10-Q 1 fhlb03311410q.htm FORM 10-Q FHLB 033114 10Q

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
 
x
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 

For the quarterly period ended March 31, 2014
OR
 
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 

Commission File Number: 000-51999
 

FEDERAL HOME LOAN BANK OF DES MOINES
(Exact name of registrant as specified in its charter)
 
Federally chartered corporation
(State or other jurisdiction of incorporation or organization)
 
42-6000149
(I.R.S. employer identification number)
 
 
 
 
 
 
 
Skywalk Level
801 Walnut Street, Suite 200
Des Moines, IA
(Address of principal executive offices)
 


50309
(Zip code)
 

Registrant's telephone number, including area code: (515) 281-1000
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
 
Accelerated filer o
 
Non-accelerated filer x
 
Smaller reporting company o

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

o Yes x No
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
 
 
Shares outstanding as of April 30, 2014
 
Class B Stock, par value $100
 
27,263,498
 
 
 
 
 
 
 
 
 




Table of Contents
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF CONDITION
(dollars and shares in thousands, except capital stock par value)
(Unaudited)

 
March 31,
2014
 
December 31,
2013
ASSETS
 
 
 
Cash and due from banks
$
361,337

 
$
448,278

Interest-bearing deposits
1,684

 
1,863

Securities purchased under agreements to resell
7,490,000

 
8,200,000

Federal funds sold
1,875,000

 
1,200,000

Investment securities
 
 
 
Trading securities (Note 3)
1,035,573

 
1,018,373

Available-for-sale securities (Note 4)
8,837,462

 
7,932,520

Held-to-maturity securities (fair value of $1,721,652 and $1,842,599) (Note 5)
1,645,231

 
1,778,306

Total investment securities
11,518,266

 
10,729,199

Advances (Note 7)
44,923,786

 
45,650,220

Mortgage loans held for portfolio, net
 
 
 
Mortgage loans held for portfolio (Note 8)
6,491,943

 
6,565,293

Allowance for credit losses on mortgage loans (Note 9)
(7,400
)
 
(8,000
)
Total mortgage loans held for portfolio, net
6,484,543

 
6,557,293

Accrued interest receivable
81,858

 
72,561

Premises, software, and equipment, net
19,260

 
18,968

Derivative assets, net (Note 10)
104,030

 
93,011

Other assets
29,381

 
32,626

TOTAL ASSETS
$
72,889,145

 
$
73,004,019

LIABILITIES
 
 
 
Deposits
 
 
 
Interest-bearing
$
632,309

 
$
467,362

Non-interest-bearing
123,563

 
231,704

Total deposits
755,872

 
699,066

Consolidated obligations (Note 11)
 
 
 
Discount notes
42,815,869

 
38,136,652

Bonds (includes $0 and $50,033 at fair value under the fair value option)
25,224,745

 
30,195,568

Total consolidated obligations
68,040,614

 
68,332,220

Mandatorily redeemable capital stock (Note 12)
8,479

 
8,719

Accrued interest payable
102,842

 
81,420

Affordable Housing Program payable
39,867

 
37,688

Derivative liabilities, net (Note 10)
49,473

 
57,420

Other liabilities
417,797

 
330,619

TOTAL LIABILITIES
69,414,944

 
69,547,152

Commitments and contingencies (Note 14)

 

CAPITAL (Note 12)
 
 
 
Capital stock - Class B putable ($100 par value); 26,704 and 26,916 issued and outstanding shares
2,670,387

 
2,691,568

Retained earnings
 
 
 
Unrestricted
638,217

 
627,473

Restricted
58,185

 
50,782

Total retained earnings
696,402

 
678,255

Accumulated other comprehensive income
107,412

 
87,044

TOTAL CAPITAL
3,474,201

 
3,456,867

TOTAL LIABILITIES AND CAPITAL
$
72,889,145

 
$
73,004,019

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

3


FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF INCOME
(dollars in thousands)
(Unaudited)

 
For the Three Months Ended
 
March 31,
 
2014
 
2013
INTEREST INCOME
 
 
 
Advances
$
52,862

 
$
48,439

Prepayment fees on advances, net
166

 
1,821

Interest-bearing deposits
45

 
149

Securities purchased under agreements to resell
785

 
1,669

Federal funds sold
306

 
440

Trading securities
8,242

 
8,171

Available-for-sale securities
22,743

 
17,121

Held-to-maturity securities
12,247

 
19,786

Mortgage loans held for portfolio
62,303

 
65,693

Total interest income
159,699

 
163,289

INTEREST EXPENSE
 
 
 
