortized cost; therefore the resulting yields do not give effect to changes in fair value.
 
 
 
3 
 
Advance interest income includes advance prepayment fee income of $133.5 million and $152.4 million during the three and nine months ended September 30, 2010 compared to $3.5 million and $6.7 million for the same periods in 2009.
 
 
 
4 
 
Average balances reflect the impact of hedging fair value and fair value option adjustments.
 
 
 
5 
 
Nonperforming loans and loans held for sale are included in average balances used to determine the average rate.
 
 
 
6 
 
Net interest margin is net interest income expressed as a percentage of average interest-earning assets.
 
 
 
* 
 
Amount is less than $0.1 million.
    
    

56


The following table presents changes in interest income and interest expense. Changes in interest income and interest expense that are not identifiable as either volume-related or rate-related, but rather equally attributable to both volume and rate changes, are allocated to the volume and rate categories based on the proportion of the absolute value of the volume and rate changes (dollars in millions).
 
 
Variance For the Three Months Ended
 
Variance For the Nine Months Ended
 
September 30, 2010 vs. September 30, 2009
 
September 30, 2010 vs. September 30, 2009
 
Total Increase
(Decrease) Due to
 
Total Increase
(Decrease)
 
Total Increase
(Decrease) Due to
 
Total Increase
(Decrease)
 
Volume
 
Rate
 
 
Volume
 
Rate
 
Interest income
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
0.1
 
 
$
(0.1
)
 
$
 
 
$
 
 
$
(0.1
)
 
$
(0.1
)
Securities purchased under agreements to resell
0.3
 
 
0.2
 
 
0.5
 
 
(0.1
)
 
 
 
(0.1
)
Federal funds sold
(1.4
)
 
(0.5
)
 
(1.9
)
 
(5.6
)
 
(6.2
)
 
(11.8
)
Short-term investments
(0.3
)
 
(0.2
)
 
(0.5
)
 
(0.7
)
 
(0.3
)
 
(1.0
)
Mortgage-backed securities
21.8
 
 
5.2
 
 
27.0
 
 
58.5
 
 
(3.5
)
 
55.0
 
Other investments
(20.3
)
 
12.7
 
 
(7.6
)
 
(24.6
)
 
20.7
 
 
(3.9
)
Advances
(19.6
)
 
99.7
 
 
80.1
 
 
(73.2
)
 
(8.7
)
 
(81.9
)
Mortgage loans
(4.7
)
 
(1.4
)
 
(6.1
)
 
(75.7
)
 
(0.7
)
 
(76.4
)
Total interest income
(24.1
)
 
115.6
 
 
91.5
 
 
(121.4
)
 
1.2
 
 
(120.2
)
 
 
 
 
 
 
 
 
 
 
 
 
Interest expense
 
 
 
 
 
 
 
 
 
 
 
Deposits
0.1
 
 
(0.3
)
 
(0.2
)
 
0.1
 
 
(1.3
)
 
(1.2
)
Consolidated obligations
 
 
 
 
 
 
 
 
 
 
 
Discount notes
(8.5
)
 
(7.6
)
 
(16.1
)
 
(56.0
)
 
(63.3
)
 
(119.3
)
Bonds
22.2
 
 
(60.0
)
 
(37.8
)
 
153.0
 
 
(350.7
)
 
(197.7
)
Other interest-bearing liabilities
(0.1
)
 
 
 
(0.1
)
 
(0.3
)
 
0.2
 
 
(0.1
)
Total interest expense
13.7
 
 
(67.9
)
 
(54.2
)
 
96.8
 
 
(415.1
)
 
(318.3
)
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
$
(37.8
)
 
$
183.5
 
 
$
145.7
 
 
$
(218.2
)
 
$
416.3
 
 
$
198.1
 
 
Our net interest income is made up of two components: asset-liability spread and earnings on capital.
 
ASSET-LIABILITY SPREAD
 
Our asset-liability spread equals the yield on total assets minus the cost of total liabilities. For the three and nine months ended September 30, 2010, our asset-liability spread was 128 and 63 basis points compared to 26 and 16 basis points for the same periods in 2009. The majority of our asset-liability spread is driven by our net interest spread. For the three and nine months ended September 30, 2010, our net interest spread was 127 and 61 basis points compared to 24 and 13 basis points for the same periods in 2009.
 
Our asset-liability spread and net interest spread improved during the three and nine months ended September 30, 2010 when compared to the same periods in 2009 due primarily to an increase in advance prepayment fees, an improvement in our funding costs due to the low interest rate environment, and an increase in investment interest income resulting from increased GSE MBS. For the three and nine months ended September 30, 2010, our asset-liability spread income was $192.7 million and $295.5 million compared to $44.2 million and $82.8 million for the same periods in 2009.
 

57


Our asset-liability spread income was impacted by the following:
 
Bonds
 
Interest expense on our bonds decreased $37.8 million and $197.7 million during the three and nine months ended September 30, 2010 when compared to the same periods in 2009 due primarily to lower interest rates. As a result of the low interest rate environment and advance prepayments, we called and extinguished certain bonds during the three and nine months ended September 30, 2010 and 2009 in an effort to lower our relative cost of funds and manage our balance sheet.
 
The decrease in interest expense was partially offset by increased average bond volumes. Average bond volumes increased during the three and nine months ended September 30, 2010 when compared to the same periods in 2009 due primarily to us replacing maturing discount notes with bonds in an effort to better match fund our longer-term assets with longer-term debt. Throughout the third quarter of 2010, as interest rates continued to fall, callable funding became more attractive and therefore we increased our callable debt issuances in order to reduce funding costs as well as protect ourselves against potential future mortgage prepayments.
 
Discount Notes
 
Interest expense on our discount notes decreased 86 and 94 percent during the three and nine months ended September 30, 2010 when compared to the same periods in 2009 due to lower interest rates and lower average volumes. Average discount note volumes decreased 65 and 71 percent during the three and nine months ended September 30, 2010 when compared to the same periods in 2009. The decrease was primarily due to us replacing maturing discount notes with bonds as a result of decreased short-term funding needs and our desire to extend the duration of our liabilities in order to better match fund our assets.
 
Advances
 
Interest income on our advance portfolio (including advance prepayment fees, net) increased 53 percent during the three months ended September 30, 2010 when compared to the same period in 2009 due primarily to an increase in advance prepayment fee income. Advance prepayment fee income, net was $133.5 million during the three months ended September 30, 2010 compared to $3.5 million for the same period in 2009. The increase was primarily due to one member prepaying approximately $1.1 billion of advances during the third quarter of 2010 and accordingly, paying a prepayment fee, which represents forgone interest payments on the prepaid advances.
 
Interest income on our advance portfolio (including advance prepayment fees, net) decreased 15 percent during the nine months ended September 30, 2010 when compared to the same period in 2009 due primarily to decreased average volumes and lower interest rates. Average advance volumes decreased 13 percent during the nine months ended September 30, 2010 when compared to the same period in 2009 due to the high level of liquidity available in the market and the low loan demand experienced by our members. The decrease was partially offset by increased advance prepayment fee income. Advance prepayment fee income, net was $152.4 million during the nine months ended September 30, 2010 compared to $6.7 million for the same period in 2009. As mentioned above, the increase was primarily due to one member prepaying approximately $1.1 billion of advances during the third quarter of 2010.
 
Mortgage Loans
 
Interest income on our mortgage loans decreased 6 and 22 percent during the three and nine months ended September 30, 2010 when compared to the same periods in 2009 due primarily to lower average volumes. Throughout the first half of 2010, principal repayments exceeded our mortgage loan originations. In addition, during the second quarter of 2009, we sold approximately $2.1 billion of mortgage loans to Federal National Mortgage Association (Fannie Mae) through the FHLBank of Chicago.
 

58


Investments
 
Interest income on our investments increased 22 and 16 percent during the three and nine months ended September 30, 2010 when compared to the same periods in 2009 primarily due to higher average volumes. During the first quarter of 2010, we purchased GSE MBS as a result of our Board of Directors approving the purchase of GSE MBS up to 5 times regulatory capital through March 31, 2010. As a result, interest income on our MBS was $75.3 million and $207.2 million during the three and nine months ended September 30, 2010 compared to $48.3 million and $152.2 million for the same periods in 2009. Refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Statements of Condition - Investments" for additional information on our MBS purchases.
 
The increase in interest income was partially offset by a decrease in average other investments and average short-term investments. Other investments decreased due to us selling certain Temporary Liquidity Guarantee Program (TLGP) debt investments and taxable municipal bonds during the nine months ended September 30, 2010. Short-term investments decreased primarily due to a lack of attractive short-term investment opportunities resulting from (i) concerns on global economic conditions and (ii) reduced counterparty exposure limits established under our Enterprise Risk Management Policy (ERMP).
 
EARNINGS ON CAPITAL
 
Our earnings on capital decreased during the three and nine months ended September 30, 2010 when compared to the same periods in 2009 due to lower amounts of capital and the low interest rate environment. For the three and nine months ended September 30, 2010, earnings on invested capital amounted to $11.1 million and $33.1 million compared to $13.9 million and $47.7 million for the same periods in 2009.
 
PROVISION FOR CREDIT LOSS ON MORTGAGE LOANS HELD FOR PORTFOLIO
 
During the three and nine months ended September 30, 2010, we experienced an increase in delinquency and loss severity on our mortgage loan portfolio, which increased estimated losses. To reserve for these estimated losses, we recorded an additional provision for credit losses of $1.6 million and $5.6 million during the three and nine months ended September 30, 2010. For additional information, refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Credit Risk - Mortgage Assets."
 
Net Interest Income by Segment
 
We report performance of our Member Finance and Mortgage Finance segments based on core net interest income. Core net interest income includes interest income and expense on economic hedge relationships included in other (loss) income and excludes advance prepayment fees, net of hedging fair value adjustments included in interest income and hedging fair value adjustments on called and extinguished debt included in interest expense. A description of these segments is included in “Item 1. Financial Statements—Note 12—Segment Information.”
 
    

59


The following table reconciles our financial performance by operating segment to total income before assessments for the three and nine months ended September 30, 2010 and 2009 (dollars in millions):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2010
 
2009
 
2010
 
2009
Core net interest income
 
 
 
 
 
 
 
Member Finance
$
27.1
 
 
$
42.3
 
 
$
95.3
 
 
$
86.1
 
Mortgage Finance
39.8
 
 
15.1
 
 
80.9
 
 
57.3
 
Total
$
66.9
 
 
$
57.4
 
 
$
176.2
 
 
$
143.4
 
 
 
 
 
 
 
 
 
Reconciliation of operating segment results to net interest income
 
 
 
 
 
 
 
Core net interest income
$
66.9
 
 
$
57.4
 
 
$
176.2
 
 
$
143.4
 
Net interest income on economic hedges
(2.7
)
 
(1.5
)
 
(6.4
)
 
(6.2
)
Advance prepayment fees, net
133.5
 
 
3.5
 
 
152.4
 
 
6.7
 
Hedging fair value adjustments
4.5
 
 
(1.3
)
 
0.8
 
 
(13.7
)
 
 
 
 
 
 
 
 
Net interest income after mortgage loan credit loss provision
202.2
 
 
58.1
 
 
323.0
 
 
130.2
 
 
 
 
 
 
 
 
 
Other (loss) income
(136.6
)
 
1.5
 
 
(171.7
)
 
49.2
 
Other expense
11.6
 
 
11.3
 
 
38.1
 
 
35.8
 
 
 
 
 
 
 
 
 
Income before assessments
$
54.0
 
 
$
48.3
 
 
$
113.2
 
 
$
143.6
 
* 
 
Amount is less than $0.1 million.
 
MEMBER FINANCE
 
Member Finance core net interest income decreased $15.2 million during the three months ended September 30, 2010 when compared to the same period in 2009 due primarily to decreased average asset volumes. The segment's average assets decreased 23 percent primarily due to a decrease in average advances as a result of the high level of liquidity available in the market and the low loan demand experienced by our members.
 
Member Finance core net interest income increased $9.2 million during the nine months ended September 30, 2010 when compared to the same period in 2009 due primarily to decreased funding costs as a result of the low interest rate environment, partially offset by decreased average asset volumes. The segment's average assets decreased 19 percent primarily due to a decrease in average advances. In addition, during the nine months ended September 30, 2010, we sold certain TLGP and taxable municipal bond investments in an effort to (i) lock in a portion of the unrealized gains associated with these assets and (ii) reduce our exposure to income statement volatility.
 
MORTGAGE FINANCE
 
Mortgage Finance core net interest income increased $24.7 million and $23.6 million during the three and nine months ended September 30, 2010 when compared to the same periods in 2009 due primarily to increased MBS volumes. During the first quarter of 2010, we purchased GSE MBS as a result of our Board of Directors approving the purchase of GSE MBS up to 5 times regulatory capital through March 31, 2010. The increase was partially offset by lower interest rates and decreased average mortgage loan volumes resulting from continued mortgage loan paydowns and the sale of mortgage loans during the second quarter of 2009. The segment's average assets increased 21 and 9 percent during the three and nine months ended September 30, 2010 when compared to the same periods in 2009.

