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EX-32 - EXHIBIT 32 - Federal Home Loan Bank of Indianapolisex32section1350certificati.htm
EX-31.3 - EXHIBIT 31.3 - Federal Home Loan Bank of Indianapolisex313december312016.htm
EX-31.2 - EXHIBIT 31.2 - Federal Home Loan Bank of Indianapolisex312december312016.htm
EX-31.1 - EXHIBIT 31.1 - Federal Home Loan Bank of Indianapolisex311december312016.htm
EX-24 - EXHIBIT 24 - Federal Home Loan Bank of Indianapolisex24powerofattorney123116.htm
EX-12 - EXHIBIT 12 - Federal Home Loan Bank of Indianapolisex12december312016.htm
EX-10.11 - EXHIBIT 10.11 - Federal Home Loan Bank of Indianapolisex1011keyemployeeseverance.htm
EX-10.3 - EXHIBIT 10.3 - Federal Home Loan Bank of Indianapolisex103pifundingandcontingen.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 FORM 10-K
 
 (Mark One)
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2016
Or
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to            
Commission file number 000-51404
 
 FEDERAL HOME LOAN BANK OF INDIANAPOLIS
(Exact name of registrant as specified in its charter)
  
 
Federally Chartered Corporation
 
35-6001443
(State or other jurisdiction of incorporation)
 
(IRS employer identification number)
 
 
 8250 Woodfield Crossing Blvd. Indianapolis, IN
 
46240
(Address of principal executive offices)
 
(Zip code)
Registrant's telephone number, including area code:
(317) 465-0200
Securities registered pursuant to Section 12(b) of the Act:
Not Applicable
Securities registered pursuant to Section 12(g) of the Act:
Class B capital stock, par value $100 per share
(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
o  Yes    x  No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
o  Yes    x  No
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 (§ 232.405) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   x  Yes     o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   x  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
o Large accelerated filer
 
o  Accelerated filer
x  Non-accelerated filer (Do not check if a smaller reporting company)
 
o Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). o  Yes    x  No
Registrant's Class B stock is not publicly traded and is only issued to members of the registrant. Such stock is issued and redeemed at par value, $100 per share, subject to certain regulatory and statutory limits. At June 30, 2016, the aggregate par value of the Class B stock held by members and former members of the registrant was approximately $1.6 billion. At February 28, 2017, 16,829,548 shares of Class B stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE: None.



Table of Contents
 
Page
 
 
Number
 
Glossary of Terms
 
Special Note Regarding Forward-Looking Statements
ITEM 1.
BUSINESS
 
Operating Segments
7 
 
Funding Sources
 
Community Investment and Affordable Housing Programs
 
Use of Derivatives
 
Supervision and Regulation
 
Membership
 
Competition
 
Employees
 
Available Information
ITEM 1A.
RISK FACTORS
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None
ITEM 2.
PROPERTIES
ITEM 3.
LEGAL PROCEEDINGS
ITEM 4.
MINE SAFETY DISCLOSURES
N/A
ITEM 5.
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
ITEM 6.
SELECTED FINANCIAL DATA
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Executive Summary
 
Results of Operations and Changes in Financial Condition
 
Operating Segments
 
Analysis of Financial Condition
 
Liquidity and Capital Resources
 
Off-Balance Sheet Arrangements
 
Contractual Obligations
 
Critical Accounting Policies and Estimates
 
Recent Accounting and Regulatory Developments
 
Risk Management
 ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
 ITEM 9A.
CONTROLS AND PROCEDURES
 ITEM 9B.
OTHER INFORMATION
 ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
 ITEM 11.
EXECUTIVE COMPENSATION
 ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
 ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
 ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
 ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 ITEM 16.
FORM 10-K SUMMARY
None
 





GLOSSARY OF TERMS

ABS: Asset-Backed Securities
Advance: Secured loan to members, former members or Housing Associates
AFS: Available-for-Sale
AHP: Affordable Housing Program
AMA: Acquired Member Assets
AOCI: Accumulated Other Comprehensive Income (Loss)
Bank Act: Federal Home Loan Bank Act of 1932, as amended
bps: basis points
CBSA: Core Based Statistical Areas, refer collectively to metropolitan and micropolitan statistical areas as defined by the United States Office of Management and Budget
CDFI: Community Development Financial Institution
CE: Credit Enhancement
CEO: Chief Executive Officer
CFI: Community Financial Institution
CFPB: Consumer Financial Protection Bureau
CFTC: United States Commodity Futures Trading Commission
CICA: Community Investment Cash Advances
CIP: Community Investment Program
Clearinghouse: A United States Commodity Futures Trading Commission-registered derivatives clearing organization
CMO: Collateralized Mortgage Obligation
CO bond: Consolidated Obligation bond
DB plan: Pentegra Defined Benefit Pension Plan for Financial Institutions
DC plan: Pentegra Defined Contribution Retirement Savings Plan for Financial Institutions
DDCP: Directors' Deferred Compensation Plan
Director: Director of the Federal Housing Finance Agency
Dodd-Frank Act: Dodd-Frank Wall Street Reform and Consumer Protection Act, as amended
ERMP: Enterprise Risk Management Policy
Exchange Act: Securities Exchange Act of 1934, as amended
Fannie Mae: Federal National Mortgage Association
FASB: Financial Accounting Standards Board
FDIC: Federal Deposit Insurance Corporation
FHA: Federal Housing Administration
FHLBank: A Federal Home Loan Bank
FHLBanks: The 11 Federal Home Loan Banks or a subset thereof
FHLBank System: The 11 Federal Home Loan Banks and the Office of Finance
FICO®: Fair Isaac Corporation, the creators of the FICO credit score
Final Membership Rule: Final Rule on FHLBank Membership issued by the Federal Housing Finance Agency effective February 19, 2016
Finance Agency: Federal Housing Finance Agency, successor to Finance Board
Finance Board: Federal Housing Finance Board, predecessor to Finance Agency
Fitch: Fitch Ratings, Inc.
FLA: First Loss Account
FOMC: Federal Open Market Committee
Form 8-K: Current Report on Form 8-K as filed with the SEC under the Exchange Act
Form 10-K: Annual Report on Form 10-K as filed with the SEC under the Exchange Act
Form 10-Q: Quarterly Report on Form 10-Q as filed with the SEC under the Exchange Act
FRB: Federal Reserve Board
Freddie Mac: Federal Home Loan Mortgage Corporation
GAAP: Generally Accepted Accounting Principles in the United States of America
GDP: Gross Domestic Product
Genworth: Genworth Mortgage Insurance Corporation
Ginnie Mae: Government National Mortgage Association
GLB Act: Gramm-Leach-Bliley Act of 1999, as amended
GSE: United States Government-Sponsored Enterprise
HERA: Housing and Economic Recovery Act of 2008, as amended
Housing Associate: Approved lender under Title II of the National Housing Act of 1934 that is either a government agency or is chartered under federal or state law with rights and powers similar to those of a corporation



HTM: Held-to-Maturity
HUD: United States Department of Housing and Urban Development
JCE Agreement: Joint Capital Enhancement Agreement, as amended, among the 11 FHLBanks
LIBOR: London Interbank Offered Rate
LRA: Lender Risk Account
LTV: Loan-to-Value
MAP-21: Moving Ahead for Progress in the 21st Century Act, enacted on July 6, 2012
MBS: Mortgage-Backed Securities
MCC: Master Commitment Contract
MDC: Mandatory Delivery Commitment
MGIC: Mortgage Guaranty Insurance Corporation
Moody's: Moody's Investor Services
MPF: Mortgage Partnership Finance®
MPP: Mortgage Purchase Program, including Original and Advantage unless indicated otherwise
MRCS: Mandatorily Redeemable Capital Stock
MVE: Market Value of Equity
NRSRO: Nationally Recognized Statistical Rating Organization
OCC: Office of the Comptroller of the Currency
OCI: Other Comprehensive Income (Loss)
OIS: Overnight Indexed Swap
ORERC: Other Real Estate-Related Collateral
OTTI: Other-Than-Temporary Impairment or -Temporarily Impaired (as the context indicates)
PFI: Participating Financial Institution
PMI: Primary Mortgage Insurance
REMIC: Real Estate Mortgage Investment Conduit
REO: Real Estate Owned
RHA: Rural Housing Service of the Department of Agriculture
RMBS: Residential Mortgage-Backed Securities
S&P: Standard & Poor's Rating Service
Safety and Soundness Act: Federal Housing Enterprises Financial Safety and Soundness Act of 1992, as amended
SEC: Securities and Exchange Commission
Securities Act: Securities Act of 1933, as amended
SERP: Federal Home Loan Bank of Indianapolis 2005 Supplemental Executive Retirement Plan and a similar frozen plan
SETP: Federal Home Loan Bank of Indianapolis 2016 Supplemental Executive Thrift Plan
SMI: Supplemental Mortgage Insurance
TBA: To Be Announced
TDR: Troubled Debt Restructuring
TVA: Tennessee Valley Authority
UCC: Uniform Commercial Code
UPB: Unpaid Principal Balance
VA: Department of Veterans Affairs
VaR: Value at Risk
VIE: Variable Interest Entity
WAIR: Weighted-Average Interest Rate




Special Note Regarding Forward-Looking Statements
 
Statements in this Form 10-K, including statements describing our objectives, projections, estimates or predictions, may be considered to be "forward-looking statements." These statements may use forward-looking terminology, such as "anticipates," "believes," "could," "estimates," "may," "should," "expects," "will," or their negatives or other variations on these terms. We caution that, by their nature, forward-looking statements involve risk or uncertainty and that actual results either could differ materially from those expressed or implied in these forward-looking statements or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. These forward-looking statements involve risks and uncertainties including, but not limited to, the following:

economic and market conditions, including the timing and volume of market activity, inflation or deflation, changes in the value of global currencies, and changes in the financial condition of market participants;
volatility of market prices, interest rates, and indices or other factors, resulting from the effects of, and changes in, various monetary or fiscal policies and regulations, including those determined by the FRB and the FDIC, or a decline in liquidity in the financial markets, that could affect the value of investments (including OTTI of private-label RMBS), or collateral we hold as security for the obligations of our members and counterparties;
demand for our advances and purchases of mortgage loans resulting from:
changes in our members' deposit flows and credit demands;
federal or state regulatory developments impacting suitability or eligibility of membership classes;
membership changes, including, but not limited to, mergers, acquisitions and consolidations of charters;
changes in the general level of housing activity in the United States and particularly our district states of Indiana and Michigan, the level of refinancing activity and consumer product preferences; and
competitive forces, including, without limitation, other sources of funding available to our members;
changes in mortgage asset prepayment patterns, delinquency rates and housing values or improper or inadequate mortgage originations and mortgage servicing;
ability to introduce and successfully manage new products and services, including new types of collateral securing advances;
political events, including administrative, legislative, regulatory, or other developments, and judicial rulings that affect us, our status as a secured creditor, our members (or certain classes of members), prospective members, counterparties, GSE's generally, one or more of the FHLBanks and/or investors in the consolidated obligations of the FHLBanks;
ability to access the capital markets and raise capital market funding at acceptable terms;
changes in our credit ratings or the credit ratings of the other FHLBanks and the FHLBank System;
changes in the level of government guarantees provided to other United States and international financial institutions;
competition from other entities borrowing funds in the capital markets;
dealer commitment to supporting the issuance of our consolidated obligations;
ability of one or more of the FHLBanks to repay its portion of the consolidated obligations, or otherwise meet its financial obligations;
ability to attract and retain skilled personnel;
ability to develop, implement and support technology and information systems sufficient to manage our business effectively;
nonperformance of counterparties to uncleared and cleared derivative transactions;
changes in terms of derivative agreements and similar agreements;
loss arising from natural disasters, acts of war or acts of terrorism;
changes in or differing interpretations of accounting guidance; and
other risk factors identified in our filings with the SEC. 

Although we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, additional disclosures may be made through reports filed with the SEC in the future, including our Forms 10-K, 10-Q and 8-K. This Form 10-K, including the Business section and Management’s Discussion and Analysis of Financial Condition and Results of Operations, should be read in conjunction with our financial statements and
notes, which begin on page F-1.



ITEM 1. BUSINESS

As used in this Form 10-K, unless the context otherwise requires, the terms "we," "us," "our," and the "Bank" refer to the Federal Home Loan Bank of Indianapolis or its management. We use certain acronyms and terms throughout this Item that are defined in the Glossary of Terms.

Unless otherwise stated, dollar amounts disclosed in Item 1 are rounded to the nearest million; therefore, dollar amounts of less than one million may not be reflected or, due to rounding, may not appear to agree to the amounts presented in thousands in the Financial Statements and related Notes to Financial Statements. Amounts used to calculate dollar and percentage changes are based on numbers in the thousands. Accordingly, calculations based upon the disclosed amounts (millions) may not produce the same results.

Background Information

The Federal Home Loan Bank of Indianapolis is a regional wholesale bank that serves its member financial institutions in Michigan and Indiana. We are one of 11 regional FHLBanks across the United States, which, along with the Office of Finance, compose the FHLBank System established in 1932. Each FHLBank is privately capitalized and funded, and receives no Congressional appropriations.

Our mission is to provide reliable and readily available liquidity to our member institutions in support of housing finance and community investment. Our advance and mortgage purchase programs provide funding to assist members with asset/liability management, interest rate risk management, profitability enhancement, and mortgage pipelines. In addition to funding, we provide various correspondent services, such as securities safekeeping and wire transfers. We also help to meet the economic and housing needs of communities and families through grants and low-cost advances that help support affordable housing and economic development initiatives.

Our Bank was organized under the authority of the Bank Act. We are wholly owned by our member institutions. All federally- insured depository institutions (including commercial banks, savings associations and credit unions), CDFIs certified by the CDFI Fund of the United States Treasury, and certain types of insurance companies are eligible to become members of our Bank if they have a principal place of business, or are domiciled in, our district states of Michigan or Indiana. Applicants for membership must meet certain requirements that demonstrate that they are engaged in residential housing finance. All member institutions are required to purchase a minimum amount of our Class B capital stock as a condition of membership. Only members may own our capital stock, except for stock held by former members or their legal successors during their stock redemption period.

Our members are also our primary customers. We are generally limited to making advances to and purchasing mortgage loans from members; however, by regulation, we are also permitted to make advances to and purchase loans from Housing Associates, but they may not purchase our stock and have no voting rights. We do not lend directly to, or purchase mortgage loans directly from, the general public.
 
Each FHLBank is a GSE and a federal instrumentality of the United States of America that operates as an independent entity with its own board of directors, management, and employees. A GSE is an entity that combines elements of private capital, public sponsorship, and public policy. The public sponsorship and public policy attributes of the FHLBanks include:

an exemption from federal, state, and local taxation, except employment and real estate taxes;
an exemption from registration under the Securities Act (although the FHLBanks are required by federal law to register a class of their equity securities under the Exchange Act);
the requirement that at least 40% of our directors be non-member "independent" directors; that two of these "independent" directors have more than four years of experience representing consumer or community interests in banking services, credit needs, housing, or consumer financial protections; and that the remaining "independent" directors have demonstrated knowledge or experience in auditing or accounting, derivatives, financial management, organizational management, project development or risk management practices, or other expertise established by Finance Agency regulations;
the United States Treasury's authority to purchase up to $4.0 billion of FHLBank consolidated obligations; and
the required allocation of 10% of annual net earnings before interest expense on MRCS to fund the AHP.