Consolidated obligations - Discount notes
9,288

 
2,307

Consolidated obligations - Bonds
97,946

 
107,596

Deposits
22

 
37

Mandatorily redeemable capital stock
45

 
58

Total interest expense
107,301

 
109,998

NET INTEREST INCOME
52,398

 
53,291

Reversal for credit losses on mortgage loans
(334
)
 

NET INTEREST INCOME AFTER REVERSAL FOR CREDIT LOSSES
52,732

 
53,291

OTHER INCOME (LOSS)
 
 
 
Net gains (losses) on trading securities
24,203

 
(6,928
)
Net gains on sale of available-for-sale securities
826

 

Net gains on consolidated obligations held at fair value
2

 
643

Net (losses) gains on derivatives and hedging activities
(23,084
)
 
10,930

Net losses on extinguishment of debt

 
(15,123
)
Other, net
1,515

 
2,729

Total other income (loss)
3,462

 
(7,749
)
OTHER EXPENSE
 
 
 
Compensation and benefits
7,684

 
7,220

Contractual services
2,080

 
1,810

Other operating expenses
2,783

 
3,034

Federal Housing Finance Agency
938

 
976

Office of Finance
1,208

 
749

Other, net
369

 
1,368

Total other expense
15,062

 
15,157

INCOME BEFORE ASSESSMENT
41,132

 
30,385

Affordable Housing Program assessment
4,118

 
3,044

NET INCOME
$
37,014

 
$
27,341

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

4



FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF COMPREHENSIVE INCOME
(dollars in thousands)
(Unaudited)

 
For the Three Months Ended
 
March 31,
 
2014
 
2013
Net income
$
37,014

 
$
27,341

Other comprehensive income (loss)
 
 
 
Net unrealized gains (losses) on available-for-sale securities
 
 
 
Unrealized gains (losses)
21,150

 
(2,972
)
Reclassification adjustment for realized net gains on the sale of available-for-sale securities included in net income
(826
)
 

Total net unrealized gains (losses) on available-for-sale securities
20,324

 
(2,972
)
Pension and postretirement benefits
44

 
224

Total other comprehensive income (loss)
20,368

 
(2,748
)
TOTAL COMPREHENSIVE INCOME
$
57,382

 
$
24,593

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




5


FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF CAPITAL
(dollars and shares in thousands)
(Unaudited)

 
Capital Stock
Class B (putable)
 
Retained Earnings
 
Accumulated Other Comprehensive Income
 
 
 
Shares
 
Par Value
 
Unrestricted
 
Restricted
 
Total
 
 
Total
Capital
BALANCE, DECEMBER 31, 2012
20,627

 
$
2,062,714

 
$
593,129

 
$
28,820

 
$
621,949

 
$
149,638

 
$
2,834,301

Proceeds from issuance of capital stock
2,322

 
232,180

 

 

 

 

 
232,180

Repurchase/redemption of capital stock
(3,170
)
 
(316,977
)
 

 

 

 

 
(316,977
)
Net shares reclassified to mandatorily redeemable capital stock
(80
)
 
(8,062
)
 

 

 

 

 
(8,062
)
Comprehensive income (loss)

 

 
21,873

 
5,468

 
27,341

 
(2,748
)
 
24,593

Cash dividends on capital stock

 

 
(13,116
)
 

 
(13,116
)
 

 
(13,116
)
BALANCE, MARCH 31, 2013
19,699

 
$
1,969,855

 
$
601,886

 
$
34,288

 
$
636,174

 
$
146,890

 
$
2,752,919

 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, DECEMBER 31, 2013
26,916

 
$
2,691,568

 
$
627,473

 
$
50,782

 
$
678,255

 
$
87,044

 
$
3,456,867

Proceeds from issuance of capital stock
3,265

 
326,536

 

 

 

 

 
326,536

Repurchase/redemption of capital stock
(3,475
)
 
(347,539
)
 

 

 

 

 
(347,539
)
Net shares reclassified to mandatorily redeemable capital stock
(2
)
 
(178
)
 

 

 

 

 
(178
)
Comprehensive income

 

 
29,611

 
7,403

 
37,014

 
20,368

 
57,382

Cash dividends on capital stock

 

 
(18,867
)
 

 
(18,867
)
 

 
(18,867
)
BALANCE, MARCH 31, 2014
26,704

 
$
2,670,387

 
$
638,217

 
$
58,185

 
$
696,402

 
$
107,412

 
$
3,474,201

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




6


FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF CASH FLOWS
(dollars in thousands)
(Unaudited)