60


Other (Loss) Income
 
The following table summarizes the components of other (loss) income (dollars in millions):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2010
 
2009
 
2010
 
2009
 
 
 
 
 
 
 
 
Service fees
$
0.3
 
 
$
0.4
 
 
$
1.2
 
 
$
1.6
 
Net gain (loss) on trading securities
8.0
 
 
(1.7
)
 
61.6
 
 
52.1
 
Net gain (loss) on sale of available-for-sale securities
 
 
31.1
 
 
 
 
(11.7
)
Net gain (loss) on bonds held at fair value
3.1
 
 
(3.2
)
 
1.9
 
 
(15.4
)
Net gain on loans held for sale
 
 
 
 
 
 
1.3
 
Net (loss) gain on derivatives and hedging activities
(23.6
)
 
1.9
 
 
(112.8
)
 
98.3
 
Loss on extinguishment of debt
(127.3
)
 
(28.5
)
 
(131.3
)
 
(80.9
)
Other, net
2.9
 
 
1.5
 
 
7.7
 
 
3.9
 
 
 
 
 
 
 
 
 
Total other (loss) income
$
(136.6
)
 
$
1.5
 
 
$
(171.7
)
 
$
49.2
 
 
Other (loss) income can be volatile from period to period depending on the type of financial activity recorded. For the three and nine months ended September 30, 2010 and 2009, other (loss) income was primarily impacted by the following events:
 
Net losses on derivatives and hedging activities increased $25.5 million and $211.1 million during the three and nine months ended September 30, 2010 when compared to the same periods in 2009 due primarily to economic hedging activity, partially offset by fair value hedging activity. We use economic hedges to manage interest rate and prepayment risks in our balance sheet as well as the risk arising from changing market prices on certain trading securities and fair value option bonds. During the three and nine months ended September 30, 2010, we recorded net losses of $12.1 million and $104.6 million on economic hedges through “Net (loss) gain on derivatives and hedging activities” compared to net losses of $7.0 million and net gains of $2.9 million for the same periods in 2009. During the three and nine months ended September 30, 2009, we sold available-for-sale securities and terminated the associated interest rate swaps, resulting in net gains on the derivative termination of $6.8 million and $82.6 million recorded through "Net (loss) gain on derivatives and hedging activities." Refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations—Hedging Activities” for a more detailed discussion of our hedging activity.
 
During the three and nine months ended September 30, 2010, we extinguished bonds with a total par value of $1.0 billion and $1.1 billion and recorded losses of $127.3 million and $131.3 million. The majority of the extinguishments were due to advance prepayments and therefore the losses are offset by the advance prepayment fee income recorded in net interest income.
 

61


During the three and nine months ended September 30, 2010, we recorded net holding gains of $3.1 million and $33.0 million on our trading securities compared to net holding losses of $4.7 million and net holding gains of $48.5 million during the same periods in 2009. As trading securities are marked-to-market, changes in holding gains and losses are reflected in other (loss) income. During the three and nine months ended September 30, 2010, we sold $0.2 billion and $3.0 billion of par value trading securities in an effort to (i) lock in a portion of the holding gains associated with these assets and (ii) reduce our exposure to income statement volatility. As a result, we recorded net realized gains of $4.9 million and $28.6 million in other (loss) income during the three and nine months ended September 30, 2010. During the three and nine months ended September 30, 2009, we sold $0.3 billion and $0.8 billion of par value trading securities and recorded net realized gains of $3.0 million and $3.6 million in other (loss) income.
 
We elected the fair value option on certain bonds that did not qualify for hedge accounting. During the three and nine months ended September 30, 2010, we recorded fair value gains on these bonds amounting to $3.1 million and $1.9 million. During the three and nine months ended September 30, 2009, we recorded fair value losses on these bonds amounting to $3.2 million and $15.4 million. In order to achieve offset to the mark-to-market on certain fair value option bonds, we executed economic derivatives. Refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations—Hedging Activities” for the impact of these economic derivatives.
 
Hedging Activities
 
If a hedging activity qualifies for hedge accounting treatment, we include the periodic cash flow components of the hedging instrument related to interest income or expense in the relevant income statement caption consistent with the hedged asset or liability. We also record the amortization of certain upfront fees received on interest rate swaps and cumulative fair value adjustments from terminated hedges in interest income or expense or other (loss) income. Changes in the fair value of both the hedging instrument and the hedged item are recorded as a component of other (loss) income in “Net (loss) gain on derivatives and hedging activities."
 
If a hedging activity does not qualify for hedge accounting treatment, we record the hedging instrument's components of interest income and expense, together with the effect of changes in fair value as a component of other (loss) income in “Net (loss) gain on derivatives and hedging activities”; however, there is no corresponding fair value adjustment for the hedged asset or liability unless changes in fair value of the asset or liability are normally marked-to-market through earnings (i.e., trading securities and fair value option bonds).
 
Since the accounting for derivatives and hedging activities affects the timing and recognition of income or expense through net interest income and other (loss) income, we may be subject to volatility in our Statements of Income.
 
    

62


The following tables categorize the net effect of hedging activities on net income by product (dollars in millions). The table excludes the interest component on derivatives that qualify for hedge accounting as this amount will be offset by the interest component on the hedged item within net interest income. Because the purpose of the hedging activity is to protect net interest income against changes in interest rates, the absolute increase or decrease of interest income from interest-earning assets or interest expense from interest-bearing liabilities is not as important as the relationship of the hedging activities to overall net income.
 
 
 
Three Months Ended September 30, 2010
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Assets
 
Consolidated
Obligations
 
Balance
Sheet
 
Total
Net Interest Income:
 
 
 
 
 
 
 
 
 
 
 
 
Net (amortization) accretion
 
$
(45.1
)
 
$
 
 
$
(0.8
)
 
$
12.0
 
 
$
 
 
$
(33.9
)
Other Income (Loss):
 
 
 
 
 
 
 
 
 
 
 
 
Gains (losses) on fair value hedges
 
1.6
 
 
 
 
 
 
(13.1
)
 
 
 
(11.5
)
(Losses) gains on economic hedges
 
(0.1
)
 
(19.6
)
 
(0.3
)
 
4.7
 
 
3.2
 
 
(12.1
)
Total net gain (loss) on derivatives and hedging activities
 
1.5
 
 
(19.6
)
 
(0.3
)
 
(8.4
)
 
3.2
 
 
(23.6
)
Gains on trading securities and fair value option bonds1
 
 
 
8.0
 
 
 
 
3.1
 
 
 
 
11.1
 
Other
 
 
 
 
 
 
 
15.7
 
 
 
 
15.7
 
Total Other Income (Loss)
 
1.5
 
 
(11.6
)
 
(0.3
)
 
10.4
 
 
3.2
 
 
3.2
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
$
(43.6
)
 
$
(11.6
)
 
$
(1.1
)
 
$
22.4
 
 
$
3.2
 
 
$
(30.7
)
 
 
 
Three Months Ended September 30, 2009
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Assets
 
Consolidated
Obligations
 
Balance
Sheet
 
Total
Net Interest Income:
 
 
 
 
 
 
 
 
 
 
 
 
Net (amortization) accretion
 
$
(12.3
)
 
$
 
 
$
(0.4
)
 
$
9.3
 
 
$
 
 
$
(3.4
)
Other Income (Loss):
 
 
 
 
 
 
 
 
 
 
 
 
Gains on fair value hedges
 
0.8
 
 
7.8
 
 
 
 
0.3
 
 
 
 
8.9
 
(Losses) gains on economic hedges
 
(0.4
)
 
(15.2
)
 
(0.2
)
 
7.0
 
 
1.8
 
 
(7.0
)
Total net gain (loss) on derivatives and hedging activities
 
0.4
 
 
(7.4
)
 
(0.2
)
 
7.3
 
 
1.8
 
 
1.9
 
Gains (losses) on trading securities and fair value option bonds1
 
 
 
9.3
 
 
 
 
(3.2
)
 
 
 
6.1
 
Total Other Income (Loss)
 
0.4
 
 
1.9
 
 
(0.2
)
 
4.1
 
 
1.8
 
 
8.0
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
$
(11.9
)
 
$
1.9
 
 
$
(0.6
)
 
$
13.4
 
 
$
1.8
 
 
$
4.6
 
 

63


 
 
Nine Months Ended September 30, 2010
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Assets
 
Consolidated
Obligations
 
Balance
Sheet
 
Total
Net Interest Income:
 
 
 
 
 
 
 
 
 
 
 
 
Net (amortization) accretion
 
$
(66.4
)
 
$
 
 
$
(1.6
)
 
$
25.3
 
 
$
 
 
$
(42.7
)
Other Income (Loss):
 
 
 
 
 
 
 
 
 
 
 
 
Gains (losses) on fair value hedges
 
2.7
 
 
(0.1
)
 
 
 
(10.8
)
 
 
 
(8.2
)
(Losses) gains on economic hedges
 
(0.9
)
 
(92.1
)
 
(1.0
)
 
26.6
 
 
(37.2
)
 
(104.6
)
Total net gain (loss) on derivatives and hedging activities
 
1.8
 
 
(92.2
)
 
(1.0
)
 
15.8
 
 
(37.2
)
 
(112.8
)
Gains on trading securities and fair value option bonds1
 
 
 
57.7
 
 
 
 
1.9
 
 
 
 
59.6
 
Other
 
 
 
 
 
 
 
15.7
 
 
 
 
15.7
 
Total Other Income (Loss)
 
1.8
 
 
(34.5
)
 
(1.0
)
 
33.4
 
 
(37.2
)
 
(37.5
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
$
(64.6
)
 
$
(34.5
)
 
$
(2.6
)
 
$
58.7
 
 
$
(37.2
)
 
$
(80.2
)
 
 
 
Nine Months Ended September 30, 2009
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Assets
 
Consolidated
Obligations
 
Balance
Sheet
 
Total
Net Interest Income:
 
 
 
 
 
 
 
 
 
 
 
 
Net (amortization) accretion
 
$
(43.8
)
 
$
 
 
$
(1.3
)
 
$
23.8
 
 
$
 
 
$
(21.3
)
Other Income (Loss):
 
 
 
 
 
 
 
 
 
 
 
 
Gains on fair value hedges
 
3.0
 
 
82.4
 
 
 
 
10.0
 
 
 
 
95.4
 
(Losses) gains on economic hedges
 
(0.7
)
 
(15.2
)
 
(2.2
)
 
10.1
 
 
10.9
 
 
2.9
 
Total net gain (loss) on derivatives and hedging activities
 
2.3
 
 
67.2
 
 
(2.2
)
 
20.1
 
 
10.9
 
 
98.3
 
Gains (losses) on trading securities and fair value option bonds1
 
 
 
17.2
 
 
 
 
(15.4
)
 
 
 
1.8
 
Total Other Income (Loss)
 
2.3
 
 
84.4
 
 
(2.2
)
 
4.7
 
 
10.9
 
 
100.1
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
$
(41.5
)
 
$
84.4
 
 
$
(3.5
)
 
$
28.5
 
 
$
10.9
 
 
$
78.8
 
 
1 
 
Represents the gains (losses) on those trading securities and fair value option bonds in which we have entered into a corresponding economic derivative to hedge the risk of changing market prices.
 
NET AMORTIZATION/ACCRETION
 
Amortization/accretion varies from period to period depending on our hedge relationship termination activities. During the three and nine months ended September 30, 2010, advance amortization increased when compared to the same periods in 2009 due primarily to us fully amortizing basis adjustments during the third quarter of 2010 as a result of advance prepayments. The increase in amortization during the nine months ended September 30, 2010 was partially offset by us unwinding certain interest rate swaps. This unwind activity subsequently results in basis adjustments that are amortized/accreted using the effective-yield method over the remaining life of the advance.
 

64


GAINS (LOSSES) ON FAIR VALUE HEDGES
 
Hedge ineffectiveness occurs when changes in fair value of the derivative and the related hedged item do not perfectly offset each other. Hedge ineffectiveness is driven by changes in the benchmark interest rate and volatility. As the benchmark interest rate changes and the magnitude of that change intensifies, so will the impact on our net realized and unrealized gains (losses) on derivatives and hedging activities. Additionally, volatility in the marketplace may intensify this impact. The change in hedge ineffectiveness gains (losses) during the three and nine months ended September 30, 2010 when compared to the same periods in 2009 was primarily due to us selling certain available-for-sale securities and terminating the associated interest rate swaps during the three and nine months ended September 30, 2009, resulting in net gains on the derivative termination of $6.8 million and $82.6 million recorded through "Net (loss) gain on derivatives and hedging activities."
 
