Form 10-Q

10-Q 1 d10q.htm FORM 10-Q Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2005

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 000-51398

FEDERAL HOME LOAN BANK OF SAN FRANCISCO

(Exact name of registrant as specified in its charter)

Federally chartered corporation

(State or other jurisdiction of incorporation or organization)

94-6000630

(I.R.S. employer identification number)

600 California Street

San Francisco, CA

(Address of principal executive offices)

94108

(Zip code)

(415) 616-1000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing for the past 90 days.

[ ] Yes [X] No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

[ ] Yes [X] No

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

[ ] Yes [X] No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.


		Shares outstanding as of October 31, 2005
Class B Stock, par value $100		87,800,142

Federal Home Loan Bank of San Francisco

Form 10-Q

Index


PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements
	Statements of Condition	1
	Statements of Income	2
	Statements of Capital Accounts	3
	Statements of Cash Flows	4
	Notes to Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30
	Quarterly Overview	30
	Financial Highlights	32
	Results of Operations	33
	Financial Condition	46
	Liquidity and Capital Resources	56
	Risk Management	59
	Critical Accounting Policies and Estimates	92
	Recent Developments	93
	Off-Balance Sheet Arrangements, Guarantees, and Other Commitments	93

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	95

Item 4.	Controls and Procedures	95

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	97

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	97

Item 3.	Defaults Upon Senior Securities	97

Item 4.	Submission of Matters to a Vote of Security Holders	97

Item 5.	Other Information	97

Item 6.	Exhibits	98

Signature		99

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

Statements of Condition

(Unaudited)


(In millions-except par value)	September 30, 2005			December 31, 2004
Assets
Cash and due from banks	$	13		$	16
Interest-bearing deposits in banks		4,946			5,251
Securities purchased under agreements to resell		1,500			—
Federal funds sold		17,188			8,461
Trading securities ($6 and $0, respectively, were pledged as collateral)		142			602
Held-to-maturity securities ($854 and $242, respectively, were pledged as collateral) (a)		28,823			23,839
Advances		152,956			140,254
Mortgage loans held for portfolio, net of allowance for credit losses on mortgage loans of $0.5 and $0.3, respectively		5,408			6,035
Accrued interest receivable		663			398
Premises and equipment, net		8			7
Derivative assets		22			43
Other assets		91			76
Total Assets	$	211,760		$	184,982
Liabilities and Capital
Liabilities:
Deposits:
Interest-bearing:
Demand and overnight	$	653		$	876
Term		37			39
Other		5			15
Non-interest-bearing—Other		4			5
Total deposits		699			935
Consolidated obligations, net:
Bonds		173,790			148,109
Discount notes		24,873			26,257
Total consolidated obligations		198,663			174,366
Mandatorily redeemable capital stock		48			55
Accrued interest payable		1,338			809
Affordable Housing Program		125			132
Payable to REFCORP		23			20
Derivative liabilities		1,349			438
Other liabilities		366			327
Total Liabilities		202,611			177,082
Commitments and Contingencies: (Note 11)
Capital (Note 7):
Capital stock-Class B-Putable ($100 par value) issued and outstanding:
90 shares and 78 shares, respectively		9,025			7,765
Restricted retained earnings		127			139
Accumulated other comprehensive loss:
Unrecognized net loss related to hedging activities		(3	)		(4	)
Total Capital		9,149			7,900
Total Liabilities and Capital	$	211,760		$	184,982

(a) Fair values of held-to-maturity securities were $28,542 and $23,757 at September 30, 2005, and December 31, 2004, respectively.

The accompanying notes are an integral part of these financial statements.

Statements of Income

(Unaudited)


	For the three months ended						For the nine months ended
(In millions)	September 30, 2005			September 30, 2004			September 30, 2005			September 30, 2004

Interest Income:
Advances	$	1,369		$	492		$	3,448		$	1,153
Prepayment fees on advances		1			2			1			6
Interest-bearing deposits in banks		39			20			103			39
Securities purchased under agreements to resell		19			6			23			22
Federal funds sold		123			25			277			68
Trading securities		3			7			13			22
Held-to-maturity securities		292			187			790			497
Mortgage loans held for portfolio		71			74			215			234
Total Interest Income		1,917			813			4,870			2,041

Interest Expense:
Consolidated obligations:
Bonds		1,574			576			3,893			1,373
Discount notes		159			104			467			269
Deposits		5			2			12			4
Mandatorily redeemable capital stock		1			—			2			—
Total Interest Expense		1,739			682			4,374			1,646
Net Interest Income		178			131			496			395

Other Income/(Loss):
Services to members		1			1			1			1
Net (loss)/gain on trading securities		(8	)		4			(13	)		(7	)
Net loss on derivatives and hedging activities		(28	)		(100	)		(75	)		(55	)
Other		—			—			2			2
Total Other Loss		(35	)		(95	)		(85	)		(59	)

Other Expense:
Operating expense		16			14			50			43
Federal Housing Finance Board		2			1			5			3
Office of Finance		1			1			3			3
Total Other Expense		19			16			58			49

Income Before Assessments		124			20			353			287
REFCORP		23			4			65			53
Affordable Housing Program		10			1			29			23
Total Assessments		33			5			94			76

Net Income	$	91		$	15		$	259		$	211

The accompanying notes are an integral part of these financial statements.

Statements of Capital Accounts

(Unaudited)


	Capital Stock-Class B-Putable					Capital Stock- Putable					Retained Earnings									Accumulated Other Comprehensive Income/(Loss)			Total Capital
(In millions)	Shares		Par Value			Shares		Par Value			Restricted			Unrestricted			Total			Accumulated Other Comprehensive Income/(Loss)			Total Capital
Balance, December 31, 2003	—		$	—		57		$	5,739		$	119		$	—		$	119		$	(12	)	$	5,846
Issuance of capital stock	10			966		7			689															1,655
Repurchase/redemption of capital stock	(2	)		(208	)	(2	)		(182	)														(390	)
Capital stock reclassified to mandatorily redeemable capital stock	—			(8	)				(20	)														(28	)
Comprehensive income:
Net income															211			211						211
Other comprehensive income:
Net amounts recognized as earnings																					4			4
Total comprehensive income																								215
Transfers to restricted retained earnings												11			(11	)		—						—
Conversion to Class B shares	63			6,285		(63	)		(6,285	)
Dividends on capital stock (4.10%)
Stock issued	1			141		1			59						(200	)		(200	)					—
Balance, September 30, 2004	72		$	7,176		—		$	—		$	130		$	—		$	130		$	(8	)	$	7,298
Balance, December 31, 2004	78		$	7,765		—		$	—		$	139		$	—		$	139		$	(4	)	$	7,900
Issuance of capital stock	14			1,463		—			—															1,463
Repurchase/redemption of capital stock	(5	)		(469	)	—			—															(469	)
Capital stock reclassified to mandatorily redeemable capital stock	—			(5	)																			(5	)
Comprehensive income:
Net income															259			259						259
Other comprehensive income:
Net amounts recognized as earnings																					1			1
Total comprehensive income																								260
Transfers from restricted retained earnings												(12	)		12			—						—
Dividends on capital stock (4.35%)
Stock issued	3			271		—			—						(271	)		(271	)					—
Balance, September 30, 2005	90		$	9,025		—		$	—		$	127		$	—		$	127		$	(3	)	$	9,149

The accompanying notes are an integral part of these financial statements.

Statements of Cash Flows

(Unaudited)


	Nine months ended
(In millions)	September 30, 2005			September 30, 2004
Cash Flows from Operating Activities:
Net Income	$	259		$	211

Adjustments to reconcile net income to net cash provided by/(used in) operating activities:
Depreciation and amortization:
Net premiums on consolidated obligations, advances, and investments		76			17
Net (discounts)/premiums on mortgage loans		(3	)		2
Concessions on consolidated obligations		23			31
Premises and equipment		2			2
Deferred net losses on interest rate exchange agreements		3			5
Decrease in Affordable Housing Program (AHP) liability and discount on AHP advances		(7	)		(5	)
Increase/(decrease) in payable to REFCORP		3			(6	)
Loss due to change in net fair value adjustment on derivative and hedging activities		33			2
Decrease in trading securities		460			287
Decrease in derivative asset accrued interest		26			23
Decrease/(increase) in derivative liability accrued interest		132			(28	)
Increase in accrued interest receivable		(265	)		(68	)
Increase in accrued interest payable		529			195
(Increase)/decrease in other assets		(5	)		32
Increase/(decrease) in other liabilities		8			(14	)
Non-cash interest on mandatorily redeemable capital stock		2			—
Total adjustments		1,017			475
Net cash provided by operating activities		1,276			686
Cash Flows from Investing Activities:
Net decrease/(increase) in interest-bearing deposits in banks		305			(885	)
Net increase in Federal funds sold		(8,727	)		(4,524	)
Net (increase)/decrease in securities purchased under agreements to resell		(1,500	)		1,800
Net (increase)/decrease in short-term held-to-maturity securities		(754	)		5
Purchases of long-term held-to-maturity securities		(11,080	)		(10,674	)
Maturities of long-term held-to-maturity securities		6,867			5,931
Principal collected on advances		1,011,598			597,598
Advances made		(1,024,583	)		(629,203	)
Principal collected on mortgage loans held for portfolio		686			643
Purchases of mortgage loans held for portfolio		(56	)		(400	)
Net (increase)/decrease in deposits for mortgage loan program with other Federal Home Loan Bank		—			7
Increase in premises and equipment		(3	)		(1	)
Net cash used in investing activities		(27,247	)		(39,703	)

Statements of Cash Flows

(Unaudited)


	Nine months ended
(In millions)	September 30, 2005			September 30, 2004
Cash Flows from Financing Activities:
Net (decrease)/increase in deposits		(236	)		35
Net increase in other borrowings		—			800
Net proceeds from issuance of consolidated obligations:
Bonds		73,661			83,554
Discount notes		168,123			168,343
Bonds transferred from other FHLBanks		97			65
Payments for maturing and retiring consolidated obligations:
Bonds		(47,094	)		(38,878	)
Discount notes		(169,563	)		(176,147	)
Proceeds from issuance of capital stock		1,463			1,655
Payments for repurchase/redemption of mandatorily redeemable capital stock		(14	)		(20	)
Payments for repurchase/redemption of capital stock		(469	)		(390	)
Net cash provided by financing activities		25,968			39,017
Net decrease in cash and cash equivalents		(3	)		—
Cash and cash equivalents at beginning of year		16			18
Cash and cash equivalents at end of period	$	13		$	18

Supplemental Disclosure:
Interest paid during the period	$	3,120		$	1,231
REFCORP payments during the period		62			59
Affordable Housing Program payments during the period		36			28

The accompanying notes are an integral part of these financial statements.

Notes to Financial Statements

(Unaudited)

(Dollars in millions)

Note 1 – Summary of Significant Accounting Policies

The significant accounting policies and the financial condition and results of operations of the Federal Home Loan Bank of San Francisco (Bank) as of December 31, 2004, are contained in the Bank’s Registration Statement on Form 10, as amended, filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934 and effective on August 29, 2005 (Registration Statement). The unaudited third quarter 2005 Financial Statements should be read in conjunction with the Registration Statement. The interim financial statements as of September 30, 2005, and for the nine months ended September 30, 2005, and September 30, 2004, have been prepared by the Bank and are not audited. In the opinion of the Bank, the interim financial statements include all adjustments necessary for a fair statement of the results for the interim periods. The results of operations for the three- and nine-month periods ended September 30, 2005, are not necessarily indicative of the results to be expected for any subsequent period or for the entire year ending December 31, 2005.

Use of Estimates. The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make a number of judgments, estimates, and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, if applicable, and the reported amounts of income, expenses, gains, and losses during the reporting period. Changes in judgments, estimates, and assumptions could potentially affect the Bank’s financial position and results of operations significantly. Although management believes these judgments, estimates, and assumptions to be reasonably accurate, actual results may differ.

Descriptions of the significant accounting policies of the Bank are included in Note 1 to the 2004 Financial Statements in the Bank’s Registration Statement. There have been no significant changes to these policies as of September 30, 2005.

Reclassifications. Certain amounts in the 2004 Financial Statements have been reclassified to conform to the 2005 presentation. In particular, for the three and nine months ended September 30, 2004, the Bank reclassified prepayment fee income on the Statements of Income. Previously, prepayment fee income was classified as a separate line item within other income. These amounts have been reclassified and are now included as a separate line item in interest income for the three and nine months ended September 30, 2004. As a result of this reclassification, net interest income and other income were adjusted by $2 for the three months ended September 30, 2004, and by $6 for the nine months ended September 30, 2004.

Note 2 – Recently Issued Accounting Standard

In May 2005, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 154, Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3 (SFAS 154), which is effective for accounting changes made in fiscal years beginning after December 15, 2005. Under the provisions of SFAS 154, voluntary changes in accounting principles are applied retrospectively to prior period financial statements unless it would be impractical. SFAS 154 supersedes Accounting Principles Board (APB)

Opinion No. 20, Accounting Changes, which required that most voluntary changes in accounting principles be recognized by including the cumulative effect of the change in the current period’s net income. SFAS 154 also makes a distinction between “retrospective application” of a change in accounting principle and the “restatement” of financial statements to reflect the correction of an error. The Bank does not currently anticipate making any voluntary changes in accounting principles and therefore does not expect the adoption of SFAS 154 to have a material impact on its financial statements.