The principal source of our funding is the proceeds from the sale to the public of FHLBank debt instruments, known as consolidated obligations, which consist of CO bonds and discount notes. The Office of Finance was established as a joint office of the FHLBanks to facilitate the issuance and servicing of consolidated obligations. The United States government does not guarantee, directly or indirectly, our consolidated obligations, which are the joint and several obligations of all FHLBanks.



The Finance Agency has been the federal regulator of the FHLBanks, Fannie Mae and Freddie Mac since July 2008. The Finance Agency's operating expenses with respect to the FHLBanks are funded by assessments on the FHLBanks. No tax dollars are used to support the operations of the Finance Agency relating to the FHLBanks.

Operating Segments

We manage our operations by grouping products and services within two operating segments. The segments identify the principal ways we provide services to our members. These segments reflect our two primary mission asset activities and the manner in which they are managed from the perspective of development, resource allocation, product delivery, pricing, credit risk and operational administration.

These operating segments are (i) traditional, which consists of credit products (including advances, letters of credit, and lines of credit), investments (including federal funds sold, securities purchased under agreements to resell, AFS securities, and HTM securities), and correspondent services and deposits; and (ii) mortgage loans, which consist of mortgage loans purchased from our members through our MPP and participating interests purchased in 2012 - 2014 from the FHLBank of Topeka in mortgage loans that were originated by certain of its PFIs under the MPF Program. The revenues, profit or loss, and total assets for each segment are disclosed in Notes to Financial Statements - Note 18 - Segment Information.

Traditional.

Credit Products. We offer our members a wide variety of credit products, including advances, letters of credit, and lines of credit. We approve member credit requests based on our assessment of the member's creditworthiness and financial condition, as well as its collateral position. All credit products must be fully collateralized by a member's pledge of eligible assets.

Our primary credit product is advances. Members utilize advances for a wide variety of purposes including:

funding for single-family mortgages and multi-family mortgages held in portfolio, including both conforming and non-conforming mortgages (as determined in accordance with secondary market criteria);
temporary funding during the origination, packaging, and sale of mortgages into the secondary market;
funding for commercial loans and, especially with respect to CFIs, funding for small business, small farm, and small agri-business portfolio loans;
asset/liability and interest rate risk management;
acquiring or holding MBS;
a cost-effective alternative to holding short-term investments to meet contingent liquidity needs;
a competitively priced alternative source of funds, especially with respect to smaller members with less diverse funding sources; and
low-cost funding to help support affordable housing and economic development initiatives.

We offer standby letters of credit, generally for up to 10 years in term, which are rated Aaa by Moody's and AA+ by S&P. Letters of credit are performance contracts that guarantee the performance of a member to a third party and are subject to the same collateralization and borrowing limits that are applicable to advances. Letters of credit may be offered to assist members in facilitating residential housing finance, community lending, asset/liability management, or liquidity. We also offer a standby letter of credit product to collateralize Indiana public deposits.

We also offer lines of credit which allow members to fund short-term cash needs without submitting a new application for each funding request.




Advances. We offer a wide array of fixed-rate and adjustable-rate advances, on which interest is generally due monthly. The maturities of advances currently offered typically range from 1 day to 10 years, although the maximum maturity may be longer in some instances. Our primary advance products include:

Fixed-rate Bullet Advances, which have fixed rates throughout the term of the advances. These advances are typically referred to as "bullet" advances because no principal payment is due until maturity. Prepayments prior to maturity may be subject to prepayment fees. These advances can include a feature that allows for delayed settlement.
Putable Advances, which are fixed-rate advances that give us an option to terminate the advance prior to maturity. We would normally exercise the option to terminate the advance when interest rates increase. Upon our exercise of the option, the member must repay the putable advance or convert it to a floating-rate instrument under the terms established at the time of the original issuance.
Fixed-rate Amortizing Advances, which are fixed-rate advances that require principal payments either monthly, annually, or based on a specified amortization schedule with a balloon payment of remaining principal at maturity.
Adjustable-rate Advances, which are sometimes called "floaters," reprice periodically based on a variety of indices, including LIBOR. LIBOR floaters are the most common type of adjustable-rate advance we extend to our members. Prepayment terms are agreed to before the advance is extended. Most frequently, no prepayment fees are required if a member prepays an adjustable rate advance on a reset date, after a pre-determined lock-out period, with the required notification. No principal payment is due prior to maturity.
Variable-rate Advances, which reprice daily. These advances may be extended on terms from one day to six months and may be prepaid on any given business day during that term without fee or penalty. No principal payment is due until maturity.
Callable Advances, which are fixed-rate advances that give the member an option to prepay the advance before maturity on call dates with no prepayment fee, which members normally would exercise when interest rates decrease.

We also offer customized advances to meet the particular needs of our members. Our entire menu of advance products is generally available to each creditworthy member, regardless of the member's asset size. Finance Agency regulations require us to price our credit products consistently and without discrimination to any member applying for advances. We are also prohibited from pricing our advances below our marginal cost of matching term and maturity funds in the marketplace, including embedded options, and the administrative cost associated with extending such advances to members. Therefore, advances are typically priced at standard spreads above our cost of funds. Our board-approved credit policy allows us to offer lower rates on certain types of advances transactions. Determinations of such rates are based on factors such as volume,
maturity, product type, funding availability and costs, and competitive factors in regard to other sources of funds.

Advances Concentration. Credit risk can be magnified if a lender's portfolio is concentrated in a few borrowers. At December 31, 2016, our top five borrowers accounted for 43% of total advances outstanding, at par. Because of this concentration in advances, we perform frequent credit and collateral reviews on our largest borrowers. In addition, we regularly analyze the implications to our financial management and profitability if we were to lose the business of one or more of these customers.




The following tables present the par value of advances outstanding to our largest borrowers ($ amounts in millions). At our discretion, and provided the borrower meets our contractual requirements, advances to borrowers that are no longer members may remain outstanding until maturity, subject to certain regulatory requirements.
December 31, 2016
 
Advances Outstanding
 
% of Total
Lincoln National Life Insurance Company
 
$
3,350

 
12
%
Flagstar Bank, FSB
 
2,980

 
11
%
Jackson National Life Insurance Company
 
2,376

 
8
%
Tuebor Captive Insurance Company LLC
 
1,660

 
6
%
IAS Services LLC
 
1,650

 
6
%
Subtotal - largest borrowers
 
12,016

 
43
%
Next five largest borrowers
 
5,601

 
20
%
Others
 
10,515

 
37
%
Total advances, par value
 
$
28,132

 
100
%
 
 
 
 
 
December 31, 2015
 
Advances Outstanding
 
% of Total
Flagstar Bank, FSB
 
$
3,541

 
13
%
Lincoln National Life Insurance Company
 
2,605

 
10
%
Jackson National Life Insurance Company
 
1,971

 
7
%
Tuebor Captive Insurance Company LLC
 
1,857

 
7
%
IAS Services LLC
 
1,650

 
6
%
Subtotal - largest borrowers
 
11,624

 
43
%
Next five largest borrowers
 
4,631

 
17
%
Others
 
10,552

 
40
%
Total advances, par value
 
$
26,807

 
100
%

For the years ended December 31, 2016, 2015, and 2014, we did not have gross interest income on advances, excluding the effects of interest-rate swaps, from any one customer that exceeded 10% of our total interest income.

See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Analysis of Financial Condition - Total Assets - Advances for additional information on advances.

Collateral. All credit products extended to a member must be fully collateralized by the member's pledge of eligible assets. Each borrowing member and its affiliates that hold pledged collateral are required to grant us a security interest in such collateral. All such security interests held by us are afforded a priority by the Competitive Equality Banking Act of 1987 over the claims of any party, including any receiver, conservator, trustee, or similar party having rights as a lien creditor, except for claims held by bona fide purchasers for value or by parties that are secured by prior perfected security interests, provided that such claims would otherwise be entitled to priority under applicable law. Moreover, with respect to federally-insured depository institution members, our claims are given certain preferences pursuant to the receivership provisions of the Federal Deposit Insurance Act.

With respect to insurance company members, however, Congress provided in the McCarran-Ferguson Act of 1945 that state law generally governs the regulation of insurance and shall not be preempted by federal law unless the federal law expressly regulates the business of insurance. Thus, if a court were to determine that the priority status afforded the FHLBanks under Section 10(e) of the Bank Act conflicts with state insurance law applicable to our insurance company members, the court might then determine that the priority of our security interest would be governed by state law, not Section 10(e). Under these circumstances, the "super lien" priority protection afforded to our security interest under Section 10(e) may not fully apply when we lend to insurance company members. However, we monitor applicable states' laws, and our security interests in collateral posted by insurance company members have express statutory protections in the jurisdictions where our members are domiciled. In addition, we take all necessary action under applicable state law to obtain and maintain a prior perfected security interest in the collateral, including by taking possession or control of the collateral when appropriate.

    



Collateral Status Categories. We take collateral under a blanket, specific listings or possession status depending on the credit quality of the borrower, the type of institution, and our lien position on assets owned by the member (i.e., blanket, specific, or partially subordinated). The blanket status is the least restrictive and allows the member to retain possession of the pledged collateral, provided that the member executes a written security agreement and agrees to hold the collateral for our benefit. Under the specific listings status, the member maintains possession of the specific collateral pledged, but the member generally provides listings of loans pledged with detailed loan information such as loan amount, payments, maturity date, interest rate, LTV, collateral type, FICO® scores, etc. Members under possession status are required to place the collateral in possession with our Bank or a third-party custodian in amounts sufficient to secure all outstanding obligations.

Eligible Collateral. Eligible collateral types include certain investment securities, one-to-four family first mortgage loans, multi-family first mortgage loans, deposits in our Bank, certain ORERC assets, such as commercial MBS, commercial real estate loans and home equity loans, and small business loans or farm real estate loans from CFIs, which are currently defined as FDIC-insured depository institutions with average total assets not exceeding $1.1 billion over the three years preceding the transaction date. This limit is subject to annual adjustment by the Director based on the Consumer Price Index and is rounded to the nearest million. While we only extend credit based on the borrowing capacity for such approved collateral, our contractual arrangements typically allow us to take other assets as collateral to provide additional protection, including (in the case of members and former members) the borrower's stock in our Bank.

We have an Anti-Predatory Lending Policy and a Subprime and Nontraditional Residential Mortgage Policy that establish guidelines for any subprime or nontraditional loans included in the collateral pledged to us. Loans that are delinquent or violate those policies do not qualify as acceptable collateral and are required to be removed from any collateral value calculation. With respect to the home mortgage lending rules adopted by the CFPB for residential loans originated on or after January 10, 2014, we accept loans that comply with or are exempt from the ability-to-pay requirements as collateral.

In order to help mitigate the market, credit, liquidity, operational and business risk associated with collateral, we apply an over-collateralization requirement to the book value or market value of pledged collateral to establish its lending value. Collateral that we have determined to contain a low level of risk, such as United States government obligations, is over-collateralized at a lower rate than collateral that carries a higher level of risk, such as small business loans. Standard requirements range from 100% for deposits (cash) to 140% - 155% for residential mortgages pledged through blanket status. Over-collateralization requirements for eligible securities range from 103% to 190%; less traditional types of collateral have standard over-collateralization ratios up to 360%.

The over-collateralization requirement applied to asset classes may also vary depending on collateral status, since lower requirements are applied as our levels of information and control over the assets increase. Over-collateralization requirements are applied using market values for collateral in listing and possession status and book value for collateral pledged through blanket status. In no event, however, would market values assigned to whole loan collateral exceed par value. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Credit Risk Management - Advances for more information.    
    
Collateral Review and Monitoring. We verify collateral balances by performing periodic, on-site collateral audits on our borrowers, which allows us to verify loan pledge eligibility, credit strength and documentation quality, as well as adherence to our Anti-Predatory Lending Policy, our Subprime and Nontraditional Residential Mortgage Policy, and other collateral policies. In addition, on-site collateral audit findings are used to adjust over-collateralization amounts to mitigate credit risk and collateral liquidity concerns.

Investments. We maintain a portfolio of investments, purchased from approved counterparties, members and their affiliates, or other FHLBanks, to provide liquidity, utilize balance sheet capacity and supplement our earnings. Our investment portfolio may only include investments deemed investment quality at the time of purchase.

Our portfolio of short-term investments in highly-rated entities ensures the availability of funds to meet our members' credit needs. Our short-term investment portfolio typically includes securities purchased under agreements to resell, which are secured by United States Treasuries or Agency MBS passthroughs, and unsecured federal funds sold. Each may be purchased with either overnight or term maturities. In the aggregate, the FHLBanks may represent a significant percentage of the federal funds sold market at any one time, although each FHLBank manages its investment portfolio separately.

The longer term investment portfolio typically generates higher returns and may consist of (i) securities issued by the United States government, its agencies, and certain GSEs, (ii) MBS and ABS issued by Fannie Mae, Freddie Mac and Ginnie Mae that derive credit enhancement from their relationship with the United States government, and (iii) other MBS, ABS, CMOs and REMICs rated AAA or equivalent by at least two NRSROs at the time of purchase.



All unsecured investments, including those with our members or their affiliates, are subject to certain selection criteria. Each unsecured counterparty must be approved and has an exposure limit, which is computed in the same manner regardless of the counterparty's status as a member, affiliate of a member or unrelated party. These criteria determine the permissible amount and maximum term of the investment. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Credit Risk Management - Investments for more information.

Under Finance Agency regulations, except for certain investments authorized under state trust law for our retirement plans, we are prohibited from investing in the following types of securities:

instruments, such as common stock, that represent an equity ownership in an entity, other than stock in small business investment companies, or certain investments targeted to low-income persons or communities;
instruments issued by non-United States entities, other than those issued by United States branches and agency offices of foreign commercial banks;
non-investment grade debt instruments, other than certain investments targeted to low-income persons or communities and instruments that were downgraded after their purchase;
whole mortgages or other whole loans, except for
those acquired under the MPP or the MPF Program;
certain investments targeted to low-income persons or communities; and
certain foreign housing loans authorized under Section 12(b) of the Bank Act; and
non-United States dollar denominated securities.

In addition, we are prohibited by a Finance Agency regulation and Advisory Bulletin, as well as internal policy, from purchasing certain types of investments, such as interest-only or principal-only stripped MBS, CMOs, REMICs or ABS; residual-interest or interest-accrual classes of CMOs, REMICs, ABS and MBS; and CMOs or REMICs with underlying collateral containing pay option/negative amortization mortgage loans, unless those loans or securities are guaranteed by the United States government, Fannie Mae, Freddie Mac or Ginnie Mae.

Finance Agency regulation further provides that the total book value of our investments in MBS and ABS must not exceed 300% of our total regulatory capital, consisting of Class B stock, retained earnings, and MRCS, as of the day we purchase the investments, based on the capital amount most recently reported to the Finance Agency. If the outstanding balances of our investments in MBS and ABS exceed the limitation at any time, but were in compliance at the time we purchased the investments, we would not be considered out of compliance with the regulation, but we would not be permitted to purchase additional investments in MBS or ABS until these outstanding balances were within the capital limitation. Generally, our goal is to maintain these investments near the 300% limit.

Deposit Products. Deposit products provide a small portion of our funding resources, while also giving members a high-quality asset that satisfies their regulatory liquidity requirements. We offer several types of deposit products to our members and other institutions including overnight and demand deposits. We may accept uninsured deposits from:

our members;
institutions eligible to become members;
any institution for which we are providing correspondent services;
interest-rate swap counterparties;
other FHLBanks; or
other federal government instrumentalities.

