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EX-32.1 - CERTIFICATION OF PRESIDENT AND CHIEF EXECUTIVE OFFICER - Federal Home Loan Bank of Des Moinesexhibit321march312011.htm
EX-31.2 - CERTIFICATION OF EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER - Federal Home Loan Bank of Des Moinesexhibit312march312011.htm
EX-32.2 - CERTIFICATION OF EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER - Federal Home Loan Bank of Des Moinesexhibit322march312011.htm
EX-31.1 - CERTIFICATION OF PRESIDENT AND CHIEF EXECUTIVE OFFICER - Federal Home Loan Bank of Des Moinesexhibit311march312011.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 March 31, 2011
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 April 30, 2011
 
Class B Stock, par value $100
 
21,628,030
 
 
 
 
 
 
 
 
 

Table of Contents
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


PART I — FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF CONDITION
(In thousands, except capital stock par value)
(Unaudited)
 
March 31,
2011
 
December 31,
2010
ASSETS
 
 
 
Cash and due from banks
$
149,665
 
 
$
105,741
 
Interest-bearing deposits
8,012
 
 
8,919
 
Securities purchased under agreements to resell (Note 3)
1,600,000
 
 
1,550,000
 
Federal funds sold
2,152,000
 
 
2,025,000
 
Investment securities
 
 
 
Trading securities (Note 4)
1,269,214
 
 
1,472,542
 
Available-for-sale securities (Note 5)
5,883,516
 
 
6,356,903
 
Held-to-maturity securities (estimated fair value of $6,622,799 and $7,395,340 at March 31, 2011 and December 31, 2010) (Note 6)
6,467,861
 
 
7,226,116
 
Total investment securities
13,620,591
 
 
15,055,561
 
Advances (Note 8)
27,962,783
 
 
29,252,529
 
Mortgage loans held for portfolio (Note 9)
7,220,002
 
 
7,434,446
 
Less allowance for credit losses on mortgage loans (Note 10)
(18,000
)
 
(13,000
)
Mortgage loans held for portfolio, net
7,202,002
 
 
7,421,446
 
Accrued interest receivable
85,321
 
 
79,314
 
Premises, software, and equipment, net
10,101
 
 
9,196
 
Derivative assets (Note 11)
4,928
 
 
11,927
 
Other assets
45,913
 
 
49,251
 
TOTAL ASSETS
$
52,841,316
 
 
$
55,568,884
 
LIABILITIES
 
 
 
Deposits
 
 
 
Interest-bearing
$
1,174,324
 
 
$
1,069,986
 
Non-interest-bearing
66,667
 
 
110,667
 
Total deposits
1,240,991
 
 
1,180,653
 
Consolidated obligations (Note 12)
 
 
 
Discount notes (includes $242,604 at fair value under the fair value option at March 31, 2011)
3,928,128
 
 
7,208,276
 
Bonds (includes $2,607,685 and $2,816,850 at fair value under the fair value option at March 31, 2011 and December 31, 2010)
44,288,601
 
 
43,790,568
 
Total consolidated obligations
48,216,729
 
 
50,998,844
 
Mandatorily redeemable capital stock (Note 13)
6,547
 
 
6,835
 
Accrued interest payable
232,157
 
 
187,091
 
Affordable Housing Program (AHP) Payable
44,320
 
 
44,508
 
Payable to REFCORP
6,489
 
 
12,467
 
Derivative liabilities (Note 11)
318,044
 
 
278,447
 
Other liabilities
29,059
 
 
30,467
 
TOTAL LIABILITIES
50,094,336
 
 
52,739,312
 
Commitments and contingencies (Note 15)
 
 
 
CAPITAL (Note 13)
 
 
 
Capital stock - Class B putable ($100 par value) authorized, issued, and outstanding 21,178 and 21,830 shares at March 31, 2011 and December 31, 2010
2,117,770
 
 
2,183,028
 
Retained earnings
565,137
 
 
556,013
 
Accumulated other comprehensive income
 
 
 
Net unrealized gain on available-for-sale securities (Note 5)
65,712
 
 
92,222
 
Pension and postretirement benefits
(1,639
)
 
(1,691
)
Total accumulated other comprehensive income
64,073
 
 
90,531
 
TOTAL CAPITAL
2,746,980
 
 
2,829,572
 
TOTAL LIABILITIES AND CAPITAL
$
52,841,316
 
 
$
55,568,884
 
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 March 31,
 
2011
 
2010
INTEREST INCOME
 
 
 
Advances
$
69,989
 
 
$
107,516
 
Prepayment fees on advances, net
3,140
 
 
1,671
 
Interest-bearing deposits
71
 
 
60
 
Securities purchased under agreements to resell
575
 
 
120
 
Federal funds sold
971
 
 
1,516
 
Investment securities
 
 
 
Trading securities
6,464
 
 
15,525
 
Available-for-sale securities
35,979
 
 
24,941
 
Held-to-maturity securities
51,115
 
 
41,762
 
Mortgage loans held for portfolio
82,985
 
 
92,334
 
Total interest income
251,289
 
 
285,445
 
INTEREST EXPENSE
 
 
 
Consolidated obligations
 
 
 
Discount notes
1,660
 
 
2,655
 
Bonds
187,236
 
 
230,115
 
Deposits
186
 
 
229
 
Mandatorily redeemable capital stock
63
 
 
40
 
Total interest expense
189,145
 
 
233,039
 
NET INTEREST INCOME
62,144
 
 
52,406
 
Provision for credit losses on mortgage loans held for portfolio
5,596
 
 
125
 
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES
56,548
 
 
52,281
 
OTHER (LOSS) INCOME
 
 
 
Service fees
286
 
 
420
 
Net (loss) gain on trading securities
(3,328
)
 
21,199
 
Net (loss) gain on consolidated obligations held at fair value
(997
)
 
6,095
 
Net gain (loss) on derivatives and hedging activities
1,984
 
 
(24,454
)
Net loss on extinguishment of debt
(4,602
)
 
(4,027
)
Other, net
136
 
 
3,260
 
Total other (loss) income
(6,521
)
 
2,493
 
OTHER EXPENSE
 
 
 
Compensation and benefits
8,371
 
 
7,750
 
Other operating expenses
4,061
 
 
4,405
 
Federal Housing Finance Agency
1,362
 
 
720
 
Office of Finance
834
 
 
608
 
Total other expense
14,628
 
 
13,483
 
INCOME BEFORE ASSESSMENTS
35,399
 
 
41,291
 
AHP
2,896
 
 
3,375
 
REFCORP
6,501
 
 
7,583
 
Total assessments
9,397
 
 
10,958
 
NET INCOME
$
26,002
 
 
$
30,333
 
 
The accompanying notes are an integral part of these financial statements.

4


FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS 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
859
 
 
85,890
 
 
 
 
 
 
85,890
 
Repurchase/redemption of capital stock
(2,150
)
 
(215,015
)
 
 
 
 
 
(215,015
)
Net shares reclassified to mandatorily redeemable capital stock
(6
)
 
(589
)
 
 
 
 
 
(589
)
Comprehensive income:
 
 
 
 
 
 
 
 
 
Net income
 
 
 
 
30,333
 
 
 
 
30,333
 
Other comprehensive income:
 
 
 
 
 
 
 
 
 
Net unrealized gain on available-for-sale securities
 
 
 
 
 
 
57,121
 
 
57,121
 
Pension and postretirement benefits
 
 
 
 
 
 
48
 
 
48
 
Total comprehensive income
 
 
 
 
 
 
 
 
87,502
 
Cash dividends on capital stock
 
 
 
 
(14,581
)
 
 
 
(14,581
)
BALANCE MARCH 31, 2010
23,307
 
 
$
2,330,705
 
 
$
499,823
 
 
$
23,234
 
 
$
2,853,762
 
 
 
 
 
 
 
 
 
 
 
BALANCE DECEMBER 31, 2010
21,830
 
 
$
2,183,028
 
 
$
556,013
 
 
$
90,531
 
 
$
2,829,572
 
Proceeds from issuance of capital stock
776
 
 
77,585
 
 
 
 
 
 
77,585
 
Repurchase/redemption of capital stock
(1,428
)
 
(142,833
)
 
 
 
 
 
(142,833
)
Net shares reclassified to mandatorily redeemable capital stock
 
 
(10
)
 
 
 
 
 
(10
)
Comprehensive income:
 
 
 
 
 
 
 
 
 
 
Net income
 
 
 
 
26,002
 
 
 
 
26,002
 
Other comprehensive income:
 
 
 
 
 
 
 
 
 
 
Net unrealized gain on available-for-sale securities
 
 
 
 
 
 
(26,510
)
 
(26,510
)
Pension and postretirement benefits
 
 
 
 
 
 
52
 
 
52
 
Total comprehensive income
 
 
 
 
 
 
 
 
(456
)
Cash dividends on capital stock
 
 
 
 
(16,878
)
 
 
 
(16,878
)
BALANCE MARCH 31, 2011
21,178
 
 
$
2,117,770
 
 
$
565,137
 
 
$
64,073
 
 
$
2,746,980
 
 
The accompanying notes are an integral part of these financial statements.
 

5


FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Three Months Ended March 31,
 
2011
 
2010
OPERATING ACTIVITIES
 
 
 
Net income
$
26,002
 
 
$
30,333
 
Adjustments to reconcile net income to net cash provided by operating activities
 
 
 
Depreciation and amortization
2,981
 
 
(2,343
)
Net loss (gain) on trading securities
3,328
 
 
(21,199
)
Net loss (gain) on consolidated obligations held at fair value
997
 
 
(6,095
)
Net change in derivatives and hedging activities
17,328
 
 
13,560
 
Net loss on extinguishment of debt
4,602
 
 
4,027
 
Other adjustments
3,676
 
 
41
 
Net change in:
 
 
 
Accrued interest receivable
(5,999
)
 
(13,695
)
Other assets
5,927
 
 
(1,646
)
Accrued interest payable
44,735
 
 
38,922
 
Other liabilities
(7,522
)
 
(1,960
)
Total adjustments
70,053
 
 
9,612
 
Net cash provided by operating activities
96,055
 
 
39,945
 
INVESTING ACTIVITIES
 
 
 
Net change in:
 
 
 
Interest-bearing deposits
19,307
 
 
(5,613
)
Securities purchased under agreements to resell
(50,000
)
 
 
Federal funds sold
(127,000
)
 
(422,000
)
Premises, software, and equipment
(1,416
)
 
(549
)
Trading securities
 
 
 
Proceeds from sales and maturities
200,000
 
 
1,006,586
 
Available-for-sale securities
 
 
 
Proceeds from maturities
441,013
 
 
572,676
 
Purchases
 
 
(122,968
)
Held-to-maturity securities
 
 
 
Net decrease (increase) in short-term
235,000
 
 
(340,000
)
Proceeds from maturities
524,138
 
 
343,956
 
Purchases
 
 
(2,475,764
)
Advances
 
 
 
Principal collected
8,279,436
 
 
8,117,346
 
Originated
(7,099,283
)
 
(5,385,506
)
Mortgage loans held for portfolio
 
 
 
Principal collected
463,840
 
 
287,325
 
Originated or purchased
(261,630
)
 
(134,352
)
Proceeds from sales of foreclosed assets
8,612
 
 
3,582
 
Net cash provided by investing activities
2,632,017
 
 
1,444,719
 
 
The accompanying notes are an integral part of these financial statements.

6


FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF CASH FLOWS (continued from previous page)
(In thousands)
(Unaudited)
 
Three Months Ended March 31,
 
2011
 
2010
FINANCING ACTIVITIES
 
 
 
Net change in deposits
69,337
 
 
108,730
 
Net payments on derivative contracts with financing elements
(2,440
)
 
(3,072
)
Net proceeds from issuance of consolidated obligations
 
 
 
Discount notes
120,666,000
 
 
115,515,538
 
Bonds
6,947,773
 
 
12,087,494
 
Payments for maturing, transferring, and retiring consolidated obligations
 
 
 
Discount notes
(123,944,722
)
 
(120,221,795
)
Bonds
(6,337,672
)
 
(8,975,076
)
Proceeds from issuance of capital stock
77,585
 
 
85,890
 
Payments for repurchase of mandatorily redeemable capital stock
(298
)
 
(1,667
)
Payments for repurchase/redemption of capital stock
(142,833
)
 
(215,015
)
Cash dividends paid
(16,878
)
 
(14,581
)
Net cash used in financing activities
(2,684,148
)
 
(1,633,554
)
 
 
 
 
Net increase (decrease) in cash and due from banks
43,924
 
 
(148,890
)
Cash and due from banks at beginning of the period
105,741
 
 
298,841
 
Cash and due from banks at end of the period
$
149,665
 
 
$
149,951
 
 
 
 
 
Supplemental Disclosures
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
316,593
 
 
$
424,349
 
AHP
$
3,084
 
 
$
4,011
 
REFCORP
$
12,479
 
 
$
10,072
 
Unpaid principal balance transferred from mortgage loans held for portfolio to real estate owned
$
8,024
 
 
$
5,064
 
 
The accompanying notes are an integral part of these financial statements.

7


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). With the passage of the Housing and Economic Recovery Act of 2008 (Housing Act), the Federal Housing Finance Agency (Finance Agency) was established and became the new independent federal regulator of Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) (collectively, Enterprises), as well as the FHLBanks and FHLBank's Office of Finance, effective July 30, 2008. The Finance Agency's mission is to provide effective supervision, regulation, and housing mission oversight of the Enterprises and FHLBanks to promote their safety and soundness, support housing finance and affordable housing, and support a stable and liquid mortgage market. The Finance Agency establishes policies and regulations governing the operations of the Enterprises and 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, thrifts, 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 our Statement of Condition. All stockholders, including current members and former members, may receive dividends on their capital stock 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 months ended March 31, 2011 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, 2010, which are contained in the Bank's 2010 annual report on Form 10-K filed with the Securities and Exchange Commission on March 18, 2011 (2010 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, 2011.
 
Descriptions of the Bank's significant accounting policies are included in “Note 1 — Summary of Significant Accounting Policies” of the Bank's 2010 Form 10-K, with the exception of one policy change noted below.
 
Office of Finance Expenses
 
The Bank is assessed for the costs of operating the Office of Finance. Effective January 1, 2011, the Office of Finance allocates its operating and capital expenditures to the FHLBanks as follows: (i) two-thirds based on each FHLBank's share of consolidated obligations outstanding and (ii) one-third based on equal pro-rata share (1/12th).

8


Note 2 — Recently Adopted and Issued Accounting Guidance
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. The required disclosures as of the end of a reporting period were effective December 31, 2010. The required disclosures about activity that occurs during a reporting period were effective for interim and annual reporting periods beginning on January 1, 2011. The Bank's adoption of this amended guidance resulted in increased financial statement disclosures, but did not impact the Bank's 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 was effective on January 1, 2010, except for the disclosures about purchases, sales, issuances, and settlements in the reconciliation for fair value measurements using significant unobservable inputs. Those disclosures were effective for fiscal years beginning on January 1, 2011, and for interim periods within those fiscal years. The Bank's adoption of this amended guidance resulted in increased financial statement disclosures at January 1, 2010 but not at January 1, 2011. The amended guidance did not impact the Bank's financial condition, results of operations, or cash flows.
 
Note 3 — Securities Purchased Under Agreements to Resell
The Bank periodically holds securities purchased under agreements to resell those securities. These amounts represent short-term secured investments and are classified as assets in the Statement of Condition. These securities purchased under agreements to resell are held in safekeeping in the name of the Bank by third-party custodians approved by the Bank. Should the market value of the underlying securities decrease below the market value required as collateral, the counterparty must either place an equivalent amount of additional securities in safekeeping in the name of the Bank or remit an equivalent amount of cash. Otherwise, the dollar value of the resale agreement will be decreased accordingly.
 
Note 4 — Trading Securities
 
Major Security Types
 
Trading securities were as follows (dollars in thousands):
 
March 31,
2011
 
December 31,
2010
TLGP1
$
1,011,539
 
 
$
1,213,481
 
Taxable municipal bonds2
257,675
 
 
259,061
 
Total
$
1,269,214
 
 
$
1,472,542
 
1
Represents corporate debentures of the issuing party that are backed by the full faith and credit of the U.S. Government.
2
Represents investments in U.S. Government subsidized Build America Bonds.
 
At March 31, 2011 and December 31, 2010, 44 and 52 percent of the Bank's trading securities were fixed rate and all of these fixed rate securities were swapped to a variable rate index through the use of an interest rate swap accounted for as an economic derivative.

9


The following table summarizes the net (loss) gain on trading securities (dollars in thousands):
 
Three Months Ended March 31,
 
2011
 
2010
Realized gain on sale of trading securities
$
 
 
$
11,665
 
Holding (loss) gain on trading securities
(3,328
)
 
9,534
 
Net (loss) gain on trading securities
$
(3,328
)
 
$
21,199
 
 
Sales. During the three months ended March 31, 2011, the Bank did not sell any trading securities. During the three months ended March 31, 2010, the Bank sold trading securities with a par value of $1.0 billion and realized a net gain of $11.7 million.
 
Note 5 — Available-for-Sale Securities
 
Major Security Types
 
Available-for-sale (AFS) securities at March 31, 2011 were as follows (dollars in thousands):
 
Amortized
Cost
 
Gross
Unrealized
Gains
1
 
Gross
Unrealized
Losses
2
 
 
Fair Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
TLGP3
$
563,688
 
 
$
1,626
 
 
$
 
 
$
565,314
 
Taxable municipal bonds4
173,421
 
 
180
 
 
8,874
 
 
164,727
 
Other U.S. obligations5
175,040
 
 
 
 
4,151
 
 
170,889
 
Government-sponsored enterprise obligations6
488,267
 
 
31,177
 
 
 
 
519,444
 
Total non-mortgage-backed securities
1,400,416
 
 
32,983
 
 
13,025
 
 
1,420,374
 
Mortgage-backed securities7
 
 
 
 
 
 
 
Government-sponsored enterprise8
4,421,096
 
 
46,101
 
 
4,055
 
 
4,463,142
 
Total
$
5,821,512
 
 
$
79,084
 
 
$
17,080
 
 
$
5,883,516
 
    
AFS securities at December 31, 2010 were as follows (dollars in thousands):
 
Amortized
Cost
 
Gross
Unrealized
Gains
1
 
Gross
Unrealized
Losses
2
 
 
Fair Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
TLGP3
$
563,688
 
 
$
2,006
 
 
$
 
 
$
565,694
 
Taxable municipal bonds4
173,421
 
 
277
 
 
9,093
 
 
164,605
 
Other U.S. obligations5
178,325
 
 
323
 
 
2,168
 
 
176,480
 
Government-sponsored enterprise obligations6
488,853
 
 
34,386
 
 
 
 
523,239
 
Total non-mortgage-backed securities
1,404,287
 
 
36,992
 
 
11,261
 
 
1,430,018
 
Mortgage-backed securities7
 
 
 
 
 
 
 
Government-sponsored enterprise8
4,859,274
 
 
70,293
 
 
2,682
 
 
4,926,885
 
Total
$
6,263,561
 
 
$
107,285
 
 
$
13,943
 
 
$
6,356,903
 
1
Gross unrealized gains include $7.8 million and $10.1 million of fair value hedging adjustments at March 31, 2011 and December 31, 2010.
2
Gross unrealized losses include $11.5 million and $9.0 million of fair value hedging adjustments at March 31, 2011 and December 31, 2010.
3
Represents corporate debentures of the issuing party that are backed by the full faith and credit of the U.S. Government.
4
Represents investments in U.S. Government subsidized Build America Bonds and State of Iowa IJOBS Program Special Obligations.
5
Represents Export-Import Bank bonds.
6
Represents Tennessee Valley Authority (TVA) and Federal Farm Credit Bank (FFCB) bonds.
7
The amortized cost of the Bank's AFS MBS includes net discounts $1.0 million and $0.6 million at March 31, 2011 and December 31, 2010.
8
Represents Fannie Mae and Freddie Mac securities.
    
At March 31, 2011 and December 31, 2010, 23 and 24 percent of the Bank's AFS securities were fixed rate and 30 and 28 percent of these fixed rate securities were swapped to a variable rate index.
 
 

10


The following table summarizes the AFS securities with unrealized losses at March 31, 2011. 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
$
149,547
 
 
$
8,874
 
 
$
 
 
$
 
 
$
149,547
 
 
$
8,874
 
Other U.S. obligations
170,889
 
 
4,151
 
 
 
 
 
 
170,889
 
 
4,151
 
Total non-mortgage-backed securities
320,436
 
 
13,025
 
 
 
 
 
 
320,436
 
 
13,025
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Government-sponsored enterprise
290,541
 
 
294
 
 
462,320
 
 
3,761
 
 
752,861
 
 
4,055
 
Total
$
610,977
 
 
$
13,319
 
 
$
462,320
 
 
$
3,761
 
 
$
1,073,297
 
 
$
17,080
 
 
The following table summarizes the AFS securities with unrealized losses at December 31, 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
$
149,328
 
 
$
9,093
 
 
$
 
 
$
 
 
$
149,328
 
 
$
9,093
 
Other U.S. obligations
146,090
 
 
2,168
 
 
 
 
 
 
146,090
 
 
2,168
 
Total non-mortgage-backed securities
295,418
 
 
11,261
 
 
 
 
 
 
295,418
 
 
11,261
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Government-sponsored enterprise
 
 
 
 
505,769
 
 
2,682
 
 
505,769
 
 
2,682
 
Total
$
295,418
 
 
$
11,261
 
 
$
505,769
 
 
$
2,682
 
 
$
801,187
 
 
$
13,943
 
 
Redemption Terms
 
The following table summarizes the amortized cost and fair value of AFS securities categorized by contractual maturity (dollars in thousands). Expected maturities of some securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.
 
 
March 31, 2011
 
December 31, 2010
Year of Contractual Maturity
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Due after one year through five years
 
$
640,702
 
 
$
647,172
 
 
$
640,825
 
 
$
648,106
 
Due after five years through ten years
 
390,357
 
 
414,712
 
 
390,812
 
 
417,558
 
Due after ten years
 
369,357
 
 
358,490
 
 
372,650
 
 
364,354
 
Total non-mortgage-backed securities
 
1,400,416
 
 
1,420,374
 
 
1,404,287
 
 
1,430,018
 
Mortgage-backed securities
 
4,421,096
 
 
4,463,142
 
 
4,859,274
 
 
4,926,885
 
Total
 
$
5,821,512
 
 
$
5,883,516
 
 
$
6,263,561
 
 
$
6,356,903
 
    
Prepayment Fees
 
During the three months ended March 31, 2011, an AFS MBS with an outstanding par value of $119.0 million prepaid and the Bank received a $14.6 million prepayment fee. The prepayment fee was recorded as interest income on AFS securities in the Statement of Income. During the three months ended March 31, 2010, the Bank did not receive any prepayment fees on AFS securities.