Note 3 – Held-to-Maturity Securities

The Bank classifies the following securities as held-to-maturity because the Bank has the positive intent and ability to hold these securities to maturity:

September 30, 2005


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Commercial paper	$	1,524	$	—	$	—		$	1,524
Housing finance agency bonds		1,211		10		—			1,221
Subtotal		2,735		10		—			2,745
Mortgage-backed securities (MBS):
GNMA		38		—		—			38
FHLMC		227		5		(1	)		231
FNMA		562		2		(11	)		553
Non-agency		25,261		9		(295	)		24,975
Total MBS		26,088		16		(307	)		25,797
Total	$	28,823	$	26	$	(307	)	$	28,542

December 31, 2004
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Commercial paper	$	748	$	—	$	—		$	748
Housing finance agency bonds		1,470		10		(1	)		1,479
Subtotal		2,218		10		(1	)		2,227
MBS:
GNMA		48		—		—			48
FHLMC		297		9		(1	)		305
FNMA		693		4		(5	)		692
Non-agency		20,583		48		(146	)		20,485
Total MBS		21,621		61		(152	)		21,530
Total	$	23,839	$	71	$	(153	)	$	23,757

Redemption Terms. The amortized cost and estimated fair value of certain securities by contractual maturity and MBS as of September 30, 2005, and December 31, 2004, are shown below. Expected maturities of certain securities and MBS will differ from contractual maturities because borrowers generally have the right to prepay obligations without prepayment fees.

September 30, 2005


Year of Maturity	Amortized Cost		Estimated Fair Value		Weighted Average Interest Rate
Due in one year or less	$	1,524	$	1,524	3.64%
Due after five years through ten years		33		33	3.84
Due after ten years		1,178		1,188	3.91
Subtotal		2,735		2,745	3.76
MBS:
GNMA		38		38	4.15
FHLMC		227		231	5.39
FNMA		562		553	4.48
Non-agency		25,261		24,975	4.73
Total MBS		26,088		25,797	4.73
Total	$	28,823	$	28,542	4.64%

December 31, 2004


Year of Maturity	Amortized Cost		Estimated Fair Value		Weighted Average Interest Rate
Due in one year or less	$	748	$	748	2.28%
Due after five years through ten years		43		43	2.31
Due after ten years		1,427		1,436	2.35
Subtotal		2,218		2,227	2.33
MBS:
GNMA		48		48	2.90
FHLMC		297		305	4.84
FNMA		693		692	4.23
Non-agency		20,583		20,485	4.19
Total MBS		21,621		21,530	4.20
Total	$	23,839	$	23,757	4.03%

The amortized cost of the Bank’s MBS classified as held-to-maturity included net premiums of $119 at September 30, 2005, and net premiums of $89 at December 31, 2004.

Interest Rate Payment Terms. Interest rate payment terms for held-to-maturity securities at September 30, 2005, and December 31, 2004, are detailed in the following table:


	September 30, 2005		December 31, 2004
Amortized cost of held-to-maturity securities other than MBS:
Fixed rate	$	1,524	$	748
Adjustable rate		1,211		1,470
Subtotal		2,735		2,218
Amortized cost of held-to-maturity MBS:
Passthrough securities:
Fixed rate		535		670
Adjustable rate		172		209
Collateralized mortgage obligations:
Fixed rate		19,772		15,887
Adjustable rate		5,609		4,855
Subtotal		26,088		21,621
Total	$	28,823	$	23,839

Certain MBS classified as fixed rate passthrough securities and fixed rate collateralized mortgage obligations have an initial fixed interest rate that subsequently converts to an adjustable interest rate on a specified date.

The Bank does not own MBS that are backed by mortgage loans purchased by another Federal Home Loan Bank (FHLBank) from the Bank’s members or from the members of other FHLBanks.

Note 4 – Advances

Redemption Terms. The Bank had advances outstanding at interest rates ranging from 1.47% to 8.75% at September 30, 2005, and 1.13% to 8.75% at December 31, 2004, as summarized below.


	September 30, 2005				December 31, 2004
Year of Maturity	Amount Outstanding			Weighted Average Interest Rate	Amount Outstanding			Weighted Average Interest Rate
Due in 1 year or less	$	63,600		3.58%	$	68,350		2.14%
Due after 1 year through 2 years		52,939		3.66		44,518		2.45
Due after 2 years through 3 years		22,113		3.83		15,830		2.65
Due after 3 years through 4 years		5,813		4.15		5,664		3.62
Due after 4 years through 5 years		6,481		3.96		3,985		3.10
Due after 5 years		2,289		4.80		1,904		5.18
Subtotal		153,235		3.70%		140,251		2.42%
SFAS 133* valuation adjustments		(285	)			(5	)
Net unamortized premiums		6				8
Total	$	152,956			$	140,254

SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, on January 1, 2001, and by SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, on July 1, 2003 (together referred to as “SFAS 133”).

Security Terms. The Bank lends to member financial institutions involved in housing finance that have a principal place of business in Arizona, California, or Nevada. The Bank is required by the Federal Home Loan Bank Act of 1932 (FHLB Act) to obtain sufficient collateral for advances to protect against losses and to accept as collateral for advances only certain U.S. government or government agency securities, residential mortgage loans or MBS, other eligible real estate-related assets, cash or deposits in the Bank, and Bank capital stock. The Bank may also accept secured small business, small farm, and small agribusiness loans as collateral from members that qualify as community financial institutions. Community financial institutions are defined for 2005 as Federal Deposit Insurance Corporation-insured depository institutions with average total assets over the preceding three-year period of $567 million or less. For additional information on security terms, see Note 7 to the 2004 Financial Statements in the Bank’s Registration Statement.

Credit and Concentration Risk. The Bank’s potential credit risk from advances is concentrated in savings institutions. As of September 30, 2005, the Bank had a concentration of advances totaling $110,729 outstanding to 3 members (Washington Mutual Bank, World Savings Bank, FSB, and Citibank (West), FSB), representing 72% of total outstanding advances (39%, 17%, and 16%, respectively). The interest income from advances to these members amounted to $958 during the third quarter of 2005 and $2,405 during the first nine months of 2005. The Bank held a security interest in collateral from each of these institutions with an estimated value in excess of their respective advances outstanding, and the Bank does not expect to incur any credit losses on these advances. Each of these members owned more than 10% of the capital stock outstanding as of September 30, 2005.

The Bank has never experienced any credit losses on advances to a member. The Bank has policies and procedures in place to manage the credit risk of advances. Based on the collateral pledged as security for advances, management’s credit analyses of members’ financial condition, and prior repayment history, no allowance for losses on advances is deemed necessary by management.

Interest Rate Payment Terms. Interest rate payment terms for advances at September 30, 2005, and December 31, 2004, are detailed below:


	September 30, 2005		December 31, 2004
Par amount of advances:
Fixed rate	$	43,023	$	68,401
Adjustable rate		110,212		71,850
Total par amount	$	153,235	$	140,251

Note 5 – Mortgage Loans Held for Portfolio

Under the Mortgage Partnership Finance^® (MPF^®) Program, the Bank may purchase qualifying mortgage loans directly from its participating members. (“Mortgage Partnership Finance” and “MPF” are registered trademarks of the Federal Home Loan Bank of Chicago.) The mortgage loans represent held-for-investment loans. Under the MPF Program, participating members originate or purchase the mortgage loans, credit-enhance them and sell them to the Bank, and generally retain the servicing of the loans. The following table presents information as of September 30, 2005, and December 31, 2004, on mortgage loans, all of which are qualifying conventional, conforming fixed rate residential mortgage loans on single-family properties:


	September 30, 2005			December 31, 2004
Fixed rate medium-term mortgage loans	$	1,963		$	2,228
Fixed rate long-term mortgage loans		3,464			3,829
Unamortized premiums		21			31
Unamortized discounts		(40	)		(53	)
Total mortgage loans held for portfolio	$	5,408		$	6,035

Medium-term loans have contractual terms of 15 years or less, and long-term loans have contractual terms of more than 15 years.

Concentration Risk. At September 30, 2005, 75% and 16% of the mortgage loan balances held by the Bank were purchased from Washington Mutual Bank and IndyMac Bank, FSB, respectively, out of the nine participating members. Of these two members, only Washington Mutual Bank owned more than 10% of the capital stock outstanding as of September 30, 2005. No other participants in the MPF Program represented more than 10% of the Bank’s mortgage loan portfolio at September 30, 2005.

Credit Risk. The allowance for credit losses on the mortgage loan portfolio was as follows:


	Three months ended				Nine months ended
	September 30, 2005		September 30, 2004		September 30, 2005		September 30, 2004
Balance, beginning of the period	$	0.4	$	0.2	$	0.3	$	—
Chargeoffs		—		—		—		—
Recoveries		—		—		—		—
Provision for credit losses		0.1		0.1		0.2		0.3
Balance, end of the period	$	0.5	$	0.3	$	0.5	$	0.3

The Bank’s allowance for credit losses consists of two components. The first component applies to each individual loan that is specifically identified as “impaired.” A loan is considered impaired when it is reported 90 days or more past due (nonaccrual) or when it is probable, based on current information and events, that the Bank will be unable to collect all principal and interest amounts due according to the contractual terms of the mortgage loan agreement. At September 30, 2005, the Bank had 19 loans totaling $2 classified as nonaccrual or impaired. Once the Bank identifies these loans, the Bank evaluates the exposure on these loans in excess of the first and second layer of loss protection (liquidation value of the real property securing the loan and primary mortgage insurance). The Bank then further evaluates any exposure in excess of these loss protection layers to determine whether the Bank’s credit loss exposure is in excess of the available credit enhancement and, if applicable, any supplemental mortgage insurance. If so, the Bank records an additional provision for credit losses. As of September 30, 2005, the Bank determined that an allowance for credit losses was not required for these loans because the amount of available credit enhancement and supplemental mortgage insurance associated with these loans was in excess of the estimated loss exposure.

The second component of the Bank’s allowance for credit losses applies to loans that are not specifically identified as impaired and is based on the Bank’s estimate of probable credit losses in the portfolio as of the financial statement date. For these loans, the Bank evaluates the credit loss exposure and considers various observable data, such as delinquency statistics, past performance, current performance, loan portfolio characteristics, collateral valuations, industry data, collectibility of credit enhancements from members or from the mortgage insurer, and prevailing economic conditions, taking into account the credit enhancement provided by the member. As of September 30, 2005, the Bank had established an allowance for credit losses of $0.5 for the mortgage loan portfolio.

At September 30, 2005, the Bank’s other assets included $0.1 of real estate owned resulting from foreclosure of one mortgage loan held by the Bank.

Note 6 – Consolidated Obligations

Consolidated obligations are the joint and several obligations of the 12 Federal Home Loan Banks (FHLBanks) and consist of consolidated obligation bonds and discount notes. Consolidated obligations are jointly issued by the FHLBanks through the Office of Finance, which serves as their agent. In connection with each debt issuance, each FHLBank specifies the type, term, and amount of debt it requests to have issued on its behalf. The Office of Finance tracks the amount of debt issued on behalf of each FHLBank. In addition, the Bank separately tracks and records as a liability its specific portion of the consolidated obligations and is the primary obligor for its specific portion of the consolidated obligations issued. The Federal Housing Finance Board (Finance Board) and the U.S. Secretary of the Treasury have oversight over the issuance of FHLBank debt through the Office of Finance.

Redemption Terms. The following is a summary of the Bank’s participation in consolidated obligation bonds at September 30, 2005, and December 31, 2004:


	September 30, 2005				December 31, 2004
Year of Maturity	Amount Outstanding			Weighted Average Interest Rate	Amount Outstanding			Weighted Average Interest Rate
Due in 1 year or less	$	60,735		3.09%	$	53,402		2.17%
Due after 1 year through 2 years		49,818		3.58		45,364		2.62
Due after 2 years through 3 years		31,300		3.77		15,512		3.13
Due after 3 years through 4 years		12,991		3.80		15,455		3.39
Due after 4 years through 5 years		11,019		4.18		9,399		3.78
Due after 5 years		9,604		4.66		9,665		4.44
Index amortizing notes		11		4.61		14		4.61
Subtotal		175,478		3.56%		148,811		2.78%
Unamortized premiums		87				64
Unamortized discounts		(146	)			(158	)
SFAS 133 valuation adjustments		(1,629	)			(608	)
Total	$	173,790			$	148,109

The Bank’s participation in consolidated obligation bonds outstanding includes callable bonds of $58,169 at September 30, 2005, and $54,235 at December 31, 2004. Contemporaneous with the issuance of callable bonds, the Bank usually enters into an interest rate swap (in which the Bank pays a variable rate and receives a fixed rate) with a call feature that mirrors the call option embedded in the bond (a sold callable swap). The Bank had notional amounts of interest rate exchange agreements hedging callable bonds of $48,270 at September 30, 2005, and $53,072 at December 31, 2004. The combined sold callable swap and callable bond enable the Bank to meet its funding needs at costs not otherwise directly attainable solely through the issuance of non-callable debt, while effectively converting the Bank’s net payment to an adjustable rate. The Bank uses fixed rate callable bonds to finance fixed rate callable advances, fixed rate MBS, and fixed rate mortgage loans.