Mortgage Loans. Mortgage loans consist of residential mortgage loans purchased from our members through our MPP and participating interests purchased in 2012-2014 from the FHLBank of Topeka in residential mortgage loans that were originated by certain of its members under the MPF Program. These programs help fulfill the FHLBank System's housing mission and provide an additional source of liquidity to FHLBank members that choose to sell mortgage loans into the secondary market rather than holding them in their own portfolios. These programs are considered AMA, a core mission activity of the FHLBanks, as defined by Finance Agency regulations. For additional information, please refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Analysis of Financial Condition - Mortgage Loans Held for Portfolio.





Mortgage Purchase Program.

Overview. We purchase mortgage loans directly from our members through our MPP. Members that participate in the MPP are known as PFIs. By regulation, we are not permitted to purchase loans directly from any institution that is not a member or Housing Associate of the FHLBank System, and we may not use a trust or other entity to purchase the loans. We purchase conforming, medium- or long-term, fixed-rate, fully amortizing, level payment loans predominantly for primary, owner-occupied, detached residences, including single-family properties, and two-, three-, and four-unit properties. Additionally, to a lesser degree, we purchase loans for primary, owner-occupied, attached residences (including condominiums and planned unit developments), second/vacation homes, and investment properties.

Our mortgage loan purchases are governed by the Finance Agency's AMA regulation. Further, while the regulation does not expressly limit us to purchasing fixed-rate loans, before purchasing adjustable-rate loans we would need to analyze whether such purchases would require Finance Agency approval under its new business activity regulation. Such regulation provides that any material change to an FHLBank's business activity that results in new risks or operations needs to be pre-approved by the Finance Agency.

Under Finance Agency regulations, all pools of mortgage loans currently purchased by us, other than government-insured mortgage loans, must have sufficient credit enhancement to be rated at least investment grade. In accordance with such regulations, we limit the pools of mortgage loans that we will purchase to those with an implied NRSRO credit rating of at least BBB.

Mortgage Standards. All loans we purchase must meet the guidelines for our MPP or be specifically approved as an exception based on compensating factors. Our guidelines generally meet or exceed the underwriting standards of Fannie Mae and Freddie Mac. For example, the maximum LTV ratio for any conventional mortgage loan at the time of purchase is 95%, and borrowers must meet certain minimum credit scores depending upon the type of property or loan. In addition, we will not knowingly purchase any loan that violates the terms of our Anti-Predatory Lending Policy or our Subprime and Nontraditional Residential Mortgage Policy. Furthermore, we require our members to warrant to us that all of the loans pledged or sold to us are in compliance with all applicable laws, including prohibitions on anti-predatory lending. All loans purchased through our MPP with applications dated on or after January 10, 2014 must qualify as "Safe-Harbor Qualified Mortgages" under CFPB rules.

Under our guidelines, a PFI must:

be an active originator of conventional mortgages and have servicing capabilities, if applicable, or use a servicer that we approve;
advise us if it has been the subject of any adverse action by either Fannie Mae or Freddie Mac; and
along with its parent company, if applicable, meet the capital requirements of each state and federal regulatory agency with jurisdiction over the member's or parent company's activities.

Mortgage Loan Concentration. Our board of directors has established a limit that restricts the current outstanding balance (as determined at the last reported month end balance) of MPP loans previously purchased from any one PFI to 50% of the total MPP portfolio balance.

For the years ended December 31, 2016, 2015, and 2014, no mortgage loans outstanding previously purchased from any one PFI contributed interest income that exceeded 10% of our total interest income, based upon a PFI's average balance of MPP loans outstanding, at par, and imputing the amount of interest income for that PFI. See Item 1A. Risk Factors - A Loss of Significant Borrowers, PFIs or Acceptable Loan Servicers Could Adversely Impact Our Profitability, Our Ability to Achieve Business Objectives, Our Ability to Pay Dividends or Redeem or Repurchase Capital Stock, and Our Risk Concentration for additional information.

Credit Enhancement. FHA mortgage loans are backed by insurance provided by the United States government and, therefore, no additional credit enhancements (such as an LRA or SMI) are required.

For conventional mortgage loans, the credit enhancement required to reach the minimum credit rating is determined by using an NRSRO credit risk model.




Our original MPP, which we ceased offering for conventional loans in November 2010, relied on credit enhancement from LRA and SMI to achieve an implied credit rating of at least AA based on an NRSRO model in compliance with Finance Agency regulations. In November 2010, we began offering MPP Advantage for new conventional MPP loans, which utilizes an enhanced fixed LRA for additional credit enhancement, resulting in an implied credit rating of at least BBB, consistent with Finance Agency regulations, instead of utilizing coverage from an SMI provider. The only substantive difference between the two programs is the credit enhancement structure. For both the original MPP and MPP Advantage, the funds in the LRA are established in an amount sufficient to cover expected losses in excess of the borrower's equity and PMI, if any, and used to pay losses on a pool basis.

Credit losses on defaulted mortgage loans in a pool are paid from these sources, until they are exhausted, in the following order:

borrower's equity;
PMI, if applicable;
LRA;
SMI, if applicable; and
our Bank.
            
LRA. We use either a "spread LRA" or a "fixed LRA" for credit enhancement. The spread LRA is used in combination with SMI for credit enhancement of conventional mortgage loans purchased under our original MPP, and the fixed LRA is used for all acquisitions of conventional mortgage loans under MPP Advantage.

Original MPP. The spread LRA is funded through a reduction to the net yield earned on the loans, and the corresponding purchase price paid to the PFI reflects our reduced net yield. The LRA for each pool of loans is funded monthly at an annual rate ranging from 6 to 20 bps, depending on the terms of the MCC, and is used to pay loan loss claims or is held until the LRA accumulates to a required "release point." The release point is 20 to 85 bps of the then outstanding principal balances of the loans in that pool, depending on the terms of the original contract. If the LRA exceeds the required release point, the excess amount is eligible for return to the PFI(s) that sold us the loans in that pool, generally subject to a minimum 5-year lock-out period after the pool is closed to acquisitions.

MPP Advantage. The LRA for MPP Advantage differs from our original MPP in that the funding of the fixed LRA occurs at the time we acquire the loan and consists of a portion of the principal balance purchased. Depending on the terms of the MCC, the LRA funding amount varies between 110 bps and 120 bps of the principal balance of the loans in the pool when purchased. There is no SMI credit enhancement for MPP Advantage. LRA funds not used to pay loan losses may be returned to the PFI subject to a release schedule detailed in each MCC based on the original LRA amount. No LRA funds are returned to the PFI for the first 5 years after the pool is closed to acquisitions. We absorb any losses in excess of LRA funds.
    
SMI. For pools of loans acquired under our original MPP, we have credit protection from loss on each loan, where eligible, through SMI, which provides insurance to cover credit losses to approximately 50% of the property's original value, depending on the SMI contract terms, and subject, in certain cases, to an aggregate stop-loss provision in the SMI policy. Some MCCs that equal or exceed $35 million of total initial principal to be sold on a "best-efforts" basis include an aggregate loss/benefit limit or "stop-loss" that is equal to the total initial principal balance of loans under the MCC multiplied by the stop-loss percentage (ranges from 200 - 400 bps), as is then in effect, and represents the maximum aggregate amount payable by the SMI provider under the SMI policy for that pool. Even with the stop-loss provision, the aggregate of the LRA and the amount payable by the SMI provider under an SMI stop-loss contract will be equal to or greater than the amount of credit enhancement required for the pool to have an implied NRSRO credit rating of at least AA at the time of purchase. Non-credit losses, such as uninsured property damage losses that are not covered by the SMI, can be recovered from the LRA to the extent that there are releasable LRA funds available. We absorb any non-credit losses greater than the available LRA. We do not have SMI coverage on loans purchased under MPP Advantage.

Pool Aggregation. We offer pool aggregation under our MPP. Our pool aggregation program is designed to reduce the credit enhancement costs to small and mid-size PFIs. PFIs are allowed to pool their loans with similar pools of loans originated by other PFIs to create aggregate pools of approximately $100 million original UPB or greater. The combination of small and mid-size PFIs' loans into one pool also assists in the evaluation of the amount of LRA needed for the overall credit enhancement.




Conventional Loan Pricing. We consider the cost of the credit enhancement (LRA and SMI, if applicable) when we formulate conventional loan pricing. Each of these credit enhancement structures is accounted for, not only in our expected return on acquired mortgage loans, but also in the risk review performed during the accumulation/pooling process. The pricing of each structure is dependent on a number of factors and is specific to the PFI or group of PFIs.

We typically receive a 0.25% fee on cash-out refinancing transactions with LTVs between 75% and 80%. Our current guidelines do not allow cash-out refinance loans above 80% LTV. We also adjust the market price we pay for loans depending upon market conditions. We continue to evaluate the scope and rate of such fees as they evolve in the industry. We do not pay a PFI any fees other than the servicing fee when the PFI retains the servicing rights.

Servicing. We do not service the mortgage loans we purchase. PFIs may elect to retain servicing rights for the loans sold to us, or they may elect to sell servicing rights to an MPP-approved servicer. As of December 31, 2016 based on the total UPB of MPP loans, 15% were serviced by CMC Funding Inc., 11% were serviced by Rushmore Loan Management Services, and 11% were serviced by Northpointe Bank, with the remaining 63% serviced by PFIs or other servicers with no one organization servicing over 10%.

Those PFIs that retain servicing rights receive a monthly servicing fee, must be approved by us, and may be required to undergo a review by a third-party quality control contractor that advises the PFIs of any deficiencies in servicing procedures or processes and then notifies us so that we can monitor the PFIs' performance. The PFIs that retain servicing rights can sell those rights at a later date with our approval. Servicing activities, whether retained or released, are subject to review by our master servicer, BNY Mellon. If we deem servicing to be inadequate, we can require that the servicing of those loans be transferred to a servicer that is acceptable to us.

The servicers are responsible for all aspects of servicing, including, among other responsibilities, the administration of any foreclosure and claims processes from the date we purchase the loan until the loan has been fully satisfied. Our MPP was designed to require loan servicers to foreclose and liquidate in the servicer's name rather than in our name. As the servicers progress through the liquidation process, we are paid in full for all unpaid principal and accrued interest on the loan through the normal remittance process.

It is the servicer's responsibility to initiate loss claims on the loans. No payments from the LRA (other than excess amounts released to the PFI over a period of time in accordance with each MCC) or SMI are made prior to the claims process. For loans that are credit-enhanced with SMI, if it is determined that a loss is covered, the SMI provider pays the claim in full and seeks reimbursement from the LRA funds. The SMI provider is entitled to reimbursement for credit losses from funds available in the LRA that are equal to the aggregate amounts contributed to the LRA less any amounts paid for previous claims and any amounts that have been released to the PFI from the LRA or paid to us to cover prior claims. If the LRA has been depleted but is still being funded, based on our contractual arrangement, we and/or the SMI provider are entitled to reimbursement from those funds as they are received, up to the full reimbursable amount of the claim. These claim payments would be reflected as additional deductions from the LRA as they were paid. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Credit Risk Management - Mortgage Loans Held for Portfolio - MPP for additional information.

Housing Goals. The Bank Act requires the Finance Agency to establish low-income housing goals for mortgage purchases. Under its housing goals regulation, the Finance Agency may establish low-income housing goals for FHLBanks that acquire, in any calendar year, more than $2.5 billion of conventional mortgages through an AMA program. If we exceed this volume threshold and fail to meet any affordable housing goals established by the Finance Agency that were determined by the Director to have been feasible, we may be required to submit a housing plan to the Finance Agency.

In 2015, our conventional mortgage purchase volume exceeded $2.5 billion. The Finance Agency determined with respect to 2015, however, that it would not require us to submit a housing plan, which could otherwise have been required under the regulation. With pre-approval from our board of directors, we purchased $3.0 billion of conventional mortgage loans through MPP Advantage during the year ended December 31, 2016. The Finance Agency similarly determined with respect to 2016 that it will not require us to submit a housing plan.




Funding Sources

The primary source of funds for each of the FHLBanks is the sale of consolidated obligations, which consist of CO bonds and discount notes. The Finance Agency and the United States Secretary of the Treasury oversee the issuance of this debt in the capital markets. Finance Agency regulations govern the issuance of debt on our behalf and authorize us to issue consolidated obligations through the Office of Finance, under Section 11(a) of the Bank Act. No FHLBank is permitted to issue individual debt without the approval of the Finance Agency.

While the primary liability for consolidated obligations issued to provide funds for a particular FHLBank rests with that FHLBank, consolidated obligations are the joint and several obligations of all of the FHLBanks under Section 11(a). Although each FHLBank is a GSE, consolidated obligations are not obligations of, and are not guaranteed by, the United States government. Consolidated obligations are backed only by the financial resources of all of the FHLBanks. Our consolidated obligations are rated Aaa by Moody's and AA+ by S&P. The aggregate par amount of the FHLBank System's outstanding consolidated obligations was approximately $989.3 billion at December 31, 2016. The par amount of the consolidated obligations for which we are the primary obligor was $50.3 billion at December 31, 2016.

Consolidated Obligation Bonds. CO bonds satisfy term funding requirements and are issued with a variety of maturities and terms under various programs. The maturities of these securities may range from 4 months to 30 years, but the maturities are not subject to any statutory or regulatory limit. CO bonds can be fixed or adjustable rate and callable or non-callable. Those issued with adjustable-rate payment terms use a variety of indices for interest rate resets, including LIBOR, Federal Funds, United States Treasury Bill, Constant Maturity Swap, Prime Rate, and others. CO bonds are issued and distributed through negotiated or competitively bid transactions with approved underwriters or selling group members.

Consolidated Obligation Discount Notes. We also issue discount notes to provide short-term funds for advances to members, liquidity, and other investments. These securities can have maturities that range from one day to one year, and are offered daily through a discount note selling group and other authorized securities dealers. Discount notes are generally sold below their face values and are redeemed at par when they mature.

Office of Finance. The issuance of consolidated obligations is facilitated and executed by the Office of Finance, which also services all outstanding debt, provides information on capital market developments to the FHLBanks, and manages our relationship with the NRSROs with respect to consolidated obligations. The Office of Finance also prepares and publishes the FHLBanks' combined quarterly and annual financial reports.

As the FHLBanks' fiscal agent for debt issuance, the Office of Finance can control the timing and amount of each issuance. Through its oversight of the United States financial markets, the United States Treasury can also affect debt issuance for the FHLBanks. See Item 1. Business - Supervision and Regulation - Government Corporations Control Act for additional information.




Community Investment and Affordable Housing Programs

Each FHLBank is required to set aside 10% of its annual net earnings before interest expense on MRCS to fund its AHP, subject to an annual FHLBank System-wide minimum of $100 million. Through our AHP, we may provide cash grants or interest subsidies on advances to our members, which are, in turn, provided to awarded projects or qualified individuals to finance the purchase, construction, or rehabilitation of very low- to moderate-income owner-occupied or rental housing. Our AHP includes the following:

Competitive Program, which is the primary grant program to finance the purchase, construction or rehabilitation of housing for individuals with incomes at or below 80% of the median income for the area, and to finance the purchase, construction, or rehabilitation of rental housing, with at least 20% of the units occupied by, and affordable for, very low-income households. Each year, 65% of our annual available AHP funds are granted through this program.