11


Note 6 — Held-to-Maturity Securities
 
Major Security Types
 
Held-to-maturity (HTM) securities at March 31, 2011 were as follows (dollars in thousands):
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
Commericial paper
$
100,000
 
 
$
 
 
$
 
 
$
100,000
 
Government-sponsored enterprise obligations1
311,178
 
 
21,456
 
 
 
 
332,634
 
State or local housing agency obligations2
101,122
 
 
1,466
 
 
303
 
 
102,285
 
TLGP3
1,250
 
 
19
 
 
 
 
1,269
 
Other4
3,758
 
 
 
 
 
 
3,758
 
Total non-mortgage-backed securities
517,308
 
 
22,941
 
 
303
 
 
539,946
 
Mortgage-backed securities5
 
 
 
 
 
 
 
Government-sponsored enterprise6
5,861,458
 
 
138,708
 
 
2,656
 
 
5,997,510
 
Other U.S. obligation7
32,688
 
 
65
 
 
7
 
 
32,746
 
Private-label8
56,407
 
 
222
 
 
4,032
 
 
52,597
 
Total mortgage-backed securities
5,950,553
 
 
138,995
 
 
6,695
 
 
6,082,853
 
Total
$
6,467,861
 
 
$
161,936
 
 
$
6,998
 
 
$
6,622,799
 
    
HTM securities at December 31, 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
311,547
 
 
26,642
 
 
 
 
338,189
 
State or local housing agency obligations2
107,242
 
 
1,495
 
 
1,321
 
 
107,416
 
TLGP3
1,250
 
 
32
 
 
 
 
1,282
 
Other4
3,705
 
 
 
 
 
 
3,705
 
Total non-mortgage-backed securities
758,744
 
 
28,169
 
 
1,355
 
 
785,558
 
Mortgage-backed securities5
 
 
 
 
 
 
 
Government-sponsored enterprise6
6,374,093
 
 
148,914
 
 
2,056
 
 
6,520,951
 
Other U.S. obligation7
34,387
 
 
149
 
 
1
 
 
34,535
 
Private-label8
58,892
 
 
 
 
4,596
 
 
54,296
 
Total mortgage-backed securities
6,467,372
 
 
149,063
 
 
6,653
 
 
6,609,782
 
Total
$
7,226,116
 
 
$
177,232
 
 
$
8,008
 
 
$
7,395,340
 
1
Represents TVA and FFCB bonds.
2
Represents Housing Finance Authority (HFA) bonds that were purchased by the Bank from housing associates in the Bank's district.
3
Represents corporate debentures issued by the Bank's members that are backed by the full faith and credit of the U.S. Government.
4
Represents an investment in a Small Business Investment Company.
5
The amortized cost of the Bank's HTM MBS includes net discounts of $6.7 million and $7.9 million at March 31, 2011 and December 31, 2010.
6
Represents Fannie Mae and Freddie Mac securities.
7
Represents 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.
8
Includes $23.7 million and $25.8 million of MPF shared funding certificates at March 31, 2011 and December 31, 2010.
 

12


The following table summarizes the HTM securities with unrealized losses at March 31, 2011. 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
 
 
 
 
 
 
 
 
 
 
 
State or local housing agency obligations
$
60,832
 
 
$
303
 
 
$
 
 
$
 
 
$
60,832
 
 
$
303
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Government-sponsored enterprise
7,334
 
 
8
 
 
380,947
 
 
2,648
 
 
388,281
 
 
2,656
 
Other U.S. obligation
4,509
 
 
5
 
 
727
 
 
2
 
 
5,236
 
 
7
 
Private-label
 
 
 
 
30,289
 
 
4,032
 
 
30,289
 
 
4,032
 
Total mortgage-backed securities
11,843
 
 
13
 
 
411,963
 
 
6,682
 
 
423,806
 
 
6,695
 
Total
$
72,675
 
 
$
316
 
 
$
411,963
 
 
$
6,682
 
 
$
484,638
 
 
$
6,998
 
 
The following table summarizes the HTM securities with unrealized losses at December 31, 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
 
State or local housing agency obligations
62,549
 
 
1,321
 
 
 
 
 
 
62,549
 
 
1,321
 
Total non-mortgage-backed securities
397,515
 
 
1,355
 
 
 
 
 
 
397,515
 
 
1,355
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Government-sponsored enterprise
217
 
 
 
 
403,347
 
 
2,056
 
 
403,564
 
 
2,056
 
Other U.S. obligation
322
 
 
 
 
799
 
 
1
 
 
1,121
 
 
1
 
Private-label
24,039
 
 
53
 
 
30,257
 
 
4,543
 
 
54,296
 
 
4,596
 
Total mortgage-backed securities
24,578
 
 
53
 
 
434,403
 
 
6,600
 
 
458,981
 
 
6,653
 
Total
$
422,093
 
 
$
1,408
 
 
$
434,403
 
 
$
6,600
 
 
$
856,496
 
 
$
8,008
 
 
Redemption Terms
 
The following table summarizes the amortized cost and fair value of HTM securities by contractual maturity (dollars in thousands). Expected maturities of some securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.
 
 
March 31, 2011
 
December 31, 2010
Year of Contractual Maturity
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Due in one year or less
 
$
101,250
 
 
$
101,269
 
 
$
335,000
 
 
$
334,966
 
Due after one year through five years
 
 
 
 
 
1,250
 
 
1,282
 
Due after five years through ten years
 
1,775
 
 
1,777
 
 
1,920
 
 
1,923
 
Due after ten years
 
414,283
 
 
436,900
 
 
420,574
 
 
447,387
 
Total non-mortgage-backed securities
 
517,308
 
 
539,946
 
 
758,744
 
 
785,558
 
Mortgage-backed securities
 
5,950,553
 
 
6,082,853
 
 
6,467,372
 
 
6,609,782
 
Total
 
$
6,467,861
 
 
$
6,622,799
 
 
$
7,226,116
 
 
$
7,395,340
 
 

13


Note 7 — Other-Than-Temporary Impairment
 
The Bank evaluates its individual AFS and HTM securities in an unrealized loss position for 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 reporting date. For securities in an unrealized loss position that meet neither of these conditions, the Bank performs analyses to determine if any of these securities are other-than-temporarily impaired.
 
Private-Label MBS
 
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. 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 March 31, 2011, the Bank obtained cash flow analyses from its designated FHLBanks for all 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 March 31, 2011 assumed current-to-trough home price declines ranging from 0 to 10 percent over the 3 to 9 month period beginning January 1, 2011. Thereafter, home prices are projected to recover using one of five different recovery paths that vary by housing market. Under these recovery paths, home prices are projected to increase within a range of 0 to 2.8 percent in the first year, 0 to 3 percent in the second year, 1.5 to 4 percent in the third year, 2 to 5 percent in the fourth year, 2 to 6 percent in each of the fifth and sixth years, and 2.3 to 5.6 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. In a securitization in which the credit enhancement for the senior securities is derived from the presence of subordinate securities, losses are generally allocated first to the subordinate securities until their principal balance is reduced to zero. The projected cash flows are based on a number of assumptions and expectations, and the results of these models can vary significantly with changes in assumptions and expectations. The scenario of cash flows determined based on the model approach described above reflects an estimated 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.
 

14


The Bank compares the present value of the cash flows expected to be collected with respect to its private-label MBS to the amortized cost bases of the securities to determine whether a credit loss exists. At March 31, 2011, the Bank's cash flow analyses for private-label MBS 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 did not consider any of these securities to be other-than-temporarily impaired at March 31, 2011 and December 31, 2010.
 
All Other Investment Securities
 
The remainder of the Bank's investment securities have experienced unrealized losses due to interest rate volatility and credit deterioration in the U.S. mortgage markets. However, the declines are considered temporary as the Bank expects to recover the amortized cost bases on its remaining investment securities in unrealized loss positions and neither intends to sell these securities nor considers it more likely than not that it will be required to sell these securities before its anticipated recovery of each security's remaining amortized cost basis. As a result, the Bank did not consider any of its other investment securities to be other-than-temporarily impaired at March 31, 2011 and December 31, 2010.
 
In addition, the Bank determined the following for its other investment securities:
 
Other U.S. obligations and GSE MBS. 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.
 
Taxable municipal bonds and state or local housing agency obligations. The creditworthiness of the issuers was sufficient to protect the Bank from losses based on current expectations.
 

Note 8 — Advances
 
Redemption Terms
 
The following table summarizes the Bank's advances outstanding by year of contractual maturity (dollars in thousands):
 
 
March 31, 2011
 
December 31, 2010
Year of Contractual Maturity
 
Amount
 
Weighted
Average
Interest
Rate %
 
Amount
 
Weighted
Average
Interest
Rate %
Overdrawn demand deposit accounts
 
$
170
 
 
 
$
208
 
 
Due in one year or less
 
5,826,904
 
 
1.73
 
6,782,825
 
 
1.76
Due after one year through two years
 
5,115,965
 
 
1.82
 
3,923,100
 
 
2.20
Due after two years through three years
 
4,330,758
 
 
1.79
 
5,647,503
 
 
1.75
Due after three years through four years
 
986,434
 
 
2.60
 
908,824
 
 
2.81
Due after four years through five years
 
1,875,195
 
 
2.69
 
1,640,803
 
 
2.23
Thereafter
 
9,186,862
 
 
2.89
 
9,599,178
 
 
2.96
Total par value
 
27,322,288
 
 
2.24
 
28,502,441
 
 
2.29
Premiums
 
221
 
 
 
 
237
 
 
 
Discounts
 
(2
)
 
 
 
(2
)
 
 
Fair value hedging adjustments
 
 
 
 
 
 
 
 
Cumulative fair value gain on existing hedges
 
560,803
 
 
 
 
663,079
 
 
 
Basis adjustments from terminated hedges
 
79,473
 
 
 
 
86,774
 
 
 
Total
 
$
27,962,783
 
 
 
 
$
29,252,529
 
 
 
 
The Bank offers advances to members that may be prepaid on pertinent dates (call dates) without incurring prepayment fees (callable advances). At March 31, 2011 and December 31, 2010, the Bank had callable advances outstanding totaling $5.8 billion and $5.9 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 March 31, 2011 and December 31, 2010, the Bank had putable advances outstanding totaling $4.2 billion and $4.8 billion.
 

15


Interest Rate Payment Terms
 
The following table summarizes the Bank's advances by interest rate payment type (dollars in thousands):
 
March 31,
2011
 
December 31,
2010
Fixed rate
$
18,842,063
 
 
$
19,932,279
 
Variable rate
8,480,225
 
 
8,570,162
 
Total par value
$
27,322,288
 
 
$
28,502,441
 
 
At March 31, 2011 and December 31, 2010, 63 and 59 percent of the Bank's fixed rate advances were swapped to a variable rate index and two percent of the Bank's variable rate advances were swapped to another variable rate index at each period end.
 
Prepayment Fees
 
The Bank charges a prepayment fee for advances that terminate prior to their stated maturity or outside of a predetermined call or put date. The fees charged are priced to make the Bank economically indifferent to the prepayment of the advance. These prepayment fees are presented net of fair value hedging adjustments and deferrals on advance modifications in the Statement of Income as "Prepayment fees on advances, net." The following table summarizes the Bank's prepayment fee on advances, net (dollars in thousands):
 
Three Months Ended March 31,
 
2011
 
2010
Gross prepayment fees
$
7,965
 
 
$
1,801
 
Fair value hedging adjustments
(4,981
)
 
(166
)
Deferrals on advance modifications
156
 
 
36
 
Prepayment fees on advances, net
$
3,140
 
 
$
1,671
 
 
For additional information related to the Bank's credit risk and security terms on advances, refer to "Note 10 — Allowance for Credit Losses."
 
Note 9 — Mortgage Loans Held for Portfolio
 
The Mortgage Partnership Finance (MPF) program (Mortgage Partnership Finance and MPF are registered trademarks of the FHLBank of Chicago) involves investment by the Bank in mortgage loans held for portfolio that are either purchased from participating financial institutions (PFIs) or funded by the Bank through 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):
 
March 31,
2011
 
December 31,
2010
Real Estate:
 
 
 
Fixed rate, medium-term single family mortgages
$
1,839,724
 
 
$
1,874,606
 
Fixed rate, long-term single family mortgages
5,348,770
 
 
5,528,714
 
Total unpaid principal balance
7,188,494
 
 
7,403,320
 
Premiums
62,561
 
 
63,975
 
Discounts
(37,368
)
 
(40,474
)
Basis adjustments from mortgage loan commitments
6,315
 
 
7,625
 
Allowance for credit losses
(18,000
)
 
(13,000
)
Total mortgage loans held for portfolio, net
$
7,202,002
 
 
$
7,421,446
 
 

16


The following table details the unpaid principal balance of the Bank's mortgage loans held for portfolio (dollars in thousands):
 
March 31,
2011
 
December 31,
2010
Conventional loans
$
6,818,423
 
 
$
7,033,089
 
Government-insured loans
370,071
 
 
370,231
 
Total unpaid principal balance
$
7,188,494
 
 
$
7,403,320
 
    

Note 10 — Allowance for Credit Losses
 
The Bank has an allowance methodology for each of its portfolio segments of financing receivables: advances, letters of credit, and other extensions of credit to borrowers (collectively, credit products), government-insured mortgage loans held for portfolio, conventional mortgage loans held for portfolio, and term Federal funds sold.
 
Credit Products
 
The Bank manages its credit exposure to credit products through an integrated approach that generally provides for a credit limit to be established for each borrower, includes an ongoing review of each borrower's financial condition, and is coupled with collateral/lending policies to limit risk of loss while balancing borrowers' needs for a reliable source of funding. In addition, the Bank lends to its borrowers in accordance with federal statutes and Finance Agency regulations.
 
Specifically, the Bank complies with the FHLBank Act, which requires it to obtain sufficient collateral to fully secure credit products. The estimated value of the collateral required to secure each borrower's credit products is calculated by applying collateral discounts, or haircuts, to the value of the collateral. Eligible collateral includes (i) whole first mortgages on improved residential property or securities representing a whole interest in such mortgages, (ii) securities issued, insured, or guaranteed by the U.S. Government or any of the government-sponsored housing enterprises, including MBS issued or guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae, (iii) cash deposited with the Bank, (iv) Federal Family Education Loan Program guaranteed student loans, and (v) other real estate-related collateral acceptable to the Bank provided such collateral has a readily ascertainable value and the Bank can perfect a security interest in such property. Community financial institutions may also pledge collateral consisting of secured small business, small agri-business, or small farm loans. As additional security, the FHLBank Act provides that the Bank have a lien on each borrower's capital stock investment; however, capital stock cannot be pledged as collateral to secure credit exposures. Collateral arrangements may vary depending upon borrower credit quality, financial condition, performance, borrowing capacity, and overall credit exposure to the borrower. The Bank can call for additional or substitute collateral to protect its security interest. Management believes that these policies effectively manage the Bank's respective credit risk from credit products.
 
Based upon the financial condition of the borrower, the Bank will either allow a borrower to retain physical possession of the collateral assigned to it, or require the borrower to specifically assign or place physical possession of the collateral with the Bank or its safekeeping agent. The Bank perfects its security interest in all pledged collateral. The FHLBank Act affords any security interest granted to the Bank by a borrower priority over the claims or rights of any other party except for claims or rights of a third party that would be entitled to priority under otherwise applicable law and are held by a bona fide purchaser for value or by a secured party holding a prior perfected security interest.
 
Using a risk-based approach and taking into consideration each borrower's financial strength, the Bank considers the types and level of collateral to be the primary tool for managing its credit exposure to credit products. At March 31, 2011 and December 31, 2010, the Bank had rights to collateral on a borrower-by-borrower basis with an estimated value in excess of its outstanding extensions of credit.
 
The Bank periodically evaluates and may make changes to its collateral guidelines. At March 31, 2011 and December 31, 2010, none of the Bank's credit products were past due, on non-accrual status, or considered impaired. In addition, there have been no troubled debt restructurings related to credit products at the Bank during the three months ended March 31, 2011.
 
Based upon the collateral held as security, its credit extension and collateral policies, management's credit analyses, and the repayment history on credit products, management has determined that there are no probable credit losses on its credit products as of March 31, 2011 and December 31, 2010. Accordingly, the Bank has not recorded any allowance for credit losses.
 

17


At March 31, 2011 and December 31, 2010, no liability to reflect an allowance for credit losses for off-balance sheet credit exposures was recorded. For additional information on the Bank's off-balance sheet credit exposure, see "Note 15 — Commitments and Contingencies."
 
Government-Insured Mortgage Loans
 
The Bank invests in government-insured fixed rate mortgage loans secured by one-to-four family residential properties. Government-insured mortgage loans are insured by the Federal Housing Administration, the Department of Veterans Affairs, and/or the Rural Housing Service of the Department of Agriculture. The servicer provides and maintains insurance or a guaranty from the applicable government agency. The servicer is responsible for compliance with all government agency requirements and for obtaining the benefit of the applicable insurance or guaranty with respect to defaulted government mortgage loans. Any losses incurred on such mortgage loans that are not recovered from the issuer or guarantor are absorbed by the servicers. As a result, the Bank did not establish an allowance for credit losses for government-insured mortgage loans at March 31, 2011 and December 31, 2010. Furthermore, due to the government guarantee or insurance, these mortgage loans are not placed on non-accrual status.
 
Conventional Mortgage Loans
 
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 (FLA) is a memo account used to track 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 $123.1 million and $124.8 million at March 31, 2011 and December 31, 2010.
 
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 an NRSRO. PFIs are required to either collateralize their credit enhancement obligation with the Bank or purchase 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 Bank records credit enhancement fees paid to PFIs as a reduction to mortgage loan interest income. Credit enhancement fees paid (including performance based credit enhancement fees available to recapture under specified master commitments) totaled $2.6 million and $3.0 million during the three months ended March 31, 2011 and 2010.
 

18


Specifically Identified Conventional Mortgage Loans. The Bank does not currently evaluate any individual conventional mortgage loans for impairment. Therefore, there is no allowance for credit losses on specifically identified conventional mortgage loans at March 31, 2011 and December 31, 2010.
 
Collectively Evaluated Conventional Mortgage Loans. The Bank collectively evaluates its conventional mortgage loan portfolio and estimates an 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 (REO), and (iii) actual historical loss severities, 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, changes in national and local economic trends.
 
Estimating Additional Credit Loss in the Conventional Mortgage Loan Portfolio. The Bank may include a margin for certain limitations in the allowance for credit losses model utilized to estimate credit losses. This margin recognizes the imprecise nature of the measurement process and represents a subjective management judgment that is intended to cover other inherent losses that may not be captured in the methodology described above at the balance sheet date.
 
Rollforward of the Allowance for Credit Losses on Conventional Mortgage Loans. As of March 31, 2011 and December 31, 2010, the Bank established an allowance for credit losses on its conventional mortgage loan portfolio. The following table presents a rollforward of the allowance for credit losses on the Bank's conventional mortgage loans, all of which are collectively evaluated for impairment, as well as the recorded investment in conventional mortgage loans (dollars in thousands):
 
March 31,
2011
 
December 31,
2010
Balance, beginning of year
$
13,000
 
 
$
1,887
 
Charge-offs
(596
)
 
(1,005
)
Provision for credit losses
5,596
 
 
12,118
 
Balance, end of period
$
18,000
 
 
$
13,000
 
Recorded investment of mortgage loans collectively evaluated for impairment1
$
6,818,423
 
 
$
7,033,089
 
1
Recorded investment approximates the unpaid principal balance of mortgage loans.
 
During the three months ended March 31, 2011, the Bank recorded a provision for credit losses of $5.6 million, bringing its allowance for credit losses to $18.0 million at March 31, 2011. The provision recorded was driven by an increase in estimated losses resulting from increased loss severities, management's expectation that loans migrating to REO and loss severities will likely increase in the future, and certain refinements made to the Bank's allowance for credit losses model.
 
The Bank is able to allocate available credit enhancement fees to recapture estimated losses in its conventional mortgage loan portfolio. Estimated available credit enhancement fees decreased to $3.3 million at March 31, 2011 from $3.7 million at December 31, 2010 primarily due to an increase in charge-off activity.
 

19


Credit Quality Indicators. Key credit quality indicators for mortgage loans include the migration of past due loans, non-accrual loans, and loans in process of foreclosure. The tables below summarize the Bank's key credit quality indicators for mortgage loans (dollar amounts in thousands):
 
March 31, 2011
 
Conventional
 
Government Insured
 
Total
Past due 30 - 59 days
$
100,923
 
 
$
13,962
 
 
$
114,885
 
Past due 60 - 89 days
28,749
 
 
6,690
 
 
35,439
 
Past due 90 days or more
110,616
 
 
4,810
 
 
115,426
 
Total past due loans
240,288
 
 
25,462
 
 
265,750
 
Total current loans
6,578,135
 
 
344,609
 
 
6,922,744
 
Total recorded investment of mortgage loans1
$
6,818,423
 
 
$
370,071
 
 
$
7,188,494
 
 
 
 
 
 
 
In process of foreclosure (included above)2
$
78,184
 
 
$
128
 
 
$
78,312
 
 
 
 
 
 
 
Serious delinquency rate3
1.7
%
 
1.3
%
 
1.6
%
 
 
 
 
 
 
Past due 90 days or more and still accruing interest
$
 
 
$
4,810
 
 
$
4,810
 
 
 
 
 
 
 
Non-accrual mortgage loans4
$
110,616
 
 
$
 
 
$
110,616
 
 
December 31, 2010
 
Conventional
 
Government Insured
 
Total
Past due 30 - 59 days
$
86,679
 
 
$
17,235
 
 
$
103,914
 
Past due 60 - 89 days
33,063
 
 
5,288
 
 
38,351
 
Past due 90 days or more
111,064
 
 
4,675
 
 
115,739
 
Total past due loans
230,806
 
 
27,198
 
 
258,004
 
Total current loans
6,802,283
 
 
343,033
 
 
7,145,316
 
Total recorded investment of mortgage loans1
$
7,033,089
 
 
$
370,231
 
 
$
7,403,320
 
 
 
 
 
 
 
In process of foreclosure (included above)2
$
78,981
 
 
$
258
 
 
$
79,239
 
 
 
 
 
 
 
Serious delinquency rate3
1.6
%
 
1.3
%
 
1.6
%
 
 
 
 
 
 
Past due 90 days or more and still accruing interest
$
 
 
$
4,675
 
 
$
4,675
 
 
 
 
 
 
 
Non-accrual mortgage loans4
$
111,064
 
 
$
 
 
$
111,064
 
1
Recorded investment approximates the unpaid principal balance of mortgage loans.
2
Includes loans where the decision of foreclosure or similar alternative such as pursuit of deed-in-lieu has been reported. Loans in process of foreclosure are included in past due or current loans depending on their payment status.
3
Represents mortgage loans that are 90 days or more delinquent expressed as a percentage of the total recorded investment.
4
Represents conventional mortgage loans that are 90 days or more delinquent.
 