The Bank’s participation in consolidated obligation bonds was as follows:


	September 30, 2005		December 31, 2004
Par amount of consolidated obligation bonds:
Non-callable	$	117,309	$	94,576
Callable		58,169		54,235
Total par amount	$	175,478	$	148,811

The following is a summary of the Bank’s participation in consolidated obligation bonds outstanding at September 30, 2005, and December 31, 2004, by the earlier of the year of contractual maturity or next call date:


Maturity or Next Call Date	September 30, 2005		December 31, 2004
Due in 1 year or less	$	112,585	$	92,655
Due after 1 year through 2 years		34,995		36,700
Due after 2 years through 3 years		15,917		5,722
Due after 3 years through 4 years		5,095		8,173
Due after 4 years through 5 years		4,492		3,003
Due after 5 years		2,383		2,544
Index amortizing notes		11		14
Total par amount	$	175,478	$	148,811

Interest Rate Payment Terms. Interest rate payment terms for consolidated obligations at September 30, 2005, and December 31, 2004, are detailed in the following table:


	September 30, 2005		December 31, 2004
Par amount of consolidated obligations:
Bonds:
Fixed rate	$	139,104	$	100,682
Adjustable rate		24,143		36,627
Step-up		7,939		7,402
Fixed rate that converts to adjustable rate		1,297		1,214
Adjustable rate that converts to fixed rate		1,845		1,695
Comparative index		949		987
Zero-coupon		165		165
Inverse floating		25		25
Index amortizing notes		11		14
Total bonds, par		175,478		148,811
Discount notes, par		25,019		26,321
Total consolidated obligations, par	$	200,497	$	175,132

Consolidated obligation discount notes are consolidated obligations issued to raise short-term funds; discount notes have original maturities up to 360 days. These notes are issued at less than their face amount and redeemed at par value when they mature. The Bank’s participation in consolidated obligation discount notes, all of which are due within one year, was as follows:


	September 30, 2005				December 31, 2004
	Amount Outstanding			Weighted Average Interest Rate	Amount Outstanding			Weighted Average Interest Rate
Par value	$	25,019		3.54%	$	26,321		2.08%
Unamortized discounts		(142	)			(63	)
SFAS 133 valuation adjustments		(4	)			(1	)
Total	$	24,873			$	26,257

Note 7 – Capital

Capital Requirements. The Bank is subject to risk-based capital requirements, which must be met with permanent capital (defined as retained earnings and Class B stock). In addition, the Bank is subject to a 5% minimum leverage capital ratio with a 1.5 weighting factor for permanent capital, and a 4% minimum total capital to assets ratio calculated without reference to the 1.5 weighting factor. As of September 30, 2005, and December 31, 2004, the Bank was in compliance with these capital rules and requirements. The FHLB Act and Finance Board regulations require that the minimum stock requirement for members must be sufficient to enable the Bank to meet its regulatory requirements for total capital, leverage capital, and risk-based capital. In addition, the Finance Board has confirmed that mandatorily redeemable capital stock is considered capital for regulatory purposes.

The following table shows the Bank’s compliance with the Finance Board’s capital requirements at September 30, 2005, and December 31, 2004.

Regulatory Capital Requirements


	September 30, 2005				December 31, 2004
(Dollars in millions)	Required		Actual		Required		Actual
Risk-based capital	$	790	$	9,200	$	689	$	7,959
Total capital to assets ratio		4.00%		4.34%		4.00%		4.30%
Total capital	$	8,470	$	9,200	$	7,399	$	7,959
Leverage ratio		5.00%		6.52%		5.00%		6.45%
Leverage capital	$	10,588	$	13,799	$	9,249	$	11,938

The Bank’s capital requirements are more fully discussed in Note 12 to the 2004 Financial Statements in the Bank’s Registration Statement.

Mandatorily Redeemable Capital Stock. In accordance with SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity (SFAS 150), the Bank had mandatorily redeemable capital stock from seven former members totaling $48 at September 30, 2005, of which $45 was scheduled for redemption in 2009 and $3 was scheduled for

redemption in 2010. At December 31, 2004, the Bank had mandatorily redeemable capital stock from four former members totaling $55, which was scheduled for redemption in 2009. These amounts included accrued interest expense (accrued stock dividends) of $2 at September 30, 2005, and $1 at December 31, 2004, and have been classified as a liability in the Statements of Condition. In accordance with the Bank’s current practice, if activity-based stock becomes excess stock because an activity no longer remains outstanding, the Bank may repurchase the excess activity-based stock on a scheduled, quarterly basis subject to certain conditions, at its discretion.

The Bank’s activity for mandatorily redeemable capital stock for the three and nine months ended September 30, 2005 and 2004, was as follows.

Mandatorily Redeemable Capital Stock Activity


	Three months ended				Nine months ended
	September 30, 2005		September 30, 2004		September 30, 2005			September 30, 2004
Balance at beginning of the period	$ 52		$	—	$	55		$	—
Mandatorily redeemable capital stock reclassified from equity upon adoption of SFAS 150	—			—		—			18
Mandatorily redeemable capital stock reclassified from equity during the period	—			8		5			10
Repurchase of mandatorily redeemable capital stock	(4	)		—		(14	)		(20	)
Dividends paid on mandatorily redeemable capital stock	—			—		2			—
Balance at end of the period	$ 48			$ 8		$ 48			$ 8

The Bank’s mandatorily redeemable capital stock is more fully discussed in Note 12 to the 2004 Financial Statements in the Bank’s Registration Statement.

Retained Earnings and Dividend Policy. By Finance Board regulation, dividends may be paid out of current net earnings or previously retained earnings. As required by the Finance Board, the Bank has a formal retained earnings policy that is reviewed at least annually. The Bank’s Retained Earnings and Dividend Policy establishes amounts to be retained in restricted retained earnings, which are not made available for dividends in the current dividend period. The Bank may be restricted from paying dividends if the Bank is not in compliance with any of its minimum capital requirements or if payment would cause the Bank to fail to meet any of its minimum capital requirements. In addition, the Bank may not pay dividends if any principal or interest due on any consolidated obligations has not been paid in full, or, under certain circumstances, if the Bank fails to satisfy certain liquidity requirements under applicable Finance Board regulations.

unrealized gains or losses are primarily a matter of timing, the unrealized gains or losses will generally reverse over the remaining contractual terms to maturity, or by the exercised call or put date, of the hedged financial instruments and associated interest rate exchange agreements. (However, the Bank may have instances in which hedging relationships are terminated prior to maturity or prior to the exercised call or put dates. The impact of terminating the hedging relationship may result in a realized gain or loss. In addition, the Bank may have instances in which it may sell trading securities prior to maturity, which may also result in a realized gain or loss.) As the cumulative net unrealized gains are reversed (by periodic net unrealized losses), the amount of cumulative net unrealized gains decreases. The amount of retained earnings required by this provision of the policy is therefore decreased, and that portion of the previously restricted retained earnings becomes unrestricted and may be made available for dividends. In this case, the potential dividend payout in a given period will be substantially the same as it would have been without the effects of SFAS 133, provided that the cumulative net effect of SFAS 133 since inception is a net gain. The purpose of this category of restricted retained earnings is to ensure that the Bank has sufficient retained earnings to offset future net unrealized losses that result from the reversal of these cumulative net unrealized gains. This ensures that the future membership base does not bear the cost of the future reversals of these unrealized gains. Although restricting retained earnings in accordance with this provision of the policy may preserve the Bank’s ability to pay dividends, the reversal of the cumulative net unrealized SFAS 133 gains in any given period may result in a net loss if the reversal exceeds net earnings before the impact of SFAS 133 for that period. Also, if the net effect of SFAS 133 since inception results in a cumulative net unrealized loss, the Bank’s other retained earnings at that time (if any) may not be sufficient to offset the net unrealized loss. As a result, the future effects of SFAS 133 may cause the Bank to reduce or temporarily suspend paying dividends.

In addition, in 2003 the Bank began holding other restricted retained earnings intended to protect members’ paid-in capital from an extremely adverse credit or operations risk event, an extremely adverse SFAS 133 quarterly result, or an extremely low (or negative) level of net income before the effects of SFAS 133 resulting from an adverse interest rate environment. Effective March 31, 2005, the Board of Directors amended the Retained Earnings and Dividend Policy to provide for this build-up of restricted retained earnings to reach $130 by the end of the third quarter of 2007. (Further information regarding this policy can be found in the Bank’s Registration Statement in Note 12 to the 2004 Financial Statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Dividends.”) The retained earnings restricted in accordance with this provision totaled $80 at September 30, 2005, and $50 at December 31, 2004.

requirement to restrict retained earnings for advance prepayment fees and other gains and losses related to the termination of interest rate exchange agreements and the early retirement of consolidated obligations related to advance prepayments. Management determined that this requirement was no longer needed because fixed rate advances are generally hedged with fixed rate interest rate swaps, which creates the equivalent of floating rate advances. If a fixed rate advance is prepaid, the fixed rate interest rate swap is also terminated. The advance prepayment fee and the gain or loss on the termination of the interest rate swap will generally offset each other. The amount previously restricted in accordance with this provision is now part of the $130 build-up of restricted retained earnings discussed above.

The Board of Directors may declare and pay dividends out of current net earnings or previously retained earnings. There is no requirement that the Board of Directors declare and pay any dividend. A decision by the Board of Directors to declare or not declare a dividend is a discretionary matter and is subject to the requirements and restrictions of the FHLB Act and applicable Finance Board requirements.

The Bank has historically paid dividends, if declared, in stock form (except fractional shares) and intends to continue this practice.

The Board of Directors may amend the Retained Earnings and Dividend Policy from time to time.

Surplus Capital Stock Repurchase Policy. The Bank’s surplus capital stock repurchase policy provides for the reduction of a member’s capital stock outstanding if a member has surplus capital stock as of the last business day of the quarter. A member’s surplus capital stock is defined as any stock holdings in excess of 115% of the member’s minimum capital stock requirement, generally excluding stock dividends earned and credited for the current year. As of September 30, 2005, Bank members held $378 in surplus capital stock. On the repurchase date, the Bank recalculates the amount of stock to be repurchased to ensure that each member continues to meet its minimum stock requirement after the stock is repurchased on the repurchase date. For this reason, the Bank repurchased only $308 in surplus capital stock on October 31, 2005.

Excess Capital Stock. As of September 30, 2005, capital stock in excess of the minimum amount required to be held in accordance with the Bank’s capital plan totaled $936. In addition to the repurchase of surplus capital stock noted above, the Bank repurchased excess capital stock totaling $2 on October 31, 2005. A member may obtain redemption of excess capital stock following a five-year redemption period, subject to certain conditions, by providing a written redemption notice to the Bank. At its discretion, under certain conditions the Bank may repurchase excess stock at any time before the five-year redemption period has expired. The Bank’s capital requirements are more fully discussed in Note 12 to the 2004 Financial Statements in the Bank’s Registration Statement.

Concentration. As of September 30, 2005, the Bank had a concentration of capital stock totaling 57 million shares outstanding to three members (Washington Mutual Bank, World Savings Bank, FSB, and Citibank (West), FSB), representing 64% of total capital stock outstanding (37%, 14%, and 13%, respectively).

Note 8 – Segment Information

The Bank analyzes financial performance based on the balances and adjusted net interest income of two operating segments, the advances-related business and the mortgage-related business, based on

the Bank’s method of internal reporting. For purposes of segment reporting, adjusted net interest income includes interest income and expenses associated with economic hedges that are recorded in “Net loss on derivatives and hedging activities” in other income. It is at the adjusted net interest income level that the Bank’s chief operating decision maker reviews and analyzes financial performance and determines the allocation of resources to the two operating segments. Except for the interest income and expenses associated with economic hedges, the Bank does not allocate other income, other expense, or assessments to its operating segments.

The advances-related business consists of advances and other credit products provided to members, related financing and hedging instruments, liquidity and other non-MBS investments associated with the Bank’s role as a liquidity provider, and member capital. Adjusted net interest income for this segment is derived primarily from the difference, or spread, between the yield on all assets associated with the business activities in this segment and the cost of funding those activities, including earnings on invested member capital and the cash flows from associated interest rate exchange agreements. The mortgage-related business consists of MBS investments, mortgage loans acquired through the MPF Program, the consolidated obligations specifically identified as funding those assets, and related hedging instruments. Adjusted net interest income for this segment is derived primarily from the difference, or spread, between the yield on the MBS and mortgage loans and the cost of the consolidated obligations funding those assets, including the cash flows from associated interest rate exchange agreements, less the provision for credit losses on mortgage loans.

The following table presents the Bank’s adjusted net interest income by operating segment and reconciles total adjusted net interest income to net interest income before assessments for the three and nine months ended September 30, 2005 and 2004.