(LOSSES) GAINS ON ECONOMIC HEDGES
 
Economic hedges are used to manage interest rate and prepayment risks in our balance sheet as well as the risk arising from changing market prices on certain trading securities and fair value option bonds. Changes in (losses) gains on economic hedges are primarily driven by the volume of hedges, changes in interest rates and volatility, and the loss of hedge accounting for certain hedge relationships failing retrospective hedge effectiveness testing. Economic hedges do not qualify for hedge accounting and, as a result, we record a fair market value gain or loss on the derivative instrument without recording the corresponding loss or gain on the hedged item. For certain assets and liabilities (i.e., trading securities and fair value option bonds), fair market value gains and losses on the economic hedges generally offset the losses and gains on the related asset or liability. In addition, interest accruals on the economic hedges are recorded as a component of other (loss) income instead of a component of net interest income. For the three and nine months ended September 30, 2010 and 2009, (losses) gains on economic hedges were impacted by the following items:
 
Balance Sheet
 
•    
We held interest rate caps on our balance sheet in order to protect against changes in interest rates on our variable rate MBS and mortgage loan prepayments. Due to a decrease in interest rates, we recorded $10.9 million and $52.3 million in losses on these interest rate caps during the three and nine months ended September 30, 2010 compared to gains of $1.8 million and $10.9 million for the same periods in 2009. We paid $95.0 million in premiums on the interest rate caps outstanding at September 30, 2010. This expense is effectively amortized over the life of the derivative through the monthly mark-to-market adjustments. As a result, expensing more of the cost up front lowers the expense in future periods.
 
•    
We purchased interest rate floors in order to protect against changes in interest rates on our variable rate MBS and mortgage loan prepayments. Due to a decrease in interest rates and volatility, we recorded $14.1 million and $15.1 million in gains on these interest rate floors during the three and nine months ended September 30, 2010. We paid $27.3 million in premiums on the interest rate floors outstanding at September 30, 2010. This expense is effectively amortized over the life of the derivative through the monthly mark-to-market adjustments.
 
Investments
 
•    
We held interest rate swaps on our balance sheet as economic hedges against adverse changes in the fair value of a portion of our trading securities (i.e. TLGP debt investments and taxable municipal bonds) indexed to LIBOR. During the three and nine months ended September 30, 2010, swap rates decreased considerably and, as a result, we recorded $15.5 million and $72.6 million in losses on the economic derivatives, coupled with $4.1 million and $19.5 million of interest expense accruals. Generally, the losses on the economic derivatives are offset by the gains on the trading securities. During the three and nine months ended September 30, 2010, gains on the trading securities amounted to $8.0 million and $57.7 million and were recorded in “Net gain on trading securities” in other (loss) income.
 
 
 
 

65


Consolidated Obligations
 
•    
We perform retrospective hedge effectiveness testing at least quarterly on all hedge relationships. If a hedge relationship fails this test, we can no longer receive hedge accounting and the derivative is accounted for as an economic hedge. Most hedge relationships that fail this test have a short duration or are nearing maturity. During the three and nine months ended September 30, 2010, we recorded losses on ineffective consolidated obligation hedge relationships of $0.9 million and gains of $1.9 million compared to losses of $0.5 million and $18.1 million for the same periods in 2009. During the three and nine months ended September 30, 2010, we had 4 and 16 ineffective consolidated obligation hedge relationships compared to 24 and 37 for the same periods in 2009.
 
•    
We held interest rate swaps on our balance sheet as economic hedges against adverse changes in the fair value of both our variable and fixed interest rate bonds elected under the fair value option. During the three and nine months ended September 30, 2010, we recorded net losses of $1.5 million and $2.3 million on these economic derivatives. Fair value adjustment losses on the variable and fixed interest rate bonds amounted to $3.1 million and $1.9 million during the three and nine months ended September 30, 2010 and were recorded in “Net gain (loss) on bonds held at fair value” in other (loss) income.
 
•    
During the three and nine months ended September 30, 2010, interest income accruals on consolidated obligation economic hedges amounted to $7.1 million and $27.0 million compared to $4.9 million and $12.3 million for the same periods in 2009. The change between periods was primarily due to the increased volume of economic hedges related to bonds elected under the fair value option.
 

66


Statements of Condition
 
SEPTEMBER 30, 2010 AND DECEMBER 31, 2009
 
Financial Highlights
 
Our total assets decreased to $60.1 billion at September 30, 2010 from $64.7 billion at December 31, 2009. Our total liabilities decreased to $57.1 billion at September 30, 2010 from $61.7 billion at December 31, 2009. Total capital increased to $3.0 billion at September 30, 2010 from $2.9 billion at December 31, 2009. The overall financial condition for the periods presented has been primarily influenced by changes in funding activities, member advances, investment purchases/sales, and mortgage loans. See further discussion of changes in our financial condition in the appropriate sections that follow.
 
Advances
 
Advances decreased 10 percent at September 30, 2010 when compared to December 31, 2009. The decrease was primarily due to the high level of liquidity available in the market and the low loan demand experienced by our members. These factors have driven demand for our advances down as well as provided incentive to our members to prepay their advances.
 
At September 30, 2010 and December 31, 2009, advances outstanding to our five largest member borrowers totaled $13.0 billion and $14.0 billion, representing 42 and 40 percent of our total advances outstanding. The Federal Home Loan Bank Act of 1932 (FHLBank Act) requires that we obtain sufficient collateral on advances to protect against losses. We have never experienced a credit loss on an advance to a member or eligible housing associate. Bank management has policies and procedures in place to appropriately manage this credit risk. Accordingly, we have not provided any allowance for losses on advances. See additional discussion regarding our collateral requirements in “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Credit Risk - Advances.”
 
The following table summarizes our advances by type (dollars in millions):
 
 
September 30, 2010
 
December 31, 2009
 
Amount
 
Percent of
Total
 
Amount
 
Percent of
Total
Simple fixed rate advances
$
15,552
 
 
50.2
%
 
$
17,192
 
 
49.0
%
Simple variable rate advances
3,292
 
 
10.6
 
 
4,134
 
 
11.8
 
Callable advances
6,643
 
 
21.5
 
 
6,635
 
 
19.0
 
Putable advances
5,484
 
 
17.7
 
 
7,071
 
 
20.2
 
 
 
 
 
 
 
 
 
Total par value
30,971
 
 
100.0
%
 
35,032
 
 
100.0
%
 
 
 
 
 
 
 
 
Fair value hedging adjustments
 
 
 
 
 
 
 
Cumulative fair value gain on existing hedges
950
 
 
 
 
590
 
 
 
Basis adjustments from terminated hedges
93
 
 
 
 
98
 
 
 
 
 
 
 
 
 
 
 
Total advances
$
32,014
 
 
 
 
$
35,720
 
 
 
 
Cumulative fair value gains on existing hedges increased $360 million at September 30, 2010 when compared to December 31, 2009 due primarily to a decrease in interest rates. Generally, the cumulative fair value gains on advances are offset by the net estimated fair value losses on the related derivative contracts.
 
Basis adjustments from terminated hedges decreased $5 million at September 30, 2010 when compared to December 31, 2009 due primarily to us fully amortizing the remaining basis adjustments on advances that prepaid during the nine months ended September 30, 2010. The decrease was partially offset by us unwinding certain interest rate swaps during the nine months ended September 30, 2010. This unwind activity subsequently results in basis adjustments that are amortized using the effective-yield method over the remaining life of the advance.

67


Mortgage Loans
 
The following table summarizes information on our mortgage loans held for portfolio (dollars in millions):
 
 
September 30,
2010
 
December 31,
2009
Single family mortgages
 
 
 
Fixed rate conventional loans
$
7,161
 
 
$
7,333
 
Fixed rate government-insured loans
371
 
 
380
 
 
 
 
 
Total unpaid principal balance
7,532
 
 
7,713
 
 
 
 
 
Premiums
58
 
 
53
 
Discounts
(44
)
 
(52
)
Basis adjustments from mortgage loan commitments
10
 
 
5
 
Allowance for credit losses
(7
)
 
(2
)
 
 
 
 
Total mortgage loans held for portfolio, net
$
7,549
 
 
$
7,717
 
 
Mortgage loans decreased 2 percent at September 30, 2010 when compared to December 31, 2009. The decrease was primarily due to principal repayments exceeding loan purchases throughout the first half of 2010. However, during the third quarter of 2010, as mortgage rates continued to decline, borrower demand increased and our MPF purchase activity began to exceed our principal repayments.
 
Mortgage loans acquired from members are concentrated primarily with Superior Guaranty Insurance Company (Superior), an affiliate of Wells Fargo Bank, N.A. At September 30, 2010 and December 31, 2009, $3.8 billion and $4.4 billion of our mortgage loans outstanding were from Superior. We have not purchased any mortgage loans from Superior since 2004.
 
During the nine months ended September 30, 2010, we experienced an increase in delinquency and loss severity on our mortgage portfolio. As a result, we recorded an additional provision for credit losses of $5.6 million during the nine months ended September 30, 2010 in order to cover our estimated losses. See additional discussion regarding our mortgage loan credit risk in “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Credit Risk - Mortgage Assets.”
 
On August 17, 2010, we provided a servicing released option for our MPF Xtra product. Under MPF Xtra, mortgage loans are passed through to a third-party investor and not maintained on our Statements of Condition. Previously, only those PFIs that retained servicing of their MPF loans were eligible for the MPF Xtra product. During the three and nine months ended September 30, 2010, we executed $152.0 million and $241.6 million of MPF Xtra loans under the master commitments of our PFIs compared to $81.6 million and $96.0 million for the same periods in 2009.
 
 

68


Investments
 
The following table summarizes the book value of our investments (dollars in millions):
 
 
September 30, 2010
 
December 31, 2009
 
Amount
 
Percent of
Total
 
Amount
 
Percent of
Total
Short-term investments
 
 
 
 
 
 
 
Interest-bearing deposits
$
4
 
 
*%
 
 
$
5
 
 
*%
 
Securities purchased under agreements to resell
2,250
 
 
11.1
 
 
 
 
 
Federal funds sold
2,036
 
 
10.1
 
 
3,133
 
 
15.1
 
Negotiable certificates of deposit
335
 
 
1.7
 
 
450
 
 
2.2
 
 
4,625
 
 
22.9
 
 
3,588
 
 
17.3
 
 
 
 
 
 
 
 
 
Long-term investments
 
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
 
Government-sponsored enterprise
12,360
 
 
61.1
 
 
11,147
 
 
53.6
 
U.S. government agency-guaranteed
36
 
 
0.2
 
 
43
 
 
0.2
 
MPF shared funding
28
 
 
0.1
 
 
33
 
 
0.1
 
Other
34
 
 
0.2
 
 
35
 
 
0.2
 
 
12,458
 
 
61.6
 
 
11,258
 
 
54.1
 
 
 
 
 
 
 
 
 
Non-mortgage-backed securities
 
 
 
 
 
 
 
Interest-bearing deposits
7
 
 
*
 
 
6
 
 
*
 
Government-sponsored enterprise obligations
859
 
 
4.2
 
 
806
 
 
3.9
 
Other U.S. obligations
83
 
 
0.4
 
 
 
 
 
State or local housing agency obligations
110
 
 
0.5
 
 
124
 
 
0.6
 
TLGP
1,785
 
 
8.8
 
 
4,260
 
 
20.5
 
Taxable municipal bonds
309
 
 
1.6
 
 
742
 
 
3.6
 
Other
4
 
 
*
 
 
6
 
 
*
 
 
3,157
 
 
15.5
 
 
5,944
 
 
28.6
%
 
 
 
 
 
 
 
 
Total investments
$
20,240
 
 
100.0
%
 
$
20,790
 
 
100.0
%
 
*
 
Amount is less than 0.1 percent.
 
Investments decreased 3 percent at September 30, 2010 when compared to December 31, 2009. A majority of the decrease was due to the sale of long-term non-MBS investments (i.e., TLGP debt investments and taxable municipal bonds) during the nine months ended September 30, 2010 in an effort to (i) lock in a portion of the holding gains associated with these assets and (ii) reduce our exposure to income statement volatility.
 
The decrease in total investments was partially offset by an increase in short-term investments and GSE MBS. Short-term investments increased due to increased overnight securities purchased under agreements to resell. During the third quarter of 2010, as a result of tighter unsecured credit limits established under our ERMP, we increased our utilization of these secured investments. In addition, GSE MBS increased due to purchases made during the first quarter of 2010 as a result of temporary authority from our Board of Directors to purchase GSE MBS up to 5 times regulatory capital through March 31, 2010. Our MBS investment authority has since reverted back to 3 times regulatory capital. As a result, we are precluded from purchasing additional MBS until our MBS balance declines below 3 times regulatory capital.

69


We evaluate our individual available-for-sale and held-to-maturity securities in an unrealized loss position for OTTI on at least a quarterly basis. As part of our OTTI evaluation, we consider our intent to sell each debt security and whether it is more likely than not that we will be required to sell the security before its anticipated recovery. If either of these conditions is met, we will recognize an OTTI charge to earnings equal to the entire difference between the security's amortized cost basis and its fair value at the balance sheet date. For securities in an unrealized loss position that meet neither of these conditions, we perform an analysis to determine if any of these securities are other-than-temporarily impaired.
 