Set-Aside Programs, which include 35% of our annual available AHP funds, are administered through the following:

Homeownership Opportunities Program, which provides assistance with down payments and closing costs to first-time homebuyers;
Neighborhood Impact Program, which provides rehabilitation assistance to homeowners to help improve neighborhoods;
Accessibility Modifications Program, which provides funding for accessibility modifications and minor home rehabilitation for eligible senior homeowners or owner-occupied households with one or more individuals having a permanent disability; and
Disaster Relief Program, which may be activated at our discretion in cases of federal or state disaster declarations for rehabilitation or down payment assistance targeted to low- or moderate-income homeowner disaster victims.

In addition, we offer a variety of specialized advance programs to support housing and community development needs. Through our CIP, we offer advances to our members involved in community economic development activities benefiting low- or moderate-income families or neighborhoods. These funds can be used for the development of housing, infrastructure improvements, or assistance to small businesses or businesses that are creating or retaining jobs in the member's community for low- and moderate-income families. These advances have maturities ranging from overnight to 20 years and are priced at our cost of funds plus reasonable administrative expenses.

Use of Derivatives

Derivatives are an integral part of our financial management strategies to manage identified risks inherent in our lending, investing and funding activities and to achieve our risk management objectives. Finance Agency regulations and our ERMP establish guidelines for the use of derivatives. Permissible derivatives include interest-rate swaps, swaptions, interest-rate cap and floor agreements, calls, puts, futures, and forward contracts. We are only permitted to execute derivative transactions to manage interest-rate risk exposure inherent in otherwise unhedged asset or liability positions, hedge embedded options in assets and liabilities including mortgage prepayment risk positions, hedge any foreign currency positions, and act as an intermediary between our members and interest-rate swap counterparties. We are prohibited from trading in or the speculative use of these instruments.

Our use of derivatives is the primary way we align the preferences of investors for the types of debt securities they want to purchase and the preferences of member institutions for the types of advances they want to hold and the types of mortgage loans they want to sell. See Notes to Financial Statements - Note 11 - Derivatives and Hedging Activities and Item 7A. Quantitative and Qualitative Disclosures About Market Risk for more information.




Supervision and Regulation

The Bank Act. We are supervised and regulated by the Finance Agency, an independent agency in the executive branch of the United States government, established by HERA.

Under the Bank Act, the Finance Agency's responsibility is to ensure that, pursuant to regulations promulgated by the Finance Agency, each FHLBank:

carries out its housing finance mission;
remains adequately capitalized and able to raise funds in the capital markets; and
operates in a safe and sound manner.

The Finance Agency is headed by a Director, who is appointed to a five-year term by the President of the United States, with the advice and consent of the Senate. The Director appoints a Deputy Director for the Division of Enterprise Regulation, a Deputy Director for the Division of FHLBank Regulation, and a Deputy Director for Housing Mission and Goals, who oversees the housing mission and goals of Fannie Mae and Freddie Mac, as well as the housing finance and community and economic development mission of the FHLBanks. HERA also established the Federal Housing Finance Oversight Board, comprised of the Secretaries of the Treasury and HUD, the Chair of the SEC, and the Director. The Federal Housing Finance Oversight Board functions as an advisory body to the Director. The Finance Agency's operating expenses are funded by assessments on the FHLBanks, Fannie Mae and Freddie Mac. As such, no tax dollars or other appropriations support the operations of the Finance Agency or the FHLBanks. In addition to reviewing our submissions of monthly and quarterly financial information on our financial condition and results of operations, the Finance Agency conducts annual on-site examinations and performs periodic on- and off-site reviews in order to assess our safety and soundness.

The United States Treasury receives a copy of the Finance Agency's annual report to Congress, monthly reports reflecting the FHLBank System's securities transactions, and other reports reflecting the FHLBank System's operations. Our annual financial statements are audited by an independent registered public accounting firm in accordance with standards issued by the Public Company Accounting Oversight Board, as well as the government auditing standards issued by the United States Comptroller General. The Comptroller General has authority under the Bank Act to audit or examine the Finance Agency and the FHLBank System and to decide the extent to which they fairly and effectively fulfill the purposes of the Bank Act. The Finance Agency's Office of Inspector General also has investigation authority over the Finance Agency and the FHLBank System.

GLB Act. The GLB Act requires that each FHLBank maintain a capital structure comprised of Class A stock, Class B stock, or both. A member can redeem Class A stock upon six months' prior written notice to its FHLBank. A member can redeem Class B stock upon five years' prior written notice to its FHLBank. Class B stock has a higher weighting than Class A stock for purposes of calculating the minimum leverage requirement applicable to each FHLBank.

The GLB Act requires that each FHLBank maintain permanent capital and total capital in sufficient amounts to comply with specified, minimum risk-based capital and leverage capital requirements. From time to time, for reasons of safety and soundness, the Finance Agency may require one or more individual FHLBanks to maintain more permanent capital or total capital than is required by the regulations. Failure to comply with these requirements or the minimum capital requirements could result in the imposition of operating agreements, cease and desist orders, civil money penalties, and other regulatory action, including involuntary merger, liquidation, or reorganization as authorized by the Bank Act.

HERA Amendments to the Bank Act. HERA eliminated the Finance Agency's authority to appoint directors to our board. HERA also eliminated the Finance Agency's authority to cap director fees (subject to the Finance Agency's review of reasonableness of such compensation) but placed additional controls over executive compensation.

Government Corporations Control Act. We are subject to the Government Corporations Control Act, which provides that, before we can issue and offer consolidated obligations to the public, the Secretary of the United States Treasury must prescribe the form, denomination, maturity, interest rate, and conditions of the obligations; the way and time issued; and the selling price.

Furthermore, this Act provides that the United States Comptroller General may review any audit of the financial statements of an FHLBank conducted by an independent registered public accounting firm. If the Comptroller General undertakes such a review, the results and any recommendations must be reported to Congress, the Office of Management and Budget, and the FHLBank in question. The Comptroller General may also conduct a separate audit of any of our financial statements.




Federal Securities Laws. Our shares of Class B stock are registered with the SEC under the Exchange Act, and we are generally subject to the information, disclosure, insider trading restrictions, and other requirements under the Exchange Act, with certain exceptions. We are not subject to the registration provisions of the Securities Act. We have been, and continue to be, subject to all relevant liability provisions of the Securities Act and the Exchange Act.

Federal and State Banking Laws. We are generally not subject to the state and federal banking laws affecting United States retail depository financial institutions. However, the Bank Act requires the FHLBanks to submit reports to the Finance Agency concerning transactions involving financial instruments and loans that involve fraud or possible fraud. In addition, we are required to maintain an anti-money laundering program, under which we are required to report suspicious transactions to the Financial Crimes Enforcement Network pursuant to the Bank Secrecy Act and the USA Patriot Act.

As a wholesale secured lender and a secondary market purchaser of mortgage loans, we are not, in general, directly subject to the various federal and state laws regarding consumer credit protection, such as anti-predatory lending laws. However, as non-compliance with these laws could affect the value of these loans as collateral or acquired assets, we require our members to warrant that all of the loans pledged or sold to us are in compliance with all applicable laws. Federal law requires that, when a mortgage loan (defined to include any consumer credit transaction secured by the principal dwelling of the consumer) is sold or transferred, the new creditor shall, within 30 days of the sale or transfer, notify the borrower of the following: the identity, address and telephone number of the new creditor; the date of transfer; how to contact an agent or party with the authority to act on behalf of the new creditor; the location of the place where the transfer is recorded; and any other relevant information regarding the new creditor. In accordance with this statute, we provide the appropriate notice to borrowers whose mortgage loans we purchase under our MPP and have established procedures to ensure compliance with this notice requirement. In the case of the participating interests in mortgage loans we purchased from the FHLBank of Topeka under the MPF Program, the FHLBank of Chicago (as the MPF Provider) issued the appropriate notice to the affected borrowers and established its own procedures to ensure compliance with the notice requirement.

Regulatory Enforcement Actions. While examination reports are confidential between the Finance Agency and an FHLBank, the Finance Agency may publicly disclose supervisory actions or agreements that the Finance Agency has entered into with an FHLBank. We are not subject to any such Finance Agency actions, and we are not aware of any current Finance Agency actions with respect to other FHLBanks that will have a material adverse effect on our financial results.

Membership

Our membership territory is comprised of the states of Michigan and Indiana. In 2016, we gained 12 new members and, due to mergers and consolidations, lost 15 members, for a net loss of 3 members.

The following table presents the composition of our members by type of financial institution.
Type of Institution
 
December 31, 2016
 
% of Total
 
December 31, 2015
 
% of Total
Commercial banks and savings associations
 
210

 
53
%
 
222

 
56
%
Credit unions
 
121

 
31
%
 
114

 
29
%
Insurance companies
 
60

 
15
%
 
58

 
14
%
CDFIs
 
3

 
1
%
 
3

 
1
%
Total member institutions
 
394

 
100
%
 
397

 
100
%

Competition

We operate in a highly competitive environment. Member demand for advances is affected by, among other factors, the cost and availability of other sources of funds, including deposits. We compete with other suppliers of wholesale funding, both secured and unsecured. Other suppliers may include the United States government, deposit insurers, the Federal Reserve Banks, investment banks, commercial banks, and in certain circumstances other FHLBanks. An example of this occurs when a financial holding company has subsidiary banks that are members of different FHLBanks and can, therefore, choose to take advances from the FHLBank with the best terms. Larger institutions may have access to all of these alternatives as well as independent access to the national and global credit markets. The availability of alternative funding sources can be affected by a variety of factors, including market conditions, members' creditworthiness and regulatory restrictions, and collateral availability and valuation.

Likewise, our MPP is subject to significant competition. The most direct competition for mortgage purchases comes from other buyers or guarantors of government-guaranteed or conventional, conforming fixed-rate mortgage loans such as Ginnie Mae, Fannie Mae and Freddie Mac.



We also compete with Fannie Mae, Freddie Mac and other GSEs as well as corporate, sovereign, and supranational entities for funds raised through the issuance of debt instruments. Increases in the supply of competing debt products, in the absence of increases in demand, typically result in higher debt costs to us or lesser amounts of debt issued on our behalf at the same cost than otherwise would be the case.

Employees

As of December 31, 2016, we had 216 full-time employees and 2 part-time employees. Employees are not represented by a collective bargaining unit.

Available Information

Our Annual and Quarterly Reports on Forms 10-K and 10-Q, together with our Current Reports on Form 8-K, are filed with the SEC through the EDGAR filing system. A link to EDGAR is available through our public website at www.fhlbi.com by selecting "News" and then "Investor Relations."

We have a Code of Conduct that is applicable to all directors, officers, and employees and the members of our Affordable Housing Advisory Council. The Code of Conduct is available on our website by scrolling to the bottom of any web page on www.fhlbi.com and then selecting "Corporate Governance" in the navigation menu.

Our 2017 Community Lending Plan describes our plan to address the credit needs and market opportunities in our district states of Michigan and Indiana. It is available on our website at www.fhlbi.com by selecting "Resources" and "Bulletins, Publications and Presentations".

Our Audit Committee operates under a written charter adopted by the board of directors that was most recently amended on September 9, 2016. The Audit Committee charter is available on our website by scrolling to the bottom of any web page on www.fhlbi.com and then selecting "Corporate Governance" in the navigation menu.

We provide our website address and the SEC's website address solely for information. Except where expressly stated, information appearing on our website and the SEC's website is not incorporated into this Annual Report on Form 10-K.

Anyone may also request a copy of any of our public financial reports, our Code of Conduct or our 2017 Community Lending Plan through our Corporate Secretary at FHLBank of Indianapolis, 8250 Woodfield Crossing Boulevard, Indianapolis, IN 46240, (317) 465-0200.





ITEM 1A. RISK FACTORS
 
We use certain acronyms and terms throughout this Item which are defined in the Glossary of Terms. We have identified the following risk factors that could have a material adverse effect on our Bank.

Changes in the Legal and Regulatory Environment for FHLBanks, Other Housing GSEs or Our Members May Adversely Affect Our Business, Demand for Advances, the Cost of Debt Issuance, and the Value of FHLBank Membership

We could be materially adversely affected by the adoption of new or revised laws, policies, regulations or accounting guidance; new or revised interpretations or applications of laws, policies, or regulations by the Finance Agency, its Office of Inspector General, the SEC, the CFTC, the CFPB, the Financial Stability Oversight Council ("FSOC"), the Comptroller General, the FASB or other federal or state financial regulatory bodies; or judicial decisions that modify the present regulatory environment. Likewise, whenever federal elections result in a new President and the related executive branch appointments and changes in the balance of political parties’ representation in Congress, there is uncertainty as to potential administrative, regulatory and legislative actions that may materially adversely affect our business. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Accounting and Regulatory Developments - Legislative and Regulatory Developments for more information.

Changes that restrict the growth or alter the risk profile of our current business or prohibit the creation of new products or services could negatively impact our earnings. For example, our earnings could be negatively impacted by regulatory changes that (i) further restrict the types, characteristics or volume of mortgages that we may purchase through our MPP or (ii) reduce the economic value of MPP to our members. In addition, the regulatory environment affecting our members could be changed in a manner that would negatively impact their ability to take full advantage of our products and services, our ability to rely on their pledged collateral, or their desire to maintain membership in our Bank. Changes to the regulatory environment that affect our debt underwriters, particularly revised capital and liquidity requirements, could also adversely affect our cost of issuing debt in the capital markets. Similarly, regulatory actions or public policy changes, including those that give preference to certain sectors, business models, regulated entities, or activities, could negatively impact us. For example, changes in the status of Fannie Mae and Freddie Mac during the next phases of their conservatorship may impact funding costs for the FHLBanks, which could negatively affect our business and results of operations. In addition, negative news articles, industry reports, and other announcements pertaining to GSEs, including Fannie Mae, Freddie Mac or any of the FHLBanks, could cause an increase in interest rates on all GSE debt, as investors may perceive their debt instruments as bearing increased risk.

The Finance Agency requires the FHLBanks to maintain sufficient liquidity through short-term investments in an amount at least equal to an FHLBank's cash outflows under two hypothetical scenarios for the treatment of maturing advances. This regulatory guidance is designed to provide sufficient liquidity to protect against temporary disruptions in the capital markets that affect the FHLBanks' access to funding. To satisfy these two scenarios, we maintain balances in shorter-term investments, which may earn lower interest rates than alternate investment options. In certain circumstances we may also need to fund shorter-term advances with short-term discount notes that have maturities beyond those of the related advances, thus increasing our short-term advance pricing or reducing net income through lower net interest spreads. To the extent these increased prices make our advances less competitive, advance levels and net interest income may be negatively affected. In addition, issuance of additional regulatory liquidity requirements in the future could adversely affect our business activities and operations.

The CFPB rules include standards for mortgage lenders to follow during the loan approval process to determine whether a borrower has the ability to repay the mortgage loan. The Dodd-Frank Act provides defenses to foreclosure and causes of action for damages if the mortgage lender does not meet the standards in the CFPB rules. A mortgage borrower can assert these defenses and causes of action against the original mortgage lender, and against purchasers and other assignees of the mortgage loan, which would include us as loan purchaser under our AMA programs or if we were to direct a servicer to foreclose on mortgage loan collateral. In addition, mortgage lenders unable to sell mortgage loans (whether because they are not QMs or otherwise) would be expected to retain such loans as assets. If we were to make advances secured, in part, by non-safe harbor QMs and subsequently liquidate such collateral, we could be subject to these defenses to foreclosure or causes of action for damages by mortgage borrowers. This risk, in turn, could reduce the value of our advances collateral, potentially reducing our likelihood of full repayment on our advances if we were required to sell such collateral.