Reconciliation of Adjusted Net Interest Income and Income Before Assessments


	Advances- Related Business		Mortgage- Related Business		Adjusted Net Interest Income		Net Interest Expense on Economic Hedges*		Net Interest Income		Other Income/ (Loss)		Other Expense		Income Before Assessments
Three months ended:
September 30, 2005	$	127	$	41	$	168	$	10	$	178	$	(35)	$	19	$	124
September 30, 2004		83		27		110		21		131		(95)		16		20
Nine months ended:
September 30, 2005	$	339	$	122	$	461	$	35	$	496		$ (85)	$	58	$	353
September 30, 2004		224		116		340		55		395		(59)		49		287

The Bank includes interest income and interest expense associated with economic hedges in its evaluation of financial performance for its two operating segments. For financial reporting purposes, the Bank does not include these amounts in net interest income in the Statements of Income, but instead records them in other income in “Net loss on derivatives and hedging activities.”

The following table presents total assets by operating segment at September 30, 2005, and December 31, 2004:


Total Assets
	Advances- Related Business		Mortgage- Related Business		Total Assets
September 30, 2005	$	179,997	$	31,763	$	211,760
December 31, 2004		156,889		28,093		184,982

Note 9 – Derivatives and Hedging Activities

Accounting for Derivative Instruments and Hedging Activities. SFAS 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. The gains and losses on derivative instruments that are reported in other comprehensive income are recognized as earnings in the periods in which earnings are affected by the variability of the cash flows of the hedged item. The gains or losses on the ineffective portion of all hedges are recognized in current period earnings. Changes in the fair value of a derivative instrument that does not qualify as a hedge of an asset or liability under SFAS 133 for asset/liability management (economic hedge) are recorded each period in current earnings.

Net losses on derivatives and hedging activities recorded in other income for the three and nine months ended September 30, 2005 and 2004, were as follows:


	Three months ended						Nine months ended
	September 30, 2005			September 30, 2004			September 30, 2005			September 30, 2004
Net losses related to fair value hedge ineffectiveness	$	(18	)	$	(93	)	$	(42	)	$	(22	)
Net losses related to cash flow hedge ineffectiveness		—			—			(1	)		—
Net gains on economic hedges		—			14			3			22
Net interest expense on derivative instruments used in economic hedges		(10	)		(21	)		(35	)		(55	)
Net losses on derivatives and hedging activities	$	(28	)	$	(100	)	$	(75	)	$	(55	)

As of September 30, 2005, the unrecognized net losses on derivative instruments accumulated in other comprehensive income to be reclassified to earnings during the next 12 months was expected to be immaterial.

The following table represents outstanding notional balances and estimated fair values of the derivatives outstanding at September 30, 2005, and December 31, 2004:


	September 30, 2005					December 31, 2004
Type of Derivative and Hedge Classification	Notional		Estimated Fair Value			Notional		Estimated Fair Value
Interest rate swaps:
Fair value	$	162,859	$	(1,432	)	$	140,979	$	(574	)
Cash flow		160		1			375		—
Economic		55,155		3			44,602		2
Interest rate swaptions: Economic		3,587		24			3,487		57
Interest rate caps/floors:
Fair value		13,837		112			12,987		(2	)
Economic		70		—			50		—
Mortgage delivery commitments*		3		—			4		—
Total	$	235,671	$	(1,292	)	$	202,484	$	(517	)

Total derivatives excluding accrued interest			$	(1,292	)			$	(517	)
Accrued interest, net				(35	)				122
Net derivative balances			$	(1,327	)			$	(395	)
Derivative assets			$	22				$	43
Derivative liabilities				(1,349	)				(438	)
Net derivative balances			$	(1,327	)			$	(395	)

*	Mortgage delivery commitments are classified as derivatives pursuant to SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (SFAS 149), with changes in their fair value recorded in other income.

The fair values of embedded derivatives presented on a combined basis with the host contract and not included in the above table are as follows:


	Estimated Fair Values of Embedded Derivatives
(In millions)	September 30, 2005			December 31, 2004
Host contract:
Advances	$	(3	)	$	(3	)
Non-callable bonds		30			(5	)
Callable bonds		1			—
Total	$	28		$	(8	)

Credit Risk—The Bank is subject to credit risk as a result of the risk of nonperformance by counterparties to the derivative agreements. All derivative agreements are subject to master netting arrangements with each counterparty to mitigate the credit risk exposure. The Bank manages counterparty credit risk through credit analyses and collateral requirements and by following the requirements of the Bank’s risk management policies and credit guidelines and the Finance Board’s Financial Management Policy. Based on the master netting arrangements, its credit analyses, and the collateral requirements in place with each counterparty, management of the Bank does not anticipate any credit losses on its agreements, and no allowance for losses is deemed necessary by management.

The contractual or notional amounts of interest rate exchange agreements reflect the extent of the Bank’s involvement in particular classes of financial instruments. The Bank had notional amounts outstanding of $235,671 at September 30, 2005, and $202,484 at December 31, 2004. The notional amount does not represent the exposure to credit loss. The Bank is subject to credit risk relating to the nonperformance by a counterparty to a non-exchange-traded interest rate exchange agreement. The amount potentially subject to credit loss is the estimated cost of replacing a favorable interest rate exchange agreement if the counterparty defaults; this amount is substantially less than the notional amount.

Maximum credit risk is defined as the estimated cost of replacing all interest rate exchange agreements the Bank has transacted with counterparties where the Bank is in a net favorable position (has a net unrealized gain) if the counterparties all defaulted and the related collateral proved to be of no value to the Bank. At September 30, 2005, and December 31, 2004, the Bank’s maximum credit risk, as defined above, was estimated at $22 and $43, respectively, including $0.2 and $24 of net accrued interest receivable, respectively. Accrued interest receivables and payables and the legal right to offset assets and liabilities by counterparty (under which amounts recognized for individual transactions may be offset against amounts recognized for other transactions with the same counterparty) are considered in determining the maximum credit risk. The Bank held cash, investment grade securities, and mortgage loans valued at $22 and $41 as collateral from counterparties as of September 30, 2005, and December 31, 2004, respectively. This collateral has not been sold or repledged. A significant number of the Bank’s interest rate exchange agreements are transacted with financial institutions such as major banks and broker-dealers. Some of these banks and broker-dealers or their affiliates buy, sell, and distribute consolidated obligations. Assets pledged as collateral by the Bank to these counterparties are more fully discussed in Note 11.

Intermediation—As an additional service to its members, the Bank enters into offsetting interest rate exchange agreements, acting as an intermediary between exactly offsetting derivatives transactions with members and other counterparties. This intermediation allows members indirect access to the derivatives market. The offsetting derivatives used in intermediary activities do not receive SFAS 133 hedge accounting treatment and are separately marked to market through earnings. The net result of the accounting for these derivatives does not significantly affect the operating results of the Bank. These amounts are recorded in other income and presented as “Net loss on derivatives and hedging activities.”

Derivatives in which the Bank is an intermediary may arise when the Bank (1) enters into derivatives with members and offsetting derivatives with other counterparties to meet the needs of its members, and (2) enters into derivatives to offset the economic effect of other derivatives that are no longer designated to either advances, investments, or consolidated obligations. The notional principal of interest rate exchange agreements arising from the Bank entering into derivatives with members and offsetting derivatives with other counterparties was $1,480 at September 30, 2005, and $1,570 at December 31, 2004. The notional amount of interest rate exchange agreements that are derivatives to offset the economic effect of other derivatives that were no longer designated to either advances, investments, or consolidated obligations was $130 at September 30, 2005, and $290 at December 31, 2004.

Note 10 – Estimated Fair Values

The following estimated fair value amounts have been determined by the Bank using available market information and the Bank’s best judgment of appropriate valuation methods. These estimates are based on pertinent information available to the Bank as of September 30, 2005, and

December 31, 2004. Although the Bank uses its best judgment in estimating the fair value of these financial instruments, there are inherent limitations in any estimation technique or valuation methodology. For example, because an active secondary market does not exist for a portion of the Bank’s financial instruments, in certain cases fair values are not subject to precise quantification or verification and may change as economic and market factors and evaluation of those factors change. Therefore, these estimated fair values are not necessarily indicative of the amounts that would be realized in current market transactions. The fair value summary tables do not represent an estimate of the overall market value of the Bank as a going concern, which would take into account future business opportunities. The estimated fair values of the Bank’s financial instruments are more fully discussed in Note 16 to the 2004 Financial Statements in the Bank’s Registration Statement.

The estimated fair values of the Bank’s financial instruments at September 30, 2005, and December 31, 2004, were as follows:

Fair Value of Financial Instruments – September 30, 2005


	Carrying Value		Net Unrealized Gains/(Losses)			Estimated Fair Value
Assets
Cash and due from banks	$	13	$	—		$	13
Interest-bearing deposits in banks		4,946		—			4,946
Securities purchased under agreements to resell		1,500		—			1,500
Federal funds sold		17,188		—			17,188
Trading securities		142		—			142
Held-to-maturity securities		28,823		(281	)		28,542
Advances		152,956		33			152,989
Mortgage loans held for portfolio, net of allowance for credit losses on mortgage loans		5,408		(75	)		5,333
Accrued interest receivable		663		—			663
Derivative assets		22		—			22
Other assets		99		(62	)		37
Total	$	211,760	$	(385	)	$	211,375

Liabilities
Deposits	$	699	$	—		$	699
Consolidated obligations:
Bonds		173,790		292			173,498
Discount notes		24,873		10			24,863
Mandatorily redeemable capital stock		48		—			48
Accrued interest payable		1,338		—			1,338
Derivative liabilities		1,349		—			1,349
Other liabilities		514		—			514
Total	$	202,611	$	302		$	202,309

Fair Value of Financial Instruments – December 31, 2004


	Carrying Value		Net Unrealized Gains/(Losses)			Estimated Fair Value
Assets
Cash and due from banks	$	16	$	—		$	16
Interest-bearing deposits in banks		5,251		—			5,251
Federal funds sold		8,461		—			8,461
Trading securities		602		—			602
Held-to-maturity securities		23,839		(82	)		23,757
Advances		140,254		39			140,293
Mortgage loans held for portfolio, net of allowance for credit losses on mortgage loans		6,035		(2	)		6,033
Accrued interest receivable		398		—			398
Derivative assets		43		—			43
Other assets		83		(52	)		31
Total	$	184,982	$	(97	)	$	184,885

Liabilities
Deposits	$	935	$	—		$	935
Consolidated obligations:
Bonds		148,109		56			148,053
Discount notes		26,257		8			26,249
Mandatorily redeemable capital stock		55		—			55
Accrued interest payable		809		—			809
Derivative liabilities		438		—			438
Other liabilities		479		—			479
Total	$	177,082	$	64		$	177,018

Note 11 – Commitments and Contingencies

All FHLBanks have joint and several liability for all FHLBank consolidated obligations. The joint and several liability regulation of the Finance Board authorizes the Finance Board to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor. The Bank has never been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank. The par amount of the outstanding consolidated obligations of all 12 FHLBanks was $920,369 at September 30, 2005, and $869,242 at December 31, 2004. The par value of the Bank’s participation in consolidated obligations was $200,497 at September 30, 2005, and $175,132 at December 31, 2004. The Bank’s joint and several liability for FHLBank consolidated obligations is more fully discussed in Note 18 to the 2004 Financial Statements in the Bank’s Registration Statement.

Commitments that legally obligate the Bank for additional advances totaled $1,597 at September 30, 2005, and $1,162 at December 31, 2004. Commitments are generally for periods up to 12 months. Based on management’s credit analyses of members’ financial condition and collateral requirements, no allowance for losses is deemed necessary by management on these advance commitments. Advances funded under these advance commitments are fully collateralized at the time of funding (see Note 4). The estimated fair value of commitments was immaterial to the balance sheet as of September 30, 2005, and December 31, 2004.

Commitments that obligate the Bank to purchase mortgage loans totaled $3 at September 30, 2005, and $4 at December 31, 2004. Commitments are generally for periods not to exceed 45 business days. In accordance with SFAS 149, commitments entered after June 30, 2003, were recorded as derivatives at their fair value through the settlement date of the commitment.

The Bank executes interest rate exchange agreements with major banks and broker-dealers that have long-term credit ratings of single-A or better from both Standard & Poor’s and Moody’s Investors Service. The Bank also executes interest rate exchange agreements with its members. The Bank enters into master agreements with netting provisions and bilateral security agreements with all counterparties and requires all member counterparties to fully collateralize their net credit exposure. As of September 30, 2005, and December 31, 2004, the Bank had pledged as collateral securities with a fair value of $845 and $243, respectively, to broker-dealers that had a net credit risk exposure to the Bank related to interest rate exchange agreements.

The Bank may be subject to various pending legal proceedings arising in the normal course of business. After consultation with legal counsel, management does not anticipate that the ultimate liability, if any, arising out of these matters will have a material effect on the Bank’s financial condition or results of operations.

The Bank had committed to the issuance of $6,341 of consolidated obligations at September 30, 2005. The Bank had committed to the issuance of $960 of consolidated obligations at December 31, 2004.

The Bank entered into $7,552 of notional amount of interest rate exchange agreements that had traded but not yet settled at September 30, 2005. The Bank entered into $900 of notional amount of interest rate exchange agreements that had traded but not yet settled at December 31, 2004.

In June 2005, the Bank entered into an amendment to its operating lease for office space at 600 California Street in San Francisco, California. This amendment provides for an extension of the original lease term for a period of approximately 11 years through June 30, 2020, and a renewal option term to extend the term of the lease for an additional five years. The monthly base rent for the extension term will be at ninety-five percent (95%) of the fair market rent at the commencement of the extension term.