Refer to “Item 1. Financial Statements—Note 6—Other-Than-Temporary Impairment” for a discussion of our OTTI analysis performed at September 30, 2010. As a result of our analysis, we determined that all gross unrealized losses on our agency and GSE MBS, taxable municipal bonds, private-label MBS, MPF shared funding securities, and negotiable certificates of deposit are temporary. We do not intend to sell these securities, and it is not more likely than not that we will be required to sell these securities before recovery of their amortized cost bases. As a result, we do not consider any of these securities to be other-than-temporarily impaired at September 30, 2010.
 
Consolidated Obligations
 
Consolidated obligations, which include bonds and discount notes, are the primary source of funds to support our advances, mortgage loans, and investments. We use derivatives to restructure interest rates on consolidated obligations to better manage our interest rate risk and funding costs. This generally means converting fixed rates to variable rates. At September 30, 2010, the book value of the consolidated obligations issued on our behalf totaled $55.0 billion compared with $59.9 million at December 31, 2009.
 
BONDS
 
The following table summarizes information on our bonds (dollars in millions):
 
 
 
September 30,
2010
 
December 31,
2009
 
 
 
 
 
Total par value
 
$
46,997
 
 
$
50,323
 
 
 
 
 
 
Premiums
 
44
 
 
50
 
Discounts
 
(33
)
 
(35
)
Fair value hedging adjustments
 
 
 
 
Cumulative fair value loss on existing hedges
 
506
 
 
149
 
Basis adjustments from terminated and ineffective hedges
 
(1
)
 
*
 
Fair value option adjustments
 
 
 
 
Cumulative fair value loss
 
3
 
 
4
 
Accrued interest payable
 
3
 
 
4
 
 
 
 
 
 
Total bonds
 
$
47,519
 
 
$
50,495
 
 
*
Amount is less than one million
 
Bonds decreased 6 percent at September 30, 2010 when compared to December 31, 2009. The decrease was primarily due to us calling $15.9 billion of higher-costing par value bonds as a result of the low interest rate environment during the nine months ended September 30, 2010. We replaced these bonds with lower costing callable debt when warranted. In addition, as a result of significant advance prepayment activity during the nine months ended September 30, 2010, we extinguished $1.1 billion of higher-costing par value bonds in order to manage our balance sheet and lower future interest expense.
 
Cumulative fair value losses on existing hedges increased $357 million at September 30, 2010 when compared to December 31, 2009 due primarily to a decrease in interest rates. Generally, the cumulative fair value losses on bonds are offset by the net estimated fair value gains on the related derivative contracts.
 

70


Basis adjustments from terminated and ineffective hedges decreased $1 million at September 30, 2010 when compared to December 31, 2009 due primarily to us unwinding certain interest rate swaps during the nine months ended September 30, 2010. This unwind activity subsequently results in basis adjustments that are amortized using the effective-yield method over the remaining life of the bond.
 
Fair Value Option Bonds
 
At September 30, 2010, we elected the fair value option on $1.5 billion of our bonds compared to $6.0 billion at December 31, 2009. We elected the fair value option on these bonds because they did not qualify for hedge accounting and, in most instances, we entered into economic derivatives to achieve some offset to the mark-to-market on the bonds. During the three and nine months ended September 30, 2010, we recorded fair value adjustment gains on these bonds of $3.1 million and $1.9 million compared to losses of $3.2 million and $15.4 million for the same periods in 2009. Refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations—Hedging Activities” for the impact of the related economic derivatives.
 
For additional information on our bonds, refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Sources of Liquidity.”
 
DISCOUNT NOTES
 
The following table summarizes our discount notes, all of which are due within one year (dollars in millions):
 
 
September 30,
2010
 
December 31,
2009
Par value
$
7,471
 
 
$
9,419
 
Discounts
*
 
 
(2
)
Total discount notes
$
7,471
 
 
$
9,417
 
 
*
Amount is less than one million
 
Discount notes decreased 21 percent at September 30, 2010 when compared to December 31, 2009. The decrease was primarily due to us replacing maturing discount notes with bonds as a result of decreased short-term funding needs and our desire to extend the duration of our liabilities. For additional information on our discount notes, refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Sources of Liquidity.”
 
Capital
 
Our capital (including capital stock, retained earnings, and accumulated other comprehensive income (loss)) was $3.0 billion at September 30, 2010 compared to $2.9 billion at December 31, 2009. Although our total capital level remained fairly stable between periods, the composition of our capital changed during the nine months ended September 30, 2010. Capital stock decreased 7 percent due primarily to the repurchase of activity-based capital stock resulting from lower advance and MPF loan activity. Retained earnings increased 9 percent due to net income earned during the nine months ended September 30, 2010, partially offset by the payment of dividends. Accumulated other comprehensive income (loss) increased $180.5 million due to an increase in unrealized gains on available-for-sale securities resulting primarily from a decrease in interest rates.
 

71


Derivatives
 
The notional amount of derivatives reflects the volume of our hedges, but it does not measure our credit exposure because there is no principal at risk. The following table categorizes the notional amount of our derivatives (dollars in millions):
 
 
September 30,
2010
 
December 31,
2009
Notional amount of derivatives
 
 
 
Interest rate swaps
 
 
 
Noncallable
$
25,362
 
 
$
34,158
 
Callable by counterparty
10,643
 
 
9,386
 
Callable by the Bank
40
 
 
60
 
 
36,045
 
 
43,604
 
 
 
 
 
Interest rate caps or floors
9,490
 
 
3,240
 
Forward settlement agreements (TBAs)
254
 
 
27
 
Mortgage delivery commitments
255
 
 
27
 
 
 
 
 
Total notional amount
$
46,044
 
 
$
46,898
 
    
We utilize derivative instruments to manage interest rate and prepayment risk in our Statements of Condition. At September 30, 2010, the notional amount of our derivative contracts decreased approximately 2 percent when compared to December 31, 2009. The decrease was primarily due to decreased noncallable interest rate swaps, partially offset by increased interest rate caps and floors and increased callable interest rate swaps. We purchased interest rate caps and floors primarily to protect against prepayments in our mortgage portfolio.
 
 

72


The following table categorizes the notional amount and the fair value of derivative instruments, excluding accrued interest, by product and type of accounting treatment (dollars in millions). The category titled fair value represents hedges that qualify for fair value hedge accounting. The category titled economic represents hedges that do not qualify for hedge accounting.
 
 
September 30, 2010
 
December 31, 2009
 
Notional
 
 Fair Value
 
Notional
 
 Fair Value
Advances
 
 
 
 
 
 
 
Fair value
$
12,243
 
 
$
(998
)
 
$
13,204
 
 
$
(613
)
Economic
206
 
 
(1
)
 
746
 
 
(1
)
Investments
 
 
 
 
 
 
 
Fair value
256
 
 
(19
)
 
239
 
 
2
 
Economic
753
 
 
(39
)
 
1,525
 
 
25
 
Mortgage assets
 
 
 
 
 
 
 
Forward settlement agreements (TBAs)
 
 
 
 
 
 
 
Economic
254
 
 
(1
)
 
27
 
 
*
 
Mortgage delivery commitments
 
 
 
 
 
 
 
Economic
255
 
 
1
 
 
27
 
 
*
 
Consolidated obligations
 
 
 
 
 
 
 
Bonds
 
 
 
 
 
 
 
Fair value
20,577
 
 
498
 
 
20,753
 
 
147
 
Economic
2,010
 
 
9
 
 
6,830
 
 
4
 
Discount notes
 
 
 
 
 
 
 
Economic
 
 
 
 
307
 
 
*
 
Balance Sheet
 
 
 
 
 
 
 
Economic
9,490
 
 
80
 
 
3,240
 
 
51
 
 
 
 
 
 
 
 
 
Total notional and fair value
$
46,044
 
 
$
(470
)
 
$
46,898
 
 
$
(385
)
 
 
 
 
 
 
 
 
Total derivatives, excluding accrued interest
 
 
(470
)
 
 
 
(385
)
Accrued interest
 
 
87
 
 
 
 
63
 
Net cash collateral and related accrued interest1
 
 
120
 
 
 
 
53
 
Net derivative balance
 
 
$
(263
)
 
 
 
$
(269
)
 
 
 
 
 
 
 
 
Net derivative assets
 
 
9
 
 
 
 
11
 
Net derivative liabilities
 
 
(272
)
 
 
 
(280
)
Net derivative balance
 
 
$
(263
)
 
 
 
$
(269
)
1 
 
Excludes $9.1 million of excess cash collateral held by us at September 30, 2010, which is recorded as a deposit liability in the Statements of Condition.
 
 
 
* 
 
Amount is less than one million.
 
Fair values of derivative instruments will fluctuate based upon changes in the interest rate environment, volatility in the marketplace, as well as the volume of derivative activities. For fair value hedge relationships, substantially all of the net fair value gains and losses on our derivative contracts are offset by net hedging fair value adjustment losses and gains on the related hedged items. Economic derivatives do not have an offsetting fair value adjustment as they are not associated with a hedged item; however, the mark-to-market on certain assets and liabilities (i.e., trading securities and fair value option bonds) are generally offset by certain economic derivatives.
 

73


Liquidity and Capital Resources
 
Our liquidity and capital positions are actively managed in an effort to preserve stable, reliable, and cost-effective sources of cash to meet current and projected future operating financial commitments, as well as regulatory and internal liquidity and capital requirements.
 
LIQUIDITY
 
Sources of Liquidity
 
Our primary source of liquidity is proceeds from the issuance of consolidated obligations (bonds and discount notes) in the capital markets. Although we are primarily liable for the portion of consolidated obligations that are issued on our behalf, we are also jointly and severally liable with the other 11 FHLBanks for the payment of principal and interest on all consolidated obligations issued by the FHLBank System. The par amounts of outstanding consolidated obligations issued on behalf of other FHLBanks for which the Bank is jointly and severally liable were approximately $751.5 billion and $870.8 billion at September 30, 2010 and December 31, 2009.
 
Consolidated obligations of the FHLBanks are rated AAA/A-1+ by S&P and Aaa/P-1 by Moody's. These are the highest ratings available for such debt from a nationally recognized statistical rating organization (NRSRO). These ratings measure the likelihood of timely payment of principal and interest on the consolidated obligations. Our ability to raise funds in the capital markets as well as our cost of borrowing can be affected by these credit ratings.
 
During the nine months ended September 30, 2010, proceeds from the issuance of bonds and discount notes were $31.3 billion and $247.3 billion compared to $20.8 billion and $607.2 billion for the same period in 2009. Shorter-term funding was relatively attractive throughout 2009 while longer-term funding was expensive due to illiquidity in the marketplace and investors' desire to invest short-term. As a result, we utilized discount notes to fund both our short- and long-term assets in 2009. Throughout 2010, longer-term funding improved and, as a result, we began replacing maturing discount notes with bonds in an effort to better match fund our longer-term assets with longer-term debt. Additionally, as interest rates continued to fall throughout the third quarter of 2010, callable funding became more attractive. Accordingly, we began issuing more callable bonds in order to reduce funding costs as well as protect ourselves against potential future mortgage prepayments.
 
In addition to the issuance of consolidated obligations, during the nine months ended September 30, 2010, we experienced increased advance prepayment activity as a result of the low interest rate environment. Advance prepayment fees, net were $152.4 million during the nine months ended September 30, 2010 due primarily to one member prepaying approximately $1.1 billion of advances during the third quarter of 2010.
 
We utilize several other sources of liquidity to carry out our business activities. These include cash, interbank loans, payments collected on advances and mortgage loans, proceeds from the issuance of capital stock, member deposits, and current period earnings. In the event of significant market disruptions or local disasters, our President or his designee is authorized to establish interim borrowing relationships with other FHLBanks and the Federal Reserve. To provide further access to funding, the FHLBank Act authorizes the U.S. Treasury to directly purchase new issue consolidated obligations of the GSEs, including FHLBanks, up to an aggregate principal amount of $4.0 billion. As of October 31, 2010, no purchases had been made by the U.S. Treasury under this authorization.
 
Uses of Liquidity
 
We use proceeds from the issuance of consolidated obligations primarily to fund advances and investment purchases. During the nine months ended September 30, 2010, as a result of the low interest rate environment, we also used proceeds from the issuance of consolidated obligations and advance prepayments to call and extinguish debt.
 
During the nine months ended September 30, 2010, advance disbursements totaled $26.9 billion compared to $30.6 billion for the same period in 2009. The decrease in advance disbursements during the nine months ended September 30, 2010 is consistent with our decrease in advance balances.
 

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During the nine months ended September 30, 2010, investment purchases (excluding overnight investments) totaled $9.3 billion compared to $22.0 billion for the same period in 2009. The decrease in investment purchases during the nine months ended September 30, 2010 was primarily due to a lack of attractive short-term investment opportunities resulting from (i) concerns on global economic conditions and (ii) reduced counterparty exposure limits established under our ERMP.
 