Other provisions in the Dodd-Frank Act could affect us and our members, depending on how the various federal regulators decide to implement this law through the issuance of regulations and their enforcement activities. For example, in November 2015, the Finance Agency, along with other prudential regulators, published a final rule on minimum margin requirements (both initial and variation margin) for "covered swap entities," which include the FHLBanks. This final rule took effect on April 1, 2016, with a March 1, 2017 implementation date for our increased variation margin requirements.

In addition, on June 15, 2016, the SEC approved a proposed rule promulgated by FINRA to require the margining of certain TBA transactions. Specifically, the approved FINRA Rule 4210 will require FINRA members to collect from, but not post to, their customer’s maintenance margin (i.e., initial margin) and variation margin on transactions that are "Covered Agency Transactions," subject to certain exemptions. A "Covered Agency Transaction" includes:

TBA transactions inclusive of ARM transactions and Specified Pool Transactions (as defined in the proposed rule), for which the difference between the trade date and contractual settlement date is greater than one business day; and
CMOs issued in conformity with a program of an agency or a GSE for which the difference between the trade date and contractual settlement date is greater than three business days.

Transactions with a counterparty in multifamily housing securities are exempt from the margin requirements provided that the securities are issued by certain US government agencies or a GSE and the FINRA member makes a written risk limit determination for each such counterparty.

Under the rule, we are exempt from posting initial margin but would be required to post variation margin to a FINRA-member counterparty in connection with covered transactions if we have more than $10 million in gross open positions with the counterparty. FINRA members will be required to comply with the new margin requirements beginning in December 2017.

Materially greater margin requirements could adversely affect the availability and pricing of our derivative transactions, making derivative trades more costly and less attractive as risk management tools.
 
Other provisions of the Dodd-Frank Act may indirectly affect us due to its effects on our members. For example, this law establishes a solvency framework to address the failure of a financial institution, which could include one or more of our members or financial counterparties. Because the Dodd-Frank Act requires several regulatory bodies to carry out its provisions, its full effect remains uncertain until after the required reports to Congress are issued and implementing regulations are adopted.

Comparable solvency frameworks have been enacted by several members of the European Union pursuant to the European Bank Recovery and Resolution Directive ("BRRD") developed by the Financial Stability Board. We engage in financial transactions with counterparties which are domiciled in countries that have adopted the BRRD. The failure of any such counterparty could subject our transactions with such party to the BRRD solvency framework, the results of which may not be wholly predictable.

In addition, the federal banking regulators are undertaking rulemaking from the Basel Committee on Bank Supervision. The FDIC, OCC, and FRB have established new minimum capital standards for financial institutions that incorporate (which in some cases may further strengthen) the Basel III regulatory capital reforms. The new capital framework could require some of our members to divest assets in order to comply with more stringent capital requirements, thereby tending to decrease their need for advances. The capital requirements may also reduce investor demand for consolidated obligations.




In 2014, the FRB, OCC and FDIC jointly adopted a rule that incorporates (and in some cases increases) Basel III liquidity requirements. The liquidity coverage ratio ("LCR") rule requires certain non-banking financial organizations ("Covered Organizations") to maintain sufficient amounts of high quality liquid assets ("HQLA") to withstand a 30-day run on the Covered Organization following severe economic stress, based on certain assumptions about outflow rates for HQLAs. If the Covered Organization qualifies as an "advanced approaches" banking organization, the HQLA requirements are also applied on a consolidated basis to each United States-based banking subsidiary of such Covered Organization with more than $10.0 billion in assets. HQLAs must be unencumbered, although they may be pledged as part of a blanket lien to a U.S. central bank or GSE, as long as they do not currently support credit or access to payment services extended to the Covered Organization by such central bank or GSE. HQLAs are divided into three classes or levels. FHLBank consolidated obligations are considered "Level 2A" liquidity assets; as such they can be counted for liquidity purposes, but are subject to a 15% haircut and are capped at 40% of the liquidity requirement. This haircut could make it more costly for any Covered Organization to hold consolidated obligations, which could reduce demand for them. The LCR rule provisions became fully effective as of January 1, 2017. There continues to be uncertainty about the extent to which implementation of these requirements by our members, investors, and debt underwriters may affect us.

Economic Conditions and Policy Could Have an Adverse Effect on Our Business, Liquidity, Financial Condition, and Results of Operations

Our business, liquidity, financial condition, and results of operations are sensitive to general domestic and international business and economic conditions, such as changes in the money supply, inflation, volatility in both debt and equity capital markets, and the strength of the local economies in which we conduct business.

Our business and results of operations are significantly affected by the fiscal and monetary policies of the United States government and its agencies, including the FRB through its regulation of the supply of money and credit in the United States. The FRB's policies either directly or indirectly influence the yield on interest-earning assets, volatility of interest rates, prepayment speeds, the cost of interest-bearing liabilities and the demand for our debt. 

The FOMC continues to maintain its policy of reinvesting principal payments from its holdings of agency debt and agency MBS in agency MBS and of rolling over maturing United States Treasury securities at auction. These policies are intended to help maintain accommodative financial conditions. However, the FRB's continuing substantial participation in both short-term and MBS markets could adversely affect us through lower yields on our investments, higher costs of debt, and disruption of member demand for our products.

Additionally, we are affected by the global economy through member ownership and investments, and through capital markets exposures. Global political, economic, and business uncertainty has led to increased volatility in capital markets and has the potential to drive volatility in the future. SEC guidance pertaining to prime money market funds resulted in a significant increase in demand for government funds and agency debt, as well as FHLBank discount notes. While this increased demand for discount notes reduced our funding costs, a reversal of such demand could reduce their attractiveness. Political events, including the United Kingdom's decision to leave the European Union and the results of the 2016 U.S. Presidential and Congressional elections, also ignited market volatility. Continued economic uncertainties could lead to further global capital market volatility, lower credit availability, and weaker economic growth. As a result, our business could be exposed to unfavorable market conditions, lower demand for mission-related assets, lower earnings, or reduced ability to pay dividends or redeem or repurchase capital stock. 

Our business and results of operations are sensitive to the condition of the housing and mortgage markets, as well as general business and economic conditions. Adverse trends in the mortgage lending sector, including declines in home prices or loan performance trends, could reduce the value of collateral securing member credit and the fair value of our MBS. This change could increase the possibility of under-collateralization, increasing the risk of loss in case of a member's failure, or could increase the risk of loss on our MBS because of additional credit impairment charges. Also, deterioration in the residential mortgage markets could negatively affect the value of our MPP portfolio, resulting in an increase in the allowance for credit losses on mortgage loans and possible additional realized losses if we were forced to liquidate our MPP portfolio.

Our district is comprised of the states of Michigan and Indiana. Increases in unemployment and foreclosure rates or decreases in job or income growth rates in either state could result in less demand for mission-related assets and therefore lower earnings. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Executive Summary -Economic Environment for more information.



A Failure or Interruption in Our Information Systems, Information Systems of Third-Party Vendors or Service Providers, or a Cybersecurity Event Could Adversely Affect Our Business, Risk Management, Financial Condition, Results of Operations, and Reputation

We rely heavily on our information systems and other technology to conduct and manage our business. Our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. These computer systems, software and networks are vulnerable to breaches, unauthorized access, damage, misuse, computer viruses or other malicious code and other events that could potentially jeopardize the confidentiality of such information or otherwise cause interruptions or malfunctions in our operations. There is no assurance that our business continuity plans, including our security measures, will provide fully effective security or prevent a failure or interruption in our operations. If we experience a significant failure or interruption in our business continuity or certain information systems, or a significant cybersecurity event, or if we fail to implement key information technology initiatives, we may be unable to conduct and manage our business functions effectively.

Despite our policies, procedures, and controls, some operational risks are beyond our control, and the failure of other parties to adequately address their operational risks could adversely affect us. In addition to internal computer systems, we outsource certain communication and information systems and other critical services to external third-party vendors and service providers, including the Office of Finance, derivatives clearing organizations, and loan servicers. Compromised security at those vendors and third parties could expose us to cyber attacks or other breaches. If one or more of these key external parties were not able to perform their functions for a period of time, at an acceptable service level, or for increased volumes, our business operations could be constrained, disrupted, or otherwise negatively affected. In addition, any failure, interruption or breach in security of these systems, or any disruption of service, could result in failures or interruptions in our ability to conduct and manage our business effectively, including, without limitation, our funding and hedging activities. There is no assurance that such failures or interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third parties on which we rely. Any failure, interruption, or breach could significantly harm our customer relations and business operations, which could negatively affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.

We have purchased participating interests in MPF Program mortgage loans that the FHLBank of Topeka acquired from its PFIs. In its role as MPF Provider, the FHLBank of Chicago provides the infrastructure and operational support for the MPF Program and is responsible for publishing and maintaining the MPF Origination, Underwriting and Servicing Guides, which detail the requirements PFIs must follow in originating or selling and servicing MPF Program mortgage loans. If the FHLBank of Chicago changes or ceases to operate the MPF Program or experiences a failure or interruption in its information systems and other technology in its operation of the MPF Program, our MPF business could be adversely impacted, which could negatively affect our financial condition, profitability and cash flows. In the same way, we could be adversely affected if any of the FHLBank of Chicago's third-party vendors that are engaged in the operation of the MPF Program were to experience operational or technical difficulties.

The Inability to Access Capital Markets on Acceptable Terms Could Adversely Affect Our Liquidity, Operations, Financial Condition and Results of Operations, and the Value of Membership in Our Bank

Our primary source of funds is the sale of consolidated obligations in the capital markets. Our ability to obtain funds through the sale of consolidated obligations depends in part on prevailing conditions in the capital markets, such as investor demand and liquidity, and on dealer commitment to inventory and support our debt. Severe financial and economic disruptions in the past, and the United States government's measures to mitigate their effects, including increased capital requirements on dealers' inventory and other regulatory changes affecting dealers, have changed the traditional bases on which market participants value GSE debt securities and consequently could affect our funding costs and practices, which could make it more difficult and more expensive to issue our debt. Any further disruption in the debt market could have an adverse impact on our interest spreads, opportunity to call and reissue existing debt or roll over maturing debt, or ability to meet the Finance Agency's mandates on FHLBank liquidity.




A Loss of Significant Borrowers, PFIs or Acceptable Loan Servicers Could Adversely Impact Our Profitability, Our Ability to Achieve Business Objectives, Our Ability to Pay Dividends or Redeem or Repurchase Capital Stock, and Our Risk Concentration
 
The loss of any large borrower could adversely impact our profitability and our ability to achieve business objectives. The loss of a large borrower could result from a variety of factors, including acquisition, consolidation of charters within a bank holding company, resolution of a financially distressed member, or regulatory changes. As of December 31, 2016, our top two borrowers, Lincoln National Life Insurance Company and Flagstar Bank, FSB, held $3.4 billion and $3.0 billion, respectively, or a total of 23% of total advances outstanding, at par.

At December 31, 2016, 28% of our outstanding par value of MPP loans had been purchased from two PFIs. One of these PFIs originates mortgages on properties in several states, while the other PFI originates mortgages on properties principally in Michigan and Indiana. We also purchase mortgage loans from many smaller PFIs that predominantly originate mortgage loans on properties in Michigan and Indiana. Therefore, our concentration of MPP loans on properties in Michigan and Indiana could continue to increase over time, as we do not currently limit such concentration.

We do not service the mortgage loans we purchase. PFIs may elect to retain servicing rights for the loans sold to us, or they may elect to sell servicing rights to an MPP-approved servicer. Federal banking regulations and Dodd-Frank Act capital requirements are causing mortgage servicing rights to be transitioned to non-depository institutions, which may reduce the availability of buyers of mortgage servicing rights. A scarcity of mortgage servicers could adversely affect our results of operations.

Downgrades of Our Credit Rating, the Credit Rating of One or More of the Other FHLBanks, or the Credit Rating of the Consolidated Obligations Could Adversely Impact Our Cost of Funds, Our Ability to Access the Capital Markets, and/or Our Ability to Enter Into Derivative Instrument Transactions on Acceptable Terms

The FHLBanks' consolidated obligations are rated Aaa/P-1 with a stable outlook by Moody's and AA+/A-1+ with a stable outlook by S&P. Rating agencies may from time to time change a rating or issue negative reports. Because each FHLBank has joint and several liability for all FHLBank consolidated obligations, negative developments at any FHLBank may affect these credit ratings or result in the issuance of a negative report regardless of an individual FHLBank's financial condition and results of operations. In addition, because of the FHLBanks' GSE status, the credit ratings of the FHLBanks are generally influenced by the sovereign credit rating of the United States.

Based on the credit rating agencies' criteria, downgrades to the United States' sovereign credit rating and outlook may occur. As a result, similar downgrades in the credit ratings and outlook on the FHLBanks and the FHLBanks' consolidated obligations may also occur, even though they are not obligations of the United States.

Uncertainty remains regarding possible longer-term effects resulting from rating actions. Any future downgrades in our credit ratings and outlook, especially a downgrade to an S&P AA rating or equivalent, could result in higher funding costs or disruptions in our access to capital markets, including additional collateral posting requirements for certain derivative instrument transactions. To the extent that we cannot access funding when needed on acceptable terms to effectively manage our cost of funds, our financial condition and results of operations and the value of membership in our Bank may be negatively affected.

Our Exposure to Credit Losses Could Adversely Affect Our Financial Condition and Results of Operations

We are exposed to credit losses from member products, investment securities and unsecured counterparties.

Member Products.

Advances. If a member fails and the appointed receiver or rehabilitator (or another applicable entity) does not either (i) promptly repay all of the failed institution's obligations to our Bank or (ii) properly assign or assume the outstanding advances, we may be required to liquidate the collateral pledged by the failed institution. The proceeds realized from the liquidation may not be sufficient to fully satisfy the amount of the failed institution's obligations plus the operational cost of liquidation, particularly if market price and interest rate volatility adversely affect the value of the collateral. Price volatility could also adversely impact our determination of over-collateralization requirements, which could ultimately cause a collateral deficiency in a liquidation scenario. In some cases, we may not be able to liquidate the collateral in a timely manner.




A deterioration of residential or commercial real estate property values could further affect the mortgages pledged as collateral for advances. In order to remain fully collateralized, we may require members to pledge additional collateral, when deemed necessary. If members are unable to fully collateralize their obligations with us, our advances could decrease further, negatively affecting our results of operations or ability to pay dividends or redeem or repurchase capital stock.

Mortgage Loans. Since the inception of the MPP, we have acquired only traditional fixed-rate loans with fixed terms of up to 30 years. If delinquencies in fixed-rate mortgages increase and residential property values decline, we could experience reduced yields or losses exceeding the protection provided by the LRA and SMI credit enhancement and CE obligations, as applicable, on mortgage loans purchased through our MPP or the participating interests in MPF Program loans acquired from the FHLBank of Topeka or another MPF FHLBank.

We are the beneficiary of third-party PMI and SMI (where applicable) coverage on conventional mortgage loans we acquire through our MPP, upon which we rely in part to reduce the risk of losses on those loans. As a result of actions by their respective state insurance regulators, however, one of our PMI providers is paying 75% of the claim amounts and another one is paying 71.5% of the claim amounts. The remaining amounts are deferred until the funds are available or the PMI provider is liquidated. It is possible that insurance regulators may impose restrictions on the ability of our other PMI/SMI providers to pay claims. If our PMI/SMI providers further reduce the portion of mortgage insurance claims they will pay to us or further delay or condition the payment of mortgage insurance claims, or if additional adverse actions are taken by their state insurance regulators, we could experience higher losses on mortgage loans.