Real Estate Owned. At March 31, 2011 and December 31, 2010, the Bank had $19.5 million and $19.1 million of REO recorded as a component of "Other assets" in the Statement of Condition.
 
Term Federal Funds Sold
 
The Bank invests in term Federal funds sold with highly rated counterparties. These investments are generally short-term (less than three months to maturity) and their carrying value approximates fair value. If the investments are not paid when due, the Bank will evaluate these investments for purposes of an allowance for credit losses. As of March 31, 2011 and December 31, 2010, all investments in term Federal funds sold were repaid according to the contractual terms.
 

20


Note 11 — Derivatives and Hedging Activities
 
Nature of Business Activity
 
The Bank is exposed to interest rate risk primarily from the effect of interest rate changes on its interest-earning assets and its related funding sources. The goal of the Bank's interest rate risk management strategies is not to eliminate interest rate risk, but to manage it within appropriate limits. To mitigate the risk of loss, the Bank has established policies and procedures, which include guidelines on the amount of exposure to interest rate changes it is willing to accept. In addition, the Bank monitors the risk to its net interest income, net interest spread, and average maturity of interest-earning assets and related funding sources.
 
Consistent with Finance Agency regulation, the Bank enters into derivatives to (i) manage the interest rate risk exposures inherent in its otherwise unhedged assets and funding positions and (ii) achieve its risk management objectives. Finance Agency regulation and the Bank's Enterprise Risk Management Policy prohibit trading in or the speculative use of these derivative instruments and limit credit risk arising from these instruments.
 
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 (e.g. advance) and the cost of the related liability (e.g. consolidated obligation). 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 (e.g. advances or mortgage assets) and liabilities;
 
manage embedded options in assets and liabilities; and
 
manage risk in its balance sheet profile.
 
Application of Derivatives
 
Derivative financial instruments are applied by the Bank in two ways:
 
as a fair value hedge of an associated financial instrument or firm commitment; or
 
as an economic hedge to manage certain defined risks in its Statement of Condition. These hedges are primarily used to manage interest rate risk exposure and offset prepayment risk in certain assets. In addition, to reduce its exposure to reset risk, the Bank may occasionally enter into forward rate agreements, which are also treated as economic hedges.
 
Derivative financial instruments are used by the Bank when they are considered to be a cost-effective alternative to achieve the Bank's financial and risk management objectives. The Bank reevaluates its hedging strategies from time to time and may change the hedging techniques it uses or adopt new strategies.
 

21


Types of Derivatives
 
The Bank may use the following derivative instruments:
 
interest rate swaps;
 
swaptions;
 
interest rate caps and floors;
 
options; and
 
future/forward contracts.
 
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 Statement of Condition or (ii) firm commitments. The Bank also formally assesses (both at the hedge's inception and at least quarterly) 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;
 
investment securities;
 
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 Finance Agency regulations. The Bank requires collateral agreements on all derivative contracts that establish collateral delivery thresholds. Based on credit analyses and collateral requirements, the Bank does not anticipate any credit losses on its derivatives at March 31, 2011. See "Note 14 — Fair Value" for a discussion on the Bank's fair value methodology for derivatives.
 
The following table presents the Bank's credit risk exposure to derivative instruments (dollars in thousands):
 
March 31,
2011
 
December 31,
2010
Credit risk exposure1
$
22,430
 
 
$
20,230
 
Less: Cash collateral held and related accrued interest
(17,502
)
 
(8,303
)
Exposure net of cash collateral
$
4,928
 
 
$
11,927
 
1
Includes net accrued interest receivable of $5.8 million and $7.8 million at March 31, 2011 and December 31, 2010.
 

22


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 (before cash collateral and related accrued interest) at March 31, 2011 was $411.8 million, for which the Bank has posted cash collateral (including accrued interest) of $94.0 million in the normal course of business. If the Bank's credit rating were lowered from its current rating to the next lower rating, the Bank would be required to deliver up to an additional $237.8 million of collateral to its derivative counterparties at March 31, 2011. The Bank's credit rating did not change during the three months ended March 31, 2011.
 
Financial Statement Effect and Additional Financial Information
 
The following tables summarizes the Bank's fair value of derivative instruments (dollars in thousands). For purposes of this disclosure, the derivative values include fair value of derivatives and related accrued interest.
 
 
March 31, 2011
Fair Value of Derivative Instruments
 
Notional
Amount
 
Derivative
Assets
 
Derivative
 Liabilities
Derivatives designated as hedging instruments
 
 
 
 
 
 
Interest rate swaps
 
$
29,907,275
 
 
$
225,246
 
 
$
697,573
 
Derivatives not designated as hedging instruments
 
 
 
 
 
 
Interest rate swaps
 
5,137,102
 
 
19,942
 
 
13,122
 
Interest rate caps
 
3,450,000
 
 
75,916
 
 
 
Forward settlement agreements (TBAs)
 
82,500
 
 
181
 
 
177
 
Mortgage delivery commitments
 
82,127
 
 
170
 
 
209
 
Total derivatives not designated as hedging instruments
 
8,751,729
 
 
96,209
 
 
13,508
 
Total derivatives before netting and collateral adjustments
 
$
38,659,004
 
 
321,455
 
 
711,081
 
Netting adjustments1
 
 
 
(299,025
)
 
(299,025
)
Cash collateral and related accrued interest
 
 
 
(17,502
)
 
(94,012
)
Total netting adjustments and cash collateral
 
 
 
(316,527
)
 
(393,037
)
Derivative assets and liabilities
 
 
 
$
4,928
 
 
$
318,044
 
 
 
December 31, 2010
Fair Value of Derivative Instruments
 
Notional
Amount
 
Derivative
Assets
 
Derivative
 Liabilities
Derivatives designated as hedging instruments
 
 
 
 
 
 
Interest rate swaps
 
$
29,679,817
 
 
$
333,057
 
 
$
798,000
 
Derivatives not designated as hedging instruments
 
 
 
 
 
 
Interest rate swaps
 
4,293,985
 
 
10,888
 
 
19,454
 
Interest rate caps and floors
 
6,950,000
 
 
103,330
 
 
 
Forward settlement agreements (TBAs)
 
95,500
 
 
512
 
 
263
 
Mortgage delivery commitments
 
96,104
 
 
210
 
 
714
 
Total derivatives not designated as hedging instruments
 
11,435,589
 
 
114,940
 
 
20,431
 
Total derivatives before netting and collateral adjustments
 
$
41,115,406
 
 
447,997
 
 
818,431
 
Netting adjustments1
 
 
 
(427,767
)
 
(427,767
)
Cash collateral and related accrued interest
 
 
 
(8,303
)
 
(112,217
)
Total netting adjustments and cash collateral
 
 
 
(436,070
)
 
(539,984
)
Derivative assets and liabilities
 
 
 
$
11,927
 
 
$
278,447
 
1
Amount represents the effect of legally enforceable master netting agreements that allowed the Bank to settle positive and negative positions by counterparty.
    

23


The following table summarizes the components of “Net gain (loss) on derivatives and hedging activities” as presented in the Statement of Income (dollars in thousands):
 
Three Months Ended March 31,
 
2011
 
2010
Derivatives and hedged items in fair value hedging relationships
 
 
 
Interest rate swaps
$
3,635
 
 
$
54
 
Derivatives not designated as hedging instruments
 
 
 
Interest rate swaps
2,513
 
 
(10,976
)
Interest rate caps and floors
(7,105
)
 
(15,705
)
Forward settlement agreements (TBAs)
(119
)
 
(153
)
Mortgage delivery commitments
(17
)
 
105
 
Net interest settlements
3,077
 
 
2,221
 
Total net loss related to derivatives not designated as hedging instruments
(1,651
)
 
(24,508
)
Net gain (loss) on derivatives and hedging activities
$
1,984
 
 
$
(24,454
)
 
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 (dollars in thousands):
 
 
Three Months Ended March 31, 2011
Hedged Item Type
 
Gain (Loss) on
Derivatives
 
(Loss) Gain on
Hedged Item
 
Net Fair Value
Hedge
Ineffectiveness
 
Effect on
Net Interest
Income1
Advances
 
$
100,778
 
 
$
(98,591
)
 
$
2,187
 
 
$
(82,077
)
Available-for-sale investments
 
5,291
 
 
(4,828
)
 
463
 
 
(2,908
)
Bonds
 
(108,022
)
 
109,007
 
 
985
 
 
70,297
 
Total
 
$
(1,953
)
 
$
5,588
 
 
$
3,635
 
 
$
(14,688
)
 
 
Three Months Ended March 31, 2010
Hedged Item Type
 
(Loss) Gain on
Derivatives
 
Gain (Loss) on
Hedged Item
 
Net Fair Value
Hedge
Ineffectiveness
 
Effect on
Net Interest
Income1
Advances
 
$
(47,250
)
 
$
48,090
 
 
$
840
 
 
$
(107,294
)
Available-for-sale investments
 
(3,520
)
 
3,636
 
 
116
 
 
(1,702
)
Bonds
 
20,774
 
 
(21,676
)
 
(902
)
 
85,796
 
Total
 
$
(29,996
)
 
$
30,050
 
 
$
54
 
 
$
(23,200
)
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.
 

24


Note 12 — 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 values of the outstanding consolidated obligations of the 12 FHLBanks were approximately $765.9 billion and $796.3 billion at March 31, 2011 and December 31, 2010.
 
BONDS
 
The following table summarizes the Bank's bonds outstanding by year of contractual maturity (dollars in thousands):
 
March 31, 2011
 
December 31, 2010
Year of Contractual Maturity
Amount
 
Weighted
Average
Interest
Rate %
 
Amount
 
Weighted
Average
Interest
Rate %
Due in one year or less
$
15,274,700
 
 
1.42
 
$
15,114,400
 
 
1.54
 
Due after one year through two years
7,859,805
 
 
2.17
 
6,549,650
 
 
2.20
 
Due after two years through three years
6,228,070
 
 
1.82
 
6,677,020
 
 
2.03
 
Due after three years through four years
3,190,745
 
 
2.55
 
2,956,105
 
 
2.16
 
Due after four years through five years
3,686,610
 
 
2.87
 
4,100,840
 
 
3.13
 
Thereafter
6,660,090
 
 
4.32
 
6,755,180
 
 
4.40
 
Index amortizing notes
1,324,318
 
 
5.12
 
1,456,014
 
 
5.12
 
Total par value
44,224,338
 
 
2.36
 
43,609,209
 
 
2.47
 
Premiums
36,335
 
 
 
 
40,003
 
 
 
Discounts
(27,826
)
 
 
 
(29,963
)
 
 
Fair value hedging adjustments
 
 
 
 
 
 
 
Cumulative fair value loss on existing hedges
86,057
 
 
 
 
181,436
 
 
 
Basis adjustments from terminated and ineffective hedges
(32,988
)
 
 
 
(11,967
)
 
 
Fair value option adjustments
 
 
 
 
 
 
 
Cumulative fair value gain
(100
)
 
 
 
(1,264
)
 
 
 Accrued interest payable
2,785
 
 
 
 
3,114
 
 
 
Total
$
44,288,601
 
 
 
 
$
43,790,568
 
 
 
    
The following table summarizes the Bank's bonds outstanding by features (dollars in thousands):
 
March 31,
2011
 
December 31,
2010
Noncallable or nonputable
$
28,344,338
 
 
$
26,929,209
 
Callable
15,880,000
 
 
16,680,000
 
Total par value
$
44,224,338
 
 
$
43,609,209
 
 
Interest Rate Payment Terms
 
The following table summarizes the Bank's bonds by interest rate payment type (dollars in thousands):
 
March 31,
2011
 
December 31,
2010
Fixed rate
$
39,444,338
 
 
$
39,309,209
 
Simple variable rate
2,550,000
 
 
1,750,000
 
Step-up
2,230,000
 
 
2,550,000
 
Total par value
$
44,224,338
 
 
$
43,609,209
 
 
At March 31, 2011 and December 31, 2010, 52 and 51 percent of the Bank's fixed rate and step-up bonds were swapped to a variable rate index.

25


Extinguishment of Debt
 
The following table summarizes the Bank's debt extinguishments (dollars in thousands):
 
Three Months Ended March 31,
 
2011
 
2010
Par value of bonds extinguished
$
32,975
 
 
$
38,360
 
Loss on extinguishment of debt
(4,602
)
 
(4,027
)
 
DISCOUNT NOTES
 
The following table summarizes the Bank's discount notes (dollars in thousands):
 
March 31, 2011
 
December 31, 2010
 
Amount
 
Weighted
Average
Interest
Rate %
 
Amount
 
Weighted
Average
Interest
Rate %
Par value
$
3,929,141
 
 
0.08
 
$
7,208,748
 
 
0.12
Discounts
(846
)
 
 
 
(472
)
 
 
Fair value option adjustment
(167
)
 
 
 
 
 
 
Total
$
3,928,128
 
 
 
 
$
7,208,276
 
 
 
 
At March 31, 2011, six percent of the Bank's discount notes were swapped to a variable rate index through the use of an interest rate swap accounted for as an economic derivative. At December 31, 2010, none of the Bank's discount notes were swapped to a variable rate index.
 
Note 13 — Capital
 
The Bank is subject to three regulatory capital requirements:
 
Risk-based capital. The Bank must 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.
 
Total regulatory capital. The Bank is required to maintain a minimum four percent capital-to-asset ratio, which is defined as total regulatory capital divided by total assets. Total regulatory capital includes all capital stock, including mandatorily redeemable capital stock, plus retained earnings.
 
Leverage capital. The Bank is required to maintain a minimum five percent 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 March 31, 2011 and December 31, 2010, the Bank did not have any nonpermanent capital.
 
If the Bank's capital falls below the required levels, the Finance Agency has authority to take actions it deems necessary to restore the Bank's capital levels and return it to safe and sound business operations.
 

26


The following table shows the Bank's compliance with the Finance Agency's three regulatory capital requirements (dollars in thousands):
 
March 31, 2011
 
December 31, 2010
 
Required
 
Actual
 
Required
 
Actual
Regulatory capital requirements
 
 
 
 
 
 
 
Risk based capital
$
834,422
 
 
$
2,689,454
 
 
$
716,508
 
 
$
2,745,876
 
Total capital-to-asset ratio
4.00
%
 
5.09
%
 
4.00
%
 
4.94
%
Total regulatory capital
$
2,113,653
 
 
$
2,689,454
 
 
$
2,222,755
 
 
$
2,745,876
 
Leverage ratio
5.00
%
 
7.63
%
 
5.00
%
 
7.41
%
Leverage capital
$
2,642,066
 
 
$
4,034,181
 
 
$
2,778,444
 
 
$
4,118,814
 
 
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.
 
Excess Capital Stock
 
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 $58.4 million and $57.7 million at March 31, 2011 and December 31, 2010.
 
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 membership capital stock necessary to make the member's membership capital stock balance equal to the operational threshold. Additionally, on a scheduled monthly basis, 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 activity-based 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):
 
March 31,
2011
 
December 31,
2010
Balance, beginning of year
$
6,835
 
 
$
8,346
 
Mandatorily redeemable capital stock issued
 
 
4
 
Capital stock subject to mandatory redemption reclassified from capital stock
10
 
 
21,394
 
Redemption of mandatorily redeemable capital stock
(298
)
 
(22,909
)
Balance, end of period
$
6,547
 
 
$
6,835
 
 
 

27


Note 14 — 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
 
 
March 31, 2011
 
December 31, 2010
Financial Instruments
 
Carrying
Value
 
  Fair
Value
 
Carrying
Value
 
 Fair
Value
Assets
 
 
 
 
 
 
 
 
Cash and due from banks
 
$
149,665
 
 
$
149,665
 
 
$
105,741
 
 
$
105,741
 
Interest-bearing deposits
 
8,012
 
 
7,942
 
 
8,919
 
 
8,836
 
Securities purchased under agreements to resell
 
1,600,000
 
 
1,600,000
 
 
1,550,000
 
 
1,550,000
 
Federal funds sold
 
2,152,000
 
 
2,152,000
 
 
2,025,000
 
 
2,025,000
 
Trading securities
 
1,269,214
 
 
1,269,214
 
 
1,472,542
 
 
1,472,542
 
Available-for-sale securities
 
5,883,516
 
 
5,883,516
 
 
6,356,903
 
 
6,356,903
 
Held-to-maturity securities
 
6,467,861
 
 
6,622,799
 
 
7,226,116
 
 
7,395,340
 
Advances
 
27,962,783
 
 
28,060,025
 
 
29,252,529
 
 
29,416,310
 
Mortgage loans held for portfolio, net
 
7,202,002
 
 
7,496,661
 
 
7,421,446
 
 
7,778,889
 
Accrued interest receivable
 
85,321
 
 
85,321
 
 
79,314
 
 
79,314
 
Derivative assets
 
4,928
 
 
4,928
 
 
11,927
 
 
11,927
 
Liabilities
 
 
 
 
 
 
 
 
Deposits
 
(1,240,991
)
 
(1,240,963
)
 
(1,180,653
)
 
(1,180,386
)
Consolidated obligations
 
 
 
 
 
 
 
 
Discount notes1
 
(3,928,128
)
 
(3,928,016
)
 
(7,208,276
)
 
(7,208,222
)
Bonds2
 
(44,288,601
)
 
(45,230,793
)
 
(43,790,568
)
 
(44,830,142
)
Total consolidated obligations
 
(48,216,729
)
 
(49,158,809
)
 
(50,998,844
)
 
(52,038,364
)
Mandatorily redeemable capital stock
 
(6,547
)
 
(6,547
)
 
(6,835
)
 
(6,835
)
Accrued interest payable
 
(232,157
)
 
(232,157
)
 
(187,091
)
 
(187,091
)
Derivative liabilities
 
(318,044
)
 
(318,044
)
 
(278,447
)
 
(278,447
)
Other
 
 
 
 
 
 
 
 
Commitments to extend credit for mortgage loans
 
(34
)
 
(34
)
 
(65
)
 
(66
)
Standby letters of credit
 
(1,828
)
 
(1,828
)
 
(1,867
)
 
(1,867
)
Standby bond purchase agreements
 
 
 
4,868
 
 
 
 
5,130
 
1
Includes $0.2 billion at fair value under the fair value option at March 31, 2011.
2
Includes $2.6 billion and $2.8 billion at fair value under the fair value option at March 31, 2011 and December 31, 2010.
 
Valuation Techniques and Significant Inputs
 
Cash and Due from Banks and Securities Purchased under Agreements to Resell. The fair value approximates the carrying value.
 
Interest-Bearing Deposits. For interest-bearing deposits with less than three months to maturity, the fair value approximates the carrying value. 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.
 
Federal Funds Sold. For overnight and term Federal funds sold with less than three months to maturity, the fair value approximates the carrying value. 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.
 

28


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 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. Prices 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 March 31, 2011, 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 discount rates used in these calculations are equivalent to the replacement advance rates for advances with similar terms. In accordance with 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.
 
The Bank uses the following inputs for measuring the fair value of advances:
 
Consolidated Obligation Curve (CO Curve). The Office of Finance constructs a market-observable curve referred to as the CO Curve. The CO Curve is constructed using the U.S. 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, recent GSE trades, and secondary market activity. The Bank utilizes the CO Curve as its input to fair value for advances because it represents the Bank's cost of funds and is used to price advances.
 
Volatility assumption. Market-based expectations of future interest rate volatility implied from current market prices for similar options.
 
Spread assumption. Represents a spread adjustment to the CO Curve.
 
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 carrying value.
 

29


Derivative Assets and Liabilities. The fair value of derivatives is generally estimated using standard valuation techniques such as discounted cash flow analyses and comparisons to similar instruments. Estimates developed using these methods are highly subjective and require judgments regarding significant matters such as the amount and timing of future cash flows, volatility of interest rates, and the selection of discount rates that appropriately reflect market and credit risks. The use of different assumptions could have a material effect on the fair value estimates. The Bank is subject to credit risk in derivatives transactions due to the potential nonperformance of its derivatives counterparties, which are generally highly rated institutions. To mitigate this risk, the Bank has entered into master netting agreements for derivatives with their counterparties. In addition, the Bank has entered into bilateral security agreements with all of its active derivatives counterparties that provide for the delivery of collateral at specified levels tied to those counterparties' credit ratings to limit its net unsecured credit exposure to those counterparties. The Bank has evaluated the potential for the fair value of the derivatives to be affected by counterparty and its own credit risk and has determined that no adjustments were significant to the overall fair value measurements.
 
The fair values of the Bank's derivative assets and derivative liabilities include accrued interest receivable/payable and cash collateral remitted to/received from counterparties. The estimated fair values of the accrued interest receivable/payable and cash collateral approximate their carrying values due to their short-term nature. The fair values of derivatives are netted by counterparty pursuant to the provisions of the Bank's master netting agreements. If these netted amounts are positive, they are classified as an asset and, if negative, they are classified as a liability.
 
The Bank's discounted cash flow model utilizes market-observable inputs (inputs that are actively quoted and can be validated to external sources). For interest-related derivatives, the Bank utilizes the LIBOR Swap Curve and a volatility assumption to estimate fair value. In limited instances, fair value estimates for interest-rate related derivatives (i.e. caps and floors) are obtained using an external pricing model that utilizes observable market data. For forward settlement agreements (TBAs), the Bank utilizes TBA securities prices that are determined by coupon class and expected term until settlement. For mortgage delivery commitments, the Bank utilizes TBA securities prices 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 carrying value. 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 the amount for 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. For bonds elected under the fair value option, fair value includes accrued interest payable. The discount rates used in these calculations are for consolidated obligations with similar terms. The Bank uses the CO Curve and a volatility assumption for measuring the fair value 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 U.S. 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.
 