Other commitments and contingencies are discussed in Notes 4, 5, 6, 7, and 9.

Note 12 – Transactions with Members

Transactions with Members. The Bank is a cooperative whose member institutions own the capital stock of the Bank and may receive dividends on their investments. In addition, certain former members that still have outstanding transactions are also required to maintain their investment in the Bank’s capital stock until the transactions mature or are paid off and the capital stock is redeemed following the five-year redemption period for capital stock, in accordance with the Bank’s capital requirements. (See Note 12 to the 2004 Financial Statements in the Bank’s Registration Statement for further information.)

All advances are issued to members, and all mortgage loans held for portfolio are purchased from members. The Bank also maintains deposit accounts for members primarily to facilitate settlement activities that are directly related to advances and mortgage loan purchases. All transactions with

members and their affiliates are entered into in the normal course of business. In instances where the member or an affiliate of the member has an officer or director who is a director of the Bank, transactions with the member or affiliate are subject to the same eligibility and credit criteria, as well as the same conditions, as transactions with all other members, in accordance with Finance Board regulations.

In addition, the Bank has investments in Federal funds sold, interest-bearing deposits, commercial paper, and MBS with members or their affiliates. All investments are transacted at market prices and MBS are purchased through securities brokers or dealers. As an additional service to its members, the Bank enters into offsetting interest rate exchange agreements, acting as an intermediary between exactly offsetting derivative transactions with members and other counterparties. These transactions are also executed at market rates.

The following tables set forth information at the dates and for the periods indicated with respect to the Bank’s transactions with members and their affiliates and former members and their affiliates with outstanding transactions:


	September 30, 2005		December 31, 2004
Assets:
Interest-bearing deposits in banks	$	1,144	$	—
Federal funds sold		2,963		608
Held-to-maturity securities*		7,146		5,022
Advances		152,956		140,254
Mortgage loans held for portfolio		5,408		6,035
Accrued interest receivable		551		315
Derivative assets		22		25
Total	$	170,190	$	152,259

Liabilities:
Deposits	$	699	$	935
Derivative liabilities		128		23
Total	$	827	$	958

Notional amount of derivatives	$	23,934	$	20,452
Letters of credit		803		783

*	Held-to-maturity securities include MBS issued by and/or purchased from the Bank’s members or their affiliates.


	Three months ended						Nine months ended
	September 30, 2005			September 30, 2004			September 30, 2005			September 30, 2004
Interest Income:
Interest-bearing deposits in banks	$	6		$	4		$	12		$	7
Federal funds sold		24			4			57			11
Held-to-maturity securities		72			47			192			129
Advances*		1,369			492			3,448			1,153
Prepayment fees on advances		1			2			1			6
Mortgage loans held for portfolio		71			74			215			234
Total	$	1,543		$	623		$	3,925		$	1,540

Interest Expense:
Deposits	$	5		$	2		$	12		$	4
Consolidated obligations*		(9	)		(38	)		(38	)		(132	)
Total	$	(4	)	$	(36	)	$	(26	)	$	(128	)

Other Income/(Loss):
Net loss on derivatives and hedging activities	$	(84	)	$	—		$	(97	)	$	(62	)
Fees earned on letters of credit		1			—			1			1
Total	$	(83	)	$	—		$	(96	)	$	(61	)

*	Includes the effect of associated derivatives with members and their affiliates.

Transactions with Certain Members. The following tables set forth information at the dates and for the periods indicated with respect to transactions with (i) members and former members holding more than 10% of the outstanding shares of the Bank’s capital stock at each respective period end, (ii) members or former members with a representative serving on the Bank’s Board of Directors at any time during the year ended on the respective dates or during the respective periods, and (iii) affiliates of the foregoing members or former members.


	September 30, 2005		December 31, 2004
Assets:
Interest-bearing deposits in banks	$	530	$	—
Federal funds sold		150		608
Held-to-maturity securities*		2,884		2,525
Advances		115,355		106,433
Mortgage loans held for portfolio		4,270		4,744
Accrued interest receivable		461		246
Derivative assets		—		10
Total	$	123,650	$	114,566

Liabilities:
Deposits	$	11	$	45
Derivative Liabilities		48		—
Total	$	59	$	45

Notional amount of derivatives	$	11,663	$	11,006
Letters of credit		202		226

*	Held-to-maturity securities include MBS securities issued by and/or purchased from the foregoing Bank members or their affiliates.


	Three months ended						Nine months ended
	September 30, 2005			September 30, 2004			September 30, 2005			September 30, 2004
Interest Income:
Interest-bearing deposits in banks	$	1		$	2		$	3		$	3
Federal funds sold		1			1			6			1
Held-to-maturity securities		29			28			82			74
Advances*		997			384			2,527			927
Prepayment fees on advances		—			—			—			1
Mortgage loans held for portfolio		54			61			167			188
Total	$	1,082		$	476		$	2,785		$	1,194

Interest Expense:
Consolidated obligations*	$	(4	)	$	(20	)	$	(19	)	$	(63	)

Other Income/(Loss):
Net loss on derivatives and hedging activities	$	(39	)	$	(1	)	$	(45	)	$	(20	)

*	Includes the effect of associated derivatives with the foregoing members or their affiliates.

Note 13 – Other

The table below discloses the categories included in operating expense.


	Three months ended				Nine months ended
	September 30, 2005		September 30, 2004		September 30, 2005		September 30, 2004
Compensation and benefits	$	10	$	9	$	30	$	28
Professional and contract services		5		2		12		6
Other		1		3		8		9
Total operating expense	$	16	$	14	$	50	$	43

The table below discloses the Affordable Housing Program (AHP) liability balances.


	Three months ended						Nine months ended
	September 30, 2005			September 30, 2004			September 30, 2005			September 30, 2004
Balance, beginning of the period	$	130		$	135		$	132		$	135
AHP assessments		10			1			29			23
AHP subsidy payments		(15	)		(6	)		(36	)		(28	)
Balance, end of the period	$	125		$	130		$	125		$	130

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Statements contained in this quarterly report on Form 10-Q, including statements describing the objectives, projections, estimates, or predictions of the future of the Federal Home Loan Bank of San Francisco (Bank), may be “forward-looking statements.” These statements may use forward-looking terms, such as “anticipates,” “believes,” “could,” “estimates,” “may,” “should,” “will,” or their negatives or other variations on these terms. The Bank cautions that by their nature, forward-looking statements involve risk or uncertainty and that actual results could differ materially from those expressed or implied in these forward-looking statements or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. These forward-looking statements involve risks and uncertainties including, but not limited to, the following: economic and market conditions; volatility of market prices, rates, and indices; political, legislative, regulatory, or judicial events; changes in the Bank’s capital structure; membership changes; changes in the demand by Bank members for Bank advances; competitive forces, including the availability of other sources of funding for Bank members; changes in investor demand for consolidated obligations and/or the terms of interest rate exchange agreements and similar agreements; the ability of the Bank to introduce new products and services to meet market demand and to manage successfully the risk associated with new products and services; the ability of each of the other FHLBanks to repay the principal and interest on consolidated obligations for which it is the primary obligor and with respect to which the Bank has joint and several liability; and timing and volume of market activity. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Bank’s interim financial statements and notes, which begin on page 1, and the Bank’s Registration Statement on Form 10, as amended, filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934 and effective on August 29, 2005 (Registration Statement).

Quarterly Overview

The Federal Home Loan Bank of San Francisco (Bank) maintains a balance between its obligation to achieve its public policy mission to promote housing, homeownership, and community development through its activities with members, and its objective to provide adequate returns on the private capital provided by its members. The Bank achieves this balance by delivering low-cost credit to help its members meet the credit needs of their communities while paying members a market-rate dividend.

The Bank’s financial strategies are designed to enable it to safely expand and contract its assets, liabilities, and capital in response to changes in membership composition and member credit needs. The Bank’s capital grows when members are required to purchase additional capital stock as they increase their advance borrowings or sell more mortgage loans to the Bank under the Mortgage Partnership Finance^® (MPF^®) Program. (“Mortgage Partnership Finance” and “MPF” are registered trademarks of the Federal Home Loan Bank of Chicago.) The Bank may also repurchase capital stock from members if their advances or mortgage loan balances decline below certain levels. As a result of these strategies, the Bank has been able to achieve its housing mission by meeting member credit needs and to pay market-rate dividends despite significant fluctuations in total assets, liabilities, and capital in recent years.

The Bank measures its dividend rate on its capital stock relative to a unique dividend benchmark that is calculated as the combined average of (i) the daily average of the overnight Federal funds effective rate and (ii) the four-year moving average of the U.S. Department of Treasury note yield

calculated as the average of the three-year and five-year U.S. Department of Treasury note yields. The benchmark is consistent with the Bank’s interest rate risk and capital management goals.

The Bank’s annualized dividend rate for the third quarter of 2005 was 4.58%, compared to 3.70% in the third quarter of 2004. The spread between the dividend and the dividend benchmark increased to 1.26% for the third quarter of 2005 from 1.22% for the third quarter of 2004. The increase in the annualized dividend rate reflects a higher net interest margin in the three months ended September 30, 2005, relative to the same period in 2004, primarily as a result of higher profit spreads on the mortgage portfolio, along with a higher yield on invested capital.

The Bank’s annualized dividend rate was 4.35% for the first nine months of 2005, compared to 4.10% in the first nine months of 2004. The spread between the dividend and the dividend benchmark decreased to 1.26% for the first nine months of 2005 from 1.67% for the first nine months of 2004. The increase in the annualized dividend rate reflects a higher yield on invested capital, partially offset by a lower net interest spread on the mortgage portfolio in the nine months ended September 30, 2005, relative to the same period in 2004.

Total assets grew $26.8 billion, or 14%, to $211.8 billion at September 30, 2005, from $185.0 billion at December 31, 2004, primarily because of an increase in advances to $153.0 billion from $140.3 billion; an increase in Federal funds sold to $17.2 billion from $8.5 billion; and an increase in held-to-maturity securities, primarily mortgage-backed securities (MBS), to $28.8 billion from $23.8 billion.

Net income was $91 million in the third quarter of 2005 compared to $15 million in the third quarter of 2004. Net income increased $48 million, or 23%, to $259 million in the first nine months of 2005 compared to $211 million in the first nine months of 2004. These increases reflect higher net interest income, which increased $47 million, or 36%, to $178 million in the third quarter of 2005 from $131 million in the third quarter of 2004 and increased $101 million, or 26%, to $496 million in the first nine months of 2005 from $395 million in the first nine months of 2004. The increases in net interest income were driven primarily by higher average interest-earning assets outstanding, combined with higher average capital balances.

The net effect of unrealized fair value adjustments on trading securities, derivatives, and hedged items resulted in a net unrealized fair value loss of $19 million in the third quarter of 2005 compared to a net unrealized fair value loss of $55 million in the third quarter of 2004.

The net effect of unrealized fair value adjustments on trading securities, derivatives, and hedged items resulted in a net unrealized fair value loss of $39 million in the first nine months of 2005 compared to a net unrealized fair value loss of $5 million in the first nine months of 2004.

Net unrealized fair value gains or losses are primarily a matter of timing because they will generally reverse over the remaining contractual terms to maturity, or by the exercised call or put date, of the hedged financial instruments and associated interest rate exchange agreements. Nearly all of the Bank’s derivatives and hedged instruments are held to maturity, call date, or put date. However, the Bank may have instances in which hedging relationships are terminated prior to maturity or prior to the exercised call or put dates. The impact of terminating a hedging relationship may result in a realized gain or loss. In addition, the Bank may have instances in which it may sell trading securities prior to maturity, which may also result in a realized gain or loss.

Financial Highlights

The following table presents a summary of certain financial information for the Bank for the periods indicated.


(Dollars in millions)	September 30, 2005		June 30, 2005		March 31, 2005		December 31, 2004		September 30, 2004
Selected Balance Sheet Items at Period End
Total Assets	$ 211,760		$ 206,727		$ 192,761		$ 184,982		$ 172,573
Advances	152,956		152,808		142,316		140,254		123,722
Mortgage Loans	5,408		5,648		5,855		6,035		6,200
Held-to-Maturity Securities	28,823		27,283		25,456		23,839		23,543
Consolidated Obligations:¹
Bonds	173,790		173,061		160,111		148,109		137,095
Discount Notes	24,873		21,261		21,277		26,257		24,089
Capital Stock –
Class B – Putable	9,025		8,725		8,117		7,765		7,176
Total Capital	9,149		8,858		8,234		7,900		7,298

Quarterly Operating Results
Net Interest Income	$ 178		$ 159		$ 159		$ 147		$ 131
Other Income	(35	)	5		(55	)	(17	)	(95	)
Other Expense	19		20		19		19		16
Assessments	33		38		23		29		5
Net Income	$ 91		$ 106		$ 62		$ 82		$ 15

Other Data
Net Interest Margin	0.34	%	0.32	%	0.34	%	0.33	%	0.32	%
Operating Expenses as a
Percent of Average Assets	0.03		0.03		0.03		0.04		0.03
Return on Equity	4.03		4.94		3.11		4.29		0.82
Annualized Dividend Rate	4.58		4.21		4.25		3.97		3.70
Spread of Dividend Rate to Dividend Benchmark²	1.26		1.13		1.38		1.32		1.22
Capital to Assets Ratio³	4.34		4.31		4.30		4.30		4.24
Duration Gap (in months)	1		0		1		1		1

All of the Federal Home Loan Banks (FHLBanks) have joint and several liability for FHLBank consolidated obligations. The joint and several liability regulation of the Federal Housing Finance Board (Finance Board) authorizes the Finance Board to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor. The Bank has never been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank. The par amount of the outstanding consolidated obligations of all 12 FHLBanks at the dates indicated was as follows:


Quarter ended	Par amount
September 30, 2005	$	920,369
June 30, 2005		908,305
March 31, 2005		872,733
December 31, 2004		869,242
September 30, 2004		850,466

The dividend benchmark is calculated as the combined average of (i) the daily average of the overnight Federal funds effective rate and (ii) the four-year moving average of the U.S. Department of Treasury note yield calculated as the average of the three-year and five-year U.S. Department of Treasury note yields.