We are also exposed to credit losses from servicers for mortgage loans purchased under our MPP or through participating interests in mortgage loans purchased from other FHLBanks under the MPF Program if they fail to perform their contractual obligations.

Investment Securities. The MBS market continues to face uncertainty over the changes in Federal Reserve holdings of MBS and the effect of existing, new or proposed governmental actions (including mortgage loan modification programs). Future declines in the housing price forecast, as well as other factors, such as increased loan default rates and loss severities and decreased prepayment speeds, may result in additional OTTI charges or unrealized losses on private-label RMBS, which could adversely affect our financial condition, operating results, or ability to pay dividends or redeem or repurchase capital stock.

We are also exposed to credit losses from third-party providers of credit enhancements on the MBS investments that we hold in our investment portfolios, including mortgage insurers, bond insurers and financial guarantors. Our results of operations could be adversely impacted if one or more of these providers fails to fulfill its contractual obligations to us.

Unsecured Counterparties. We assume unsecured credit risk when entering into money market transactions and financial derivatives transactions with domestic and foreign counterparties or through derivatives clearing organizations. A counterparty default could result in losses if our credit exposure to that counterparty is not fully collateralized or if our credit obligations associated with derivative positions are over-collateralized. The insolvency or other inability of a significant counterparty, including a clearing organization, to perform its obligations under such transactions or other agreements could have an adverse effect on our financial condition and results of operations, as well as our ability to engage in routine derivative transactions. If we are unable to transact additional business with those counterparties, our ability to effectively use derivatives could be adversely affected, which could impair our ability to manage some aspects of our interest rate risk.

Our ability to engage in routine derivatives, funding and other transactions could be adversely affected by the actions and commercial soundness of financial institutions that transact business with our counterparties. Financial services institutions are interrelated as a result of trading, clearing, counterparty and/or other relationships. Consequently, financial difficulties experienced by one or more financial services institutions could lead to market-wide disruptions that may impair our ability to find suitable counterparties for routine business transactions.




Changes in Interest Rates Could Have an Adverse Effect on Our Earnings

Our ability to prepare for changes in interest rates, or to hedge related exposures such as basis risk, significantly affects the success of our asset and liability management activities and our level of net interest income.

The effect of interest rate changes can be exacerbated by prepayment and extension risk, which is the risk that mortgage-based investments will be refinanced by borrowers in low interest-rate environments or will remain outstanding longer than expected at below-market yields when interest rates increase. Decreases in interest rates typically cause mortgage prepayments to increase, which may result in increased premium amortization expense and a decrease in the yield of our mortgage assets as we experience a return of principal that we must re-invest in a lower rate environment. While these prepayments would reduce the asset balance, our balance of consolidated obligations may remain outstanding. Conversely, increases in interest rates typically cause mortgage prepayments to decrease or mortgage cash flows to slow, possibly resulting in the debt funding the portfolio to mature and the replacement debt to be issued at a higher cost, thus reducing our interest spread.

In prior years, adverse conditions in the housing and mortgage markets, along with a large drop in market interest rates, allowed us to call a portion of our debt and reissue it at a lower cost, resulting in mortgage spreads that were wider than historic norms and, therefore, resulted in higher earnings. More recently, however, we have had fewer opportunities to achieve those wider spreads in that manner. In addition, the outstanding balance of the investment securities that were purchased at higher spreads, as well as the earnings from those investments, have been decreasing. Going forward, we expect these trends to continue to have a moderating effect on our earnings.

Competition Could Negatively Impact Advances, the Supply of Mortgage Loans for our MPP, Our Access to Funding and Our Earnings

We operate in a highly competitive environment. Demand for advances is affected by, among other factors, the cost and availability of other sources of liquidity for our members, including deposits. We compete with other suppliers of wholesale funding, both secured and unsecured. Such other suppliers may include the United States government, deposit insurers, the Federal Reserve Banks, investment banking concerns, commercial banks and, in certain circumstances, other FHLBanks. Large institutions may also have independent access to the national and global credit markets. The availability of alternative funding sources to members can significantly influence the demand for advances and can vary as a result of a variety of factors, including market conditions, members' creditworthiness, and availability of collateral. Lower demand for advances could negatively impact our earnings.

Likewise, our MPP is subject to significant competition. The most direct competition for purchases of mortgages comes from other buyers of conventional, conforming, fixed-rate mortgage loans, such as Fannie Mae and Freddie Mac. In addition, PFIs face increased origination competition from originators that are not members of our Bank. Increased competition can result in a smaller share of the mortgages available for purchase through our MPP and, therefore, lower earnings.

We also compete with Fannie Mae, Freddie Mac, and other GSEs as well as corporate, sovereign, and supranational entities for funds raised through the issuance of CO bonds and discount notes. Increases in the supply of competing debt products may, in the absence of increases in demand, result in higher debt costs to us or lesser amounts of debt issued at the same cost than otherwise would be the case. There can be no assurance that our supply of funds through issuance of consolidated obligations will be sufficient to meet our future operational needs.




A Failure of the Business and Financial Models and Related Processes Used to Evaluate Various Financial Risks and Derive Certain Estimates in Our Financial Statements Could Produce Unreliable Projections or Valuations, which Could Adversely Affect Our Business, Financial Condition, Results of Operations and Risk Management

We are exposed to market, business and operational risk, in part due to the significant use of business and financial models when evaluating various financial risks and deriving certain estimates in our financial statements. Our business could be adversely affected if these models fail to produce reliable projections or valuations. These models, which rely on various inputs including, but not limited to, loan volumes and pricing, market conditions for our consolidated obligations, interest rate spreads and prepayment speeds, implied volatility of options contracts, and cash flows on mortgage-related assets, require management to make critical judgments about the appropriate assumptions that are used in the determinations of such risks and estimates and may overstate or understate the value of certain financial instruments, future performance expectations, or our level of risk exposure. Our models could produce unreliable results for a number of reasons, including, but not limited to, invalid or incorrect assumptions underlying the models, the need for manual adjustments in response to rapid changes in economic conditions, incorrect coding of the models, incorrect data being used by the models or inappropriate application of a model to products or events outside the model's intended use. In particular, models are less dependable when the economic environment is outside of historical experience, as has been the case in recent years. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates and Risk Management -Operational Risk Management for more information.

A Significant or Prolonged Delay in the Initiation or Completion of Foreclosure Proceedings on Mortgage Loans May Have an Adverse Effect on Our Business, Financial Condition and Results of Operations

The processing of foreclosures continues to be slow in certain states due to prolonged foreclosure proceedings resulting from changes in state foreclosure laws, court procedures, post-foreclosure application of state eviction laws and the pipeline of foreclosures resulting from these delays. In addition, inadequate court budgets in certain states could further delay the processing of foreclosures. The foregoing factors continue to have a noticeable effect on the scheduling and enforcement of court-ordered foreclosure sales.

A significant or prolonged delay of mortgage foreclosure proceedings may have adverse effects on our mortgage investments' revenue and expenses and the market value of the underlying collateral, which could adversely affect our business, financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.

A Failure to Meet Minimum Regulatory Capital Requirements Could Affect Our Ability to Pay Dividends, Redeem or Repurchase Capital Stock, and Attract New Members

We are required to maintain sufficient capital to meet specific minimum requirements established by the Finance Agency. If we violate any of these requirements or if our board or the Finance Agency determines that we have incurred, or are likely to incur, losses resulting, or expected to result, in a charge against capital, we would not be able to redeem or repurchase any capital stock while such charges are continuing or expected to continue, even if the statutory redemption period had expired for some or all of such stock. Violations of our capital requirements could also restrict our ability to pay dividends, lend, invest, or purchase mortgage loans or participating interests in mortgage loans, or other business activities. Additionally, the Finance Agency could direct us to call upon our members to purchase additional capital stock to meet our minimum regulatory capital requirements. Members may be unable or unwilling to satisfy such calls for additional capital, thereby adversely affecting their ability to continue doing business with us.

The formula for calculating risk-based capital includes factors that depend on interest rates and other market metrics outside our control and could cause the minimum requirement to increase to a point exceeding our capital level. Further, if our retained earnings were to become inadequate, the Finance Agency could initiate restrictions consistent with those associated with a failure of a minimum capital requirement.

The Dodd-Frank Act requires certain financial companies with total consolidated assets of more than $10.0 billion and that are regulated by a primary federal financial regulatory agency to conduct annual stress tests to determine whether the companies have the capital necessary to absorb losses under adverse economic conditions. The Finance Agency has implemented annual stress testing for the FHLBanks. We must report the results of our stress tests to the Finance Agency and the FRB on an annual basis, and we must also publicly disclose a summary of stress test results for the "severely adverse" scenario on an annual basis.




The severity of the hypothetical scenarios devised by the Finance Agency and the FRB and employed in these stress tests is not defined by law or regulation, and is thus subject to the regulators' discretion. Nonetheless, the results of the stress testing process may affect our approach to managing and deploying capital. The stress testing and capital planning processes may, among other things, require us to increase our capital levels, modify our business strategies, or decrease our exposure to various asset classes.

The stability of our capital is also important in maintaining the value of membership in our Bank. Failure to pay dividends or redeem or repurchase stock at par, or a call upon our members to purchase additional stock to restore capital, could make it more difficult for us to attract new members or retain existing members.

Restrictions on the Redemption, Repurchase, or Transfer of the Bank's Capital Stock Could Result in an Illiquid Investment for the Holder

Under the GLB Act, Finance Agency regulations, and our capital plan, our capital stock may be redeemed upon the expiration of a five-year redemption period, subject to certain conditions. Capital stock may become subject to redemption following the redemption period after a member (i) provides a written redemption notice to the Bank; (ii) gives notice of intention to withdraw from membership; (iii) attains nonmember status by merger or acquisition, charter termination, or other involuntary membership termination; or (iv) has its Bank capital stock transferred by a receiver or other liquidating agent for that member to a nonmember entity. In addition, we may elect to repurchase some or all of the excess capital stock of a shareholder at any time at our sole discretion.

There is no guarantee, however, that we will be able to redeem shareholders' capital stock, even at the end of the prescribed redemption period, or to repurchase their excess capital stock. If a redemption or repurchase of capital stock would cause us to fail to meet our minimum regulatory capital requirements, Finance Agency regulations and our capital plan would prohibit the redemption or repurchase. Moreover, only capital stock that is not required to meet a member's membership capital stock requirement or to support a member or nonmember shareholder's outstanding activity with the Bank (excess capital stock) may be redeemed at the end of the redemption period. Restrictions on the redemption or repurchase of our capital stock could result in an illiquid investment for holders of our stock. In addition, since our capital stock may only be owned by our members (or, under certain circumstances, former members and certain successor institutions), and our capital plan requires our approval before a member or nonmember shareholder may transfer any of its capital stock to another member or nonmember shareholder, we cannot provide assurance that we would allow a member or nonmember shareholder to transfer any excess capital stock to another member or nonmember shareholder at any time.

Providing Financial Support to Other FHLBanks Could Negatively Impact the Bank's Liquidity, Earnings and Capital and Our Members

We are jointly and severally liable with the other FHLBanks for the consolidated obligations issued on behalf of the FHLBanks through the Office of Finance. If another FHLBank were to default on its obligation to pay principal and interest on any consolidated obligations, the Finance Agency may allocate the outstanding liability among one or more of the remaining FHLBanks on a pro rata basis or on any other basis the Finance Agency may determine. In addition to possibly making payments due on consolidated obligations under our joint and several liability, we may voluntarily or involuntarily provide financial assistance to another FHLBank in order to resolve a condition of financial distress. Such assistance could negatively affect our financial condition, our results of operation and the value of membership in our Bank. Moreover, a Finance Agency regulation provides for an FHLBank System-wide annual minimum contribution to AHP of $100 million, and we could be liable for a pro rata share of that amount (based on the FHLBanks' combined net earnings for the previous year), up to 100% of our net earnings for the previous year. Thus, our ability to pay dividends to our members or to redeem or repurchase capital stock could be affected by the financial condition of one or more of the other FHLBanks.




ITEM 2. PROPERTIES

We own an office building containing approximately 117,000 square feet of office and storage space at 8250 Woodfield Crossing Boulevard, Indianapolis, IN, of which we use approximately 65,000 square feet. We lease or hold for lease to various tenants the remaining 52,000 square feet. We also maintain two leased off-site backup facilities of approximately 6,800 square feet and 200 square feet, respectively, that are on electrical distribution grids that are separate from each other and from our office building. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Operational Risk Management for additional information.

In the opinion of management, our physical properties are suitable and adequate. All of our properties are insured to approximately replacement cost. In the event we were to need more space, our lease terms with tenants generally provide the ability to move tenants to comparable space at other locations at our cost for moving and outfitting any replacement space to meet our tenants' needs.

ITEM 3. LEGAL PROCEEDINGS

In the ordinary course of business, we may from time to time become a party to lawsuits involving various business matters. We are unaware of any lawsuits presently pending which, individually or in the aggregate, could have a material effect on our financial condition or results of operations.

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

We use certain acronyms and terms throughout this Item that are defined in the Glossary of Terms.

No Trading Market

Our Class B capital stock is not publicly traded, and there is no established market for such stock. Members may be required to purchase additional shares of Class B stock from time to time in order to meet minimum stock purchase requirements under our capital plan. Our Class B stock may be redeemed, at a par value of $100 per share, up to five years after we receive a written redemption request by a member, subject to regulatory limits and the satisfaction of any ongoing stock purchase requirements applicable to the member. We may repurchase shares held by members in excess of their required holdings at our discretion at any time in accordance with our capital plan.
 
Our Class B common stock is registered under the Exchange Act. None of our capital stock is registered under the Securities Act because our shares of capital stock are "exempt securities" under the Securities Act, and therefore purchases and sales of stock by our members are not subject to registration under the Securities Act.

Number of Shareholders

As of February 28, 2017, we had 395 shareholders and $1.7 billion par value of regulatory capital stock, which includes Class B common stock and MRCS issued and outstanding.

Dividends

A cooperative enterprise enjoys the benefits of an integrated customer/shareholder base; however, there are certain tensions inherent in our membership structure that are unusual and unique to the FHLBanks. Because only member institutions and certain former members can own shares of our capital stock and, by statute and regulation, stock can be issued and repurchased only at par, there is no open market for our stock and no opportunity for stock price appreciation. As a result, return on equity can be received only in the form of dividends. 

Dividends may, but are not required to, be paid on our Class B capital stock. Our board of directors may declare and pay dividends in either cash or capital stock or a combination thereof, subject to Finance Agency regulations. Under these regulations, stock dividends cannot be paid if our excess stock is greater than 1% of our total assets. At December 31, 2016, our excess stock was 0.49% of our total assets.





Our board of directors' decision to declare dividends is influenced by our financial condition, overall financial performance and retained earnings, as well as actual and anticipated developments in the overall economic and financial environment including the level of interest rates and conditions in the mortgage and credit markets. In addition, our board of directors considers several other factors, including our risk profile, our relationship with our members and the stability of our current capital stock position and membership.