30


Fair Value Hierarchy
 
The Bank records trading securities, AFS securities, derivative assets and liabilities, certain REO, and certain consolidated obligations for which the fair value option has been elected at fair value in the Statement 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 hierarchy 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 Statement 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 consolidated obligations 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 REO 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 March 31, 2011, the Bank had made no reclassifications to its fair value hierarchy.
 
 

31


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 Statement of Condition at March 31, 2011 (dollars in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustment1
 
Total
Assets
 
 
 
 
 
 
 
 
 
Trading securities
 
 
 
 
 
 
 
 
 
TLGP
$
 
 
$
1,011,539
 
 
$
 
 
$
 
 
$
1,011,539
 
Taxable municipal bonds
 
 
257,675
 
 
 
 
 
 
257,675
 
Available-for-sale securities
 
 
 
 
 
 
 
 
 
TLGP
 
 
565,314
 
 
 
 
 
 
565,314
 
Taxable municipal bonds
 
 
164,727
 
 
 
 
 
 
164,727
 
Other U.S. obligations
 
 
170,889
 
 
 
 
 
 
170,889
 
Government-sponsored enterprise obligations
 
 
519,444
 
 
 
 
 
 
519,444
 
Government-sponsored enterprise MBS
 
 
4,463,142
 
 
 
 
 
 
4,463,142
 
Derivative assets
 
 
 
 
 
 
 
 
 
Interest rate related
 
 
321,104
 
 
 
 
(316,527
)
 
4,577
 
Forward settlement agreements (TBAs)
181
 
 
 
 
 
 
 
 
181
 
Mortgage delivery commitments
 
 
170
 
 
 
 
 
 
170
 
Total assets at fair value
$
181
 
 
$
7,474,004
 
 
$
 
 
$
(316,527
)
 
$
7,157,658
 
Liabilities
 
 
 
 
 
 
 
 
 
Discount notes2
$
 
 
$
(242,604
)
 
$
 
 
$
 
 
$
(242,604
)
Bonds3
 
 
(2,607,685
)
 
 
 
 
 
(2,607,685
)
Derivative liabilities
 
 
 
 
 
 
 
 
 
Interest rate related
 
 
(710,695
)
 
 
 
393,037
 
 
(317,658
)
Forward settlement agreements (TBAs)
(177
)
 
 
 
 
 
 
 
(177
)
Mortgage delivery commitments
 
 
(209
)
 
 
 
 
 
(209
)
Total liabilities at fair value
$
(177
)
 
$
(3,561,193
)
 
$
 
 
$
393,037
 
 
$
(3,168,333
)
1
Amount represents 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 discount notes recorded under the fair value option.
3
Represents bonds recorded under the fair value option.
 
    

32


The following table summarizes, for each hierarchy level, the Banks' assets and liabilities that are measured at fair value in the Statement of Condition at December 31, 2010 (dollars in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustment1
 
Total
Assets
 
 
 
 
 
 
 
 
 
Trading securities
 
 
 
 
 
 
 
 
 
TLGP
$
 
 
$
1,213,481
 
 
$
 
 
$
 
 
$
1,213,481
 
Taxable municipal bonds
 
 
259,061
 
 
 
 
 
 
259,061
 
Available-for-sale securities
 
 
 
 
 
 
 
 
 
TLGP
 
 
565,694
 
 
 
 
 
 
565,694
 
Taxable municipal bonds
 
 
164,605
 
 
 
 
 
 
164,605
 
Other U.S. obligations
 
 
176,480
 
 
 
 
 
 
176,480
 
Government-sponsored enterprise obligations
 
 
523,239
 
 
 
 
 
 
523,239
 
Government-sponsored enterprise MBS
 
 
4,926,885
 
 
 
 
 
 
4,926,885
 
Derivative assets
 
 
 
 
 
 
 
 
 
Interest rate related
 
 
447,275
 
 
 
 
(436,070
)
 
11,205
 
Forward settlement agreements (TBAs)
512
 
 
 
 
 
 
 
 
512
 
Mortgage delivery commitments
 
 
210
 
 
 
 
 
 
210
 
Total assets at fair value
$
512
 
 
$
8,276,930
 
 
$
 
 
$
(436,070
)
 
$
7,841,372
 
Liabilities
 
 
 
 
 
 
 
 
 
Bonds2
$
 
 
$
(2,816,850
)
 
$
 
 
$
 
 
$
(2,816,850
)
Derivative liabilities
 
 
 
 
 
 
 
 
 
Interest rate related
 
 
(817,454
)
 
 
 
539,984
 
 
(277,470
)
Forward settlement agreements (TBAs)
(263
)
 
 
 
 
 
 
 
(263
)
Mortgage delivery commitments
 
 
(714
)
 
 
 
 
 
(714
)
Total liabilities at fair value
$
(263
)
 
$
(3,635,018
)
 
$
 
 
$
539,984
 
 
$
(3,095,297
)
1
Amount represents 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 REO 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 REO are recorded as either a component of "Other, net” in the Statement of Income or “other assets” in the Statement of Condition if there are available credit enhancement fees to recapture the estimated losses. At March 31, 2011, the fair value of REO in which a fair value adjustment was recorded during the three months ended March 31, 2011 was approximately $0.2 million.
 
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 Statement 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 months ended March 31, 2011 and 2010, the Bank elected to record certain bonds that did not qualify for hedge accounting at fair value under the fair value option. In addition, during the three months ended March 31, 2011, the Bank elected to record certain discount notes that did not qualify for hedge accounting at fair value under the fair value option. In most instances, the Bank executed interest rate swaps accounted for as economic derivatives in order to achieve some offset to the mark-to-market on the fair value option consolidated obligations.
 

33


The following table summarizes the activity related to consolidated obligations in which the fair value option has been elected (dollars in thousands):
 
Three Months Ended March 31,
 
2011
 
2010
 
Bonds
 
Discount Notes
 
Bonds
 
Discount Notes
Balance, beginning of period
$
2,816,850
 
 
$
 
 
$
5,997,867
 
 
$
 
New consolidated obligations elected for fair value option
 
 
242,725
 
 
2,250,000
 
 
 
Maturities and terminations
(210,000
)
 
 
 
(2,315,000
)
 
 
Net loss (gain) on consolidated obligations held at fair value
1,164
 
 
(167
)
 
(6,095
)
 
 
Change in accrued interest/unaccreted balance
(329
)
 
46
 
 
3,174
 
 
 
Balance, end of period
$
2,607,685
 
 
$
242,604
 
 
$
5,929,946
 
 
$
 
    
The following table summarizes the changes in fair value included in the Statement of Income for consolidated obligations in which the fair value option has been elected (dollars in thousands):
 
Three Months Ended March 31,
 
2011
 
2010
 
Bonds
 
Discount Notes
 
Bonds
 
Discount Notes
Interest expense1
$
(2,992
)
 
$
(46
)
 
$
(10,667
)
 
$
 
Net (loss) gain on consolidated obligation held at fair value
(1,164
)
 
167
 
 
6,095
 
 
 
Total change in fair value
$
(4,156
)
 
$
121
 
 
$
(4,572
)
 
$
 
1
Includes the discount amortization on fair value option discount notes.
 
For consolidated obligations recorded under the fair value option, the related contractual interest expense as well as the discount amortization on fair value option discount notes is recorded as part of net interest income in the Statement of Income. The remaining changes are recorded as “Net (loss) gain on consolidated obligations held at fair value” in the Statement of Income. At March 31, 2011 and December 31, 2010, the Bank determined no credit risk adjustments for nonperformance were necessary to the consolidated obligations recorded under the fair value option. Concessions paid on consolidated obligations under the fair value option are expensed as incurred and recorded in “Other expense” in the Statement of Income.
 
The following table summarizes the difference between the fair value and the remaining contractual principal balance outstanding of consolidated obligations for which the fair value option has been elected (dollars in thousands):
 
March 31, 2011
 
December 31, 2010
 
Bonds
 
Discount Notes
 
Bonds
 
Discount Notes
Unpaid principal balance
$
2,605,000
 
 
$
243,175
 
 
$
2,815,000
 
 
$
 
Fair value
2,607,685
 
 
242,604
 
 
2,816,850
 
 
 
Fair value over principal balance
$
2,685
 
 
$
(571
)
 
$
1,850
 
 
$
 
 

34


Note 15 — 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 values of the outstanding consolidated obligations issued on behalf of other FHLBanks for which the Bank is jointly and severally liable were approximately $717.8 billion and $745.5 billion at March 31, 2011 and December 31, 2010.
 
The following table summarizes additional off-balance sheet commitments for the Bank (dollars in thousands):
 
March 31, 2011
 
December 31, 2010
 
Expire within one year
 
Expire after one year
 
Total
 
Expire within one year
 
Expire after one year
 
Total
Standby letters of credit outstanding1
$
3,422,286
 
 
$
159,559
 
 
$
3,581,845
 
 
$
4,719,035
 
 
$
129,894
 
 
$
4,848,929
 
Standby bond purchase agreements outstanding
 
 
665,623
 
 
665,623
 
 
 
 
684,014
 
 
684,014
 
Commitments to fund or purchase mortgage loans
82,161
 
 
 
 
82,161
 
 
96,169
 
 
 
 
96,169
 
Commitments to issue bonds
295,308
 
 
 
 
295,308
 
 
560,000
 
 
 
 
560,000
 
Commitments to issue discount notes
209,488
 
 
 
 
209,488
 
 
 
 
 
 
 
1
Excludes unconditional commitments to issue standby letters of credit of $15.0 million at March 31, 2011.
 
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. The original terms of standby letters of credit range from less than one month to 13 years, with a final expiration in 2020. Unearned fees for standby letters of credit are recorded in “Other liabilities” in the Statement of Condition and amounted to $1.8 million and $1.9 million at March 31, 2011 and December 31, 2010.
 
The Bank monitors the creditworthiness of its standby letters of credit based on an evaluation of its borrowers. The Bank has established parameters for the measurement, review, classification, and monitoring of credit risk related to these standby letters of credit. 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. All standby letters of credit are fully collateralized at the time of issuance. The estimated fair value of standby letters of credit at March 31, 2011 and December 31, 2010 is reported in “Note 14 — Fair Value.”
 
Standby Bond Purchase Agreements. The Bank has entered into standby bond purchase agreements with state housing authorities within its district whereby, for a fee, it agrees to serve as a liquidity provider if required, to purchase and hold the housing authority's bonds until the designated marketing agent can find a suitable investor or the housing authority repurchases the bond according to a schedule established by the standby agreement. Each standby agreement dictates the specific terms that would require the Bank to purchase the bond. The standby bond purchase agreements entered into by the Bank have expiration periods of up to seven years, currently no later than 2016. At March 31, 2011 and December 31, 2010, the Bank had standby bond purchase agreements with 4 housing authorities. During the three months ended March 31, 2011, the Bank was not required to purchase any bonds under these agreements. For the three months ended March 31, 2011 and 2010, the Bank received fees for the guarantees that amounted to $0.4 million. The estimated fair value of standby bond purchase agreements at March 31, 2011 and December 31, 2010 is reported in “Note 14 — Fair Value.”
 
Commitments to Fund or Purchase Mortgage Loans. The Bank enters into commitments that unconditionally obligate them to fund or purchase mortgage loans. Commitments are generally for periods not to exceed 45 days. Of these outstanding commitments, $82.1 million and $96.1 million at March 31, 2011 and December 31, 2010 represent commitments that obligate the Bank to purchase closed mortgage loans from its members. These commitments are considered derivatives and their estimated fair value at March 31, 2011 and December 31, 2010 is reported in “Note 11 — Derivatives and Hedging Activities” as mortgage delivery commitments. The remaining commitments obligate the Bank to table fund mortgage loans. These commitments are not considered derivatives and their estimated fair value at March 31, 2011 and December 31, 2010 is reported in “Note 14 — Fair Value” as commitments to extend credit for mortgage loans.
 

35


Other Commitments. On February 1, 2011, the Bank entered into an agreement with the Iowa Finance Authority to purchase up to $100 million of taxable single family mortgage revenue bonds. The agreement expires on December 31, 2011. As of March 31, 2011, the Bank had not purchased any mortgage revenue bonds under this agreement.
As described in “Note 10 — Allowance for Credit Losses”, for managing the inherent credit risk in the MPF program, participating members receive base and performance based credit enhancement fees from the Bank. When the Bank incurs losses for certain MPF products, it reduces performance based credit enhancement fee payments to applicable members until the amount of the loss is recovered up to the limit of the FLA. The FLA is an indicator of the potential losses for which the Bank is liable (before the member's credit enhancement is used to cover losses). The FLA amounted to $123.1 million and $124.8 million at March 31, 2011 and December 31, 2010.
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 $1.2 million by December 31, 2012, $0.8 million by December 31, 2015, and $0.3 million by December 31, 2020. At March 31, 2011, 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 16 — Activities with Stockholders
 
Under the Bank's Capital Plan, voting rights are conferred upon the Bank's members 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 March 31, 2011 and December 31, 2010, 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.
 
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 Statement 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.
 

36


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.
 
The following table summarizes the Bank's outstanding transactions with Directors' Financial Institutions (dollars in thousands):
 
 
March 31, 2011
 
December 31, 2010
 
 
Amount
 
% of Total
 
Amount
 
% of Total
Advances
 
$
546,552
 
 
2.0
 
$
567,413
 
 
2.0
Mortgage loans
 
71,982
 
 
1.0
 
74,361
 
 
1.0
Capital stock
 
38,235
 
 
1.8
 
40,230
 
 
1.8
 
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. The following tables summarize outstanding capital stock balances, advance par values, and unpaid principal balances on mortgage loans with stockholders and their affiliates holding 10 percent or more of outstanding capital stock (including stock classified as mandatorily redeemable) (dollars in thousands):
 
 
March 31, 2011
 
 
Capital Stock
 
 
 
Mortgage
 
Interest
Stockholder
 
Amount
 
% of Total
 
Advances
 
Loans
 
Income1
Transamerica Life Insurance Company
 
$
203,575
 
 
9.6
 
$
4,350,000
 
 
$
 
 
$
3,662
 
Monumental Life Insurance Company2
 
27,800
 
 
1.3
 
400,000
 
 
 
 
287
 
Total
 
$
231,375
 
 
10.9
 
$
4,750,000
 
 
$
 
 
$
3,949
 
 
 
December 31, 2010
 
 
Capital Stock
 
 
 
Mortgage
 
Interest
Stockholder
 
Amount
 
% of Total
 
Advances
 
Loans
 
Income3
Transamerica Life Insurance Company
 
$
210,250
 
 
9.6
 
$
4,500,000
 
 
$
 
 
$
19,120
 
Monumental Life Insurance Company2
 
27,800
 
 
1.3
 
400,000
 
 
 
 
1,221
 
Total
 
$
238,050
 
 
10.9
 
$
4,900,000
 
 
$
 
 
$
20,341
 
1
Represents interest income earned on advances during the three months ended March 31, 2011.
2
Monumental Life Insurance Company is an affiliate of Transamerica Life Insurance Company.
3
Represents interest income earned on advances during the year ended December 31, 2010.
 
Note 17 — Activities with Other FHLBanks
 
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 March 31, 2011 and 2010, the Bank recorded $0.5 million and $0.4 million in service fee expense to the FHLBank of Chicago.
 
Overnight Funds. The Bank may lend or borrow unsecured overnight funds to or from other FHLBanks. All such transactions are at current market rates. The Bank did not make any loans to other FHLBanks during the three months ended March 31, 2011 and 2010. The Bank borrowed $40.0 million from the FHLBank of Chicago during the three months ended March 31, 2011. The Bank borrowed $25.0 million from the FHLBank of Cincinnati during the three months ended March 31, 2010.
 
 

37


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, 2010, filed with the Securities and Exchange Commission (SEC) on March 18, 2011 (2010 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:
 
 

38


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:
 
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);
 
competitive forces, including without limitation, other sources of funding available to our borrowers that could impact the demand for our advances, other entities purchasing mortgage loans in the secondary mortgage market, and other entities borrowing funds in the capital markets.
 
risks related to the other 11 FHLBanks that could trigger our joint and several liability for debt issued by the other 11 FHLBanks;
 
the volatility of results due to changes in the fair value of certain assets, liabilities, and derivative financial instruments;
 
the volatility of market prices, interest rates, credit quality, and other indices that could affect the value of investments and collateral held by us as security for borrower and counterparty obligations;
 
general economic and market conditions that could impact the volume of business we do with our members, including, but not limited to, the timing and volatility of market activity, inflation/deflation, employment rates, housing prices, the condition of the mortgage and housing markets on our mortgage-related assets, and the condition of the capital markets on our consolidated obligations;
 
the availability of derivative financial instruments in the quantities needed for risk management purposes from acceptable counterparties;
 
changes in the relative attractiveness of consolidated obligations due to actual or perceived changes in the FHLBanks' credit ratings and the recent S&P action to revise the long-term credit rating outlook on the United States of America from stable to negative;
 
increases in borrower defaults on mortgage loans;
 
member failures, or other member changes, including changes resulting from mergers or changes in the principal place of business of members; and
 
changes in our capital structure and capital 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 2010 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.
 

39


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. Our member institutions may include commercial banks, savings institutions, credit unions, insurance companies, and community development financial institutions.
 
For the three months ended March 31, 2011, we recorded net income of $26.0 million compared to $30.3 million for the same period in 2010. Our net income calculated in accordance with accounting principles generally accepted in the United States of America (GAAP) was primarily impacted by our other losses and net interest income during the three months ended March 31, 2011.
 
We recorded other losses of $6.5 million during the three months ended March 31, 2011 compared to other income of $2.5 million during the same period in 2010. The decrease in other (loss) income was primarily due to net losses on trading securities, partially offset by net gains on derivatives and hedging activities. During the three months ended March 31, 2011, we recorded a net loss of $3.3 million on our trading securities compared to a net gain of $21.2 million during the same period in 2010. Trading securities are marked-to-market with changes in fair value reflected through other (loss) income. The net loss on trading securities during the three months ended March 31, 2011 was primarily due to increases in interest rates. The net gain on trading securities during the three months ended March 31, 2010 included a net realized gain of $11.7 million from the sale of $1.0 billion par value securities and $9.5 million in unrealized gains due to changes in interest rates.
 
Net gains on derivatives and hedging activities increased $26.5 million during the three months ended March 31, 2011 when compared to the same period in 2010. The increase was primarily due to reduced losses from economic hedging activity. We use economic derivatives to manage interest rate risk, including mortgage prepayment risk. During the three months ended March 31, 2011, losses on economic derivatives were $1.6 million compared to $24.6 million during the same period in 2010. 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 economic hedging activity.
     
For the three months ended March 31, 2011, we recorded net interest income of $62.1 million compared to $52.4 million for the same period in 2010. The increase in net interest income was primarily due to improved funding costs and increased interest income on our mortgage-backed securities (MBS). During the first quarter of 2011, interest income on MBS included a $14.6 million prepayment fee for the prepayment of an available-for-sale (AFS) MBS. In addition, interest income on our held-to-maturity (HTM) MBS portfolio increased due to our purchase of MBS during the latter half of the first quarter in 2010. The increase in net interest income was partially offset by lower advance and mortgage loan interest income resulting from lower average volumes. For additional discussion on these items, refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — Net Interest Income.”
 
Our total assets decreased $2.8 billion at March 31, 2011 when compared to December 31, 2010 due primarily to a decline in investment securities and advances. Our investment securities declined primarily due to principal repayments on our MBS. Our advances declined due to the continued high level of liquidity in the market and the low loan demand experienced by our members. Our total liabilities decreased $2.6 billion at March 31, 2011 when compared to December 31, 2010 due primarily to a decline in consolidated obligations resulting from a decline in total assets.
 
As part of evaluating financial performance, we adjust GAAP net income before assessments (GAAP net income) and GAAP net interest income before provision for credit losses (GAAP net interest income) for the impact of (i) market adjustments relating to derivative and hedging activities and instruments held at fair value, (ii) realized gains (losses) on the sale of investment securities, (iii) holding gains (losses) on trading securities, and (iv) other unpredictable transactions, including asset prepayment fees and debt extinguishment losses. The resulting non-GAAP measure, referred to as our core earnings, reflects both core net interest income before provision for credit losses (core net interest income) and core net income before assessments (core net income). Because we are primarily a "hold-to-maturity" investor, management believes that the core earnings measure is helpful in understanding our operating results and provides a meaningful period-to-period comparison in contrast to GAAP income, which can be impacted by transactions that are considered to be unpredictable or the result of mark-to-market activity driven by market volatility. Additionally, the core earnings measure is used to assess performance under our incentive compensation plans and to ensure management remains focused on long-term value and performance.
 

40


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.
 
The following table summarizes the reconciliation between GAAP net interest income and core net interest income (dollars in millions):
 
Three Months Ended March 31,
 
2011
 
2010
Net interest income before provision for credit losses (GAAP)
$
62.1
 
 
$
52.4
 
Excludes:
 
 
 
Prepayment fees on advances, net
3.1
 
 
1.7
 
Prepayment fees on investments
14.6
 
 
 
Fair value hedging adjustments
0.2
 
 
(0.1
)
Total core net interest income adjustments
17.9
 
 
1.6
 
Includes items reclassified from other (loss) income:
 
 
 
Net interest income on economic hedges
3.1
 
 
2.2
 
Core net interest income before provision for credit losses
$
47.3
 
 
$
53.0
 
 
The following table summarizes the reconciliation between GAAP net income and core net income (dollars in millions):
 
Three Months Ended March 31,
 
2011
 
2010
Net income before assessments (GAAP)
$
35.4
 
 
$
41.3
 
Excludes:
 
 
 
Core net interest income adjustments (per table above)
17.9
 
 
1.6
 
Net (loss) gain on trading securities
(3.3
)
 
21.2
 
Net (loss) gain on consolidated obligations held at fair value
(1.0
)
 
6.1
 
Net gain (loss) on derivatives and hedging activities
2.0
 
 
(24.5
)
Net loss on extinguishment of debt
(4.6
)
 
(4.0
)
Includes:
 
 
 
Net interest income on economic hedges
3.1
 
 
2.2
 
Amortization of hedging costs1
(1.1
)
 
 
Core net income before assessments
$
26.4
 
 
$
43.1
 
1
Beginning in the first quarter of 2011 and on a go forward basis, we will adjust our GAAP net income to reflect the amortization of upfront payments and any gains or losses on the sale of derivative instruments with an upfront payment over the life of the instrument.
 