During the nine months ended September 30, 2010, we called $15.9 billion of higher-costing par value bonds compared to $2.5 billion for the same period in 2009 in an effort to lower our relative cost of funds in the future. In addition, to manage our balance sheet and lower future interest expense, we extinguished $1.1 billion of higher-costing par value bonds during the nine months ended September 30, 2010 and recorded losses of $131.3 million on these debt extinguishments.
 
Other uses of liquidity include purchases of mortgage loans, repayment of member deposits, consolidated obligations, and interbank loans, redemption or repurchase of capital stock, and payment of dividends.
 
Liquidity Requirements
 
Finance Agency regulations mandate three liquidity requirements. First, we are required to maintain contingent liquidity sufficient to meet our liquidity needs which shall, at a minimum, cover five calendar days of inability to access the consolidated obligation debt markets. Second, we are required to have available at all times an amount greater than or equal to members' current deposits invested in advances with maturities not to exceed five years, deposits in banks or trust companies, and obligations of the U.S. Treasury. Third, we are required to maintain, in the aggregate, unpledged qualifying assets in an amount at least equal to the amount of our participation in total consolidated obligations outstanding. At September 30, 2010 and December 31, 2009, we were in compliance with all three of the Finance Agency's liquidity requirements.
 
In addition to the liquidity measures discussed above, the Finance Agency has provided the Bank with guidance to maintain sufficient liquidity, through short-term investments, in an amount at least equal to our anticipated cash outflows under two different scenarios. One scenario (roll-off scenario) assumes that we can not access the capital markets for the issuance of debt for a period of 10 to 20 days with initial guidance set at 15 days and that during that time members do not renew any maturing, prepaid, and called advances. The second scenario (renew scenario) assumes that we can not access the capital markets for the issuance of debt for a period of three to seven days with initial guidance set at five days and that during that time we will automatically renew maturing and called advances for all members except very large, highly rated members. This guidance is designed to protect against temporary disruptions in the debt markets that could lead to a reduction in market liquidity and thus the inability for us to provide advances to our members. At September 30, 2010 and December 31, 2009, we were in compliance with this liquidity guidance.
 
CAPITAL
 
Capital Requirements
 
We are subject to three regulatory capital requirements. First, the FHLBank Act requires that we maintain at all times permanent capital greater than or equal to the sum of our credit, market, and operations risk capital requirements, all calculated in accordance with Finance Agency regulations. Only permanent capital, defined as Class B capital stock and retained earnings, can satisfy this risk based capital requirement. Second, the FHLBank Act requires a minimum four percent capital-to-asset ratio, which is defined as total capital divided by total assets. Third, the FHLBank Act imposes a five percent minimum leverage ratio, which is defined as the sum of permanent capital weighted 1.5 times and nonpermanent capital weighted 1.0 times divided by total assets. For purposes of compliance with the regulatory minimum capital-to-asset and leverage ratios, capital includes all capital stock, including mandatorily redeemable capital stock, plus retained earnings.
 
If our capital falls below the required levels, the Finance Agency has authority to take actions necessary to return us to safe and sound business operations within the regulatory minimum ratios. On September 29, 2010, we received a letter from the Finance Agency stating we were adequately capitalized at June 30, 2010. At September 30, 2010, management believes we continue to be adequately capitalized. For additional information, refer to "Item 1. Financial Statements - Note 11 - Capital."
 
    

75


The following table summarizes our regulatory capital (dollars in millions):
 
 
September 30,
2010
 
December 31,
2009
GAAP capital stock
$
2,296
 
 
$
2,461
 
Retained earnings
529
 
 
484
 
Mandatorily redeemable capital stock
5
 
 
8
 
Total regulatory capital stock
$
2,830
 
 
$
2,953
 
 
The decrease in GAAP capital stock at September 30, 2010 when compared to December 31, 2009 was primarily due to a decrease in activity-based capital stock. Activity-based capital stock fluctuates with the outstanding balances of advances made to members and mortgage loans purchased from members. Retained earnings increased due to net income earned during the nine months ended September 30, 2010, partially offset by the payment of dividends. At September 30, 2010 and December 31, 2009, a majority of the capital stock subject to mandatory redemption was due to the voluntary termination of membership as a result of out of district mergers or consolidations.
 
Capital stock owned by members in excess of their minimum investment requirements is known as excess capital stock. We had excess capital stock (including excess mandatorily redeemable capital stock) of $60.5 million and $61.8 million at September 30, 2010 and December 31, 2009.
 
Dividends
 
Our dividend philosophy is to pay out a sustainable dividend equal to or above the average three-month LIBOR rate for the covered period. While three-month LIBOR is our dividend benchmark, the actual dividend payout is impacted by Board of Director policies, regulatory requirements, financial projections, and actual performance. Therefore, the actual dividend rate may be higher or lower than average three-month LIBOR.
 
For the nine months ended September 30, 2010, we paid cash dividends of $38.0 million compared to $29.0 million for the same period in 2009. The annualized dividend rate paid for the nine months ended September 30, 2010 and 2009 was 2.00 percent and 1.34 percent.
 
Critical Accounting Policies and Estimates
 
For a discussion of our critical accounting policies and estimates, refer to our 2009 Form 10-K. There have been no material changes to our critical accounting policies and estimates during the nine months ended September 30, 2010.
 
Legislative and Regulatory Developments
 
PROPOSED RULE ON ELIGIBLE INVESTMENTS FOR DERIVATIVES CLEARING ORGANIZATIONS
 
On November 3, 2010, the Commodity Futures Trading Commission (CFTC) issued a proposed rule with a comment deadline of December 3, 2010 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 U.S. federal government. Currently, GSE securities are eligible investments under CFTC regulations. If this change is adopted as proposed, the demand for FHLBank debt may be adversely impacted.
 
PROPOSED RULE ON SHARING OF FINANCIAL INFORMATION
 
On September 30, 2010, the Finance Agency published for comment a proposed rule implementing a provision in the Housing and Economic Recovery Act (HERA) requiring the Finance Agency to make available to each FHLBank information relating to the financial condition of all other FHLBanks. Information shared under the proposed rule would include the final report of examination for each FHLBank and any other supervisory reports that the Finance Agency presents to an FHLBank’s board of directors. Comments on the proposed rule are due on November 29, 2010.
 

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PROPOSED RULE ON FINANCE AGENCY ENFORCEMENT POWERS
 
On August 12, 2010, the Finance Agency published for comment a proposed rule detailing its civil enforcement powers and the rules of practice and procedure for enforcement proceedings against FHLBanks and related parties. The proposed rule would implement the enhanced enforcement authority granted to the Finance Agency under HERA. Enforcement actions covered under the proposed rule include, among others, the authority to remove FHLBank officers and to impose civil monetary penalties on FHLBanks. Comments on the proposed rule were due on October 12, 2010.
 
PROPOSED RULE ON FINANCE AGENCY'S OFFICE OF OMBUDSMAN
 
On August 6, 2010, the Finance Agency published for comment a proposed rule that would establish within the Finance Agency an Office of the Ombudsman, which would consider complaints and appeals from the FHLBanks, Office of Finance, and any person that has a business relationship with the FHLBanks or the Office of Finance regarding the regulation and supervision of the FHLBanks or the Office of Finance by the Finance Agency. Comments on the proposed rule were due on September 7, 2010.
 
TAX-EXEMPT BONDS SUPPORTED BY FHLB LETTERS OF CREDIT
 
Legislation is being considered in Congress 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. HERA first allowed for this authority, provided that the bonds were issued between July 30, 2008 and December 31, 2010.
 
BASEL COMMITTEE ON BANKING SUPERVISION CAPITAL FRAMEWORK
 
The Basel Committee on Banking Supervision (Basel Committee) has developed a new capital regime for internationally active banks. Banks subject to the new regime will be required to have increased amounts of capital with core capital being more strictly defined to include only common equity and other capital assets that are able to fully absorb losses. While it is uncertain how the new regime will be implemented by the U.S. regulatory authorities, the new regime could encourage some of our members to divest their assets in order to comply with the more stringent capital requirements, thereby tending to decrease their need for advances. In addition, new liquidity requirements being developed by the Basel Committee could also make advances and investments in FHLBank obligations less attractive for banks subject to these requirements depending on how such requirements are implemented by the U.S. regulatory authorities.
 
FINANCIAL REGULATORY REFORM
 
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) was enacted into law. The Dodd-Frank Act, among other things: (i) creates a consumer financial protection agency; (ii) creates the Financial Stability Oversight Council, an inter-agency oversight council that will identify and provide for the regulation of systemically important financial institutions by the Federal Reserve Board; (iii) regulates the over-the-counter derivatives market; (iv) reforms the credit rating agencies; (v) imposes new executive compensation proxy and disclosure requirements; (vi) establishes new requirements, including a risk-retention requirement, for MBS; (vii) makes a number of changes to the federal deposit insurance system; and (viii) creates a federal insurance office that will monitor the insurance industry.
 
The FHLBanks' business operations, funding costs, rights, obligations, and/or the manner in which FHLBanks carry out their housing-finance mission may be affected by the Dodd-Frank Act. For example, regulations on the over-the-counter derivatives market that may be issued under the Dodd-Frank Act could materially affect an FHLBank's ability or cost to hedge its interest rate risk exposure from advances, achieve the FHLBank's risk management objectives, and act as an intermediary between its members and counterparties. The Commodity Futures Trading Commission and the SEC are requesting comments and promulgating rules regarding the implementation of the derivatives provisions in the Dodd-Frank Act. Furthermore, if the FHLBanks are identified as being systemically important financial institutions under the Dodd-Frank Act, they would be subject to heightened prudential standards established by the Federal Reserve Board. These standards include, at a minimum, risk-based capital requirements, liquidity requirements, risk management, a resolution plan, and concentration limits. Other standards could encompass such matters as a requirement to issue contingent capital instruments, additional public disclosures, and limits on short-term debt. The Dodd-Frank Act also requires systemically important financial institutions to report to the Federal Reserve on the nature and extent of their credit exposures to other significant companies and undergo semi-annual stress tests. In addition, under the Volcker Rule provision in the Dodd-Frank Act, such institutions are subject to higher capital requirements and quantitative limits with regard to their proprietary trading. On October 6, 2010, the Financial Stability Oversight Council published advanced notices of proposed rulemaking on the criteria it should use in designating systemically important financial institutions and on a study that it is required to undertake regarding the implementation of the Volcker Rule.

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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 Federal Deposit Insurance Corporation (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 our members to hold more deposits than other non-deposit liabilities.
 
The Dodd-Frank Act also requires the Treasury Department to submit to Congress by January 31, 2011 recommendations on how to end the conservatorships of Fannie Mae and Freddie Mac and on housing finance reform issues generally. On that subject, the Treasury Department and the Housing and Urban Development Department issued a series of questions for public comment in April and held a public conference in August regarding reforms to the housing finance system. It is uncertain at this time what recommendations will be made by the Administration, what housing finance reforms, if any, will be enacted based upon these recommendations, and how any reforms that may be enacted will impact our members, our mission, and our relationship to the federal government.
 
FINANCE AGENCY PROPOSED RULE ON FHLBANK CONSERVATORSHIP AND RECEIVERSHIP
 
On July 9, 2010, the Finance Agency published in the Federal Register a proposed rule implementing the conservatorship and receivership provisions of HERA, which apply to Fannie Mae, Freddie Mac and the FHLBanks. The proposed rule addresses the status and priority of claims, the relationships among various classes of creditors and equity-holders, and the priorities for contract parties and other claimants with regard to the resolution of an FHLBank that is put into conservatorship or receivership by the Finance Agency. Comments on the proposed rule were due on September 7, 2010.
 
STATEMENT ON PROPERTY ASSESSED CLEAN ENERGY PROGRAMS
 
On July 6, 2010, the Finance Agency issued a statement regarding the Property Assessed Clean Energy (PACE) retrofit lending programs which provide financing for borrowers to install energy conservation improvements to residential or commercial property. A number of states have recently enacted laws authorizing PACE programs. Loans made under some of these state programs may have a priority lien over existing mortgages, resulting in new credit risks for holders or investors of these mortgages. Because of these credit risks, the Finance Agency in its statement directed the FHLBanks to review their collateral policies and procedures in order to assure that the collateral pledged by our members for their advances is not adversely impacted by energy retrofit programs.
 
TRANSACTION ACCOUNT PROGRAMS
 
On June 28, 2010, the FDIC published in the Federal Register a final rule extending the Transaction Account Guarantee (TAG) program to December 31, 2010 for banks currently participating in the program. The TAG program provides FDIC insurance for all funds held at participating banks in qualifying non-interest bearing transaction accounts. The final rule also allowed the FDIC to further extend the TAG program without further rulemaking, for a period of time not to exceed December 31, 2011, upon a determination by the FDIC that continuing economic difficulties warrant the extension.
 
In addition, the Dodd-Frank Act requires the FDIC and the National Credit Union Administration to provide unlimited deposit insurance for non-interest bearing transaction accounts. This Dodd-Frank Act requirement is effective 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 30, 2010, the FDIC published in the Federal Register a proposed rule to implement this provision in the Dodd-Frank Act and announced that it will not be extending its TAG program beyond the scheduled expiration date of December 31, 2010. These programs provide an alternative source of funds for many of our members that compete with our advance business.
 