Our capital plan provides for two sub-series of Class B capital stock: Class B-1 and Class B-2. Class B-1 is stock held by our members that is not subject to a redemption request, while Class B-2 is required stock that is subject to a redemption request. Class B-1 shareholders receive a higher dividend than Class B-2 shareholders. The Class B-2 dividend is presently equal to 80% of the amount of the Class B-1 dividend and can only be changed by an amendment to our capital plan with approval of the Finance Agency. The amount of the dividend to be paid is based on the average number of shares of each sub-series held by the member during the dividend payment period (applicable quarter). For more information, see Notes to Financial Statements - Note 15 - Capital and Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Capital Resources.

We are exempt from federal, state, and local taxation, except for employment and real estate taxes. Despite our tax-exempt status, any cash dividends paid by us to our members are taxable dividends to the members, and our members do not benefit from the exclusion for corporate dividends received. The preceding statement is for general information only; it is not tax advice. Members should consult their own tax advisors regarding particular federal, state, and local tax consequences of purchasing, holding, and disposing of our Class B stock, including the consequences of any proposed change in applicable law.

We paid quarterly cash dividends as set forth in the following table ($ amounts in thousands).
 
 
Class B-1
 
Class B-2
By Quarter Paid
 
Dividend on Capital Stock
 
Interest Expense on MRCS
 
Total
 
Annualized Dividend Rate (1)
 
Dividend on Capital Stock
 
Interest Expense on MRCS
 
Total
 
Annualized Dividend Rate (1)
2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter 1
 
$
15,545

 
$
1,824

 
$
17,369

 
4.25
%
 
$
19

 
$
54

 
$
73

 
3.40
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter 4
 
$
14,966

 
$
1,844

 
$
16,810

 
4.25
%
 
$
11

 
$
57

 
$
68

 
3.40
%
Quarter 3
 
14,637

 
1,804

 
16,441

 
4.25
%
 

 
74

 
74

 
3.40
%
Quarter 2
 
14,384

 
1,930

 
16,314

 
4.25
%
 

 
87

 
87

 
3.40
%
Quarter 1 
 
15,797

 
29

 
15,826

 
4.25
%
 

 
98

 
98

 
3.40
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter 4
 
$
15,179

 
$
14

 
$
15,193

 
4.25
%
 
$

 
$
111

 
$
111

 
3.40
%
Quarter 3
 
15,905

 
17

 
15,922

 
4.25
%
 

 
115

 
115

 
3.40
%
Quarter 2
 
15,393

 
11

 
15,404

 
4.00
%
 

 
115

 
115

 
3.20
%
Quarter 1
 
17,003

 
10

 
17,013

 
4.00
%
 
2

 
124

 
126

 
3.20
%

(1) 
Reflects the annualized dividend rate on all of our average capital stock outstanding in Class B-1 and Class B-2, respectively, regardless of its classification for financial reporting purposes as either capital stock or MRCS. The Class B-2 dividend is paid at 80% of the amount of the Class B-1 dividend.

     




ITEM 6. SELECTED FINANCIAL DATA
 
We use certain acronyms and terms in this Item that are defined in the Glossary of Terms. The following table should be read in conjunction with the financial statements and related notes and the discussion set forth in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The table presents a summary of selected financial information derived from audited financial statements as of and for the years ended as indicated ($ amounts in millions).
 
 
As of and for the Years Ended December 31,
 
 
2016
 
2015
 
2014
 
2013
 
2012
Statement of Condition:
 
 
 
 
 
 
 
 
 
 
Advances
 
$
28,096

 
$
26,909

 
$
20,789

 
$
17,337

 
$
18,130

Mortgage loans held for portfolio, net
 
9,501

 
8,146

 
6,820

 
6,168

 
5,994

Cash and investments (1)
 
16,008

 
15,347

 
14,090

 
14,099

 
16,950

Total assets
 
53,907

 
50,608

 
41,853

 
37,764

 
41,220

Discount notes
 
16,802

 
19,251

 
12,568

 
7,435

 
8,924

CO bonds
 
33,467

 
27,862

 
25,503

 
26,584

 
27,408

Total consolidated obligations
 
50,269

 
47,113

 
38,071

 
34,019

 
36,332

MRCS
 
170

 
14

 
16

 
17

 
451

Capital stock
 
1,493

 
1,528

 
1,551

 
1,610

 
1,634

Retained earnings (2)
 
887

 
835

 
777

 
730

 
584

AOCI
 
56

 
23

 
47

 
22

 
(10
)
Total capital
 
2,436

 
2,386

 
2,375

 
2,362

 
2,208

 
 
 
 
 
 
 
 
 
 
 
Statement of Income:
 
 
 
 
 
 
 
 
 
 
Net interest income
 
$
198

 
$
196

 
$
184

 
$
223

 
$
239

Provision for (reversal of) credit losses
 

 

 
(1
)
 
(4
)
 
8

Net OTTI credit losses
 

 

 

 
(2
)
 
(4
)
Other income (loss), excluding net OTTI credit losses
 
6

 
10

 
13

 
71

 
(9
)
Other expenses
 
78

 
72

 
68

 
68

 
60

AHP assessments
 
13

 
13

 
13

 
25

 
18

Net income
 
$
113

 
$
121

 
$
117


$
203


$
140

 
 
 
 
 
 
 
 


 
 
Selected Financial Ratios:
 
 
 
 
 
 
 
 
 
 

Net interest margin (3)
 
0.39
%
 
0.44
%
 
0.47
%
 
0.56
%
 
0.58
%
Return on average equity (4)
 
4.92
%
 
5.13
%
 
4.72
%
 
8.82
%
 
6.77
%
Return on average assets
 
0.22
%
 
0.27
%
 
0.30
%
 
0.51
%
 
0.34
%
Weighted average dividend rate (5)
 
4.25
%
 
4.12
%
 
4.18
%
 
3.50
%
 
3.13
%
Dividend payout ratio (6)
 
53.87
%
 
52.48
%
 
58.96
%
 
28.37
%
 
35.15
%
Total capital ratio (7)
 
4.52
%
 
4.71
%
 
5.68
%
 
6.25
%
 
5.36
%
Total regulatory capital ratio (8)
 
4.73
%
 
4.70
%
 
5.60
%
 
6.24
%
 
6.48
%
Average equity to average assets
 
4.46
%
 
5.23
%
 
6.29
%
 
5.75
%
 
5.04
%

(1) 
Consists of cash, interest-bearing deposits, securities purchased under agreements to resell, federal funds sold, AFS securities, and HTM securities.
(2) 
Includes restricted and unrestricted retained earnings.
(3) 
Net interest income expressed as a percentage of average interest-earning assets.
(4)  
Net income expressed as a percentage of average total capital.
(5) 
Dividends paid in cash during the year divided by the average amount of Class B capital stock eligible for dividends (i.e., excludes MRCS).
(6) 
Dividends paid in cash during the year divided by net income for the year. The ratio for the year ended December 31, 2014 includes a supplemental dividend of 2.0% related to 2013 results.
(7) 
Capital stock plus retained earnings and AOCI expressed as a percentage of total assets.
(8) 
Capital stock plus retained earnings and MRCS expressed as a percentage of total assets.




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

Presentation 

This discussion and analysis by management of the Bank's financial condition and results of operations should be read in conjunction with the Financial Statements and related Notes to Financial Statements contained in this Form 10-K.

As used in this Item, unless the context otherwise requires, the terms "we," "us," "our," and the "Bank" refer to the Federal Home Loan Bank of Indianapolis or its management. We use certain acronyms and terms throughout this Item that are defined in the Glossary of Terms.

Unless otherwise stated, amounts disclosed in this section of the Form 10-K are rounded to the nearest million; therefore, dollar amounts of less than one million may not be reflected and, due to rounding, may not appear to agree to the amounts presented in thousands in the Financial Statements and related Notes to Financial Statements. Amounts used to calculate dollar and percentage changes are based on numbers in the thousands. Accordingly, calculations based upon the disclosed amounts (millions) may not produce the same results.

Executive Summary
 
Overview. We are a regional wholesale bank that: makes secured loans in the form of advances to our members; purchases whole mortgage loans from our members; purchases other investments; and provides other financial services to our members. 

We are wholly owned by our member institutions. All member institutions are required to purchase a minimum amount of our Class B capital stock as a condition of membership.
 
Our principal source of funding is the proceeds from the sale to the public of FHLBank debt instruments, called consolidated obligations, which are the joint and several obligation of all FHLBanks. We obtain additional funds from deposits, other borrowings, and the sale of capital stock to our members.

Our primary source of revenue is interest earned on advances, mortgage loans, and long- and short-term investments.
 
Our net interest income is primarily determined by the interest spread between the interest rate earned on our assets and the interest rate paid on our share of the consolidated obligations. We use funding and hedging strategies to manage the related interest-rate risk.

We group our products and services within two operating segments:

Traditional, which consists of (i) credit products (including advances, letters of credit, and lines of credit), (ii) investments (including federal funds sold, securities purchased under agreements to resell, AFS securities and HTM securities) and (iii) correspondent services and deposits; and
Mortgage loans, which consist of (i) mortgage loans purchased from our members through our MPP and (ii) participating interests purchased in 2012 - 2014 from the FHLBank of Topeka in mortgage loans originated by certain of its PFIs under the MPF Program.

Economic Environment. The Bank’s financial performance is influenced by the level and volatility of market interest rates, national and regional economic conditions, and the strength of housing markets.

In December 2016, the FOMC increased the federal funds target range by 25 bps to a range of 0.50% to 0.75%, citing expanding economic activity, an improving labor market and increasing household expenditures. The previous target range increase occurred in December 2015, following nearly ten years without an increase. In February 2017, the FOMC announced it is maintaining the federal funds target range, based on a strengthening labor market and a moderate pace of economic expansion. The FOMC also stated its intent to maintain its accommodative policy of reinvesting principal payments received from its agency debt and MBS holdings. Yields on U.S. Treasuries rose during the fourth quarter of 2016, with the 10-year yield increasing to 2.45% at the end of the quarter, 84 bps higher than at the end of the third quarter of 2016.




U.S. GDP increased 1.6% during 2016 according to the Bureau of Economic Analysis' second estimate. Positive contributions from personal consumption expenditures, residential fixed investment, and federal, state and local government spending were cited as sources for 2016 growth. However, the growth rate for 2016 was lower than the 2.6% increase recorded for 2015, partially attributed to a downturn in private inventory investment, decelerations in personal consumption expenditures and residential fixed investment, and a downturn in nonresidential fixed investment.

The U.S. Bureau of Labor Statistics reported continued job growth during the fourth quarter of 2016, citing job growth in health care and social assistance. The U.S. unemployment rate was 4.8% for January, 2017. Indiana and Michigan’s preliminary unemployment rates for January, 2017 were 4.0% and 5.0%, respectively.

Freddie Mac’s November 2016 Economic and Housing Research Outlook anticipates that rising interest rates will reduce activity in the housing market. The mortgage market is projected to sustain a more significant adverse impact from rising interest rates. The report suggests that a fiscal stimulus could ease the expected adverse impact of anticipated rising rates.

Indiana University’s Business Research Center projects an average annual income growth rate for Indiana of 4.7% through 2019, slightly higher than its projection of 4.6% average annual growth nationally for the same period. The unemployment rate is projected to remain fairly stable through 2019. The University of Michigan Research Seminar in Quantitative Economics projects continuing job growth in the range of 0.9% to 1.2% through 2018. The report cites professional and business services together with the construction industry as the drivers of the continued recovery, and notes an expectation for a slight decline of manufacturing jobs.

Impact on Operating Results. Market interest rates and trends affect yields and margins on earning assets, including advances, purchased mortgage loans, and our investment portfolio, which contribute to our overall profitability. Additionally, market interest rates drive mortgage origination and prepayment activity, which can lead to both favorable and unfavorable interest margin volatility in our MPP and MBS portfolios.

Lending and investing activity by our member institutions is a key driver for our balance sheet and income growth. Such activity is a function of both prevailing interest rates and economic activity. The national economic data suggests positive trends moving at a fairly slow pace. These positive economic trends are expected to drive interest rates higher, which could impair growth of the mortgage market. A less active mortgage market could affect demand for advances and activity levels in our mortgage program. However, borrowing patterns between our insurance company and depository members tend to differ during various economic and market conditions, thereby easing the potential magnitude of core business fluctuations during business cycles. Member demand for liquidity during stressed market conditions can lead to advances growth.

Local economic factors, particularly relating to the housing and mortgage markets, influence demand for advances and MPP sales activity by our member institutions. Economic data for Indiana and Michigan suggest improving conditions, though at a modest pace.





Results of Operations and Changes in Financial Condition
 
Results of Operations for the Years Ended December 31, 2016 and 2015. The following table presents the comparative highlights of our results of operations ($ amounts in millions).
 
 
Years Ended December 31,
 
 
 
 
Comparative Highlights
 
2016
 
2015
 
$ Change
 
% Change
Net interest income
 
$
198

 
$
196

 
$
2

 
1
%
Provision for (reversal of) credit losses
 

 

 

 
90
%
Net interest income after provision for credit losses
 
198

 
196

 
2

 
1
%
Other income
 
6

 
10

 
(4
)
 
(46
%)
Other expenses
 
78

 
72

 
6

 
8
%
Income before assessments
 
126

 
134

 
(8
)
 
(6
%)
AHP assessments
 
13

 
13

 

 
(2
%)
Net income
 
113

 
121

 
(8
)
 
(7
%)
Total other comprehensive income (loss)
 
33

 
(24
)
 
57

 
241
%
Total comprehensive income
 
$
146

 
$
97

 
$
49

 
51
%

The decrease in net income for the year ended December 31, 2016 compared to 2015 was primarily due to higher other expenses and lower net proceeds from litigation settlements related to certain private-label RMBS, partially offset by higher net interest income.

The increase in total other comprehensive income for the year ended December 31, 2016 compared to 2015 was primarily due to unrealized gains on non-OTTI AFS securities in 2016 compared to unrealized losses on those securities in 2015.

Results of Operations for the Years Ended December 31, 2015 and 2014. The following table presents the comparative highlights of our results of operations ($ amounts in millions).
 
 
Years Ended December 31,
 
 
 
 
Comparative Highlights
 
2015
 
2014
 
$ Change
 
% Change
Net interest income
 
$
196

 
$
184

 
$
12

 
6
%
Provision for (reversal of) credit losses
 

 
(1
)
 
1

 
63
%
Net interest income after provision for credit losses
 
196

 
185

 
11

 
6
%
Other income
 
10

 
13

 
(3
)
 
(17
%)
Other expenses
 
72

 
68

 
4

 
5
%
Income before assessments
 
134

 
130

 
4

 
4
%
AHP assessments
 
13

 
13

 

 
3
%
Net income
 
121

 
117

 
4

 
4
%
Total other comprehensive income (loss)
 
(24
)
 
25

 
(49
)
 
(195
%)
Total comprehensive income
 
$
97

 
$
142

 
$
(45
)
 
(31
%)

The increase in net income for the year ended December 31, 2015 compared to 2014 was primarily due to an increase in net interest income, partially offset by lower net proceeds from litigation settlements related to certain private-label RMBS.

Total other comprehensive loss for the year ended December 31, 2015 compared to total other comprehensive income in 2014 was primarily due to unrealized losses on AFS securities in 2015 compared to unrealized gains on those securities in 2014.