³	For this purpose, capital includes mandatorily redeemable capital stock.

Results of Operations

The primary source of Bank earnings is net interest income, which is the interest earned on advances, mortgage loans, and investments, less interest paid on consolidated obligations, deposits, and other borrowings. The following Average Balance Sheets tables present average balances of earning asset categories and the sources that fund those earning assets (liabilities and capital) for the three and nine months ended September 30, 2005 and 2004, together with the related interest income and expense. They also present the average rate on total earning assets and the average cost of total funding sources. The Change in Net Interest Income tables detail the changes in interest income and interest expense for the third quarter of 2005 compared to the third quarter of 2004 and for the first nine months of 2005 compared to the first nine months of 2004. Changes in both volume and interest rates influence changes in net interest income and the net interest margin.

Average Balance Sheets


	Three months ended
	September 30, 2005						September 30, 2004
(In millions)	Average Balance		Interest Income/ Expense		Average Rate		Average Balance		Interest Income/ Expense		Average Rate
Assets
Interest-earning assets:
Interest-bearing deposits in banks	$	4,466	$	39	3.46	%	$	5,386	$	20	1.48	%
Securities purchased under agreements to resell		2,163		19	3.48			1,635		6	1.46
Federal funds sold		14,078		123	3.47			7,166		25	1.39
Trading securities:
MBS		248		3	4.80			352		5	5.65
Other investments		—		—	—			403		2	1.97
Held-to-maturity securities:
MBS		24,440		267	4.33			19,516		176	3.59
Other investments		2,676		25	3.71			2,810		11	1.56
Mortgage loans		5,535		71	5.09			6,266		74	4.70
Advances¹		153,038		1,370	3.55			120,518		494	1.63
Deposits for mortgage loan program with other FHLBank		1		—	3.53			2		—	1.59
Loans to other FHLBanks		1		—	—			17		—	1.40
Total interest-earning assets		206,646		1,917	3.68			164,071		813	1.97
Other assets²		2,342		—	—			1,603		—	—
Total Assets	$	208,988	$	1,917	3.64	%	$	165,674	$	813	1.95	%
Liabilities and Capital
Interest-bearing liabilities:
Consolidated obligations:
Bonds¹	$	178,231	$	1,574	3.50	%	$	127,093	$	576	1.80	%
Discount notes¹		18,594		159	3.39			29,246		104	1.41
Deposits		626		5	3.17			734		2	1.08
Borrowings from other FHLBanks		14		—	3.50			7		—	1.14
Mandatorily redeemable capital stock		48		1	4.58			6		—	3.70
Other borrowings		26		—	4.01			12		—	2.32
Total interest-bearing liabilities		197,539		1,739	3.49			157,098		682	1.73
Other liabilities²		2,493		—	—			1,388		—	—
Total Liabilities		200,032		1,739	3.45			158,486		682	1.71
Total Capital		8,956		—	—			7,188		—	—
Total Liabilities and Capital	$	208,988	$	1,739	3.30	%	$	165,674	$	682	1.64	%
Net Interest Income			$	178					$	131
Net Interest Spread³					0.19	%					0.24	%
Net Interest Margin⁴					0.34	%					0.32	%
Total Average Assets/Capital Ratio⁵		23.2x						23.0x
Interest-bearing Assets/ Interest-bearing Liabilities		1.0x						1.0x

¹	Interest income/expense and average rates include the effect of associated interest rate exchange agreements.

²	Includes forward settling transactions and fair value adjustments in accordance with Statement of Financial Accounting Standards (SFAS) No. 133 and No. 115.

³	Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities.

⁴	Net interest margin is net interest income (annualized) divided by average interest-earning assets.

⁵	For this purpose, capital includes mandatorily redeemable capital stock.

Change in Net Interest Income: Rate/Volume Analysis

Three Months Ended September 30, 2005, Compared to Three Months Ended September 30, 2004


	Increase/ (Decrease)			Attributable to Changes in¹
(In millions)	Increase/ (Decrease)			Average Volume			Average Rate
Interest-earning assets:
Interest-bearing deposits in banks	$	19		$	(8	)	$	27
Securities purchased under agreements to resell		13			5			8
Federal funds sold		98			60			38
Trading securities:
MBS		(2	)		(1	)		(1	)
Other investments		(2	)		—			(2	)
Held-to-maturity securities:
MBS		91			54			37
Other investments		14			(1	)		15
Mortgage loans		(3	)		(9	)		6
Advances²		876			288			588
Total interest-earning assets		1,104			388			716

Interest-bearing liabilities:
Consolidated obligations:
Bonds²		998			449			549
Discount notes²		55			(91	)		146
Deposits		3			(1	)		4
Mandatorily redeemable capital stock		1			1			—
Total interest-bearing liabilities		1,057			358			699
Net interest income	$	47		$	30		$	17

¹	Combined rate/volume variances, a third element of the calculation, are allocated to the rate and volume variances based on their relative sizes.

²	Interest income/expense and average rates include the interest effect of associated interest rate exchange agreements.

Average Balance Sheets


	Nine months ended
	September 30, 2005						September 30, 2004
(In millions)	Average Balance		Interest Income/ Expense		Average Rate		Average Balance		Interest Income/ Expense		Average Rate
Assets
Interest-earning assets:
Interest-bearing deposits in banks	$	4,632	$	103	2.97	%	$	4,184	$	39	1.25	%
Securities purchased under agreements to resell		901		23	3.41			2,653		22	1.11
Federal funds sold		12,127		277	3.05			7,800		68	1.16
Trading securities:
MBS		293		12	5.48			375		16	5.70
Other investments		30		1	4.46			571		6	1.40
Held-to-maturity securities:
MBS		23,235		733	4.22			17,498		469	3.58
Other investments		2,368		57	3.22			2,783		28	1.34
Mortgage loans		5,742		215	5.01			6,366		234	4.91
Advances¹		148,338		3,449	3.11			110,842		1,159	1.40
Deposits for mortgage loan program with other FHLBank		—		—	3.01			4		—	3.61
Loans to other FHLBanks		5		—	2.67			16		—	1.09
Total interest-earning assets		197,671		4,870	3.29			153,092		2,041	1.78
Other assets²		2,061		—	—			1,961		—	—
Total Assets	$	199,732	$	4,870	3.26	%	$	155,053	$	2,041	1.76	%
Liabilities and Capital
Interest-bearing liabilities:
Consolidated obligations:
Bonds¹	$	166,874	$	3,893	3.12	%	$	115,426	$	1,373	1.59	%
Discount notes¹		21,531		467	2.90			30,604		269	1.17
Deposits		566		12	2.83			594		4	0.90
Borrowings from other FHLBanks		13		—	2.81			2		—	1.40
Mandatorily redeemable capital stock		51		2	4.35			8		—	4.10
Other borrowings		20		—	3.09			7		—	1.72
Total interest-bearing liabilities		189,055		4,374	3.09			146,641		1,646	1.50
Other liabilities²		2,130		—	—			1,729		—	—
Total Liabilities		191,185		4,374	3.06			148,370		1,646	1.48
Total Capital		8,547		—	—			6,683		—	—
Total Liabilities and Capital	$	199,732	$	4,374	2.93	%	$	155,053	$	1,646	1.42	%
Net Interest Income			$	496					$	395
Net Interest Spread³					0.20	%					0.28	%
Net Interest Margin⁴					0.34	%					0.34	%
Total Average Assets/Capital Ratio⁵		23.4x						23.2x
Interest-bearing Assets/Interest-bearing Liabilities		1.0x						1.0x

¹	Interest income/expense and average rates include the effect of associated interest rate exchange agreements.

²	Includes forward settling transactions and fair value adjustments in accordance with SFAS No. 133 and No. 115.

³	Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities.

⁴	Net interest margin is net interest income (annualized) divided by average interest-earning assets.

⁵	For this purpose, capital includes mandatorily redeemable capital stock.

Change in Net Interest Income: Rate/Volume Analysis

Nine Months Ended September 30, 2005, Compared to Nine Months Ended September 30, 2004


	Increase/ (Decrease)			Attributable to Changes in¹
(In millions)	Increase/ (Decrease)			Average Volume			Average Rate
Interest-earning assets:
Interest-bearing deposits in banks	$	64		$	9		$	55
Securities purchased under agreements to resell		1			(45	)		46
Federal funds sold		209			96			113
Trading securities:
MBS		(4	)		(3	)		(1	)
Other investments		(5	)		(18	)		13
Held-to-maturity securities:
MBS		264			179			85
Other investments		29			(10	)		39
Mortgage loans		(19	)		(24	)		5
Advances²		2,290			843			1,447
Total interest-earning assets		2,829			1,027			1,802
Interest-bearing liabilities:
Consolidated obligations:
Bonds²		2,520			1,172			1,348
Discount notes²		198			(200	)		398
Deposits		8			(1	)		9
Mandatorily redeemable capital stock		2			2			—
Total interest-bearing liabilities		2,728			973			1,755
Net interest income	$	101		$	54		$	47

¹	Combined rate/volume variances, a third element of the calculation, are allocated to the rate and volume variances based on their relative sizes.

²	Interest income/expense and average rates include the interest effect of associated interest rate exchange agreements.

The net interest margin increased 2 basis points during the third quarter of 2005 compared to the third quarter of 2004. The increase primarily reflects higher spreads on the combined mortgage loan and MBS portfolios and a higher yield on invested capital.

The net interest margin was 0.34% during the first nine months of both 2005 and 2004. The net interest margin remained flat because of offsetting factors resulting from a higher yield on

invested capital, offset by lower profit spreads on the combined mortgage loan and MBS portfolios.

The net interest spread was 5 basis points lower during the third quarter of 2005 compared to the third quarter of 2004, reflecting a larger proportion of lower-spread advances relative to the overall asset mix. The decrease was partially offset by higher spreads on the combined mortgage loan and MBS portfolios and a higher yield on invested capital. In addition, the yields and interest income on MBS and mortgage loans increased in the third quarter of 2005 and decreased in the third quarter of 2004 because of the effects of retrospective adjustments for amortization of purchase premiums and discounts from the acquisition dates of the mortgage loans and MBS in accordance with SFAS

No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases (SFAS 91).

The net interest spread was 8 basis points lower for the first nine months of 2005 compared to the first nine months of 2004. This decrease was primarily due to lower profit spreads on the combined mortgage loan and MBS portfolios, reflecting higher market rates on short- and intermediate-term financing, coupled with lower-spread advances relative to the overall asset mix. In addition, the yields and interest income on MBS and mortgage loans decreased in the nine months ended September 30, 2005, and increased in the nine months ended September 30, 2004, because of the effects of retrospective adjustments for amortization of purchase premiums and discounts from the acquisition dates of the mortgage loans and MBS in accordance with SFAS 91.

Net Interest Income.

Third Quarter of 2005 Compared to Third Quarter of 2004—Net interest income in the third quarter of 2005 was $178 million, a 36% increase from $131 million in the third quarter of 2004. The increase was largely the result of higher average interest-earning assets outstanding, particularly advances, MBS investments, and Federal funds sold, combined with higher average capital balances and higher earnings on capital.

Interest income on non-MBS investments (interest-bearing deposits in banks, securities purchased under agreements to resell, Federal funds sold, and other non-MBS investments classified as held-to-maturity and trading securities) contributed $142 million to the increase in interest income in the third quarter of 2005 compared to the third quarter of 2004. Of this increase, $56 million was the result of a 34% rise in average non-MBS investment balances, primarily in Federal funds sold, and $86 million was the result of higher average yields on investments.

Interest income from the mortgage portfolio (MBS and mortgage loans) increased $86 million in the third quarter of 2005 compared to the third quarter of 2004. Of this increase, $53 million was the result of a 24% increase in average MBS outstanding, $36 million was the result of the impact of higher average yields on MBS investments, and $6 million was the result of higher average yields on mortgage loans, partially offset by a $9 million decrease as a result of lower average mortgage loans outstanding. The increase was net of the impact in the third quarter of 2005 of retrospective adjustments for amortization of purchase premiums and discounts from the acquisition dates of the mortgage loans and MBS in accordance with SFAS 91, which increased interest income by $6,000. In contrast, during the third quarter of 2004, retrospective adjustments made in accordance with SFAS 91 decreased interest income by $7 million.