For additional discussion on pending legislative and regulatory developments, refer to our 2009 Form 10-K.

78


Risk Management
 
We have risk management policies, established by our Board of Directors, that monitor and control our exposure to market, liquidity, credit, operational, and business risk. Our primary objective is to manage assets, liabilities, and derivative exposures in ways that protect the par redemption value of our capital stock from risks, including fluctuations in market interest rates and spreads. Our risk management policies protect us from significant earnings volatility. We periodically evaluate these policies in order to respond to changes in our financial position and general market conditions. This periodic evaluation may result in changes to our risk management policies.
 
Our Board of Directors determined that we should operate under a risk management philosophy of maintaining an AAA rating. An AAA rating provides us with ready access to funds in the capital markets. In line with this objective, our ERMP establishes risk measures to monitor our market risk and liquidity risk. Effective July 1, 2010, our Board of Directors approved certain changes to our ERMP. While these changes did not impact the overall goals of managing risks, they did change some of the detailed provisions, processes, and measures utilized to manage risk. The following is a list of the risk measures in place at September 30, 2010 and whether or not they are monitored by a policy limit:
 
Market Risk:
 
Market Value of Capital Stock Sensitivity (policy limit)
Estimate of Daily Market Value Sensitivity (policy limit)
Projected 12-month GAAP Income Sensitivity (policy limit) Economic Value of Capital Stock
Liquidity Risk:
 
Regulatory Liquidity (policy limit)
 
Market Value of Capital Stock Sensitivity (MVCS) and Economic Value of Capital Stock (EVCS) are our key market risk measures.
 
MARKET RISK
 
We define market risk as the risk that MVCS or net interest income will change as a result of changes in market conditions such as interest rates, spreads, and volatilities. Interest rate risk was the predominant type of market risk exposure during the nine months ended September 30, 2010 and 2009. Our general approach toward managing interest rate risk is to acquire and maintain a portfolio of assets, liabilities, and hedges, which, taken together, limit our expected exposure to interest rate risk. Management regularly reviews our sensitivity to interest rate changes by monitoring our market risk measures in parallel and non-parallel interest rate shifts and spread and volatility movements. Our key market risk measures are quantified in the “Market Value of Capital Stock Sensitivity” and “Economic Value of Capital Stock” sections that follow.
 
Market Value of Capital Stock Sensitivity
 
We define MVCS as an estimate of the market value of assets minus the market value of liabilities adjusted for the market value of derivatives divided by the total shares of capital stock outstanding. It represents an estimation of the “liquidation value” of one share of our capital stock if all assets and liabilities were liquidated at current market prices. MVCS does not fully represent our long-term value, as it takes into account short-term market price fluctuations. These fluctuations are generally unrelated to the long-term value of the cash flows from our assets and liabilities.
 
The MVCS calculation uses market prices, as well as interest rates and volatilities, and assumes a static balance sheet. The timing and variability of balance sheet cash flows are calculated by an internal model. To ensure the accuracy of the market value calculation, we reconcile the computed market prices of complex instruments, such as derivatives and mortgage assets, to market observed prices or dealers' quotes.
 
Interest rate risk stress tests of MVCS involve instantaneous parallel and non-parallel shifts in interest rates. The resulting percentage change in MVCS from the base case value is an indication of longer-term repricing risk and option risk embedded in the balance sheet.
 
To protect the MVCS from large interest rate swings, we use hedging transactions, such as entering into or canceling interest rate swaps on existing debt, altering the funding structure supporting MBS and MPF purchases, and purchasing interest rate swaptions, caps, and floors.
 

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Effective July 1, 2010, the policy limits for MVCS are 2.2 percent, 5 percent and 12 percent declines from the base case in the up and down 50, 100 and 200 basis point parallel interest rate shift scenarios and 4.4 percent, 10 percent and 20 percent declines from the base case in the up and down 50, 100 and 200 basis point non-parallel interest rate shift scenarios. Any breach of policy limits requires an immediate action to bring the exposure back within policy limits, as well as a report to the Board of Directors. Prior to July 1, 2010, there were no policy limits established for the up and down 50 basis point parallel interest rate shift scenarios or the up and down 50, 100 and 200 basis point non-parallel interest rate shift scenarios.
 
The following tables show our base case and change from base case MVCS in dollars per share and percent change respectively, based on outstanding shares, including shares classified as mandatorily redeemable, assuming instantaneous parallel shifts in interest rates at each quarter-end during 2010 and 2009:
 
 
Market Value of Capital Stock (Dollars per Share)
 
Down 200
 
Down 100
 
Down 501
 
Base Case
 
Up 501
 
Up 100
 
Up 200
2010
 
 
 
 
 
 
 
 
 
 
 
 
 
September
$
101.4
 
 
$
101.9
 
 
$
106.2
 
 
$
107.9
 
 
$
107.8
 
 
$
106.7
 
 
$
100.9
 
June
$
95.0
 
 
$
100.8
 
 
N/A
 
 
$
105.9
 
 
N/A
 
 
$
104.7
 
 
$
99.6
 
March
$
78.7
 
 
$
100.5
 
 
N/A
 
 
$
102.9
 
 
N/A
 
 
$
99.8
 
 
$
94.2
 
2009
 
 
 
 
 
 
 
 
 
 
 
 
 
December
$
85.1
 
 
$
100.2
 
 
N/A
 
 
$
100.2
 
 
N/A
 
 
$
97.2
 
 
$
92.0
 
September
$
78.4
 
 
$
91.7
 
 
N/A
 
 
$
95.5
 
 
N/A
 
 
$
93.5
 
 
$
89.0
 
June
$
72.1
 
 
$
86.9
 
 
N/A
 
 
$
91.2
 
 
N/A
 
 
$
90.4
 
 
$
87.4
 
March
$
42.7
 
 
$
59.2
 
 
N/A
 
 
$
76.3
 
 
N/A
 
 
$
86.9
 
 
$
85.7
 
 
 
Percent Change from Base Case
 
Down 200
 
Down 100
 
Down 501
 
Base Case
 
Up 501
 
Up 100
 
Up 200
2010
 
 
 
 
 
 
 
 
 
 
 
 
 
September
(6.0
)%
 
(5.6
)%
 
(1.6
)%
 
%
 
(0.1
)%
 
(1.2
)%
 
(6.5
)%
June
(10.3
)%
 
(4.8
)%
 
N/A
 
 
%
 
N/A
 
 
(1.1
)%
 
(6.0
)%
March
(23.5
)%
 
(2.3
)%
 
N/A
 
 
%
 
N/A
 
 
(3.0
)%
 
(8.5
)%
2009
 
 
 
 
 
 
 
 
 
 
 
 
 
December
(15.1
)%
 
 %
 
N/A
 
 
%
 
N/A
 
 
(0.3
)%
 
(8.2
)%
September
(17.9
)%
 
(4.0
)%
 
N/A
 
 
%
 
N/A
 
 
(2.1
)%
 
(6.8
)%
June
(20.9
)%
 
(4.7
)%
 
N/A
 
 
%
 
N/A
 
 
(9.0
)%
 
(4.2
)%
March
(44.0
)%
 
(22.3
)%
 
N/A
 
 
%
 
N/A
 
 
14.0
 %
 
12.3
 %
 
1 
 
Policy limits for the up and down 50 basis point parallel interest rate shift scenarios were implemented effective July 1, 2010.
 
The following tables show our base case and change from base case MVCS in dollars per share and percent change respectively, based on outstanding shares, including shares classified as mandatorily redeemable, assuming instantaneous non-parallel shifts in interest rates at September 30, 2010:
 
 
Market Value of Capital Stock (Dollars per Share)
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
2010
 
 
 
 
 
 
 
 
 
 
 
 
 
September
$
103.1
 
 
$
102.8
 
 
$
104.4
 
 
$
107.9
 
 
$
112.4
 
 
$
116.6
 
 
$
112.8
 
 
Percent Change from Base Case
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
2010
 
 
 
 
 
 
 
 
 
 
 
 
 
September
(4.5
)%
 
(4.7
)%
 
(3.2
)%
 
%
 
4.2
%
 
8.0
%
 
4.6
%
 

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The increase in base case MVCS at September 30, 2010 compared with December 31, 2009 was primarily attributable to the following:
 
•    
Decreased option-adjusted spread on our mortgage assets. During the nine months ended September 30, 2010, the spread between mortgage interest rates and LIBOR decreased significantly when compared to the fourth quarter of 2009, which increased the market value of our mortgage assets.
 
•    
Increased retained earnings. Retained earnings increased during the nine months ended September 30, 2010 due primarily to earnings in excess of dividend payments. As we retain earnings, our equity position increases, thereby increasing MVCS.
 
During the first quarter of 2008, our Board of Directors suspended all policy limits pertaining to the down 200 basis point parallel interest rate shift scenario due to the low interest rate environment. During the third quarter of 2010, we temporarily adjusted all policy limits pertaining to the parallel and non-parallel interest rate shift scenarios in anticipation of a recalibration to our prepayment model. The temporarily adjusted policy limits for MVCS are 15.2 percent, 6.6 percent, 3.0 percent, 1.8 percent, 4.2 percent, and 10.4 percent declines from base case in the down 200, down 100, down 50, up 50, up 100, and up 200 basis point parallel interest rate shift scenarios. For the non-parallel interest rate shift scenarios, the temporarily adjusted policy limits are 27.2 percent, 11.6 percent, 5.2 percent, 4.0 percent, 9.2 percent and 22.4 percent declines from base case in the down 200, down 100, down 50, up 50, up 100, and up 200 basis point shocks. These temporary policy limits will be removed at the time our prepayment model recalibration is complete.
 
Economic Value of Capital Stock
 
We define EVCS as the net present value of expected future cash flows of our assets and liabilities, discounted at our cost of funds, divided by the total shares of capital stock outstanding. This method reduces the impact of day-to-day price changes (i.e. mortgage option-adjusted spread) which cannot be attributed to any of the standard market factors, such as movements in interest rates or volatilities. Thus, EVCS provides an estimated measure of the long-term value of one share of our capital stock.
 
The following table shows EVCS in dollars per share based on outstanding shares, including shares classified as mandatorily redeemable, at each quarter-end during 2010 and 2009.
 
Economic Value of Capital Stock (Dollars Per Share)
2010
 
 
September
 
$
119.3
 
June
 
$
114.0
 
March
 
$
114.2
 
2009
 
 
December
 
$
108.7
 
September
 
$
106.9
 
June
 
$
102.1
 
March
 
$
86.3
 
 
The improvement in our EVCS at September 30, 2010 when compared to December 31, 2009 was primarily attributable to the following:
 
•    
Increased retained earnings. Retained earnings increased during the nine months ended September 30, 2010 due primarily to earnings in excess of dividend payments. As we retain earnings, our equity position increases, thereby increasing EVCS.
 
•    
High mortgage spreads. Mortgage spreads over swap rates, which are used in our model for projecting future mortgage rates, widened during the period. The higher spreads increased the economic value of mortgage assets because it increased projected mortgage rates and hence decreased the projected prepayment speeds.
 
•    
Decreased interest rates. During the nine months ended September 30, 2010, interest rates decreased when compared to the fourth quarter of 2009, which increased EVCS due to a slightly longer duration of our assets compared to our liabilities for most of the period.

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LIQUIDITY RISK
 
We define liquidity risk as the risk that we will be unable to meet our obligations as they come due or meet the credit needs of our members and housing associates in a timely and cost efficient manner. To manage this risk, we maintain liquidity in accordance with Finance Agency regulations. Refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Liquidity” for additional details on our liquidity management.
 
CREDIT RISK
 
We define credit risk as the potential that our borrowers or counterparties will fail to meet their obligations in accordance with agreed upon terms. Our primary credit risks arise from our ongoing lending, investing, and hedging activities. Our overall objective in managing credit risk is to operate a sound credit granting process and to maintain appropriate credit administration, measurement, and monitoring practices.
 
Advances
 
We are required by regulation to obtain and maintain a security interest in eligible collateral at the time we originate or renew an advance and throughout the life of the advance. Eligible collateral includes whole first mortgages on improved residential property or securities representing a whole interest in such mortgages; securities issued, insured, or guaranteed by the U.S. Government or any of the GSEs, including without limitation MBS issued or guaranteed by Fannie Mae, Freddie Mac, or Government National Mortgage Association; cash deposited with us; guaranteed student loans; and other real estate-related collateral acceptable to us provided such collateral has a readily ascertainable value and we can perfect a security interest in such property. Additionally, community financial institutions may pledge collateral consisting of secured small business, small farm, or small agribusiness loans, including secured business and agri-business lines of credit.
 