Our core net income decreased $16.7 million during the three months ended March 31, 2011 when compared to the same period in 2010. The decrease was primarily due to decreased core net interest income and an increase in our provision for credit losses on mortgage loans. During the three months ended March 31, 2011, core net interest income decreased $5.7 million when compared to the same period in 2010 due primarily to lower interest rates and lower average asset volumes, partially offset by improved funding costs.
 
Average advance volumes decreased due to the continued high level of liquidity in the market and the low loan demand experienced by our members. Average trading security volumes decreased due to the sale of certain TLGP debt investments and taxable municipal bonds during 2010. Average mortgage loan volumes decreased due to principal repayments exceeding mortgage loan originations throughout 2010 and during the three months ended March 31, 2011.
 
During the three months ended March 31, 2011, we also recorded an additional provision for credit losses of $5.6 million. The provision recorded was driven by an increase in estimated losses resulting from increased loss severities, management's expectation that loans migrating to REO and loss severities will likely increase in the future, and certain refinements made to our allowance for credit losses model.
 
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.”
 

41


Conditions in the Financial Markets
 
THREE MONTHS ENDED MARCH 31, 2011 AND 2010 AND DECEMBER 31, 2010
 
Interest Rates
 
The following table shows information on key average market interest rates:
 
First Quarter
2011
3-Month
Average
 
First Quarter
2010
3-Month
Average
 
December 31,
2010
Ending Rate
Federal funds target1
0.16
%
 
0.14
%
 
0.13
%
Three-month LIBOR1
0.31
 
 
0.26
 
 
0.30
 
2-year U.S. Treasury1
0.68
 
 
0.90
 
 
0.60
 
10-year U.S. Treasury1
3.44
 
 
3.70
 
 
3.30
 
30-year residential mortgage note1
4.85
 
 
5.00
 
 
4.86
 
1
Source is Bloomberg.
    
The Federal Reserve's key interest rate, the Federal funds target, maintained a range of 0.00 to 0.25 percent throughout the first quarter of 2011 in order to stimulate economic growth. Three-month LIBOR increased during the first quarter of 2011 due primarily to global concerns surrounding the unrest in Egypt and the Middle East. As the regime in Egypt was removed from power, three-month LIBOR returned to its pre-event level. The U.S. Treasury market generally traded within a 50 basis point range during the first quarter of 2011. Mortgage rates generally moved in tandem with the U.S. Treasury market during the first quarter of 2011.
 
In March 2011, the U.S. Treasury announced that it would begin to wind down its portfolio of agency-guaranteed MBS by selling $10 billion in holdings per month throughout 2011. The market impact from this announcement was a modest increase in mortgage yields.
 
Funding Spreads
FHLB spreads to LIBOR (basis points)1
First Quarter 2011
3-Month
Average
 
First Quarter
2010
3-Month
Average
 
December 31,
2010
Ending Spread
3-month
(13.1
)
 
(8.9
)
 
(11.3
)
2-year
(4.3
)
 
(7.2
)
 
(5.6
)
5-year
6.0
 
 
6.2
 
 
9.9
 
10-year
36.4
 
 
41.2
 
 
39.9
 
1
Source is the Office of Finance.
    
As a result of our credit quality and standing in the capital markets, we generally have ready access to funding at relatively competitive interest rates. During the first quarter of 2011, in some instances, our short-term and longer-term funding spreads improved relative to LIBOR. Spreads changed due to many factors, including, but not limited to, increased investor appetite for longer-term, highly-rated debt, flight to quality as a result of global unrest and environmental disasters, and decreased issuances of agency debentures.
 
 
 

42


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 2010 Form 10-K. The Statement of Condition data at March 31, 2011 and Statement of Income data for the three months ended March 31, 2011 were derived from the unaudited financial statements and condensed notes at the beginning of this Form 10-Q. The Statement of Condition data at December 31, 2010 was derived from audited financial statements and notes not included in this report but filed in our 2010 Form 10-K. The Statement of Condition data at September 30, 2010, June 30, 2010, and March 31, 2010 and the Statement of Income data for the three months ended December 31, 2010, September 30, 2010, June 30, 2010, and March 31, 2010 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 Statement of Income data for the three months ended March 31, 2011 is not necessarily indicative of the results that may be achieved for our full 2011 fiscal year.
Statement of Condition
March 31, 2011
 
December 31, 2010
 
September 30, 2010
 
June 30, 2010
 
March 31, 2010
(dollars in millions)
 
 
 
 
 
 
 
 
 
Investments1
$
17,381
 
 
$
18,639
 
 
$
20,240
 
 
$
19,179
 
 
$
23,236
 
Advances
27,963
 
 
29,253
 
 
32,014
 
 
32,491
 
 
33,027
 
Mortgage loans held for portfolio, gross2
7,220
 
 
7,434
 
 
7,556
 
 
7,537
 
 
7,559
 
Total assets
52,841
 
 
55,569
 
 
60,068
 
 
59,442
 
 
64,623
 
Consolidated obligations
 
 
 
 
 
 
 
 
 
 
 
Discount notes
3,928
 
 
7,208
 
 
7,471
 
 
3,485
 
 
4,706
 
Bonds
44,289
 
 
43,791
 
 
47,518
 
 
51,075
 
 
53,623
 
Total consolidated obligations3
48,217
 
 
50,999
 
 
54,989
 
 
54,560
 
 
58,329
 
Mandatorily redeemable capital stock
7
 
 
7
 
 
5
 
 
7
 
 
7
 
Capital stock — Class B putable4
2,118
 
 
2,183
 
 
2,296
 
 
2,307
 
 
2,331
 
Retained earnings
565
 
 
556
 
 
529
 
 
501
 
 
500
 
Accumulated other comprehensive income
64
 
 
91
 
 
147
 
 
103
 
 
23
 
Total capital
2,747
 
 
2,830
 
 
2,972
 
 
2,911
 
 
2,854
 
 
For the Three Months Ended
Statement of Income
March 31, 2011
 
December 31, 2010
 
September 30, 2010
 
June 30, 2010
 
March 31, 2010
(dollars in millions)
 
 
 
 
 
 
 
 
 
Net interest income5
$
62.1
 
 
$
86.3
 
 
$
203.8
 
 
$
72.4
 
 
$
52.4
 
Provision for credit losses on mortgage loans
5.6
 
 
6.5
 
 
1.6
 
 
3.9
 
 
0.1
 
Other (loss) income 6
(6.5
)
 
10.2
 
 
(136.6
)
 
(37.6
)
 
2.5
 
Other expense
14.6
 
 
22.1
 
 
11.6
 
 
13.0
 
 
13.5
 
Net income
26.0
 
 
49.8
 
 
39.7
 
 
13.2
 
 
30.3
 
Selected Financial Ratios7
 
 
 
 
 
 
 
 
 
Net interest spread8
0.37
%
 
0.51
%
 
1.27
%
 
0.37
%
 
0.23
%
Net interest margin9
0.46
 
 
0.58
 
 
1.35
 
 
0.46
 
 
0.32
 
Return on average equity
3.79
 
 
6.80
 
 
5.32
 
 
1.84
 
 
4.25
 
Return on average capital stock
4.93
 
 
8.87
 
 
6.87
 
 
2.28
 
 
5.11
 
Return on average assets
0.19
 
 
0.34
 
 
0.26
 
 
0.08
 
 
0.19
 
Average equity to average assets
5.08
 
 
4.99
 
 
4.93
 
 
4.56
 
 
4.38
 
Regulatory capital ratio10
5.09
 
 
4.94
 
 
4.71
 
 
4.74
 
 
4.39
 
Dividend payout ratio11
64.91
 
 
46.26
 
 
29.15
 
 
90.04
 
 
48.07
 

43


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 on mortgage loans was $18.0 million, $13.0 million, $6.8 million, $5.6 million, and $1.9 million at March 31, 2011, December 31, 2010, September 30, 2010, June 30, 2010, and March 31, 2010.
3
The par values of the outstanding consolidated obligations for all 12 FHLBanks were $765.9 billion, $796.3 billion, $805.9 billion, $846.4 billion, and $870.9 billion at March 31, 2011, December 31, 2010, September 30, 2010, June 30, 2010, and March 31, 2010.
4
Total capital stock includes excess capital stock of $58.4 million, $57.7 million, $60.5 million, $51.6 million, and $52.9 million at March 31, 2011, December 31, 2010, September 30, 2010, June 30, 2010, and March 31, 2010.
5
Represents net interest income before the provision for credit losses on mortgage loans.
6
Other (loss) income includes, among other things, net (losses) gains on trading securities, net (losses) gains on consolidated obligations held at fair value, net losses on the extinguishment of debt, and net gains (losses) on derivatives and hedging activities.
7
Amounts used to calculate selected financial ratios are based on numbers in thousands. Accordingly, recalculations using numbers in millions may not produce the same results.
8
Represents yield on total interest-earning assets minus cost of total interest-bearing liabilities.
9
Represents net interest income expressed as a percentage of average interest-earning assets.
10
Represents period-end regulatory capital expressed as a percentage of period-end total assets. Regulatory capital includes all capital stock, including mandatorily redeemable capital stock, and retained earnings.
11
Represents dividends declared and paid in the stated period expressed as a percentage of net income in the stated period.
 
Results of Operations
 
THREE MONTHS ENDED MARCH 31, 2011 AND 2010
 
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 months ended March 31, 2011 and 2010 (dollars in millions). These items are further described in the sections that follow.
 
Three Months Ended March 31,
 
2011
 
2010
 
$ Change
 
% Change
Net interest income before provision
$
62.1
 
 
$
52.4
 
 
$
9.7
 
 
18.5
 %
Provision for credit losses on mortgage loans
5.6
 
 
0.1
 
 
5.5
 
 
5,500.0
 
Other (loss) income
(6.5
)
 
2.5
 
 
(9
)
 
(360.0
)
Other expense
14.6
 
 
13.5
 
 
1.1
 
 
8.1
 
Assessments
9.4
 
 
11.0
 
 
(1.6
)
 
(14.5
)
Net income
$
26.0
 
 
$
30.3
 
 
$
(4.3
)
 
(14.2
)%
 

44


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 table presents average balances and rates of major interest rate sensitive asset and liability categories for the three months ended March 31, 2011 and 2010. The table also presents 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).        
 
Three Months Ended March 31, 2011
 
Three Months Ended March 31, 2010
 
Average
Balance1
 
Yield/Cost
 
Interest
Income/
Expense
 
Average
Balance1
 
Yield/Cost
 
Interest
Income/
Expense
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
111
 
 
0.26
%
 
$
0.1
 
 
$
76
 
 
0.32
%
 
$
 
Securities purchased under agreements to resell
1,747
 
 
0.13
 
 
0.6
 
 
462
 
 
0.11
 
 
0.1
 
Federal funds sold
2,608
 
 
0.15
 
 
1.0
 
 
4,932
 
 
0.12
 
 
1.5
 
Short-term investments
124
 
 
0.15
 
 
 
 
633
 
 
0.56
 
 
0.9
 
Mortgage-backed securities2,3
10,868
 
 
2.80
 
 
75.1
 
 
12,016
 
 
1.88
 
 
55.6
 
Other investments2,4
3,288
 
 
2.26
 
 
18.4
 
 
5,435
 
 
1.92
 
 
25.8
 
Advances5
28,315
 
 
1.05
 
 
73.1
 
 
34,676
 
 
1.28
 
 
109.2
 
Mortgage loans6
7,297
 
 
4.61
 
 
83.0
 
 
7,621
 
 
4.91
 
 
92.3
 
Total interest-earning assets
54,358
 
 
1.87
 
 
251.3
 
 
65,851
 
 
1.76
 
 
285.4
 
Noninterest-earning assets
412
 
 
 
 
 
 
241
 
 
 
 
 
Total assets
$
54,770
 
 
1.86
%
 
$
251.3
 
 
$
66,092
 
 
1.75
%
 
$
285.4
 
Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
Deposits
$
1,167
 
 
0.06
%
 
$
0.2
 
 
$
1,298
 
 
0.07
%
 
$
0.2
 
Consolidated obligations
 
 
 
 
 
 
 
 
 
 
 
Discount notes5
5,270
 
 
0.13
 
 
1.7
 
 
9,292
 
 
0.12
 
 
2.7
 
Bonds5
44,733
 
 
1.70
 
 
187.2
 
 
51,254
 
 
1.82
 
 
230.1
 
Other interest-bearing liabilities
8
 
 
3.22
 
 
0.1
 
 
8
 
 
1.94
 
 
 
Total interest-bearing liabilities
51,178
 
 
1.50
 
 
189.2
 
 
61,852
 
 
1.53
 
 
233.0
 
Noninterest-bearing liabilities
811
 
 
 
 
 
 
1,347
 
 
 
 
 
Total liabilities
51,989
 
 
1.48
 
 
189.2
 
 
63,199
 
 
1.50
 
 
233.0
 
Capital
2,781
 
 
 
 
 
 
2,893
 
 
 
 
 
Total liabilities and capital
$
54,770
 
 
1.40
%
 
$
189.2
 
 
$
66,092
 
 
1.43
%
 
$
233.0
 
Net interest income and spread
 
 
0.37
%
 
$
62.1
 
 
 
 
0.23
%
 
$
52.4
 
Net interest margin7
 
 
0.46
%
 
 
 
 
 
0.32
%
 
 
Average interest-earning assets to interest-bearing liabilities
 
 
106.21
%
 
 
 
 
 
106.47
%
 
 
Composition of net interest income
 
 
 
 
 
 
 
 
 
 
 
Asset-liability spread
 
 
0.38
%
 
$
52.0
 
 
 
 
0.25
%
 
$
41.7
 
Earnings on capital
 
 
1.48
%
 
10.1
 
 
 
 
1.50
%
 
10.7
 
Net interest income
 
 
 
 
$
62.1
 
 
 
 
 
 
$
52.4
 
1
Average balances do not reflect the effect of derivative master netting arrangements with counterparties.
2
The average balance of available-for-sale securities is reflected at amortized cost; therefore the resulting yields do not give effect to changes in fair value.
3
MBS interest income includes a $14.6 million prepayment fee during the three months ended March 31, 2011 as a result of an AFS MBS prepayment.
4
Other investments include: TLGP investments, taxable municipal bonds, other U.S. obligations, GSE obligations, state or local housing agency obligations, and an equity investment in a SBIC.
5
Average balances reflect the impact of fair value hedging and fair value option adjustments.
6
Nonperforming loans are included in average balances used to determine the average yield.
7
Represents net interest income expressed as a percentage of average interest-earning assets.

45


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
 
March 31, 2011 vs. March 31, 2010
 
Total Increase
(Decrease) Due to
 
Total Increase
(Decrease)
 
Volume
 
Rate
 
Interest income
 
 
 
 
 
Interest-bearing deposits
$
0.1
 
 
$
 
 
$
0.1
 
Securities purchased under agreements to resell
0.5
 
 
 
 
0.5
 
Federal funds sold
(0.8
)
 
0.3
 
 
(0.5
)
Short-term investments
(0.5
)
 
(0.4
)
 
(0.9
)
Mortgage-backed securities
(5.7
)
 
25.2
 
 
19.5
 
Other investments
(11.4
)
 
4.0
 
 
(7.4
)
Advances
(18.3
)
 
(17.8
)
 
(36.1
)
Mortgage loans
(3.8
)
 
(5.5
)
 
(9.3
)
Total interest income
(39.9
)
 
5.8
 
 
(34.1
)
Interest expense
 
 
 
 
 
Deposits
 
 
 
 
 
Consolidated obligations
 
 
 
 
 
Discount notes
(1.2
)
 
0.2
 
 
(1.0
)
Bonds
(28.3
)
 
(14.6
)
 
(42.9
)
Other interest-bearing liabilities
 
 
0.1
 
 
0.1
 
Total interest expense
(29.5
)
 
(14.3
)
 
(43.8
)
Net interest income
$
(10.4
)
 
$
20.1
 
 
$
9.7
 
    
Our net interest income is made up of two components: asset-liability spread and earnings on capital.
 
ASSET-LIABILITY SPREAD
 
Asset-liability spread equals the yield on total assets minus the cost of total liabilities. For the three months ended March 31, 2011, our asset-liability spread was 38 basis points compared to 25 basis points for the same period in 2010. The majority of our asset-liability spread is driven by our net interest spread. For the three months ended March 31, 2011, our net interest spread was 37 basis points compared to 23 basis points for the same period in 2010. Asset-liability spread income was impacted by the following:
 
Bonds
 
Interest expense on bonds decreased 19 percent during the three months ended March 31, 2011 when compared to the same period in 2010 due to lower average volumes and lower interest rates. Average bond volumes decreased due primarily to a decline in average assets. In addition, we called $4.9 billion and $2.2 billion of bonds during the three months ended March 31, 2011 and 2010 in an effort to reposition our balance sheet and reduce future debt costs.

46


Advances
 
Interest income on advances (including prepayment fees on advances, net) decreased 33 percent during the three months ended March 31, 2011 when compared to the same period in 2010 due to lower average volumes and lower interest rates. Average advance volumes decreased due to the continued high level of liquidity in the market and the low loan demand experienced by our members.
 
Investments
 
Interest income on investments increased 13 percent during the three months ended March 31, 2011 when compared to the same period in 2010 primarily due to increased interest income on our MBS. During the first quarter of 2011, we received a $14.6 million prepayment fee for the prepayment of an AFS MBS. In addition, interest income on our held-to-maturity MBS increased $10.5 million during the three months ended March 31, 2011 when compared to the same period in 2010 due to us purchasing MBS during the latter half of the first quarter in 2010.
 
The increase in interest income was partially offset by a decrease in average investment volumes. Average investments decreased due primarily to us selling certain TLGP debt investments and taxable municipal bonds during 2010. In addition, a lack of attractive short-term investment opportunities and MBS principal prepayments contributed to the decrease in average investments during the three months ended March 31, 2011.
 
Mortgage Loans
 
Interest income on mortgage loans decreased 10 percent during the three months ended March 31, 2011 when compared to the same period in 2010 due to lower interest rates and lower average volumes. Average mortgage loan volumes decreased due to principal repayments exceeding mortgage loan originations.
 
Discount Notes
 
Interest expense on discount notes decreased 41 percent during the three months ended March 31, 2011 when compared to the same period in 2010 due to lower average volumes. Average discount note volumes decreased primarily due to us replacing maturing discount notes with bonds as a result of improved longer-term funding costs and our desire to extend the duration of our liabilities.
 
EARNINGS ON CAPITAL
 
Our earnings on capital decreased during the three months ended March 31, 2011 when compared to the same period in 2010 due primarily to decreased average capital. For the three months ended March 31, 2011, earnings on invested capital amounted to $10.1 million compared to $10.7 million for the same period in 2010.
 
PROVISION FOR CREDIT LOSSES ON MORTGAGE LOANS HELD FOR PORTFOLIO
 
During the three months ended March 31, 2011, we recorded a provision for credit losses of $5.6 million, bringing our allowance for credit losses to $18.0 million at March 31, 2011. The provision recorded was driven by an increase in estimated losses resulting from increased loss severities, management's expectation that loans migrating to REO and loss severities will likely increase in the future, and certain refinements made to our allowance for credit losses model. For additional discussion on our allowance for credit losses, refer to "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management — Credit Risk — Mortgage Assets.”
 
 

47


Other (Loss) Income
 
The following table summarizes the components of other (loss) income (dollars in millions):
 
Three Months Ended March 31,
 
2011
 
2010
Service fees
$
0.3
 
 
$
0.4
 
Net (loss) gain on trading securities
(3.3
)
 
21.2
 
Net (loss) gain on consolidated obligations held at fair value
(1.0
)
 
6.1
 
Net gain (loss) on derivatives and hedging activities
2.0
 
 
(24.5
)
Net loss on extinguishment of debt
(4.6
)
 
(4.0
)
Other, net
0.1
 
 
3.3
 
Total other (loss) income
$
(6.5
)
 
$
2.5
 
    
Other (loss) income can be volatile from period to period depending on the type of financial activity recorded. Other (loss) income was primarily impacted by the following events:
 
At March 31, 2011 and December 31, 2010, trading securities were $1.3 billion and $1.5 billion. Trading securities are marked-to-market with changes in fair value reflected through other (loss) income. During the three months ended March 31, 2011, we recorded a net loss of $3.3 million on our trading securities compared to a net gain of $21.2 million during the same period in 2010. The net loss during the three months ended March 31, 2011 was primarily due to increases in interest rates. The net gain during the three months ended March 31, 2010 included a net realized gain of $11.7 million from the sale of $1.0 billion par value securities and $9.5 million in unrealized gains due to changes in interest rates.
 
We recorded net gains of $2.0 million on derivatives and hedging activities during the three months ended March 31, 2011 compared to net losses of $24.5 million for the same period in 2010. The change between periods was primarily due to economic hedging activity. We use economic derivatives to manage interest rate risk, including mortgage prepayment risk. During the three months ended March 31, 2011, losses on economic derivatives were $1.6 million compared to $24.6 million during the same period in 2010. 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 economic hedging activity.
 
During the three months ended March 31, 2011 and 2010, we elected the fair value option on certain bonds that did not qualify for hedge accounting. In addition, during the three months ended March 31, 2011, we began electing the fair value option on certain discount notes that did not qualify for hedge accounting. We recorded fair value losses of $1.0 million on these consolidated obligations during the three months ended March 31, 2011 compared to fair value gains of $6.1 million during the same period in 2010. In order to achieve some offset to the mark-to-market from fair value option instruments, 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.
 
Income recorded in "Other, net" decreased $3.2 million during the three months ended March 31, 2011 when compared to the same period in 2010 primarily due to losses on the sale of real estate owned (REO). During the three months ended March 31, 2011, we liquidated 71 REO assets compared to 25 during the same period in 2010.

48


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 gain (loss) 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 gain (loss) 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 instruments).
 
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 Statement of Income.
 