Interest income from advances increased $876 million, which consisted of $288 million from a 27% increase in average advances outstanding, reflecting higher member demand during the third quarter of 2005 relative to the third quarter of 2004, and $588 million as a result of higher average yields because of increases in interest rates for new advances coupled with paydowns and maturities of lower-yielding advances.

Paralleling the growth in interest-earning assets, average consolidated obligations (bonds and discount notes) funding the earning assets increased 26%, resulting in a $1.1 billion increase in interest expense for the third quarter of 2005 relative to the third quarter of 2004. Higher average consolidated obligation balances, which were issued primarily to finance growth in intermediate-

term advances, contributed $358 million to the increase in interest expense during the third quarter of 2005. Higher interest rates on consolidated obligations outstanding in the third quarter of 2005 compared to the third quarter of 2004 contributed $695 million to the increase in interest expense.

Nine Months Ended September 30, 2005, Compared to Nine Months Ended September 30, 2004—Net interest income in the first nine months of 2005 was $496 million, a 26% increase from $395 million in the first nine months of 2004. The increase was largely the result of higher average interest-earning assets outstanding, particularly in the advances and MBS portfolios, combined with higher average capital balances.

Interest income on non-MBS investments contributed $298 million to the increase in interest income in the first nine months of 2005 compared to the first nine months of 2004, primarily as a result of higher average yields on investments.

Interest income from the mortgage portfolio increased $241 million in the first nine months of 2005 compared to the first nine months of 2004. Of this increase, $176 million was the result of a 32% increase in average MBS outstanding, $84 million was the result of higher average yields on MBS investments, and $5 million was the result of higher average yields on mortgage loans, partially offset by a $24 million decrease as a result of lower average mortgage loans outstanding. The increase was net of the impact in the first nine months of 2005 of retrospective adjustments for amortization of purchase premiums and discounts from the acquisition dates of the mortgage loans and MBS in accordance with SFAS 91, which decreased interest income by $6 million. In contrast, during the first nine months of 2004, retrospective adjustments made in accordance with SFAS 91 increased interest income by $2 million.

Interest income from advances increased $2.3 billion, which consisted of $843 million from a 34% increase in average advances outstanding, reflecting higher member demand during the first nine months of 2005 relative to the first nine months of 2004, and $1.5 billion as a result of higher average yields because of increases in interest rates for new advances coupled with paydowns and maturities of lower-yielding advances.

Paralleling the growth in interest-earning assets, average consolidated obligations funding the earning assets increased 29%, resulting in a $2.7 billion increase in interest expense for the first nine months of 2005 relative to the first nine months of 2004. Higher average consolidated obligation bond balances, which were issued primarily to finance growth in intermediate-term advances, contributed $1.2 billion to the increase in interest expense during the first nine months of 2005, while lower average balances of consolidated obligation discount notes offset the increase in interest expense by $200 million. In addition, higher interest rates on consolidated obligations outstanding in the first nine months of 2005 compared to the first nine months of 2004 contributed $1.7 billion to the increase in interest expense.

The Bank experienced significant growth in average interest-earning asset portfolios and net interest income during the third quarter of 2005 compared to the third quarter of 2004 and during the first nine months of 2005 compared to the first nine months of 2004. This growth was driven primarily by member demand for advances and growth in average MBS and liquidity investment balances. Member demand for wholesale funding from the Bank can vary greatly depending on a number of factors, including economic and market conditions, competition from other wholesale funding sources, member deposit inflows and outflows, the activity level of the primary and secondary mortgage markets, and strategic decisions made by individual member institutions. As a result, Bank asset levels and operating results may vary significantly from period to period.

Other Income/(Loss).

Third Quarter of 2005 Compared to Third Quarter of 2004—Other income/(loss) was a net loss of $35 million in the third quarter of 2005 compared to a net loss of $95 million in the third quarter of 2004. The decreased loss was primarily the result of unrealized fair value adjustments associated with derivatives and hedging activities under the provisions of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, on January 1, 2001, and SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, on July 1, 2003 (together referred to as “SFAS 133”).

Under SFAS 133, the Bank is required to carry all of its derivative instruments on the balance sheet at fair value. If derivatives meet the hedging criteria, including effectiveness measures, specified in SFAS 133, the underlying hedged instruments may also be carried at fair value so that some or all of the unrealized gain or loss recognized on the derivative is offset by a corresponding unrealized loss or gain on the underlying hedged instrument. The unrealized gain or loss on the “ineffective” portion of all hedges, which represents the amount by which the change in the fair value of the derivative differs from the change in the fair value of the hedged item or the variability in the cash flows of the forecasted transaction, is recognized in current period earnings. In addition, certain derivatives are associated with assets or liabilities but do not qualify as fair value or cash flow hedges under SFAS 133. These economic hedges are recorded on the balance sheet at fair value with the unrealized gain or loss recorded in earnings without any offsetting unrealized loss or gain from the associated asset or liability.

In general, the Bank’s derivatives and hedged instruments are held to maturity, call date, or put date. Therefore, nearly all of the SFAS 133 cumulative net gains and losses that are unrealized fair value gains or losses are primarily a matter of timing and will generally reverse over the remaining contractual terms to maturity, or by the exercised call or put date, of the hedged financial instruments and associated interest rate exchange agreements. However, the Bank may have instances in which hedging relationships are terminated prior to maturity or prior to the exercised call or put dates. The impact of terminating a hedging relationship may result in a realized gain or loss. In addition, the Bank may have instances in which it may sell trading securities prior to maturity, which may also result in a realized gain or loss.

The table below shows the accounting classification of hedges and the categories of hedged items that contributed to the gains and losses on derivatives and hedged items that were recorded in earnings in the third quarter of 2005 and 2004.

Sources of Gains/(Losses) on Derivatives and Hedged Items Recorded in Earnings

Three Months Ended September 30, 2005, Compared to Three Months Ended September 30, 2004


(In millions)	Three months ended
	September 30, 2005														September 30, 2004
	Gain/(Loss)								Net Interest Expense on Economic Hedges						Gain/(Loss)								Net Interest Expense on Economic Hedges
Hedged Item	Fair Value Hedges			Cash Flow Hedges		Economic Hedges			Net Interest Expense on Economic Hedges			Total			Fair Value Hedges			Cash Flow Hedges		Economic Hedges			Net Interest Expense on Economic Hedges			Total
Advances	$	—		$	—	$	(4	)	$	(2	)	$	(6	)	$	—		$	—	$	—		$	—		$	—
Consolidated obligations		(18	)		—		(4	)		(7	)		(29	)		(93	)		—		17			(18	)		(94	)
MBS		—			—		8			(1	)		7			—			—		(3	)		(3	)		(6	)
Total	$	(18	)	$	—	$	—		$	(10	)	$	(28	)	$	(93	)	$	—	$	14		$	(21	)	$	(100	)

During the third quarter of 2005, net losses on derivatives and hedging activities totaled $28 million compared to net losses of $100 million in the third quarter of 2004. These amounts included net interest expense on derivative instruments used in economic hedges of $10 million in the third quarter of 2005 and $21 million in the third quarter of 2004. The majority of this net interest expense is attributable to a funding strategy that employs callable interest rate swaps matched to discount notes to create, in effect, callable debt. These callable swaps allow the Bank to receive a floating rate linked to the three-month London Interbank Offered Rate (LIBOR) and to pay a fixed rate coupon based on the maturity of the callable swap. The original terms of these callable swaps typically range from three to ten years.

Excluding the $10 million impact from net interest expense on derivative instruments used in economic hedges, fair value adjustments in the third quarter of 2005 were primarily unrealized net losses of $18 million, which consisted of $18 million in net losses on fair value hedges related to consolidated obligations, $4 million in net losses on derivative instruments used in economic hedges of advances, and $4 million in net losses on derivative instruments used in economic hedges of consolidated obligations, partially offset by $8 million in net gains on the economic hedges related to MBS classified as trading.

Excluding the $21 million impact from net interest expense on derivative instruments used in economic hedges, fair value adjustments in the third quarter of 2004 were primarily unrealized net losses of $79 million, which consisted of $93 million in net losses on fair value hedges related to consolidated obligations and $3 million in net losses on the economic hedges related to MBS classified as trading, partially offset by net gains of $17 million on derivative instruments used in economic hedges of consolidated obligations.

Nine Months Ended September 30, 2005, Compared to Nine Months Ended September 30, 2004—Other income/(loss) was a net loss of $85 million in the first nine months of 2005 compared to a net loss of $59 million in the first nine months of 2004. The $26 million increased loss was primarily the result of unrealized fair value adjustments associated with derivatives and hedging activities under the provisions of SFAS 133, as discussed above.

Sources of Gains/(Losses) on Derivatives and Hedged Items Recorded in Earnings

Nine Months Ended September 30, 2005, Compared to Nine Months Ended September 30, 2004


(In millions)	Nine months ended
	September 30, 2005															September 30, 2004
Hedged Item	Gain/(Loss)									Net Interest Expense on Economic Hedges			Total			Gain/(Loss)								Net Interest Expense on Economic Hedges			Total
Hedged Item	Fair Value Hedges			Cash Flow Hedges			Economic Hedges			Net Interest Expense on Economic Hedges			Total			Fair Value Hedges			Cash Flow Hedges		Economic Hedges			Net Interest Expense on Economic Hedges			Total
Advances	$	2		$	—		$	1		$	(6	)	$	(3	)	$	2		$	—	$	(2	)	$	1		$	1
Consolidated obligations		(44	)		(1	)		(11	)		(24	)		(80	)		(24	)		—		17			(43	)		(50	)
MBS		—			—			13			(5	)		8			—			—		8			(12	)		(4	)
Mortgage purchase commitments		—			—			—			—			—			—			—		(1	)		—			(1	)
Intermediated		—			—			—			—			—			—			—		—			(1	)		(1	)
Total	$	(42	)	$	(1	)	$	3		$	(35	)	$	(75	)	$	(22	)	$	—	$	22		$	(55	)	$	(55	)

During the first nine months of 2005, net losses on derivatives and hedging activities totaled $75 million compared to net losses of $55 million in the first nine months of 2004. These amounts included net interest expense on derivative instruments used in economic hedges of $35 million in the first nine months of 2005 and $55 million in the first nine months of 2004. The majority of this net interest expense is attributable to a funding strategy that employs callable interest rate swaps matched to discount notes to create, in effect, callable debt. These callable swaps allow the Bank to receive a floating rate linked to the three-month LIBOR and to pay a fixed rate coupon based on the maturity of the callable swap. The original terms of these callable swaps typically range from three to ten years.

Excluding the $35 million impact from net interest expense on derivative instruments used in economic hedges, fair value adjustments in the first nine months of 2005 were primarily unrealized net losses of $40 million, which consisted of net losses of $56 million attributable to the hedges related to consolidated obligations, net gains of $3 million attributable to the hedges related to advances, and net gains of $13 million attributable to the economic hedges related to MBS classified as trading.

Excluding the $55 million impact from net interest expense on derivative instruments used in economic hedges, fair value adjustments in the first nine months of 2004 consisted of $7 million in net losses on the fair value hedges related to consolidated obligations and $8 million in net gains on the economic hedges related to MBS classified as trading, partially offset by net losses of $1 million related to mortgage purchase commitments.

Return on Equity. Return on equity (ROE) was 4.03% (annualized) in the third quarter of 2005, an increase of 321 basis points from the third quarter of 2004. This increase reflects the 507% rise in net income, to $91 million in the third quarter of 2005 from $15 million in the third quarter of 2004. The increase primarily reflects a $72 million decrease in net losses on derivatives and hedged items

(net losses of $28 million in the third quarter of 2005 compared to net losses of $100 million the same period in 2004). In addition, net interest income rose $47 million, or 36%, to $178 million in the third quarter of 2005 from $131 million in the third quarter of 2004, further contributing to the increase in ROE.

ROE was 4.05% (annualized) for the first nine months of 2005, a decrease of 16 basis points compared to the first nine months of 2004. This decrease reflects a $20 million increase in net losses on derivatives and hedged items (net losses of $75 million in the first nine months of 2005 compared to net losses of $55 million in the first nine months of 2004). Lower profit spreads on the combined MBS and mortgage loan portfolios also contributed to the decrease. The decreases were partially offset by the $101 million, or 26%, rise in net interest income, to $496 million in the first nine months of 2005 from $395 million in the first nine months of 2004.

Dividends. The Bank’s annualized dividend rate increased to 4.58% for the third quarter of 2005 from 3.70% in the third quarter of 2004. The spread between the dividend rate and the dividend benchmark increased to 1.26% for the third quarter of 2005 from 1.22% for the third quarter of 2004. These increases were primarily due to higher profit spreads on the mortgage portfolio in the third quarter of 2005 compared to the third quarter of 2004, reflecting the impact of retrospective adjustments for the amortization of net purchase premiums in accordance with SFAS 91, and a higher yield on invested capital.

The Bank’s annualized dividend rate increased to 4.35% for the first nine months of 2005, from 4.10% for the first nine months of 2004. The increase in the dividend rate was primarily due to a higher yield on invested capital, partially offset by lower net interest spreads in the first nine months of 2005 compared to the first nine months of 2004, including narrower profit spreads on the mortgage portfolio primarily driven by retrospective adjustments for the amortization of net purchase premiums in accordance with SFAS 91.