Credit risk arises from the possibility that a borrower is unable to repay their obligation and the collateral pledged to us is insufficient to cover the amount of exposure in default. We manage credit risk by securing borrowings with sufficient collateral acceptable to us, monitoring borrower creditworthiness through internal and independent third-party analysis, and performing collateral review and valuation procedures to verify the sufficiency of pledged collateral. We are required by law to make advances solely on a secured basis and have never experienced a credit loss on an advance since our inception. We maintain policies and practices to monitor our exposure and take action where appropriate. In addition, we have the ability to call for additional or substitute collateral, or require delivery of collateral, during the life of a loan to protect our security interest.
 
Although management has policies and procedures in place to manage credit risk, we may be exposed to this risk if our outstanding advance value exceeds the liquidation value of our collateral. We mitigate this risk by applying collateral discounts, requiring most borrowers to execute a blanket lien, taking delivery of collateral, and limiting extensions of credit. Collateral discounts, or haircuts, are applied to the unpaid principal balance or market value, if available, of the collateral to determine the advance equivalent value of the collateral securing each borrower's obligations. The amount of these discounts will vary based on the type of collateral and security agreement. We determine these discounts or haircuts using data based upon historical price changes, discounted cash flow analyses, and loan level modeling.
 
At September 30, 2010 and December 31, 2009, borrowers pledged $88.7 billion and $86.3 billion of collateral (net of applicable discounts) to support activity with us, including advances. Borrowers pledge collateral in excess of their collateral requirement mainly to demonstrate available liquidity and to borrow additional amounts in the future.
 
    
 

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Mortgage Assets
 
We are exposed to mortgage asset credit risk through our participation in the MPF program and MBS activities. Mortgage asset credit risk is the risk that we will not receive timely payments of principal and interest due from mortgage borrowers because of borrower defaults. Credit risk on mortgage assets is affected by numerous characteristics, including loan type, borrower's credit history, and other factors such as home price fluctuations, unemployment levels, and other economic factors in the local market or nationwide.
 
MPF LOANS
 
Through our participation in the MPF program, we invest in conventional and government-insured residential mortgage loans that are acquired through or purchased from a PFI. We currently offer six MPF loan products to our PFIs: Original MPF, MPF 100, MPF 125, MPF Plus, Original MPF Government, and MPF Xtra. For additional discussion of our MPF products, see “Item 1. Business - Products and Services —Mortgage Finance—MPF Loan Types” in our 2009 Form 10-K.
 
The following table presents the unpaid principal balance of our MPF portfolio by product type (dollars in billions):
 
 
 
September 30, 2010
 
December 31, 2009
Product Type
 
Dollars
 
Percent
 
Dollars
 
Percent
Original MPF
 
$
0.6
 
 
8.0
%
 
$
0.5
 
 
6.5
%
MPF 100
 
0.1
 
 
1.3
 
 
0.1
 
 
1.3
 
MPF 125
 
2.7
 
 
36.0
 
 
2.4
 
 
31.2
 
MPF Plus
 
3.7
 
 
49.4
 
 
4.3
 
 
55.8
 
Total conventional loans
 
7.1
 
 
94.7
 
 
7.3
 
 
94.8
 
 
 
 
 
 
 
 
 
 
Government-insured loans
 
0.4
 
 
5.3
 
 
0.4
 
 
5.2
 
 
 
 
 
 
 
 
 
 
Total mortgage loans
 
$
7.5
 
 
100.0
%
 
$
7.7
 
 
100.0
%
 
We manage the credit risk on mortgage loans acquired in the MPF program by (i) using agreements to establish credit risk sharing responsibilities with our PFIs, (ii) monitoring the performance of the mortgage loan portfolio and creditworthiness of PFIs, and (iii) establishing prudent credit loss reserves to reflect management's estimate of probable credit losses inherent in the portfolio. Our management of credit risk in the MPF program involves several layers of legal loss protection that are defined in agreements among us and our PFIs.
 
For our government-insured MPF loans, our loss protection consists of the loan guarantee and contractual obligation of the loan servicer to repurchase the loan when certain criteria are met.
 
For our conventional MPF loans, PFIs retain a portion of the credit risk on the MPF loans they sell to us by providing credit enhancement. The required PFI credit enhancement may vary depending on the MPF product alternatives selected.
 
PFIs are paid a credit enhancement fee for managing the credit risk on conventional MPF loans, and in some instances all or a portion of the credit enhancement fee may be performance based. Credit enhancement fees are paid monthly and are determined based on the remaining unpaid principal balance of the MPF loans in the master commitment. To the extent we experience losses in a master commitment, we may be able to recapture credit enhancement fees paid to the PFI to offset potential credit losses.
 
 

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For our conventional MPF loans, the availability of loss protection may differ slightly among MPF products. Our loss protection consists of the following loss layers, in order of priority:
 
•    
Homeowner Equity.
 
•    
Primary Mortgage Insurance (PMI). PMI is on all loans with homeowner equity of less than 20 percent of the original purchase price or appraised value.
 
•    
First Loss Account. The first loss account specifies our potential loss exposure under each master commitment prior to the PFI's credit enhancement obligation. If we experience losses in a master commitment, these losses will either be (i) recovered through the recapture of performance based credit enhancement fees from the PFI or (ii) absorbed by us. The first loss account balance for all master commitments is a memorandum account and was $121.4 million and $116.4 million at September 30, 2010 and December 31, 2009.
 
•    
Credit Enhancement Obligation of PFI. PFIs have a credit enhancement obligation to absorb losses in excess of the first loss account in order to limit our loss exposure to that of an investor in an MBS that is rated the equivalent of AA by a NRSRO. PFIs are required to either collateralize their credit enhancement obligation with us or to purchase supplemental mortgage insurance (SMI) from mortgage insurers. All of our SMI providers have had their external ratings for claims-paying ability or insurer financial strength downgraded below AA. Ratings downgrades imply an increased risk that these SMI providers will be unable to fulfill their obligations to reimburse us for claims under insurance policies.
 
On August 7, 2009, the Finance Agency granted a waiver for one year on the AA rating requirement of SMI providers for existing loans and commitments in the MPF program. The waiver required us to evaluate the claims-paying ability of our SMI providers and hold retained earnings or take other steps necessary to mitigate the risks associated with using an SMI provider having a rating below AA. On July 29, 2010, the Finance Agency extended the waiver for an additional year, subject to the same conditions. We evaluated the claims-paying ability of our SMI providers during the third quarter of 2010 and determined that, as of October 31, 2010, it was not necessary to hold retained earnings or take other steps necessary to mitigate the risk of using these SMI providers. As new information regarding the claims-paying ability of our SMI providers becomes available, we will reevaluate the need to hold retained earnings or take other steps necessary to mitigate this risk.
 
The following table summarizes our conventional loan delinquencies as well as our real estate owned (dollars in thousands):
 
 
Unpaid Principal Balance
 
September 30,
2010
 
December 31, 2009
 
 
 
 
30 - 59 days delinquent and not in foreclosure
$
94,494
 
 
$
91,960
 
60 - 89 days delinquent and not in foreclsoure
36,313
 
 
34,966
 
90 days or more delinquent and not in foreclosure
33,648
 
 
45,803
 
In process of foreclosure1
76,045
 
 
56,894
 
 
$
240,500
 
 
$
229,623
 
 
 
 
 
Real estate owned inventory
$
17,782
 
 
$
12,178
 
 
 
 
 
Serious delinquency rate2
1.5
%
 
1.4
%
 
1 
 
Includes loans where the decision of foreclosure or similar alternative such as pursuit of deed-in-lieu has been reported.
 
 
 
2 
 
Conventional loans that are 90 days or more past due or in the process of foreclosure expressed as a percentage of the total conventional loan portfolio unpaid principal balance. We only hold fixed rate prime conventional mortgage loans.
 

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The following table presents additional information on our mortgage loans held for portfolio (dollars in thousands):
 
 
September 30,
2010
 
December 31,
2009
 
 
 
 
Total unpaid principal balance of mortgage loans past due 90 days or more
and still accruing interest1
$
3,470
 
 
$
5,306
 
 
 
 
 
Total unpaid principal balance of nonaccrual mortgage loans2
$
108,742
 
 
$
102,028
 
 
 
 
 
Allowance for Credit Losses on Mortgage Loans:
 
 
 
Balance, beginning of period
$
1,887
 
 
$
500
 
    Charge-offs
(734
)
 
(88
)
    Provision for credit losses
5,647
 
 
1,475
 
Balance, end of period
$
6,800
 
 
$
1,887
 
 
 
 
 
Ratio of charge-offs during the period to average loans outstanding during the period
*
 
 
*
 
 
 
 
 
 
Nine Months Ended September 30,
Interest Shortfall on Nonaccrual Mortgage Loans:
2010
 
2009
Gross interest income that would have been recorded based on
original terms during the period
$
3,852
 
 
$
2,644
 
Interest actually recognized in net income during the period
 
 
 
Interest shortfall
$
3,852
 
 
$
2,644
 
1 
 
Represents government-insured mortgage loans. A government insured mortgage loan that is 90 days or more past due is not placed on nonaccrual status because of the (i) U.S. Government guarantee of the loan and (ii) contractual obligation of the loan servicer to repurchase the loan when certain criteria are met.
 
 
 
2 
 
Nonaccrual mortgage loans are defined as conventional mortgage loans that are 90 days or more past due.
 
 
 
*
 
Amount is less than 0.01 percent.
    
We estimate our allowance for credit losses based upon both quantitative and qualitative factors that may vary based upon the MPF product. Quantitative factors include, but are not limited to, a rolling twelve-month average of (i) loan delinquencies, (ii) loans migrating to real estate owned, and (iii) actual historical losses, as well as credit enhancement fees available to recapture estimated losses assuming a declining portfolio balance adjusted for prepayments. Qualitative factors include, but are not limited to, management judgment and experience and changes in national and local economic trends.
 
During the nine months ended September 30, 2010, we recorded a provision for credit losses of $5.6 million, bringing our allowance for credit losses to $6.8 million at September 30, 2010. The provision recorded was due to estimated losses in our mortgage portfolio increasing as a result of increased delinquency and loss severity and management's expectation that loans migrating to real estate owned will likely increase. We allocate available credit enhancement fees to recapture estimated losses. As charge-off activity has increased, estimated available credit enhancement fees decreased to $4.3 million at September 30, 2010 from $6.9 million at December 31, 2009.
 
During 2009, as a result of increased delinquency and loss severity and decreased estimated credit enhancement fees available to recapture losses, we increased our provision for credit losses by $1.5 million, resulting in an allowance for credit losses of $1.9 million at December 31, 2009.

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MORTGAGE-BACKED SECURITIES
 
Finance Agency regulations allow us to invest in MBS guaranteed by the U.S. Government, GSEs, and other MBS that are rated AAA by S&P, Aaa by Moody's, or AAA by Fitch on the purchase date. We are exposed to credit risk to the extent these MBS fail to perform adequately. We do ongoing analysis to evaluate the investments and creditworthiness of the issuers, trustees, and servicers for potential credit issues.
 
At September 30, 2010, we owned $12.5 billion of MBS, of which $12.4 billion or 99 percent were guaranteed by the U.S. Government or issued by GSEs and $0.1 billion or one percent were MPF shared funding certificates or private-label MBS. At December 31, 2009, we owned $11.3 billion of MBS, of which $11.2 billion or 99 percent were guaranteed by the U.S. Government or issued by GSEs and $0.1 billion or one percent were MPF shared funding certificates or private-label MBS.
 
Our MPF shared funding certificates are mortgage-backed certificates created from conventional conforming mortgages using a senior/subordinated tranche structure. We record these investments as held-to-maturity. We do not consolidate our investment in MPF shared funding certificates since we are not the sponsor or primary beneficiary of these variable interest entities. As of October 31, 2010, all of our MPF shared funding certificates were rated AA or higher by a NRSRO.
 
Our private-label MBS are variable rate securities backed by prime loans. We record these investments as held-to-maturity. The following table shows our private-label MBS and credit ratings (dollars in millions):
 
Credit Rating
 
September 30,
2010
 
December 31,
2009
 
 
 
 
 
AAA
 
$
19
 
 
$
20
 
AA
 
11
 
 
11
 
A
 
4
 
 
4
 
 
 
 
 
 
Total private-label MBS
 
$
34
 
 
$
35
 
 
The following table summarizes the characteristics of our private-label MBS by year of securitization at September 30, 2010 (dollars in millions):
 
Year of
 Securitization
 
Unpaid Principal Balance
 
Gross Unrealized Losses
 
Fair Value
 
Investment
Grade %1
 
Watchlist %2
 
 
 
 
 
 
 
 
 
 
 
2003 and earlier
 
$
34
 
 
$
5
 
 
$
29
 
 
100
%
 
73
%
 
1 
 
Investment grade includes securities that are rated BBB or higher by any NRSRO.
 
 
 
2 
 
Includes any securities placed on negative watch by any NRSRO. As of October 31, 2010, three of our private-label MBS were on negative watch by a NRSRO.
 