The following tables categorize the net effect of hedging activities on net income by product for the three months ended March 31, 2011 (dollars in millions):
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Loans
 
Bonds
 
Discount Notes
 
Balance
Sheet
 
Total
Net Interest Income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net (amortization) accretion1
 
$
(11.0
)
 
$
 
 
$
(0.8
)
 
$
7.9
 
 
$
 
 
$
 
 
$
(3.9
)
Net interest settlements
 
(82.1
)
 
(2.9
)
 
 
 
70.3
 
 
 
 
 
 
(14.7
)
Total net interest income
 
(93.1
)
 
(2.9
)
 
(0.8
)
 
78.2
 
 
 
 
 
 
(18.6
)
Net Gain (Loss) on Derivatives and Hedging Activities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gains on fair value hedges
 
2.2
 
 
0.4
 
 
 
 
1.0
 
 
 
 
 
 
3.6
 
Gains (losses) on economic hedges
 
 
 
2.1
 
 
(0.2
)
 
3.5
 
 
0.1
 
 
(7.1
)
 
(1.6
)
Total net gain (loss) on derivatives and hedging activities
 
2.2
 
 
2.5
 
 
(0.2
)
 
4.5
 
 
0.1
 
 
(7.1
)
 
2.0
 
Subtotal
 
(90.9
)
 
(0.4
)
 
(1.0
)
 
82.7
 
 
0.1
 
 
(7.1
)
 
(16.6
)
Net loss on trading securities2
 
 
 
(3.1
)
 
 
 
 
 
 
 
 
 
(3.1
)
Net (loss) gain on consolidated obligations held at fair value2
 
 
 
 
 
 
 
(1.1
)
 
0.1
 
 
 
 
(1.0
)
Net amortization3
 
 
 
 
 
 
 
(0.5
)
 
 
 
 
 
(0.5
)
Total net effect of hedging activities
 
$
(90.9
)
 
$
(3.5
)
 
$
(1.0
)
 
$
81.1
 
 
$
0.2
 
 
$
(7.1
)
 
$
(21.2
)
1
Represents the amortization/accretion of hedging fair value adjustments for both open and closed hedge positions included in net interest income.
2
Represents the gains/losses on those trading securities and fair value option consolidated obligations in which we have entered into a corresponding economic derivative to hedge the risk of changing market prices. As a result, this line item may not agree to the Statement of Income.
3
Represents the amortization/accretion of hedging fair value adjustments from terminated hedges included in other (loss) income.
 
 

49


The following tables categorize the net effect of hedging activities on net income by product for the three months ended March 31, 2010 (dollars in millions):
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Loans
 
Bonds
 
Discount Notes
 
Balance
Sheet
 
Total
Net Interest Income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net (amortization) accretion1
 
$
(9.6
)
 
$
 
 
$
(0.4
)
 
$
6.8
 
 
$
 
 
$
 
 
$
(3.2
)
Net interest settlements
 
(107.3
)
 
(1.7
)
 
 
 
85.8
 
 
 
 
 
 
(23.2
)
Total net interest income
 
(116.9
)
 
(1.7
)
 
(0.4
)
 
92.6
 
 
 
 
 
 
(26.4
)
Net Gain (Loss) on Derivatives and Hedging Activities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gains (losses) on fair value hedges
 
0.9
 
 
0.1
 
 
 
 
(0.9
)
 
 
 
 
 
0.1
 
(Losses) gains on economic hedges
 
(0.5
)
 
(23.4
)
 
 
 
15.1
 
 
(0.1
)
 
(15.7
)
 
(24.6
)
Total net gain (loss) on derivatives and hedging activities
 
0.4
 
 
(23.3
)
 
 
 
14.2
 
 
(0.1
)
 
(15.7
)
 
(24.5
)
Subtotal
 
(116.5
)
 
(25.0
)
 
(0.4
)
 
106.8
 
 
(0.1
)
 
(15.7
)
 
(50.9
)
Net gain on trading securities2
 
 
 
24.1
 
 
 
 
 
 
 
 
 
 
24.1
 
Net gain on consolidated obligations held at fair value2
 
 
 
 
 
 
 
6.1
 
 
 
 
 
 
6.1
 
Total net effect of hedging activities
 
$
(116.5
)
 
$
(0.9
)
 
$
(0.4
)
 
$
112.9
 
 
$
(0.1
)
 
$
(15.7
)
 
$
(20.7
)
1
Represents the amortization/accretion of hedging fair value adjustments for both open and closed hedge positions included in net interest income.
2
Represents the gains/losses on those trading securities and fair value option consolidated obligations in which we have entered into a corresponding economic derivative to hedge the risk of changing market prices. As a result, this line item may not agree to the Statement of Income.
 
NET AMORTIZATION/ACCRETION
 
Amortization/accretion varies from period to period depending on our hedge relationship termination activities. During the three months ended March 31, 2011, the increase in net amortization was primarily due to advance hedge relationships. Advance amortization increased when compared to the same period in 2010 due primarily to the full amortization of basis adjustments on advances that prepaid during the three months ended March 31, 2011.
 
NET INTEREST SETTLEMENTS
 
Net interest settlements represent the interest component on derivatives that qualify for hedge accounting. These amounts vary from period to period depending on our hedging activities and interest rates and are partially offset by the interest component on the related hedged item within net interest income.
 
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 gains (losses) on fair value hedges. Volatility in the marketplace may also intensify this impact.
 

50


(LOSSES) GAINS ON ECONOMIC HEDGES
 
Derivatives accounted for as economic hedges are used to manage interest rate risk, including mortgage prepayment risk, in our Statement of Condition. Changes in (losses) gains on economic hedges are primarily driven by changes in interest rates and volatility as well as the amount of economic hedges outstanding. 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 instruments), 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. Losses and gains on economic hedges were primarily impacted by the following items:
 
Investments
 
We held interest rate swaps on our balance sheet as economic hedges against changes in the fair value of a portion of our trading securities (i.e. TLGP debt investments and taxable municipal bonds) indexed to LIBOR. Due to changes in interest rates, we recorded $6.1 million in gains on the economic derivatives during the three months ended March 31, 2011, partially offset by $4.0 million of interest expense accruals. Generally, the gains on the economic derivatives are offset by the losses on the trading securities. During the three months ended March 31, 2011, losses on the trading securities were $3.1 million and were recorded in “Net (loss) gain on trading securities” in other (loss) income. During the three months ended March 31, 2010, we recorded $14.5 million in losses on the economic derivatives, coupled with $8.9 million of interest expense accruals, and recorded gains on the trading securities of $24.1 million.
 
Bonds
 
We perform retrospective hedge effectiveness testing monthly 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. During the three months ended March 31, 2011, we recorded losses on ineffective bond hedge relationships of $3.9 million compared to gains of $2.3 million for the same period in 2010. The losses were due to changes in interest rates.
 
During the three months ended March 31, 2011, interest income accruals on economic bond hedges amounted to $7.7 million compared to $11.7 million for the same period in 2010. The decrease was due to changes in interest rates and a decrease in the number of economic bond hedges.
 
Balance Sheet
 
We held interest rate caps on our balance sheet in order to protect against changes in mortgage prepayments and increases in interest rates on our variable rate MBS. During the three months ended March 31, 2011, due to decreased market volatility, we recorded $5.8 million in losses on these interest rate caps compared to losses of $15.7 million for the same period in 2010. The net losses during the three months ended March 31, 2011 were partially offset by realized gains of $0.6 million from the sale of certain interest rate caps. We paid $75.3 million in premiums on the interest rate caps outstanding at March 31, 2011. This premium cost is effectively amortized over the life of the derivative through the monthly mark-to-market adjustments.
 
We held interest rate floors on our balance sheet in order to protect against decreases in interest rates. During the three months ended March 31, 2011, due to changes in interest rates and the sale of all outstanding interest rate floors, we recorded net losses of $1.3 million. We did not hold any interest rate floors during the three months ended March 31, 2010.
 
 
 

51


Statement of Condition
 
MARCH 31, 2011 AND DECEMBER 31, 2010
 
Financial Highlights
 
Our total assets decreased to $52.8 billion at March 31, 2011 from $55.6 billion at December 31, 2010. Our total liabilities decreased to $50.1 billion at March 31, 2011 from $52.7 billion at December 31, 2010. Total capital was $2.7 billion at March 31, 2011 compared to $2.8 billion at December 31, 2010. The overall financial condition for the periods presented has been primarily influenced by changes in funding activities, advances, investments, and mortgage loans. See further discussion of changes in our financial condition in the appropriate sections that follow.
 

Advances
 
The following table summarizes our advances by type of institution (dollars in millions):
 
March 31,
2011
 
December 31,
2010
Commercial banks
$
11,729
 
 
$
12,821
 
Thrifts
1,295
 
 
1,540
 
Credit unions
703
 
 
707
 
Insurance companies
12,900
 
 
12,783
 
Total member advances
26,627
 
 
27,851
 
Housing associates
550
 
 
500
 
Non-member borrowers
145
 
 
152
 
Total par value
$
27,322
 
 
$
28,503
 
 
Our advances decreased 4 percent at March 31, 2011 when compared to December 31, 2010. The decrease was due to the continued high level of liquidity in the market and the low loan demand experienced by our members. These factors drove down demand for new advances, reduced the propensity of members to renew advances, and incented members to prepay advances.
 
The following table summarizes our advances by product type (dollars in millions):
 
March 31, 2011
 
December 31, 2010
 
Amount
 
% of Total
 
Amount
 
% of Total
Variable rate
$
8,480
 
 
31.0
%
 
$
8,570
 
 
30.1
%
Fixed rate
18,418
 
 
67.4
 
 
19,503
 
 
68.4
 
Amortizing
424
 
 
1.6
 
 
430
 
 
1.5
 
Total par value
27,322
 
 
100.0
%
 
28,503
 
 
100.0
%
Fair value hedging adjustments
 
 
 
 
 
 
 
Cumulative fair value gain on existing hedges
561
 
 
 
 
663
 
 
 
Basis adjustments from terminated hedges
80
 
 
 
 
87
 
 
 
Total advances
$
27,963
 
 
 
 
$
29,253
 
 
 
    
Cumulative fair value gains on existing hedges decreased $102 million at March 31, 2011 when compared to December 31, 2010 due primarily to an increase 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 $7 million at March 31, 2011 when compared to December 31, 2010 due primarily to the normal amortization of basis adjustments.
 
At March 31, 2011 and December 31, 2010, advances outstanding to our five largest member borrowers totaled $12.2 billion and $12.7 billion, representing 45 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 recorded any allowance for credit losses on our 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.”

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Mortgage Loans
 
The following table summarizes information on our mortgage loans held for portfolio (dollars in millions):
 
March 31,
2011
 
December 31,
2010
Fixed rate conventional loans
$
6,818
 
 
$
7,033
 
Fixed rate government-insured loans
370
 
 
370
 
Total unpaid principal balance
7,188
 
 
7,403
 
Premiums
63
 
 
64
 
Discounts
(37
)
 
(41
)
Basis adjustments from mortgage loan commitments
6
 
 
8
 
Allowance for credit losses
(18
)
 
(13
)
Total mortgage loans held for portfolio, net
$
7,202
 
 
$
7,421
 
    
Our mortgage loans decreased 3 percent at March 31, 2011 when compared to December 31, 2010. The decrease was primarily due to principal repayments exceeding loan purchases. As interest rates increased during the three months ended March 31, 2011, our MPF funding volumes decreased and prepayments began to slow down.
 
At March 31, 2011 and December 31, 2010, mortgage loans acquired from Superior Guaranty Insurance Company (Superior), an affiliate of Wells Fargo Bank, N.A., amounted to $3.2 billion and $3.5 billion. We have not purchased mortgage loans from Superior since 2004.
 
During the three months ended March 31, 2011, we recorded an additional provision for credit losses of $5.6 million. The provision recorded was driven by an increase in estimated losses resulting from increased loss severities, management's expectation that loans migrating to REO and loss severities will likely increase in the future, and certain refinements made to our allowance for credit losses model. For additional discussion on our mortgage loan credit risk, refer to "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management — Credit Risk — Mortgage Assets.”
 
Effective March 28, 2011, based on a decision of the MPF Governance Committee, participating MPF FHLBanks are now allowed to adjust the base price of MPF loan products provided by the FHLBank of Chicago.

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Investments
 
The following table summarizes the book value of our investments (dollars in millions):
 
March 31, 2011
 
December 31, 2010
 
Amount
 
% of Total
 
Amount
 
% of Total
Short-term investments
 
 
 
 
 
 
 
Interest-bearing deposits
$
1
 
 
%
 
$
1
 
 
%
Securities purchased under agreements to resell
1,600
 
 
9.2
 
 
1,550
 
 
8.3
 
Federal funds sold
2,152
 
 
12.4
 
 
2,025
 
 
10.9
 
Negotiable certificates of deposit
 
 
 
 
335
 
 
1.8
 
Commerical paper
100
 
 
0.6
 
 
 
 
 
Total short-term investments
3,853
 
 
22.2
 
 
3,911
 
 
21.0
 
Long-term investments
 
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
 
Government-sponsored enterprise
10,324
 
 
59.4
 
 
11,301
 
 
60.6
 
Other U.S. obligation
33
 
 
0.2
 
 
34
 
 
0.2
 
Private-label
57
 
 
0.3
 
 
59
 
 
0.3
 
Total mortgage-backed securities
10,414
 
 
59.9
 
 
11,394
 
 
61.1
 
Non-mortgage-backed securities
 
 
 
 
 
 
 
Interest-bearing deposits
7
 
 
 
 
8
 
 
0.1
 
Government-sponsored enterprise obligations
831
 
 
4.8
 
 
835
 
 
4.5
 
Other U.S. obligations
171
 
 
1.0
 
 
176
 
 
0.9
 
State or local housing agency obligations
101
 
 
0.6
 
 
107
 
 
0.6
 
TLGP
1,578
 
 
9.1
 
 
1,780
 
 
9.5
 
Taxable municipal bonds
422
 
 
2.4
 
 
424
 
 
2.3
 
Other
4
 
 
 
 
4
 
 
 
Total non-mortgage-backed securities
3,114
 
 
17.9
 
 
3,334
 
 
17.9
 
Total long-term investments
13,528
 
 
77.8
 
 
14,728
 
 
79.0
 
Total investments
$
17,381
 
 
100.0
%
 
$
18,639
 
 
100.0
%
 
Our investments decreased 7 percent at March 31, 2011 when compared to December 31, 2010. The decrease was primarily due to principal repayments on our MBS, partially offset by increased Federal funds sold and securities purchased under agreements to resell as well as the purchase of commercial paper.
 
We evaluate our individual AFS 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 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 reporting 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 7 — Other-Than-Temporary Impairment” for a discussion of our OTTI analysis performed at March 31, 2011. As a result of our analysis, we determined that all gross unrealized losses on our investment portfolio 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 March 31, 2011.
 

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Consolidated Obligations
 
Consolidated obligations, which include bonds and discount notes, are the primary source of funds to support our advances, investments, and mortgage loans. 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 March 31, 2011 and December 31, 2010, the book value of consolidated obligations issued on our behalf totaled $48.2 billion and $51.0 billion.
 
BONDS
 
The following table summarizes information on our bonds (dollars in millions):
 
March 31,
2011
 
December 31,
2010
Total par value
$
44,224
 
 
$
43,609
 
Premiums
37
 
 
40
 
Discounts
(28
)
 
(30
)
Fair value hedging adjustments
 
 
 
Cumulative fair value loss on existing hedges
86
 
 
182
 
Basis adjustments from terminated and ineffective hedges
(33
)
 
(12
)
Fair value option adjustments
 
 
 
Cumulative fair value gain
 
 
(1
)
Accrued interest payable
3
 
 
3
 
Total bonds
$
44,289
 
 
$
43,791
 
 
Our bonds increased 1 percent at March 31, 2011 when compared to December 31, 2010. The increase was primarily due to us issuing callable debt during the three months ended March 31, 2011 in order to reduce interest rate sensitivity in our mortgage portfolio.
 
Cumulative fair value losses on existing hedges decreased $96 million at March 31, 2011 when compared to December 31, 2010 due primarily to an increase 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.
 
The change in basis adjustments from terminated and ineffective hedges at March 31, 2011 when compared to December 31, 2010 was due primarily to us unwinding certain interest rate swaps. During the three months ended March 31, 2011, we recalibrated our internal prepayment model which slowed down the projected speed of mortgage prepayments and lengthened the average life of our mortgage assets. To maintain a relatively neutral risk profile, we unwound certain interest rate swaps on our fixed rate debt in order to lengthen the life of the liabilities funding the mortgage assets. This unwind activity subsequently resulted in basis adjustments that are amortized using the effective-yield method over the remaining life of the bond.
 
Fair Value Option Bonds
 
At March 31, 2011 and December 31, 2010, approximately $2.6 billion and $2.8 billion of our bonds were recorded under the fair value option. We elected the fair value option on these bonds because they did not qualify for hedge accounting and, in most instances, we entered into interest rate swaps accounted for as economic derivatives to achieve some offset to the mark-to-market on the fair value option bonds. During the three months ended March 31, 2011, we recorded fair value adjustment losses on these bonds of $1.1 million and fair value adjustment losses of $0.4 million on the related economic derivatives. During the three months ended March 31, 2010, we recorded fair value adjustment gains on the bonds of $6.1 million and fair value adjustment gains of $1.0 million on the related economic derivatives.
 

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DISCOUNT NOTES
 
The following table summarizes our discount notes, all of which are due within one year (dollars in millions):
 
March 31,
2011
 
December 31,
2010
Par value
$
3,929
 
 
$
7,209
 
Discounts
(1
)
 
(1
)
Total
$
3,928
 
 
$
7,208
 
    
Discount notes decreased 46 percent at March 31, 2011 when compared to December 31, 2010. The decrease was primarily due to us replacing maturing discount notes with bonds as a result of improved longer-term funding costs and our desire to extend the duration of our liabilities.
 
Fair Value Option Discount Notes
 
During the three months ended March 31, 2011, we began electing the fair value option on certain discount notes that did not qualify for hedge accounting. At March 31, 2011, approximately $0.2 billion of our discount notes were recorded under the fair value option. We entered into interest rate swaps accounted for as economic derivatives to achieve some offset to the mark-to-market on these discount notes. During the three months ended March 31, 2011, we recorded fair value adjustment gains on these discount notes of $0.1 million and fair value adjustment gains of $0.1 million on the related economic derivatives.
 
For additional information on our consolidated obligations, 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) was $2.7 billion at March 31, 2011 compared to $2.8 billion at December 31, 2010. Our capital stock decreased 3 percent due primarily to the repurchase of activity-based capital stock resulting from lower advance and MPF loan activity. Our retained earnings, which totaled $565.1 million at March 31, 2011, increased 2 percent due to net income earned during the three months ended March 31, 2011, partially offset by the payment of dividends. Our accumulated other comprehensive income decreased $26.5 million due to a decrease in unrealized gains on available-for-sale securities resulting primarily from an increase in interest rates.
 

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Derivatives
 
We use derivatives to manage interest rate risk, including mortgage prepayment risk, in our Statement of Condition and to achieve our risk management objectives. 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):
 
March 31,
2011
 
December 31,
2010
Interest rate swaps
 
 
 
Noncallable
$
21,552
 
 
$
20,709
 
Callable by counterparty
13,457
 
 
13,229
 
Callable by the Bank
35
 
 
35
 
Total interest rate swaps
35,044
 
 
33,973
 
Interest rate caps
3,450
 
 
4,350
 
Interest rate floors
 
 
2,600
 
Forward settlement agreements (TBAs)
83
 
 
96
 
Mortgage delivery commitments
82
 
 
96
 
Total notional amount
$
38,659
 
 
$
41,115
 
    
The notional amount of our derivative contracts decreased 6 percent at March 31, 2011 when compared to December 31, 2010. The decrease was primarily due to the sale of interest rate floors. During the three months ended March 31, 2011, as a result of us recalibrating our internal prepayment model and increased interest rates, we sold all of our interest rate floors. Refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management — Market Risk — Market Value of Capital Stock Sensitivity” for additional details on our prepayment model recalibration and interest rate sensitivity.
   
 
 
 

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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 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 values of outstanding consolidated obligations issued on behalf of other FHLBanks for which the Bank is jointly and severally liable were approximately $717.8 billion and $745.5 billion at March 31, 2011 and December 31, 2010.
 
Our ability to raise funds in the capital markets as well as our cost of borrowing may be affected by our credit ratings. As of March 31, 2011, consolidated obligations of the FHLBanks were 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.
 
On April 18, 2011, S&P affirmed the AAA long-term credit rating on the United States of America but revised its outlook to negative from stable. This action stemmed from the United States economic and fiscal risks and large external debtor position. Following this action, on April 20, 2011, S&P affirmed the FHLBank System's AAA credit rating as well as our individual AAA credit rating, but revised the outlook on both of these credit ratings to negative from stable. These rating agency actions did not have a material impact on our ability to raise funds in the capital markets or our cost of borrowing and we do not anticipate them to have a material impact on us in the future.
 
During the three months ended March 31, 2011, proceeds from the issuance of bonds and discount notes were $6.9 billion and $120.7 billion compared to $12.1 billion and $115.5 billion for the same period in 2010. We increased our utilization of discount notes primarily to fund advances and term investments as well as to provide general liquidity throughout the three months ended March 31, 2011 and 2010. We decreased our utilization of bonds during the three months ended March 31, 2011 when compared to the same period in 2010 due primarily to a decline in total average assets. As longer-term funding costs remained favorable during the three months ended March 31, 2011, we replaced maturing discount notes with bonds, when warranted, to extend the duration of our liabilities. Many of these bonds had callable features in order to reduce interest rate sensitivity in our mortgage portfolio.
 
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 government-sponsored enterprises, including FHLBanks, up to an aggregate principal amount of $4.0 billion. As of April 30, 2011, 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 three months ended March 31, 2011, advance disbursements totaled $7.1 billion compared to $5.4 billion for the same period in 2010. Despite an increase in advance disbursements, our overall advance balance declined during the three months ended March 31, 2011 as a result of maturities and prepayments exceeding advance originations.
 
During the three months ended March 31, 2011, investment purchases (excluding overnight investments) totaled $8.5 billion compared to $4.2 billion for the same period in 2010. The increase was primarily due to us purchasing commercial paper and term Federal funds sold during the three months ended March 31, 2011.
 

58


Other uses of liquidity include purchases of mortgage loans, repayment of member deposits and consolidated obligations, redemption or repurchases of capital stock, payment of expenses, and payment of dividends. During the three months ended March 31, 2011 and 2010, we called $4.9 billion and $2.2 billion of higher-costing par value bonds in an effort to reposition our balance sheet.
 