The spread between the dividend rate and the dividend benchmark decreased to 1.26% for the first nine months of 2005 from 1.67% for the first nine months of 2004. The decrease was due, in part, to the decline in the net interest spread on the mortgage portfolio. In addition, higher market interest rates in the first nine months of 2005 compared to the first nine months of 2004 caused an increase in the dividend benchmark and in earnings on invested capital, but as interest rates rise, the yield on invested capital after assessments increases by a smaller amount than the increase in the benchmark yield.

As discussed below, to provide for a build-up of retained earnings, the Bank retained from current earnings $8 million in the third quarter of 2005 and $7 million in the third quarter of 2004, which reduced the annualized dividend rate by 36 basis points in the third quarter of 2005 and by 40 basis points in the third quarter of 2004. The Bank retained from current earnings $23 million in the first nine months of 2005 and $21 million in the first nine months of 2004, which reduced the annualized dividend rate by 37 basis points in the first nine months of 2005 and by 44 basis points in the first nine months of 2004.

By Finance Board regulation, dividends may be paid out of current net earnings or previously retained earnings. As required by the Finance Board, the Bank has a formal retained earnings policy that is reviewed at least annually. The Bank’s Retained Earnings and Dividend Policy establishes amounts to be retained in restricted retained earnings, which are not made available for dividends in the current dividend period. The Bank may be restricted from paying dividends if the Bank is not

in compliance with any of its minimum capital requirements or if payment would cause the Bank to fail to meet any of its minimum capital requirements. In addition, the Bank may not pay dividends if any principal or interest due on any consolidated obligations has not been paid in full, or, under certain circumstances, if the Bank fails to satisfy certain liquidity requirements under applicable Finance Board regulations. The Finance Board’s regulatory liquidity requirements state: (i) each FHLBank must maintain eligible high quality assets (advances with a maturity not exceeding five years, Treasury security investments, and deposits in banks or trust companies) in an amount equal to or greater than the deposits received from members, and (ii) each FHLBank must hold contingency liquidity in an amount sufficient to meet its liquidity needs for at least five business days without access to the consolidated obligation debt markets. At September 30, 2005, advances maturing within five years totaled $150.9 billion, significantly in excess of the $0.7 billion of member deposits on that date. At December 31, 2004, advances maturing within five years totaled $138.3 billion, also significantly in excess of the $0.9 billion of member deposits on that date. In addition, as of September 30, 2005, and December 31, 2004, the Bank’s estimated total sources of funds obtainable from liquidity investments, repurchase agreement borrowings collateralized by the Bank’s marketable securities, and advance repayments would have allowed the Bank to meet its liquidity needs for more than 90 days without access to the consolidated obligation debt markets.

In accordance with the Retained Earnings and Dividend Policy, the Bank retains in restricted retained earnings any cumulative net unrealized gains in earnings (net of applicable assessments) resulting from SFAS 133. Retained earnings restricted in accordance with this provision totaled $47 million at September 30, 2005, and $83 million at December 31, 2004. In general, the Bank’s derivatives and hedged instruments are held to maturity, call date, or put date. Therefore, nearly all of the SFAS 133 cumulative net gains and losses that are unrealized fair value gains or losses are primarily a matter of timing and will generally reverse over the remaining contractual terms to maturity, or by the exercised call or put date, of the hedged financial instruments and associated interest rate exchange agreements. (However, the Bank may have instances in which hedging relationships are terminated prior to maturity or prior to the exercised call or put dates. The impact of terminating a hedging relationship may result in a realized gain or loss. In addition, the Bank may have instances in which it may sell trading securities prior to maturity, which may also result in a realized gain or loss.) As the cumulative net unrealized gains are reversed (by periodic net unrealized losses), the amount of cumulative net unrealized gains decreases. The amount of retained earnings required by this provision of the policy is therefore decreased; that portion of the previously restricted retained earnings becomes unrestricted and may be made available for dividends. In this case, the potential dividend payout in a given period will be substantially the same as it would have been without the effects of SFAS 133, provided that the cumulative net effect of SFAS 133 since inception is a net gain. The purpose of the SFAS 133 category of restricted retained earnings is to ensure that the Bank has sufficient retained earnings to offset future net unrealized losses that result from the reversal of these cumulative net unrealized gains. This ensures that the future membership base does not bear the cost of the future reversals of these unrealized gains. Although restricting retained earnings in accordance with this provision of the policy may preserve the Bank’s ability to pay dividends, the reversal of the cumulative net unrealized SFAS 133 gains in any given period may result in a net loss if the reversal exceeds net earnings before the impact of SFAS 133 for that period. Also, if the net effect of SFAS 133 since inception results in a cumulative net unrealized loss, the Bank’s other retained earnings at that time (if any) may not be sufficient to offset the net unrealized loss. As a result, the future effects of SFAS 133 may cause the Bank to reduce or temporarily suspend paying dividends.

effects of SFAS 133 resulting from an adverse interest rate environment. Effective March 31, 2005, the Board of Directors amended the Retained Earnings and Dividend Policy to provide for this build-up of restricted retained earnings to reach $130 million by the end of the third quarter of 2007. (Further information regarding this policy can be found in the Bank’s Registration Statement in Note 12 to the 2004 Financial Statements.) The retained earnings restricted in accordance with this provision totaled $80 million at September 30, 2005, and $50 million at December 31, 2004.

Prior to the first quarter of 2005, the Bank also retained in restricted retained earnings the amount of advance prepayment fees and other gains and losses related to the termination of interest rate exchange agreements and the early retirement of consolidated obligations related to advance prepayments that would have been reflected in future dividend periods if the advances had not been prepaid. This was based on the Bank’s historical strategy of funding fixed rate advances with fixed rate debt. If a fixed rate advance was prepaid after interest rates had fallen, the Bank would receive a large advance prepayment fee. If the associated debt were also extinguished, the large loss on debt extinguishment would generally offset most of the advance prepayment fee. However, if it were not possible to extinguish the debt, the Bank would experience an immediate positive income impact from the up-front advance prepayment fee, but would have an ongoing obligation to pay a high fixed rate of interest on the remaining debt until maturity. The purpose of this category of restricted retained earnings was to ensure that the burden of any high-cost debt that was not extinguished was not borne by the Bank’s future membership base. Retained earnings restricted in accordance with this provision totaled $6 million at December 31, 2004. Effective March 31, 2005, the Board of Directors amended the Retained Earnings and Dividend Policy to eliminate the requirement to restrict retained earnings for advance prepayment fees and other gains and losses related to the termination of interest rate exchange agreements and the early retirement of consolidated obligations related to advance prepayments. Management determined that this requirement was no longer needed because fixed rate advances are generally hedged with fixed rate interest rate swaps, which creates the equivalent of floating rate advances. If a fixed rate advance is prepaid, the fixed rate interest rate swap is also terminated. The advance prepayment fee and the gain or loss on the termination of the interest rate swap will generally offset each other. The amount previously restricted in accordance with this provision is now part of the $130 million build-up of restricted retained earnings discussed above.

The Bank has historically paid dividends, if declared, in stock form (except fractional shares) and intends to continue this practice.

The Board of Directors may amend the Retained Earnings and Dividend Policy from time to time.

Financial Condition

Total assets were $211.8 billion at September 30, 2005, a 14% increase from $185.0 billion at December 31, 2004. Average total assets were $209.0 billion for the third quarter of 2005, a 26% increase compared to $165.7 billion for the third quarter of 2004. Average total assets were $199.7 billion for the first nine months of 2005, a 29% increase compared to $155.1 billion for the first nine months of 2004. These increases were largely driven by strong growth in advances.

Total liabilities were $202.6 billion at September 30, 2005, a 14% increase from $177.1 billion at December 31, 2004. Average total liabilities were $200.0 billion for the third quarter of 2005, a 26% increase compared to $158.5 billion for the third quarter of 2004. Average total liabilities were $191.2 billion for the first nine months of 2005, a 29% increase compared to $148.4 billion for the first nine months of 2004. The increase in liabilities reflects increases in consolidated obligations, paralleling the growth in assets. Consolidated obligations were $198.7 billion at September 30, 2005, and $174.4 billion at December 31, 2004. Average consolidated obligations were $196.8 billion in the third quarter of 2005 and $156.3 billion in the third quarter of 2004. Average consolidated obligations were $188.4 billion in the first nine months of 2005 and $146.0 billion in the first nine months of 2004.

All FHLBanks have joint and several liability for FHLBank consolidated obligations. The joint and several liability regulation of the Finance Board authorizes the Finance Board to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor. The Bank has never been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank. The par amount of the outstanding consolidated obligations of all 12 FHLBanks was $920.4 billion at September 30, 2005, and $869.2 billion at December 31, 2004.

Some FHLBanks have been the subject of regulatory actions pursuant to which their boards of directors and/or managements have agreed with the Office of Supervision of the Finance Board to, among other requirements, maintain higher levels of capital. The Bank cannot provide assurance that it has been informed or will be informed of additional regulatory actions taken at these or other FHLBanks.

As of September 30, 2005, Standard and Poor’s continued to rate nine of the FHLBanks with a long-term crediting rating of AAA, and three of the FHLBanks with a long-term credit rating of AA+. As of September 30, 2005, Moody’s Investors Service continued to rate all the FHLBanks AAA. Changes in FHLBank individual long-term credit ratings do not necessarily affect the credit rating of the consolidated obligations issued on behalf of the FHLBanks. Rating agencies may from time to time change a rating because of various factors, including operating results or actions taken, business developments, or changes in their opinion regarding, among other things, the general outlook for a particular industry or the economy. Rating agencies may change the ratings of the FHLBank System or any FHLBank in the future.

The Bank has evaluated the publicly disclosed FHLBank regulatory actions and long-term credit ratings of the FHLBanks as of September 30, 2005, and as of each period end presented and has determined that they have not increased the likelihood that the Bank will be required by the Finance Board to repay any principal or interest associated with consolidated obligations for which the Bank is not the primary obligor.

Financial condition is further discussed under “Segment Information.”

Segment Information

The Bank analyzes financial performance based on the adjusted net interest income of two operating segments: the advances-related business and the mortgage-related business. For purposes of segment reporting, adjusted net interest income includes the net interest expense on derivative instruments used in economic hedges that are recorded in “Net loss on derivatives and hedging activities” in other income. For a reconciliation of the Bank’s operating segment adjusted net interest income to the Bank’s total net interest income, see Note 8 to the Financial Statements.

Advances-Related Business. The advances-related business consists of advances and other credit products provided to members, related financing and hedging instruments, liquidity and other non-MBS investments associated with the Bank’s role as a liquidity provider, and member capital.

Assets associated with this segment increased to $180.0 billion (85% of total assets) at September 30, 2005, from $156.9 billion (85% of total assets) at December 31, 2004, an increase of $23.1 billion, or 15%. The increase was primarily due to higher demand for advances by the Bank’s members.

Adjusted net interest income for this segment was $127 million in the third quarter of 2005, an increase of $44 million, or 53%, compared to $83 million in the third quarter of 2004. In the first nine months of 2005, adjusted net interest income for this segment was $339 million, an increase of $115 million, or 51%, compared to $224 million in the first nine months of 2004. The increases were primarily due to an increase in average advance and capital balances and a higher yield on invested capital. The increases were partially offset by a decline in advance prepayment fees, which decreased $1 million, to $1 million in the third quarter of 2005 from $2 million in the third quarter of 2004, and decreased $5 million, to $1 million in the first nine months of 2005 from $6 million in the first nine months of 2004. Higher interest rates at the time of the advance prepayments relative to interest rates at the time the advances were originally transacted led to lower prepayment fees on advances prepaid during 2005. In addition, a lower volume of advances were prepaid in the third quarter and first nine months of 2005 compared to the year-earlier periods. Members prepaid $0.4 billion of advances in the third quarter of 2005, compared to $0.6 billion in the third quarter of 2004. Members prepaid $1.0 billion of advances in the first nine months of 2005, compared to $1.6 billion in the first nine months of 2004.

Adjusted net interest income for this segment represented 76% and 75% of total adjusted net interest income for the third quarter of 2005 and 2004, respectively, and 74% and 66% of total adjusted net interest income for the first nine months of 2005 and 2004, respectively.

Advances—Advances outstanding increased 9%, to $153.0 billion at September 30, 2005, from $140.3 billion at December 31, 2004. Advances outstanding included unrealized fair value losses of $285 million at September 30, 2005, and unrealized fair value losses of $5 million at December 31, 2004. The increase in the unrealized fair value losses of hedged advances from December 31, 2004, to September 30, 2005, was primarily attributable to the effects of higher short-term and intermediate-term interest rates on the fair value of hedged fixed rate advances and hedged adjustable rate advances that contain caps on the interest rates that members may pay.

The components of the advances portfolio at September 30, 2005, and December 31, 2004, are presented in the following table.

Advances Portfolio by Product Type


(In millions)	September 30, 2005		December 31, 2004
Standard advances:
Adjustable – LIBOR-indexed	$	81,995	$	45,252
Adjustable – other indices		366		342
Fixed		38,648		65,003
Daily variable rate		3,486		4,010
Subtotal