Changes in Financial Condition for the Year Ended December 31, 2016. The following table presents the comparative highlights of our changes in financial condition ($ amounts in millions).
Condensed Statements of Condition
 
December 31, 2016
 
December 31, 2015
 
$ Change
 
% Change
Advances
 
$
28,096

 
$
26,909

 
$
1,187

 
4
%
Mortgage loans held for portfolio, net
 
9,501

 
8,146

 
1,355

 
17
%
Cash and Investments (1)
 
16,008

 
15,347

 
661

 
4
%
Other assets (2)
 
302

 
206

 
96

 
46
%
Total assets (2)
 
$
53,907

 
$
50,608

 
$
3,299

 
7
%
 
 
 
 
 
 
 
 
 
Consolidated obligations (2)
 
$
50,269

 
$
47,113

 
$
3,156

 
7
%
MRCS
 
170

 
14

 
156

 
1,109
%
Other liabilities
 
1,032

 
1,095

 
(63
)
 
(6
%)
Total liabilities (2)
 
51,471

 
48,222

 
3,249

 
7
%
Capital stock, Class B putable
 
1,493

 
1,528

 
(35
)
 
(2
%)
Retained earnings (3)
 
887

 
835

 
52

 
6
%
AOCI
 
56

 
23

 
33

 
146
%
Total capital
 
2,436

 
2,386

 
50

 
2
%
Total liabilities and capital (2)
 
$
53,907

 
$
50,608

 
$
3,299

 
7
%
 
 
 
 
 
 
 
 
 
Total regulatory capital (4)
 
$
2,550

 
$
2,377

 
$
173

 
7
%

(1) 
Includes cash, interest-bearing deposits, securities purchased under agreements to resell, federal funds sold, AFS and HTM securities.
(2) 
December 31, 2015 balances reclassified for change in accounting principle related to concessions on consolidated obligations.
(3) 
Includes restricted retained earnings at December 31, 2016 and 2015 of $152 million and $130 million, respectively.
(4) 
Total capital less AOCI plus MRCS.

The increase in total assets at December 31, 2016 compared to December 31, 2015 was primarily attributable to an increase in mortgage loans and advances.

The increase in total liabilities was attributable to a net increase in consolidated obligations to fund our asset growth, and to a lesser extent, an increase in MRCS reflecting a reclassification of all of the captive insurers' capital stock as a result of the Final Membership Rule.

The increase in total capital was primarily due to growth of retained earnings and members' purchases of additional capital stock, partially offset by the reclassification of all of the captive insurers' capital stock to MRCS.

Outlook. We believe that our financial performance will continue to provide reasonable, risk-adjusted returns for our members across a wide range of business, financial, and economic environments. 

Events in the capital and housing markets in the last several years have created opportunities for us to generate spreads well above historical levels on certain types of transactions. The frequency and value of higher-spread investment opportunities have diminished, however, despite low costs for our consolidated obligations. Going forward, we expect the spreads on our assets to continue to normalize.

During recent years, growth in our advances business has occurred in both depository and insurance sectors. However, we continue to face pressures in advances growth from alternative sources of wholesale funds available to our membership, consolidation in the financial services industry and the loss of business with captive insurance companies. Although we believe that advances outstanding to our member institutions could continue to increase, we do not expect a significant change during 2017 in our total balance of advances.





Mortgage loans held for portfolio increased 17% during 2016, reflecting increased purchase volumes from some PFIs as well as purchases from members that began selling mortgages to us in 2016 under MPP Advantage. Factors affecting the volume of mortgage loans purchased include interest rates, competition, the general level of housing activity in the United States, the level of mortgage refinancing activity, and consumer product preferences. Should interest rates continue to trend upward, activity in the mortgage market, particularly refinancing, would be expected to slow, and our mortgage purchase volume would be expected to decline. However, the impact of a decline in purchase volume would be eased by a slower pace of portfolio attrition. We anticipate modest growth of our purchased mortgage portfolio in 2017.

Our investment securities portfolio increased 14% during 2016 as a result of purchases of GSE debentures and MBS, while our private-label RMBS portfolio continued to run off. Since our MBS portfolio ratio has declined below the 300% regulatory capital limitation, we expect a slight increase in our GSE MBS investments as capacity for MBS purchases becomes available. We also expect a continued increase in our GSE debenture portfolio during 2017.

The cost of our consolidated obligations will depend on several factors, including the direction and level of market interest rates, competition from other issuers of agency debt, changes in the investment preferences of potential buyers of agency debt securities, global demand, pricing in the interest-rate swap market, and other technical market factors. SEC guidance limiting the ability of prime money market funds to invest in commercial paper has created a pricing advantage for FHLBank funding and has led to increased demand for FHLBank debt instruments by money market funds.

In addition to having embedded prepayment options and basis risk exposure, which increase both our market risk and earnings volatility, the amortization of purchased premiums on mortgage assets could also cause volatility in our earnings. However, we do not anticipate any major changes in the composition of our statement of condition that would increase earnings sensitivity to changes in the market environment. 

We will continue to engage in various hedging strategies and use derivatives to assist in mitigating the volatility of earnings and the market value of equity that arises from the maturity structure of our financial assets and liabilities. Although derivatives are used to mitigate market risk, they also introduce the potential for short-term earnings volatility due to basis risk since we use the OIS curve in place of the LIBOR rate curve as the discount rate to estimate the fair values of collateralized LIBOR-based interest-rate related derivatives while the hedged items are still valued using the LIBOR rate curve.

We strive to keep our operating expense ratios relatively low while maintaining adequate systems, support and staffing. We expect operating expenses to increase in 2017 due to continued initiatives to enhance our member service capabilities, operating systems and operations risk management.

Our board of directors' decision to declare dividends is influenced by our financial condition, overall financial performance and retained earnings, as well as actual and anticipated developments in the overall economic and financial environment including the level of interest rates and conditions in the mortgage and credit markets. In addition, our board of directors considers several other factors, including our risk profile, our relationship with our members and the stability of our current capital stock position and membership.

Analysis of Results of Operations for the Years Ended December 31, 2016, 2015 and 2014.

Net Interest Income. Net interest income, which is primarily the interest income on advances, mortgage loans held for portfolio, short-term investments, and investment securities less the interest expense on consolidated obligations and interest-bearing deposits, is our primary source of earnings. 
 




The following table present average daily balances, interest income and expense, and average yields of our major categories of interest-earning assets and the sources funding those interest-earning assets ($ amounts in millions).
 
Years Ended December 31,
 
2016
 
2015
 
2014
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Federal funds sold and securities purchased under agreements to resell
$
4,215

 
$
17

 
0.40
%
 
$
3,698

 
$
4

 
0.12
%
 
$
3,090

 
$
2

 
0.07
%
Investment securities (1)
11,872

 
182

 
1.53
%
 
10,012

 
149

 
1.48
%
 
10,543

 
154

 
1.46
%
Advances (2)
25,974

 
220

 
0.85
%
 
22,988

 
127

 
0.55
%
 
18,693

 
107

 
0.58
%
Mortgage loans held for
portfolio (2)
8,792

 
274

 
3.12
%
 
7,734

 
264

 
3.42
%
 
6,333

 
231

 
3.65
%
Other assets (interest-earning) (3) 
313

 
2

 
0.63
%
 
213

 

 
(0.17
%)
 
271

 
1

 
0.26
%
Total interest-earning assets
51,166

 
695

 
1.36
%
 
44,645

 
544

 
1.22
%
 
38,930

 
495

 
1.27
%
Other assets (4)
326

 
 
 
 
 
378

 
 
 
 
 
299

 
 
 
 
Total assets
$
51,492

 
 
 
 
 
$
45,023

 
 
 
 
 
$
39,229

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Capital:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
597

 
1

 
0.12
%
 
$
706

 

 
0.01
%
 
$
765

 

 
0.01
%
Discount notes
16,129

 
64

 
0.40
%
 
12,617

 
19

 
0.16
%
 
8,513

 
7

 
0.08
%
CO bonds (2)
31,662

 
425

 
1.34
%
 
28,546

 
328

 
1.15
%
 
26,456

 
303

 
1.15
%
MRCS (5)
152

 
7

 
4.35
%
 
15

 
1

 
3.53
%
 
17

 
1

 
6.01
%
Other borrowings

 

 
%
 

 

 
%
 

 

 
%
Total interest-bearing liabilities
48,540

 
497

 
1.02
%
 
41,884

 
348

 
0.83
%
 
35,751

 
311

 
0.87
%
Other liabilities
653

 
 
 
 
 
782

 
 
 
 
 
1,009

 
 
 
 
Total capital
2,299

 
 
 
 
 
2,357

 
 
 
 
 
2,469

 
 
 
 
Total liabilities and capital
$
51,492

 
 
 
 
 
$
45,023

 
 
 
 
 
$
39,229

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
 
$
198

 
 
 
 
 
$
196

 
 
 
 
 
$
184

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net spread on interest-earning assets less interest-bearing liabilities
 
 
 
 
0.34
%
 
 
 
 
 
0.39
%
 
 
 
 
 
0.40
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest margin (6)
 
 
 
 
0.39
%
 
 
 
 
 
0.44
%
 
 
 
 
 
0.47
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Average interest-earning assets to interest-bearing liabilities
1.05

 
 
 
 
 
1.07

 
 
 
 
 
1.09

 
 
 
 

(1) 
Consists of AFS securities and HTM securities. The average balances of investment securities are based on amortized cost; therefore, the resulting yields do not reflect changes in the estimated fair value of AFS securities that are reflected as a component of OCI, nor do they reflect OTTI-related non-credit losses. Interest income/expense includes the effect of associated derivative transactions.
(2) 
Interest income/expense and average yield include all other components of interest, including the impact of net interest payments or receipts on derivatives in qualifying hedge relationships, amortization of hedge accounting adjustments, and prepayment fees on advances.
(3) 
Consists of interest-bearing deposits, loans to other FHLBanks (if applicable), and grantor trust assets that are carried at estimated fair value. Includes the rights or obligations to cash collateral, which are included in the estimated fair value of derivative assets or derivative liabilities.
(4) 
Includes changes in the estimated fair value of AFS securities and the effect of OTTI-related non-credit losses on AFS and HTM securities.
(5) 
Year ended December 31, 2014 includes impact of fourth quarter 2013 supplemental dividend paid in February 2014.
(6) 
Net interest income expressed as a percentage of the average balance of interest-earning assets. 





Changes in both volume and interest rates determine changes in net interest income and net interest margin. Changes in interest income and interest expense that are not identifiable as either volume-related or rate-related, but are attributable to both volume and rate changes, have been allocated to the volume and rate categories based upon the proportion of the volume and rate changes. The following table presents the changes in interest income and interest expense by volume and rate ($ amounts in millions).
 
 
Years Ended December 31,
 
 
2016 vs. 2015
 
2015 vs. 2014
Components
 
Volume
 
Rate
 
Total
 
Volume
 
Rate
 
Total
Increase (decrease) in interest income:
 
 

 
 

 
 

 
 
 
 
 
 
Federal funds sold and securities purchased under agreements to resell
 
$
1

 
$
12

 
$
13

 
$

 
$
2

 
$
2

Investment securities
 
15

 
18

 
33

 
(8
)
 
3

 
(5
)
Advances
 
18

 
75

 
93

 
24

 
(4
)
 
20

Mortgage loans held for portfolio
 
34

 
(24
)
 
10

 
49

 
(16
)
 
33

Other assets (interest earning)
 

 
2

 
2

 

 
(1
)
 
(1
)
Total
 
68

 
83

 
151

 
65

 
(16
)
 
49

Increase (decrease) in interest expense:
 
 

 
 

 
 

 
 
 
 
 
 
Interest-bearing deposits
 

 
1

 
1

 

 

 

Discount notes
 
7

 
38

 
45

 
4

 
8

 
12

CO bonds
 
38

 
59

 
97

 
24

 
1

 
25

MRCS
 
6

 

 
6

 

 

 

Total
 
51

 
98

 
149

 
28

 
9

 
37

Increase (decrease) in net interest income
 
$
17

 
$
(15
)
 
$
2

 
$
37

 
$
(25
)
 
$
12

 
Yields. The yield on total interest-earning assets for the year ended December 31, 2016 was 1.36%, an increase of 14 bps compared to 2015, resulting primarily from higher yields on advances and investment securities, partially offset by lower yields on mortgage loans. The decrease in the yields on mortgage loans was due to an increase in prepayments of our higher-yielding MPP loans, resulting in accelerated amortization of purchased premiums on our newer loans. The cost of total interest-bearing liabilities for the year ended December 31, 2016 was 1.02%, an increase of 19 bps from the prior year period due to higher funding costs on consolidated obligations and accelerated amortization of concession fees associated with the exercise of our call option on certain CO bonds that funded our mortgage portfolios and which were reissued at a lower cost. The net effect was a reduction in the net interest spread to 0.34% for the year ended December 31, 2016 from 0.39% for the year ended December 31, 2015.

The yield on total interest-earning assets for the year ended December 31, 2015 was 1.22%, a decrease of 5 bps compared to 2014, resulting primarily from lower yields on advances and mortgage loans. The yield on advances decreased 3 bps primarily due to lower prepayment fees and related amortization. The yield on mortgage loans decreased 23 bps due primarily to prepayments of our higher-yielding MPP loans, and the resulting accelerated amortization of purchased premiums. The net effect of the lower yields was a slight reduction in the net interest spread to 0.39% for the year ended December 31, 2015 from 0.40% for the year ended December 31, 2014.

Average Balances. The average balances of interest-earning assets for the year ended December 31, 2016 increased compared to 2015, largely related to advances, investment securities and mortgage loans. The average amount of advances outstanding increased by 13% for the year ended December 31, 2016, compared to 2015 generally due to members' higher funding needs. The increase in the average balances of investment securities was due primarily to purchases of GSE debentures and MBS. Additionally, the average amount of mortgage loans held for portfolio outstanding increased by 14% for the year ended December 31, 2016, compared to 2015 due to higher purchases from members under MPP Advantage. The increase in average interest-bearing liabilities was due to an increase in consolidated obligations to fund the increases in the average balances of all interest-earning assets.

Higher average balances of interest-earning assets, net of interest-bearing liabilities, more than offset the impact of lower yields for the year ended December 31, 2015 compared to 2014. The increase in interest-earning assets was largely related to advances and mortgage loans held for portfolio. The average amount of advances outstanding increased 23% for the year ended December 31, 2015 compared to 2014 due primarily to members' higher funding needs. The average amount of mortgage loans held for portfolio outstanding increased 22% for the year ended December 31, 2015, compared to 2014 due to increased purchases under MPP Advantage. The increase in average interest-bearing liabilities was primarily due to an increase in consolidated obligations to fund the increases in advances and mortgage loans and included an increase in the funding mix from CO bonds to discount notes.




Prepayment Fees. The following table presents advance prepayment fees and the associated swap termination fees recognized in interest income at the time of the prepayments ($ amounts in millions).
 
 
Years Ended December 31,
Recognized prepayment/termination fees
 
2016
 
2015
 
2014
Prepayment fees on advances
 
$

 
$

 
$
3

Associated swap termination fees
 

 
1

 
(1
)
Prepayment fees on advances, net
 
$

 
$
1

 
$
2


The following table presents deferred advance prepayment fees and deferred swap termination fees associated with those advance prepayments ($ amounts in millions).
 
 
Years Ended December 31,
Deferred prepayment/termination fees
 
2016
 
2015
 
2014
Deferred prepayment fees on advances - adjustment to interest coupon on modified advance
 
$
2

 
$
3

 
$
24

Deferred prepayment fees on advances - amortized over life of modified advance
 

 

 

Deferred prepayment fees on advances
 
2

 
3

 
24

Deferred associated swap termination fees - amortized over life of modified advance
 
(1
)
 
(3
)