The following table summarizes the characteristics of our private-label MBS by year of securitization at December 31, 2009 (dollars in millions):
 
Year of
 Securitization
 
Unpaid Principal Balance
 
Gross Unrealized Losses
 
Fair Value
 
Investment
Grade %1
 
Watchlist %2
 
 
 
 
 
 
 
 
 
 
 
2003 and earlier
 
$
35
 
 
$
7
 
 
$
28
 
 
100
%
 
%
 
1 
 
Investment grade includes securities that are rated BBB or higher by any NRSRO.
 
 
 
2 
 
Includes any securities placed on negative watch by any NRSRO.
    

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The following table summarizes the fair value of our private-label MBS as a percentage of unpaid principal balance by quarter:
 
Year of
Securitization
 
September 30,
2010
 
June 30,
2010
 
March 31,
2010
 
December 31,
2009
 
September 30,
2009
 
 
 
 
 
 
 
 
 
 
 
2003 and earlier
 
85
%
 
84
%
 
81
%
 
80
%
 
81
%
 
The following table shows portfolio characteristics of the underlying collateral of our private-label MBS:
 
Portfolio Characteristics
 
September 30,
2010
 
December 31,
2009
Weighted average FICO® score at origination1
 
725
 
 
725
 
Weighted average loan-to-value at origination
 
65
%
 
65
%
Weighted average original credit enhancement
 
4
%
 
4
%
Weighted average credit enhancement
 
9
%
 
9
%
Weighted average collateral delinquency rate2
 
5
%
 
5
%
 
1 
 
FICO® is a widely used credit industry model developed by Fair, Isaac, and Company, Inc. to assess borrower credit quality with scores ranging from a low of 300 to a high of 850.
 
 
 
2 
 
Represents the percentage of underlying loans that are 60 days or more past due.
    
The following table shows the state concentrations of our private-label MBS calculated based on unpaid principal balances:
 
State Concentrations
 
September 30, 2010
 
December 31, 2009
 
 
 
 
 
Florida
 
14.2
%
 
14.1
%
California
 
12.7
 
 
13.1
 
Georgia
 
12.1
 
 
11.9
 
New York
 
9.6
 
 
9.4
 
New Jersey
 
5.2
 
 
5.1
 
All other1
 
46.2
 
 
46.4
 
 
 
 
 
 
Total
 
100.0
%
 
100.0
%
 
1 
 
There are no individual states with a concentration greater than 4.5 percent and 4.4 percent at September 30, 2010 and December 31, 2009.
 
At September 30, 2010, we do not consider any of our private-label MBS to be other-than-temporarily impaired. For more information on our evaluation of OTTI, refer to “Item 1. Financial Statements—Note 6—Other-Than-Temporary Impairment.”
 
Investments
 
We maintain an investment portfolio to provide investment income, provide liquidity, support the business needs of our members, and support the housing market through the purchase of mortgage-related assets. Finance Agency regulations and policies adopted by our Board of Directors limit the type of investments we may purchase.
 

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We invest in both short- and long-term investments. Our short-term portfolio includes, but is not limited to, interest-bearing deposits, Federal funds sold, and securities purchased under agreements to resell. Our long-term portfolio includes, but is not limited to, interest-bearing deposits, TLGP debt, taxable municipal bonds, state and local housing finance agency bonds, GSE obligations, and MBS.
 
Our primary credit risk on investments is the counterparties' ability to meet repayment terms. We mitigate this credit risk by investing in highly-rated investments and establishing unsecured credit limits to counterparties based on the credit quality and capital level of the counterparty as well as our capital level. Because our investments are transacted with highly-rated counterparties, our credit risk is low; accordingly, we have not set aside specific reserves for our investment portfolio. We do, however, maintain a level of retained earnings to absorb any unexpected losses from our investments that may arise from stress conditions.
 
The following table shows our total investment securities by investment credit rating (excluding accrued interest receivable) (dollars in millions):
 
 
 
September 30, 2010
 
December 31, 2009
Credit Rating1
 
Amount
 
% of Total
Investments
 
Amount
 
% of Total
Investments
Long-term
 
 
 
 
 
 
 
 
AAA2
 
$
15,427
 
 
76.2
%
 
$
16,687
 
 
80.3
%
AA
 
180
 
 
0.9
 
 
503
 
 
2.4
 
A
 
4
 
 
*
 
 
5
 
 
*
 
BBB3
 
 
 
 
 
3
 
 
*
 
Total long-term
 
$
15,611
 
 
77.1
 
 
$
17,198
 
 
82.7
 
 
 
 
 
 
 
 
 
 
Short-term
 
 
 
 
 
 
 
 
A-1 or higher/P-12
 
3,950
 
 
19.6
 
 
3,310
 
 
15.9
 
A-2/P-2
 
675
 
 
3.3
 
 
278
 
 
1.4
 
Total short-term
 
4,625
 
 
22.9
 
 
3,588
 
 
17.3
 
 
 
 
 
 
 
 
 
 
Unrated4
 
4
 
 
*
 
 
4
 
 
*
 
 
 
 
 
 
 
 
 
 
Total
 
$
20,240
 
 
100.0
%
 
$
20,790
 
 
100.0
%
 
1 
 
Represents the lowest credit rating by any NRSRO.
 
 
 
2 
 
TLGP investments and interest bearing deposits are rated either AAA or A-1 because they are guaranteed by the U.S. Government or FDIC.
 
 
 
3 
 
Represents a municipal bond that has all future principal and interest payments escrowed.
 
 
 
4 
 
Unrated securities represent an equity investment in Small Business Investment Company.
 
 
 
* 
 
Amount is less than 0.1 percent.
 
Short-term investments increased at September 30, 2010 when compared to December 31, 2009 due to increased overnight securities purchased under agreements to resell. During the third quarter of 2010, as a result of tighter unsecured credit limits established under our ERMP, we increased our utilization of these secured investments. Long-term investments decreased at September 30, 2010 when compared to December 31, 2009 due primarily to us selling certain TLGP debt investments and taxable municipal bonds in an effort to (i) lock in a portion of the holding gains associated with these assets and (ii) reduce our exposure to income statement volatility.
 
As of October 31, 2010, approximately 0.1 percent of our total investments were on negative watch by a NRSRO. All of these investments were private-label MBS. As of October 31, 2010, none of our investments held at September 30, 2010 have had their credit ratings subsequently downgraded.
    

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Derivatives
 
Most of our hedging strategies use over-the-counter derivative instruments that expose us to counterparty credit risk because the transactions are executed and settled between two parties. When an over-the-counter derivative has a market value above zero, the counterparty owes us that value over the remaining life of the derivative. Credit risk arises from the possibility the counterparty will not be able to fulfill its commitment to pay the amount owed to us.
 
We manage this credit risk by spreading our transactions among many highly rated counterparties, by entering into collateral exchange agreements with counterparties that include minimum collateral thresholds, and by monitoring our exposure to each counterparty on a daily basis. In addition, all of our collateral exchange agreements include master netting arrangements whereby the fair values of all interest rate derivatives (including accrued interest receivables and payables) with each counterparty are offset for purposes of measuring credit exposure. The collateral exchange agreements require the delivery of collateral consisting of cash or very liquid, highly rated securities if credit risk exposures rise above the minimum thresholds.
 
The following tables show our derivative counterparty credit exposure, excluding mortgage delivery commitments, and after applying netting agreements and collateral (dollars in millions):
 
 
 
September 30, 2010
Credit Rating1
 
Active
Counterparties
 
Notional
Amount2
 
Total
Exposure at
Fair Value3
 
Value
of Collateral
Pledged4
 
Exposure
Net of
Collateral5
 
 
 
 
 
 
 
 
 
 
 
AAA
 
1
 
 
$
235
 
 
$
 
 
$
 
 
$
 
AA
 
7
 
 
20,201
 
 
 
 
 
 
 
A
 
13
 
 
25,325
 
 
69
 
 
61
 
 
8
 
BBB
 
1
 
 
28
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
22
 
 
$
45,789
 
 
$
69
 
 
$
61
 
 
$
8
 
 
 
 
December 31, 2009
Credit Rating1
 
Active
Counterparties
 
Notional
Amount2
 
Total
Exposure at
Fair Value3
 
Value
of Collateral
Pledged
 
Exposure
Net of
Collateral5
 
 
 
 
 
 
 
 
 
 
 
AAA
 
1
 
 
$
276
 
 
$
 
 
$
 
 
$
 
AA
 
7
 
 
17,419
 
 
5
 
 
 
 
5
 
A
 
14
 
 
29,176
 
 
9
 
 
3
 
 
6
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
22
 
 
$
46,871
 
 
$
14
 
 
$
3
 
 
$
11
 
 
1 
 
Credit rating is the lower of the S&P, Moody's, and Fitch ratings stated in terms of the S&P equivalent.
 
 
 
2 
 
Notional amounts serve as a factor in determining periodic interest amounts to be received and paid and generally do not represent actual amounts to be exchanged or directly reflect our exposure to counterparty credit risk.
 
 
 
3 
 
For each counterparty, this amount includes derivatives with a net positive market value including the related accrued interest receivable/payable (net).
 
 
 
4 
 
Excludes $9.1 million of excess cash collateral held by us at September 30, 2010, which is recorded as a deposit liability in the Statements of Condition.
 
 
 
5 
 
Amount equals total exposure at fair value less value of collateral pledged as determined at the counterparty level.
 
 

89


OPERATIONAL RISK
 
We define operational risk as the risk of loss resulting from inadequate or failed internal processes, people, systems, or external events. Operational risk is inherent in all of our business activities and processes. Management has established policies and procedures to reduce the likelihood of operational risk and designed our annual risk assessment process to provide ongoing identification, measurement, and monitoring of operational risk.
 
BUSINESS RISK
 
We define business risk as the risk of an adverse impact on our profitability resulting from external factors that may occur in both the short- and long-term. Business risk includes political, strategic, reputation, regulatory, and/or environmental factors, many of which are beyond our control. From time to time, proposals are made, or legislative and regulatory changes are considered, which could affect our cost of doing business. We control business risk through strategic and annual business planning and monitoring of our external environment.
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
See “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations—Risk Management—Market Risk” and the sections referenced therein for quantitative and qualitative disclosures about market risk.
 
ITEM 4. CONTROLS AND PROCEDURES
 
Disclosure Controls and Procedures
 
Management is responsible for establishing and maintaining a system of disclosure controls and procedures designed to ensure that information required to be disclosed in reports we file or submit under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms; and (ii) accumulated and communicated to our management, including our President and Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of controls and procedures.
 
Management has evaluated the effectiveness of the design and operation of its disclosure controls and procedures with the participation of the President and Chief Executive Officer and Chief Financial Officer as of the end of the quarterly period covered by this report. Based on that evaluation, the President and Chief Executive Officer and Chief Financial Officer have concluded that the Bank's disclosure controls and procedures were effective as of the end of the fiscal quarter covered by this report.
 
Internal Control Over Financial Reporting
 
For the third quarter of 2010, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 

90


PART II—OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS
 
We are not currently aware of any pending or threatened legal proceedings against us that could have a material adverse effect on our financial condition, results of operations, or cash flows.
 
ITEM 1A. RISK FACTORS
 
For a discussion of our risk factors, refer to our 2009 Form 10-K. There have been no material changes to our risk factors during the three months ended September 30, 2010.
 
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
Not applicable.
 
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
 
None.
 
ITEM 4. (REMOVED AND RESERVED)
 
ITEM 5. OTHER INFORMATION
 
None.
 
ITEM 6. EXHIBITS
 
 
 
3.1
 
Organization Certificate of the Federal Home Loan Bank of Des Moines dated October 13, 1932. *
 
 
 
3.2
 
Bylaws of the Federal Home Loan Bank of Des Moines, as amended and restated effective February 26, 2009. **
 
 
 
4.1
 
Federal Home Loan Bank of Des Moines Capital Plan, as amended, dated March 24, 2009, approved by the Finance Agency on March 6, 2009. ***
 
 
 
31.1
 
Certification of the president and chief executive officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
31.2
 
Certification of the executive vice president and chief financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.1
 
Certification of the president and chief executive officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.2
 
Certification of the executive vice president and chief financial officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
*
 
Incorporated by reference to the correspondingly numbered exhibit to our Registration Statement on Form 10 filed with the SEC on May 12, 2006.
 
 
 
**
 
Incorporated by reference to the correspondingly numbered exhibit to our Form 8-K filed with the SEC on March 2, 2009.
 
 
 
***
 
Incorporated by reference to the correspondingly numbered exhibit to our Form 8-K/A filed with the SEC on March 31, 2009.
 

91


SIGNATURE
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
FEDERAL HOME LOAN BANK OF DES MOINES
 
 
(Registrant)
 
 
 
 
 
 
 
Date:
 
November 10, 2010
 
 
 
 
 
 
 
 
 
 
 
 
By:
 
/s/ Richard S. Swanson
 
 
 
 
Richard S. Swanson
President and Chief Executive Officer
 
 
 
 
 
 
 
By:
 
/s/ Steven T. Schuler
 
 
 
 
Steven T. Schuler
Executive Vice President and Chief Financial Officer
 
 
 

92