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 where we are unable 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 March 31, 2011 and December 31, 2010, 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 March 31, 2011 and December 31, 2010, 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. At March 31, 2011 and December 31, 2010, we were in compliance with all three of the Finance Agency's regulatory capital requirements. For additional information, refer to "Item 1. Financial Statements — Note 13 — Capital."
 
Capital Stock
Our capital stock has a par value of $100 per share, and all shares are issued, exchanged, redeemed, and repurchased only by us at the stated par value. We have two subclasses of capital stock: membership capital stock and activity-based capital stock. Each member must purchase and hold membership capital stock equal to a percentage of its total assets as of the preceding December 31st. Each member is also required to purchase activity-based capital stock equal to a percentage of its outstanding transactions and commitments and to hold that activity-based capital stock as long as the transactions and commitments remain outstanding.
 
Although activity-based capital stock is subject to the five year notice of redemption period prescribed under our Capital Plan, we typically repurchase excess activity-based capital stock that exceeds an operational threshold set forth in the Capital Plan on a scheduled monthly basis, subject to certain limitations set forth in our Capital Plan.
 
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 $58.4 million and $57.7 million at March 31, 2011 and December 31, 2010.
 

59


The following table summarizes our capital stock by member type (dollars in millions):
 
March 31,
2011
 
December 31,
2010
Commercial banks
$
1,005
 
 
$
1,050
 
Thrifts
114
 
 
128
 
Credit unions
94
 
 
96
 
Insurance companies
905
 
 
909
 
Total GAAP capital stock
2,118
 
 
2,183
 
Mandatorily redeemable capital stock
7
 
 
7
 
Total regulatory capital stock1
$
2,125
 
 
$
2,190
 
1
 
Approximately 74 and 75 percent of our total regulatory capital stock outstanding at March 31, 2011 and December 31, 2010 was activity-based capital stock that fluctuates with the outstanding balances of advances made to members and mortgage loans purchased from members.
 
The decrease in regulatory capital stock at March 31, 2011 when compared to December 31, 2010 was primarily due to the repurchase of activity-based capital stock resulting from lower outstanding advance and mortgage loan balances.
 
Retained Earnings
In August 2003, the Finance Agency issued a directive that encouraged all 12 FHLBanks to establish retained earnings targets and to specify the priority for increasing retained earnings relative to paying dividends. Our Enterprise Risk Management Policy (ERMP) requires a minimum retained earnings level based on the level of market risk, credit risk, and operational risk within the Bank. If realized financial performance results in actual retained earnings below the minimum level, we, as determined by our Board of Directors, will establish an action plan, which may include a dividend cap at less than the current earned dividend, to enable us to return to our targeted level of retained earnings within twelve months. At March 31, 2011, our actual retained earnings were above the minimum level, and therefore no action plan was necessary.
 
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 three months ended March 31, 2011, we paid cash dividends of $16.9 million compared to $14.6 million for the same period in 2010. The annualized dividend rate paid for the three months ended March 31, 2011 and 2010 was 3.00 percent and 2.00 percent.
Joint Capital Enhancement Agreement
Effective February 28, 2011, we entered into a Joint Capital Enhancement Agreement (JCE Agreement) with the other 11 FHLBanks. The JCE Agreement provides that upon satisfaction of the FHLBanks' obligations to REFCORP, each FHLBank will, on a quarterly basis, allocate at least 20 percent of its net income to a Separate Restricted Retained Earnings Account (RRE Account). Currently, the REFCORP obligations are expected to be fully satisfied during the 2011 calendar year. Under the JCE Agreement, each FHLBank will be required to build its RRE Account to one percent of its total outstanding consolidated obligations, which for this purpose is based on the most recent quarter's average carrying value of all consolidated obligations for which an FHLBank is the primary obligor, excluding fair value option and hedging adjustments.
 

60


The JCE Agreement further requires each FHLBank to submit an application to the Finance Agency for approval to amend its capital plan or capital plan submission, as applicable, consistent with the terms of the JCE Agreement. Under the JCE Agreement, if the FHLBanks' REFCORP obligation terminates before the Finance Agency has approved all proposed capital plan amendments submitted pursuant to the JCE Agreement, each FHLBank will nevertheless be required to commence the required allocation to its separate restricted retained earnings account beginning as of the end of the calendar quarter in which the final payments are made by the FHLBanks with respect to their REFCORP obligations. Depending on the earnings of the FHLBanks, the REFCORP obligations could be satisfied as of the end of the second quarter of 2011. As of the date of this report, representatives of the Bank have been in discussions with the Finance Agency on amending its capital plan to incorporate the terms of the JCE Agreement. Such discussions regarding the proposed capital plan amendments could result in amendments to the JCE Agreement, including, among other things, possible revisions to the termination provisions. For additional details on the JCE Agreement, see “Item 1. Business — Capital and Dividends” in our 2010 Form 10-K.
 
Critical Accounting Policies and Estimates
 
For a discussion of our critical accounting policies and estimates, refer to our 2010 Form 10-K. There have been no material changes to our critical accounting policies and estimates during the three months ended March 31, 2011.
 

Legislative and Regulatory Developments
 
Our legislative and regulatory environment continues to change as financial regulators issue proposed and/or final rules to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) enacted in July 2010 and Congress begins to debate proposals for housing finance and GSE reform.
 
DODD-FRANK ACT
 
As discussed in our 2010 Form 10-K, the Dodd-Frank Act will likely impact the FHLBanks' business operations, funding costs, rights, obligations, and/or the environment in which the FHLBanks carry out their housing finance mission. Certain regulatory actions during the period covered by this report resulting from the Dodd-Frank Act that may have an important impact on us are summarized below, although the full effect of the Dodd-Frank Act will become known only after the required regulations, studies, and reports are issued and finalized.
 
New Requirements for our Derivatives Transactions
 
The Dodd-Frank Act provides for new statutory and regulatory requirements for derivative transactions, including those utilized by us to hedge our interest rate and other risks. As a result of these requirements, certain derivative transactions will be required to be cleared through a third-party central clearinghouse and traded on regulated exchanges or new swap execution facilities. Such cleared trades are expected to be subject to initial and variation margin requirements established by the clearinghouse and its clearing members. While clearing swaps may reduce counterparty credit risk, the margin requirements for cleared trades have the potential of making derivative transactions more costly.
The Dodd-Frank Act will also change the regulatory landscape for derivative transactions that are not subject to mandatory clearing requirements (uncleared trades). While we expect to continue to enter into uncleared trades on a bilateral basis, such trades are expected to be subject to new regulatory requirements, including new mandatory reporting requirements, new documentation requirements, and new minimum margin and capital requirements imposed by bank and other federal regulators. Under the proposed margin rules, we will have to post both initial margin and variation margin to our swap dealer counterparties, but may be eligible in both instances for modest unsecured thresholds as "low risk financial end users." Pursuant to additional Finance Agency proposals, we will be required to collect both initial margin and variation margin from our swap dealer counterparties, without any thresholds. These margin requirements and any related capital requirements could adversely impact the liquidity and pricing of certain uncleared derivative transactions entered into by us and thus make uncleared trades more costly.
The U.S. Commodity Futures Trading Commission (CFTC) has issued a proposed rule requiring that collateral posted by swaps customers to a clearinghouse in connection with cleared swaps be legally segregated on a customer basis. However, in connection with this proposed rule the CFTC has left open the possibility that customer collateral would not have to be legally segregated but could instead be commingled with all collateral posted by other customers of the clearing member. Such commingling would put our collateral at risk in the event of a default by another customer of our clearing member. To the extent that the CFTC's final rule places our posted collateral at greater risk of loss in the clearing structure than under the current over-the-counter market structure, we may be adversely impacted.

61


The Dodd-Frank Act will require swap dealers and certain other large users of derivatives to register as “swap dealers” or “major swap participants,” as the case may be, with the CFTC and/or the SEC. Based on the definitions in the proposed rules jointly issued by the CFTC and SEC, it does not appear likely that we will be required to register as a “major swap participant,” although this remains a possibility. Also, based on the definitions in the proposed rules, it does not appear likely that we will be required to register as a “swap dealer” as a result of the derivative transactions that we enter into with dealer counterparties for the purpose of hedging and managing our interest rate risk, which constitute the majority of our derivative transactions.
It is also unclear how the final rule will treat caps, floors, and other derivatives embedded in advances to our members. The CFTC and SEC have issued joint proposed rules further defining the term “swap” under the Dodd-Frank Act. These proposed rules and accompanying interpretive guidance clarify that certain products will or will not be regulated as “swaps.” However, at this time it remains unclear whether certain transactions between us and our member customers will be treated as “swaps.” Depending on how the terms “swap” and “swap dealer” are finally defined in the final regulations, we may be faced with the business decision of whether to continue to offer “swaps” to member customers if those transactions would require us to register as a swap dealer. Designation as a swap dealer would subject us to significant additional regulation and cost including, without limitation, registration with the CFTC, new internal and external business conduct standards, additional reporting requirements, and additional swap-based capital and margin requirements. Even if we are designated as a swap dealer, the proposed regulation would permit us to apply to the CFTC to limit such designation to those specified activities for which we are acting as a swap dealer. Upon such designation, our hedging activities would not be subject to the full requirements that will generally be imposed on traditional swap dealers.
We, together with the other FHLBanks, are actively participating in the development of the regulations under the Dodd-Frank Act by formally commenting to the regulators regarding a variety of rules that could impact the FHLBanks. It is not expected that final rules implementing the Dodd-Frank Act will become effective until the latter half of 2011 and delays beyond that time are possible.
 
REGULATION OF CERTAIN NONBANK FINANCIAL COMPANIES
 
Federal Reserve Board Proposed Rule on Regulatory Oversight of Nonbank Financial Companies
 
On February 11, 2011, the Federal Reserve Board issued a proposed rule that would define certain key terms to determine which nonbank financial companies will be subject to the Federal Reserve's regulatory oversight. The proposed rule provides that a company is “predominantly engaged in financial activities” if:
 
the annual gross financial revenue of the company represents 85 percent or more of the company's gross revenue in either of its two most recent completed fiscal years; or
 
the company's total financial assets represent 85 percent or more of the company's total assets as of the end of either of its two most recently completed fiscal years.
 
We believe we would be deemed predominantly engaged in financial activities under either prong of the proposed rule. In pertinent part to us, the proposed rule also defines “significant nonbank financial company” to mean a nonbank financial company that had $50 billion or more in total assets as of the end of its most recently completed fiscal year. If we are determined to be a nonbank financial company subject to the Federal Reserve's regulatory oversight, then our operations and business may be adversely affected by such oversight.
 
Oversight Council Notice of Proposed Rulemaking on Authority to Supervise and Regulate Certain Nonbank Financial Companies
 
On January 26, 2011, the Oversight Council issued a proposed rule that would implement the Oversight Council's authority to subject nonbank financial companies to the supervision of the Federal Reserve Board and certain prudential standards. The proposed rule defines “nonbank financial company” broadly enough to likely cover the Bank. Also, under the proposed rule, the Oversight Council will consider certain factors in determining whether to subject a nonbank financial company to supervision and prudential standards. Some factors identified include: (i) the availability of substitutes for the financial services and products the entity provides as well as the entity's size; (ii) interconnectedness with other financial firms; (iii) leverage, liquidity risk; and (iv) maturity mismatch and existing regulatory scrutiny. If we are determined to be a nonbank financial company subject to the Oversight Council's regulatory requirements, then our operations and business are likely to be affected. 

62


Oversight Council Recommendations on Implementing the Volcker Rule
 
In January 2011, the Oversight Council issued recommendations for implementing certain prohibitions on proprietary trading, commonly referred to as the Volcker Rule. Institutions subject to the Volcker Rule may be subject to various limits with regard to their proprietary trading and various regulatory requirements to ensure compliance with the Volcker Rule. If we are made subject to the Volcker Rule, then we may be subject to additional limitations on the composition of our investment portfolio beyond FHFA regulations. These limitations may potentially result in less profitable investment alternatives. Further, complying with related regulatory requirements would be likely to increase our regulatory requirements and incremental costs. The FHLBank System's consolidated obligations generally are exempt from the operation of this rule, subject to certain limitations, including the absence of conflicts of interest and certain financial risks.
 
FDIC REGULATORY ACTIONS
 
FDIC Interim Final Rule on Dodd-Frank Orderly Liquidation Resolution Authority
 
On January 25, 2011, the FDIC issued an interim final rule on how the FDIC would treat certain creditor claims under the new orderly liquidation authority established by the Dodd-Frank Act. The Dodd-Frank Act provides for the appointment of the FDIC as receiver for a financial company, not including FDIC-insured depository institutions, in instances where the failure of the company and its liquidation under other insolvency procedures (such as bankruptcy) would pose a significant risk to the financial stability of the United States. The interim final rule provides, among other things:
 
a valuation standard for collateral on secured claims;
 
that all unsecured creditors must expect to absorb losses in any liquidation and that secured creditors will only be protected to the extent of the fair value of their collateral;
 
a clarification of the treatment for contingent claims; and
 
that secured obligations collateralized with U.S. government obligations will be valued at fair market value. 
 
Valuing most collateral at fair value, rather than par, could adversely impact the value of our investments in the event of the issuer's insolvency. Comments on this interim final rule were due by March 28, 2011.
 
FDIC Final Rule on Assessment System
 
On February 25, 2011, the FDIC issued a final rule to revise the assessment system applicable to FDIC insured financial institutions. The rule, among other things, implements a provision in the Dodd-Frank Act to redefine the assessment base used for calculating deposit insurance assessments. Specifically, the rule changes the assessment base for most institutions from adjusted domestic deposits to average consolidated total assets minus average tangible equity. This rule became effective on April 1, 2011, so FHLBank advances are now included in our members' assessment base. The rule also eliminates an adjustment to the base assessment rate paid for secured liabilities, including FHLBank advances, in excess of 25 percent of an institution's domestic deposits since these are now part of the assessment base. The change in assessment base may affect member demand for our advances.
 

63


JOINT REGULATORY ACTIONS
 
Proposed Rule on Incentive-Based Compensation Arrangements
 
On April 14, 2011, seven federal financial regulators, including the Finance Agency, published a proposed rule that would prohibit “covered financial institutions” from entering into incentive-based compensation arrangements that encourage inappropriate risks.
 
Applicable to the FHLBanks and the Office of Finance, the rule would:
 
prohibit excessive compensation;
 
prohibit incentive compensation that could lead to material financial loss;
 
require an annual report;
 
require policies and procedures; and
 
require mandatory deferrals of 50 percent of incentive compensation over three years for executive officers.
 
Covered persons under the rule would include senior management responsible for the oversight of firm wide activities or material business lines, and non-executive employees or groups of those employees whose activities may expose the institution to a material loss.
 
Under the proposed rule, covered financial institutions would be required to comply with three key risk management principles related to the design and governance of incentive-based compensation: balanced design, independent risk management controls, and strong governance.
 
The proposed rule identifies four methods to balance compensation design and make it more sensitive to risk: risk adjustment of awards, deferral of payment, longer performance periods and reduced sensitivity to short-term performance. Larger covered financial institutions, like the Bank, would also be subject to a mandatory 50 percent deferral of incentive-based compensation for executive officers and board oversight of incentive-based compensation for certain risk-taking employees who are not executive officers. The proposed rule would impact the design of our compensation policies and practices, including our incentive compensation policies and practices, if adopted as proposed. Comments on the proposed rule are due by May 31, 2011.
 
Proposed Rule on Credit Risk Retention for Asset-Backed Securities
 
On April 29, 2011, the Federal banking agencies, the Finance Agency, the Department of Housing and Urban Development, and the SEC jointly issued a proposed rule, which proposes requiring sponsors of asset-backed securities to retain a minimum of five percent economic interest in a portion of the credit risk of the assets collateralizing asset-backed securities, unless all the assets securitized satisfy specified qualifications.
 
The proposed rule specifies criteria for qualified residential mortgages, commercial real estate, auto, and commercial loans that would make them exempt from the risk retention requirement. The criteria for qualified residential mortgages is described in the proposed rulemaking as those underwriting and product features which, based on historical data, are associated with low risk even in periods of decline of housing prices and high unemployment.
 
Key issues in the proposed rule include: (i) the appropriate terms for treatment as a qualified residential mortgage; (ii) the extent to which Fannie Mae and Freddie Mac related securitizations will be exempt from the risk retention rules; and (iii) the possibility of creating a category of high quality non-qualified residential mortgage loans that would have less than a five percent risk retention requirement.
 
If adopted as proposed, the rule could reduce the number of loans originated by our members, which could negatively impact member demand for our products. Comments on this proposed rule are due on June 10, 2011.
 

64


HOUSING FINANCE AND GSE REFORM
 
In the wake of the financial crisis and related housing problems, both Congress and the Obama Administration are considering changes to the U.S. housing finance structure, specifically reforming or eliminating Fannie Mae and Freddie Mac. These efforts may have implications for the FHLBanks.
 
On February 11, 2011, the Department of the Treasury and the U.S. Department of Housing and Urban Development issued a report to Congress entitled Reforming America's Housing Finance Market. The report's primary focus is to provide options for Congressional consideration regarding the long-term structure of housing finance, including reforms specific to Fannie Mae and Freddie Mac. In addition, the Obama Administration noted it would work, in consultation with the Finance Agency and Congress, to restrict the areas of mortgage finance in which Fannie Mae, Freddie Mac and the FHLBanks operate so that overall government support of the mortgage market will be substantially reduced over time.
 
Although the FHLBanks are not the primary focus of this report, they are recognized as playing a vital role in helping smaller financial institutions access liquidity and capital to compete in an increasingly competitive marketplace. The report suggests the following possible reforms for the FHLBank System:  
 
focus the FHLBanks on small- and medium-sized financial institutions;
 
restrict membership by allowing each institution eligible for membership to be an active member in only a single FHLBank;
 
limit the level of outstanding advances to larger members; and
 
reduce FHLBank investment portfolios and their composition, focusing FHLBanks on providing liquidity for insured depository institutions.  
 
The report also supports exploring additional means to provide funding to housing lenders, including potentially the development of a covered bond market.
 
In response, several bills have been introduced in Congress. While none propose specific changes to the FHLBanks, we could nonetheless be affected in numerous ways by changes to the U.S. housing finance structure and to Fannie Mae and Freddie Mac. For example, the FHLBanks traditionally have allocated a significant portion of their investment portfolio to investments in Fannie Mae and Freddie Mac debt securities and other guaranteed MBS. Accordingly, the FHLBanks' investment strategies would likely be affected by winding down those entities. Winding down those two GSEs, or limiting the amount of mortgages they purchase, also could increase demand for FHLBank advances if FHLBank members respond by retaining more of their mortgage loans in portfolio, using advances to fund the loans.
 
It is also possible that Congress will consider any or all of the specific changes to the FHLBanks suggested by the Administration's proposal. If legislation is enacted incorporating these changes, the FHLBanks could be significantly limited in their ability to make advances to their members and subject to additional limitations on their investment authority. Additionally, if Congress enacts legislation encouraging the development of a covered bond market, FHLBank advances could be reduced in time as larger members use covered bonds as an alternative form of wholesale mortgage financing.
 
The ultimate effect of housing finance and GSE reform on the FHLBanks is unknown at this time and will depend on the legislation, if any, that is finally enacted.
 

65


FINANCE AGENCY REGULATORY ACTIONS
 
Final Rule on Temporary Increases in Minimum Capital Levels
 
On March 3, 2011, the Finance Agency issued a final rule effective April 4, 2011 authorizing the Director of the Finance Agency to increase the minimum capital level for an FHLBank if the Director determines that the current level is insufficient to address such FHLBank's risks. The rule provides the factors that the Director may consider in making this determination including the FHLBank's:
               
current or anticipated declines in the value of assets held by it;
 
ability to access liquidity and funding;
 
credit, market, operational and other risks;
 
current or projected declines in its capital;
 
material compliance with regulations, written orders, or agreements;
 
housing finance market conditions;
 
level of retained earnings;
 
initiatives, operations, products or practices that entail heightened risk;
 
ratio of market value of equity to the par value of capital stock; and/or
 
other conditions as notified by the Director.
 
The rule provides that the Director shall consider the need to maintain, modify or rescind any such increase no less than every 12 months. If we are required to increase our minimum capital level, we may need to lower or suspend dividend payments to increase retained earnings to satisfy such increase. Alternatively, we could satisfy an increased capital requirement by disposing of assets to decrease the size of our balance sheet relative to total outstanding capital stock, which may adversely impact our results of operations and financial condition and ability to satisfy our mission.  
 
Regulatory Policy Guidance on Reporting of Fraudulent Financial Instruments
 
On January 27, 2010, the Finance Agency issued a regulation requiring the FHLBanks to report to the Finance Agency upon the discovery of any fraud or possible fraud related to the purchase or sale of financial instruments or loans. On March 29, 2011, the Finance Agency issued immediately effective final guidance which sets forth fraud reporting requirements for the FHLBanks under the regulation. The guidance, among other things, provides examples of fraud that should be reported to the Finance Agency and the Finance Agency's Office of Inspector General. In addition, the guidance requires FHLBanks to establish and maintain effective internal controls, policies, procedures, and operational training to discover and report fraud or possible fraud. Although complying with the guidance will increase our regulatory requirements, we do not expect any material incremental costs or adverse impact to our business.
 

66


Proposed Rule on Private Transfer Fee Covenants
 
On February 8, 2011, the Finance Agency issued a proposed rule that would restrict us from purchasing, investing in, or taking security interests in, mortgage loans on properties encumbered by private transfer fee covenants, securities backed by such mortgage loans, and securities backed by the income stream from such covenants, except for certain transfer fee covenants. Excepted transfer fee covenants would include covenants to pay a private transfer fee to covered associations (including organizations comprising owners of homes, condominiums, or cooperatives or certain other tax-exempt organizations that use the private transfer fees exclusively for the direct benefit of the property. The foregoing restrictions would apply only to mortgages on properties encumbered by private transfer fee covenants created on or after February 8, 2011, and to such securities backed by such mortgages, and to securities issued after that date and backed by revenue from private transfer fees regardless of when the covenants were created. We would be required to comply with the regulation within 120 days of the publication of the final rule. To the extent that a final rule limits the type of collateral we accept for advances and the type of loans eligible for purchase under the MPF program, our business may be adversely impacted. Comments on the proposed rule were due by April 11, 2011.
 
Advance Notice of Proposed Rulemaking on Use of NRSRO Credit Ratings
 
On January 31, 2011, the Finance Agency issued an advanced notice of proposed rulemaking that would implement a provision in the Dodd-Frank Act that requires all federal agencies to remove regulations that require use of NRSRO credit ratings in the assessment of a security. The notice seeks comment regarding certain specific Finance Agency regulations applicable to FHLBanks including risk-based capital requirements, prudential requirements, investments, and consolidated obligations. Comments on this advance notice of rulemaking were due on March 17, 2011.
 
Advance Notice of Proposed Rulemaking on FHLBank Members
 
On December 27, 2010, the Finance Agency issued an advance notice of proposed rulemaking to address its regulations on FHLBank membership to ensure such regulations are consistent with maintaining a nexus between FHLBank membership and the housing and community development mission of the FHLBanks. Refer to our 2010 Form 10-K for additional discussion on this proposed rulemaking.
 
 

67


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. We periodically evaluate these policies in order to respond to changes in our financial position and general market conditions.
 
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 March 10, 2011, 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 and processes utilized to manage risk. The following is a list of the risk measures in place at March 31, 2011 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 (MVCS) Sensitivity 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 income will change as a result of changes in market conditions such as interest rates, spreads, and volatilities. Interest rate risk, including mortgage prepayment risk, was our predominant type of market risk exposure during the three months ended March 31, 2011 and 2010. 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 often 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 swap, caps, and floors.
 

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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 24 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.
 
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. This suspension remained effective at March 31, 2011. 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 were 15.3 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 were 27.3 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. Effective February 14, 2011, upon completion of the prepayment model recalibration, these temporary policy limits were removed and the original policy limits were restored.
 
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 2011 and 2010:
 
Market Value of Capital Stock (dollars per share)
 
Down 200
 
Down 100
 
Down 501
 
Base Case
 
Up 501
 
Up 100
 
Up 200
2011
 
 
 
 
 
 
 
 
 
 
 
 
 
March
$
93.6
 
 
$
108.3
 
 
$
111.7
 
 
$
109.7
 
 
$
108.9
 
 
$
107.6
 
 
$
103.0
 
2010
 
 
 
 
 
 
 
 
 
 
 
 
 
December
89.1
 
 
105.7
 
 
111.2
 
 
111.1
 
 
111.2
 
 
110.2
 
 
107.5
 
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
 
 
% Change from Base Case
 
Down 200
 
Down 100
 
Down 501
 
Base Case
 
Up 501
 
Up 100
 
Up 200
2011
 
 
 
 
 
 
 
 
 
 
 
 
 
March
(14.7
)%
 
(1.3
)%
 
1.8
 %
 
%
 
(0.8
)%
 
(1.9
)%
 
(6.1
)%
2010
 
 
 
 
 
 
 
 
 
 
 
 
 
December
(19.8
)
 
(4.8
)
 
0.1
 
 
 
 
0.2
 
 
(0.7
)
 
(3.2
)
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
)
1
Policy limits for the up and down 50 basis point parallel interest rate shift scenarios were implemented effective July 1, 2010.
 

69


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 each quarter-end during 2011 and 2010:
 
Market Value of Capital Stock (dollars per share)1
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
2011
 
 
 
 
 
 
 
 
 
 
 
 
 
March
$
104.3
 
 
$
108.3
 
 
$
109.8
 
 
$
109.7
 
 
$
109.8
 
 
$
107.9
 
 
$
102.8
 
2010
 
 
 
 
 
 
 
 
 
 
 
 
 
December
101.1
 
 
105.9
 
 
109.5
 
 
111.1
 
 
111.4
 
 
110.8
 
 
107.4
 
September
103.1
 
 
102.8
 
 
104.4
 
 
107.9
 
 
112.4
 
 
116.6
 
 
112.8
 
 
% Change from Base Case1
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
2011
 
 
 
 
 
 
 
 
 
 
 
 
 
March
(4.9
)%
 
(1.2
)%
 
0.1
 %
 
%
 
0.1
%
 
(1.6
)%
 
(6.3
)%
2010
 
 
 
 
 
 
 
 
 
 
 
 
 
December
(8.9
)
 
(4.7
)
 
(1.4
)
 
 
 
0.3
 
 
(0.3
)
 
(3.3
)
September
(4.5
)
 
(4.7
)
 
(3.2
)
 
 
 
4.2
 
 
8.0
 
 
4.6
 
1
Policy limits for the non-parallel interest rate shift scenarios were implemented effective July 1, 2010.
 
The decrease in base case MVCS at March 31, 2011 compared with December 31, 2010 was primarily attributable to the following:
 
Decrease in our funding costs relative to LIBOR. Because the MVCS methodology focuses on the "liquidation value" of one share of capital stock, we calculate the present value of our assets and liabilities based on current interest rates. During the three months ended March 31, 2011, our cost of funds relative to LIBOR decreased, thereby increasing the present value of our liabilities and decreasing the value of MVCS.
 
Increased option-adjusted spread on our mortgage assets. During the three months ended March 31, 2011, the spread between mortgage interest rates and LIBOR increased when compared to the fourth quarter of 2010, which decreased the market value of our mortgage assets.
 
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 2011 and 2010.
Economic Value of Capital Stock (dollars per share)
2011
 
 
March
 
$
112.0
 
2010
 
 
December
 
$
120.6
 
September
 
$
119.3
 
June
 
$
114.0
 
March
 
$
114.2
 
    

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The decrease in our EVCS at March 31, 2011 when compared to December 31, 2010 was primarily attributable to the following:
 
Recalibration of our prepayment model. During the three months ended March 31, 2011, we recalibrated our prepayment model in order to generate prepayment speeds that were more aligned with actual prepayment experience. This model change slowed down the projected speed of mortgage prepayments and, therefore, lengthened the average life of our mortgage assets. As the mortgage asset cash flows lengthened, they were discounted using a higher cost of funds, thereby decreasing EVCS during the three months ended March 31, 2011.
 
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 Finance Agency regulation to obtain sufficient collateral to fully secure our advances and other credit products. Eligible collateral includes (i) whole first mortgages on improved residential property or securities representing a whole interest in such mortgages, (ii) securities issued, insured, or guaranteed by the U.S. Government or any of the government-sponsored housing enterprises, including MBS issued or guaranteed by Fannie Mae, Freddie Mac, or Government National Mortgage Association, (iii) cash deposited with us, (iv) Federal Family Education Loan Program guaranteed student loans, and (v) 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. Community financial institutions may also pledge collateral consisting of secured small business, small agribusiness, or small farm loans. As additional security, the FHLBank Act provides that we have a lien on each borrower's capital stock investment; however, capital stock cannot be pledged as collateral to secure credit exposures.
 
Credit risk arises from the possibility that a borrower is unable to repay its 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 maintain policies and practices to monitor our exposure and take action where appropriate and have never experienced a credit loss on an advance since our inception. In addition, we have the ability to call for additional or substitute collateral, or require delivery of collateral, during the life of an advance 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 or haircuts, 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 March 31, 2011 and December 31, 2010, borrowers pledged $87.4 billion and $97.5 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.
 
Based upon the collateral held as security, our credit extension and collateral policies, management's credit analyses, and the repayment history on our credit products, management did not anticipate any credit losses on our advances and other credit products as of March 31, 2011 and December 31, 2010. Accordingly, we have not recorded any allowance for credit losses.

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Mortgage Assets
 
We are exposed to mortgage asset credit risk through our participation in the MPF program and investments in MBS. 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 a number of factors, 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. MPF Xtra loan products are passed through to a third-party investor and are not maintained on our Statement of Condition.
 
The following table presents the unpaid principal balance of our MPF portfolio by product type (dollars in millions):
Product Type
 
March 31,
2011
 
December 31,
2010
Original MPF
 
$
615
 
 
$
604
 
MPF 100
 
87
 
 
94
 
MPF 125
 
2,950
 
 
2,909
 
MPF Plus
 
3,166
 
 
3,426
 
MPF Government
 
370
 
 
370
 
Total unpaid principal balance
 
$
7,188
 
 
$
7,403
 
 
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.
 
Government-Insured Mortgage Loans. For our government-insured mortgage 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. Therefore, there is no allowance for credit losses on government-insured mortgage loans.
 
Conventional Mortgage Loans. For our conventional mortgage loans, we have several layers of legal loss protection that are defined in agreements among us and our PFIs. These loss layers may vary depending on the MPF product alternatives selected and consist of (i) homeowner equity, (ii) primary mortgage insurance, (iii) first loss account, and (iv) credit enhancement obligation of PFI. For a detailed discussion of these loss layers, refer to “Item 1. Financial Statements — Note 10 — Allowance for Credit Losses.”
 
Our 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 an 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. As of March 31, 2011, we determined that 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 evaluate the need to hold retained earnings or take other steps necessary to mitigate this risk.
 
 

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The following tables present additional information on our mortgage loans held for portfolio (dollars in thousands):
 
Three Months Ended March 31,
Interest Shortfall on Nonaccrual Mortgage Loans:
2011
 
2010
Gross interest income that would have been recorded based on original terms during the period
$
1,462
 
 
$
1,587
 
Interest actually recognized into net income during the period
 
 
 
Shortfall
$
1,462
 
 
$
1,587
 
 
March 31,
2011
 
December 31,
2010
Total unpaid principal balance of mortgage loans past due 90 days or more and still accruing interest
$
4,810
 
 
$
4,675
 
 
 
 
 
Total unpaid principal balance of nonaccrual mortgage loans
$
110,616
 
 
$
111,064
 
 
 
 
 
Allowance for Credit Losses on Mortgage Loans:
 
 
 
Balance, beginning of period
$
13,000
 
 
$
1,887
 
    Charge-offs
(596
)
 
(1,005
)
    Provision for credit losses
5,596
 
 
12,118
 
Balance, end of period
$
18,000
 
 
$
13,000
 
    
We place a conventional mortgage loan on non-accrual status if we determine that either the collection of interest or principal is doubtful or interest or principal is 90 days or more past due. We do not place a government-insured mortgage loan on non-accrual status because of the U.S. government guarantee of the loan and contractual obligation of the loan servicer to repurchase the loan when certain criteria are met. For a summary of our mortgage loan delinquencies and non-accrual loans at March 31, 2011 and December 31, 2010, refer to “Item 1. Financial Statements — Note 10 — Allowance for Credit Losses.”
 
We utilize an allowance for credit losses to reserve for estimated losses in our conventional mortgage portfolio. During the three months ended March 31, 2011, we recorded a provision for credit losses of $5.6 million, bringing our allowance for credit losses to $18.0 million at March 31, 2011. The provision recorded was driven by an increase in estimated losses resulting from increased loss severities, management's expectation that loans migrating to REO and loss severities will likely increase in the future, and certain refinements made to our allowance for credit losses model.
 
We are able to allocate available credit enhancement fees to recapture estimated losses in our conventional mortgage loan portfolio. Estimated available credit enhancement fees decreased to $3.3 million at March 31, 2011 from $3.7 million at December 31, 2010 primarily due to an increase in charge-off activity. The ratio of charge-offs to average loans outstanding during the three months ended March 31, 2011 and 2010 was less than 0.01 percent.
 
MORTGAGE-BACKED SECURITIES
 
We limit our investments in MBS to those guaranteed by the U.S. Government, issued by a GSE, or that carry the highest investment grade rating by any NRSRO at the time of purchase. 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 March 31, 2011, we owned $10.4 billion of MBS, of which $10.3 billion or approximately 99 percent were guaranteed by the U.S. Government or issued by GSEs and $0.1 billion or approximately 1 percent were private-label MBS. At December 31, 2010, we owned $11.4 billion of MBS, of which $11.3 billion or approximately 99 percent were guaranteed by the U.S. Government or issued by GSEs and $0.1 billion or approximately 1 percent were private-label MBS.
 

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Private-label MBS consist of MPF shared funding certificates and other private-label MBS. MPF shared funding certificates are mortgage-backed certificates created from conventional conforming mortgages using a senior/subordinated tranche structure. We record these investments as HTM. 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 April 30, 2011, all of our MPF shared funding certificates were rated AA or higher by a NRSRO.
 
Other private-label MBS are variable rate securities backed by prime loans that were securitized prior to 2004. We record these investments as HTM. The following table summarizes characteristics of our other private-label MBS (dollars in thousands):
Other Private-label MBS Characteristics
 
March 31,
2011
Credit ratings1:
 
 
AAA
 
$
18,420
 
AA
 
10,039
 
A
 
4,134
 
BB
 
131
 
Total
 
$
32,724
 
 
 
 
Amortized cost (unpaid principal balance)
 
$
32,724
 
Gross unrealized losses
 
3,923
 
Fair value
 
$
28,801
 
 
 
 
Weighted average percentage of fair value to unpaid principal balance
 
88
%
Original weighted average FICO® score
 
725
 
Original weighted average credit support
 
4
%
Weighted average credit support
 
9
%
Weighted average collateral delinquency rate2
 
6
%
1
As of March 31, 2011, 99 percent of our other private-label MBS were on negative watch by a NRSRO. Subsequent to March 31, 2011, two of our other private-label MBS were downgraded to an A rating and two of our other private-label MBS were downgraded to a BBB rating.
2
Represents the percentage of underlying loans that are 60 days or more past due.
     
The following table shows the state concentrations of our other private-label MBS calculated based on unpaid principal balances:
State Concentrations
 
March 31,
2011
 
December 31,
2010
Florida
 
14.3
%
 
14.2
%
California
 
12.7
 
 
12.7
 
Georgia
 
12.2
 
 
12.2
 
New York
 
9.7
 
 
9.6
 
New Jersey
 
5.0
 
 
5.0
 
All other1
 
46.1
 
 
46.3
 
Total
 
100.0
%
 
100.0
%
1
There were no individual states with a concentration greater than 4.7 percent at March 31, 2011 and December 31, 2010.
 
At March 31, 2011, 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 7 — Other-Than-Temporary Impairment.”
 

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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 our ERMP limit the type of investments we may purchase.
 
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, securities purchased under agreements to resell, negotiable certificates of deposit, and commercial paper. Our long-term portfolio includes, but is not limited to, other U.S. obligations, GSE obligations, state or local housing agency obligations, TLGP debt, taxable municipal bonds, 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 at March 31, 2011 (excluding accrued interest receivable) (dollars in millions):
 
 
Long-Term Rating1
 
Short-Term Rating1
 
 
 
 
 
 
AAA
 
AA
 
A
 
A-1 / P-1
 
A-2 / P-2
 
Unrated
 
Total
Interest-bearing deposits2
 
$
7
 
 
$
 
 
$
 
 
$
1
 
 
$
 
 
$
 
 
$
8
 
Securities purchased under agreements to resell
 
 
 
 
 
 
 
1,600
 
 
 
 
 
 
1,600
 
Federal funds sold
 
 
 
 
 
 
 
1,682
 
 
470
 
 
 
 
2,152
 
Investment securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
State or local housing agency obligations
 
38
 
 
63
 
 
 
 
 
 
 
 
 
 
101
 
Commerical paper
 
 
 
 
 
 
 
100
 
 
 
 
 
 
100
 
TLGP2
 
1,578
 
 
 
 
 
 
 
 
 
 
 
 
1,578
 
Taxable municipal bonds
 
309
 
 
113
 
 
 
 
 
 
 
 
 
 
422
 
Other U.S. obligations
 
171
 
 
 
 
 
 
 
 
 
 
 
 
171
 
Government-sponsored enterprise obligations
 
831
 
 
 
 
 
 
 
 
 
 
 
 
831
 
Other3
 
 
 
 
 
 
 
 
 
 
 
4
 
 
4
 
Total non-mortgage-backed securities
 
2,927
 
 
176
 
 
 
 
100
 
 
 
 
4
 
 
3,207
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Government-sponsored enterprise
 
10,324
 
 
 
 
 
 
 
 
 
 
 
 
10,324
 
Other U.S. obligations
 
33
 
 
 
 
 
 
 
 
 
 
 
 
33
 
Private-label
 
41
 
 
12
 
 
4
 
 
 
 
 
 
 
 
57
 
Total mortgage-backed securities
 
10,398
 
 
12
 
 
4
 
 
 
 
 
 
 
 
10,414
 
Total investments4
 
$
13,332
 
 
$
188
 
 
$
4
 
 
$
3,383
 
 
$
470
 
 
$
4
 
 
$
17,381
 
1
Represents the lowest credit rating available for each security based on an NRSRO.
2
Interest bearing deposits and TLGP investments are rated either AAA or A-1/P-1 because they are guaranteed by the FDIC or U.S. Government.
3
Other "unrated" investments represents an equity investment in a Small Business Investment Company.
4
At March 31, 2011, 13 percent of our total investments were unsecured.
    

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The following table shows our total investment securities by investment credit rating at December 31, 2010 (excluding accrued interest receivable) (dollars in millions):
 
 
Long-Term Rating1
 
Short-Term Rating1
 
 
 
 
 
 
AAA
 
AA
 
A
 
A-1 / P-1
 
A-2 / P-2
 
Unrated
 
Total
Interest-bearing deposits2
 
$
8
 
 
$
 
 
$
 
 
$
1
 
 
$
 
 
$
 
 
$
9
 
Securities purchased under agreements to resell
 
 
 
 
 
 
 
1,550
 
 
 
 
 
 
1,550
 
Federal funds sold
 
 
 
 
 
 
 
1,360
 
 
665
 
 
 
 
2,025
 
Investment securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Negotiable certificates of deposit
 
 
 
 
 
 
 
335
 
 
 
 
 
 
335
 
State or local housing agency obligations
 
41
 
 
66
 
 
 
 
 
 
 
 
 
 
107
 
TLGP2
 
1,780
 
 
 
 
 
 
 
 
 
 
 
 
1,780
 
Taxable municipal bonds
 
311
 
 
113
 
 
 
 
 
 
 
 
 
 
424
 
Other U.S. obligations
 
176
 
 
 
 
 
 
 
 
 
 
 
 
176
 
Government-sponsored enterprise obligations
 
835
 
 
 
 
 
 
 
 
 
 
 
 
835
 
Other3
 
 
 
 
 
 
 
 
 
 
 
4
 
 
4
 
Total non-mortgage-backed securities
 
3,143
 
 
179
 
 
 
 
335
 
 
 
 
4
 
 
3,661
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Government-sponsored enterprise
 
11,301
 
 
 
 
 
 
 
 
 
 
 
 
11,301
 
Other U.S. obligations
 
34
 
 
 
 
 
 
 
 
 
 
 
 
34
 
MPF shared funding
 
24
 
 
2
 
 
 
 
 
 
 
 
 
 
26
 
Other
 
19
 
 
10
 
 
4
 
 
 
 
 
 
 
 
33
 
Total mortgage-backed securities
 
11,378
 
 
12
 
 
4
 
 
 
 
 
 
 
 
11,394
 
Total investments4
 
$
14,529
 
 
$
191
 
 
$
4
 
 
$
3,246
 
 
$
665
 
 
$
4
 
 
$
18,639
 
1
Represents the lowest credit rating available for each security based on an NRSRO.
2
Interest bearing deposits and TLGP investments are rated either AAA or A-1/P-1 because they are guaranteed by the FDIC or U.S. Government.
3
Other "unrated" investments represents an equity investment in a Small Business Investment Company.
4
At December 31, 2010, 13 percent of our total investments were unsecured.
 
Long-term investments decreased at March 31, 2011 when compared to December 31, 2010 due primarily to principal repayments on MBS. Short-term investments increased at March 31, 2011 when compared to December 31, 2010 due primarily to increased Federal funds sold and securities purchased under agreements to resell as well as the purchase of commercial paper.
 
At March 31, 2011, approximately 0.2 percent of our total investments were on negative watch by a NRSRO. All of these investments were private-label MBS. Subsequent to March 31, 2011, two of our private-label MBS were downgraded to an A credit rating and two of our private-label MBS were downgraded to a BBB credit rating. No other investments held by us at March 31, 2011 were placed on negative watch or 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 after applying netting agreements and cash collateral (dollars in millions):
 
 
March 31, 2011
Credit Rating1
 
Total Notional
 
Credit Exposure Net of Cash Collateral
 
Other Collateral Held
 
Net Credit Exposure
AAA
 
$
135
 
 
$
 
 
$
 
 
$
 
AA
 
15,668
 
 
 
 
 
 
 
A
 
22,761
 
 
5
 
 
 
 
5
 
BBB
 
13
 
 
 
 
 
 
 
Subtotal
 
38,577
 
 
5
 
 
 
 
5
 
Member institutions2
 
82
 
 
 
 
 
 
 
Total
 
$
38,659
 
 
$
5
 
 
$
 
 
$
5
 
 
 
December 31, 2010
Credit Rating1
 
Total Notional
 
Credit Exposure Net of Cash Collateral
 
Other Collateral Held
 
Net Credit Exposure
AAA
 
$
135
 
 
$
 
 
$
 
 
$
 
AA
 
18,882
 
 
 
 
 
 
 
A
 
21,989
 
 
12
 
 
 
 
12
 
BBB
 
13
 
 
 
 
 
 
 
Subtotal
 
41,019
 
 
12
 
 
 
 
12
 
Member institutions2
 
96
 
 
 
 
 
 
 
Total
 
$
41,115
 
 
$
12
 
 
$
 
 
$
12
 
1
Credit rating is the lower of the S&P, Moody's, and Fitch ratings stated in terms of the S&P equivalent.
2
Represents mortgage delivery commitments with our member institutions.
 
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.
 

77


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.
 
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 first quarter of 2011, 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.
 
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 2010 Form 10-K. There have been no material changes to our risk factors during the three months ended March 31, 2011.
 
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.

78


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.***
10.1
Joint Capital Enhancement Agreement effective February 28, 2011****
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.
****
Incorporated by reference to exhibit 99.1 on our Form 8-K filed with the SEC on March 1, 2011.
 

79


SIGNATURES
 
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:
 
May 12, 2011
 
 
 
 
 
 
 
 
 
 
 
 
By:
 
/s/ Richard S. Swanson
 
 
 
 
Richard S. Swanson
President and Chief Executive Officer
(Principal Executive Officer)
 
 
 
 
 
 
 
By:
 
/s/ Steven T. Schuler
 
 
 
 
Steven T. Schuler
Executive Vice President and Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)
 
 
 

80