 
For the Three Months Ended
 
March 31,
 
2014
 
2013
OPERATING ACTIVITIES
 
 
 
Net income
$
37,014

 
$
27,341

Adjustments to reconcile net income to net cash provided by operating activities
 
 
 
Depreciation and amortization
(3,732
)
 
(3,405
)
Net (gains) losses on trading securities
(24,203
)
 
6,928

Net gains on sale of available-for-sale securities
(826
)
 

Net gains on consolidated obligations held at fair value
(2
)
 
(643
)
Net change in derivatives and hedging activities
21,358

 
(5,702
)
Net losses on extinguishment of debt

 
15,123

Other adjustments
(1,405
)
 
4,700

Net change in:
 
 
 
Accrued interest receivable
(9,550
)
 
(7,389
)
Other assets
2,432

 
1,715

Accrued interest payable
21,390

 
6,556

Other liabilities
(831
)
 
(4,754
)
Total adjustments
4,631

 
13,129

Net cash provided by operating activities
41,645

 
40,470

INVESTING ACTIVITIES
 
 
 
Net change in:
 
 
 
Interest-bearing deposits
(38,196
)
 
20,010

Securities purchased under agreements to resell
710,000

 
(2,020,000
)
Federal funds sold
(675,000
)
 
(450,000
)
Premises, software, and equipment
(889
)
 
(2,836
)
Trading securities
 
 
 
Proceeds from maturities of long-term
7,003

 
4,595

Purchases of long-term

 
(140,579
)
Available-for-sale securities
 
 
 
Proceeds from sales and maturities of long-term
505,237

 
272,647

Purchases of long-term
(1,216,342
)
 
(374,076
)
Held-to-maturity securities
 
 
 
Proceeds from maturities of long-term
132,733

 
411,323

Advances
 
 
 
Principal collected
15,911,267

 
12,788,054

Originated
(15,199,350
)
 
(11,031,485
)
Mortgage loans held for portfolio
 
 
 
Principal collected
191,569

 
526,708

Originated or purchased
(123,840
)
 
(359,206
)
Proceeds from sales of foreclosed assets
5,419

 
6,986

Net cash provided by (used in) investing activities
209,611

 
(347,859
)
The accompanying notes are an integral part of these financial statements.

7


FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF CASH FLOWS (continued from previous page)
(dollars in thousands)
(Unaudited)

 
For the Three Months Ended
 
March 31,
 
2014
 
2013
FINANCING ACTIVITIES
 
 
 
Net change in deposits
3,233

 
15,530

Net payments on derivative contracts with financing elements
(1,971
)
 
(1,984
)
Net proceeds from issuance of consolidated obligations
 
 
 
Discount notes
36,783,899

 
20,614,205

Bonds
4,021,253

 
11,575,042

Payments for maturing and retiring consolidated obligations
 
 
 
Discount notes
(32,106,084
)
 
(23,960,336
)
Bonds
(8,998,239
)
 
(7,659,844
)
Bonds transferred to other FHLBanks

 
(92,606
)
Proceeds from issuance of capital stock
326,536

 
232,180

Payments for repurchase/redemption of capital stock
(347,539
)
 
(316,977
)
Net payments for repurchase/redemption of mandatorily redeemable capital stock
(418
)
 
(6,733
)
Cash dividends paid
(18,867
)
 
(13,116
)
Net cash (used in) provided by financing activities
(338,197
)
 
385,361

Net (decrease) increase in cash and due from banks
(86,941
)
 
77,972

Cash and due from banks at beginning of the period
448,278

 
252,113

Cash and due from banks at end of the period
$
361,337

 
$
330,085

 
 
 
 
SUPPLEMENTAL DISCLOSURES
 
 
 
Interest paid
$
181,037

 
$
215,318

Affordable Housing Program payments
$
1,939

 
$
2,033

Transfers of mortgage loans to real estate owned
$
3,255

 
$
5,168

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


8


FEDERAL HOME LOAN BANK OF DES MOINES
CONDENSED NOTES TO THE UNAUDITED FINANCIAL STATEMENTS

Background Information

The Federal Home Loan Bank of Des Moines (the Bank) is a federally chartered corporation organized on October 31, 1932, that is exempt from all federal, state, and local taxation (except real property taxes) and is one of 12 district Federal Home Loan Banks (FHLBanks). The FHLBanks were created under the authority of the Federal Home Loan Bank Act of 1932 (FHLBank Act). With the passage of the Housing and Economic Recovery Act of 2008 (Housing Act), the Federal Housing Finance Agency (Finance Agency) was established and became the new independent federal regulator of Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) (collectively, Enterprises), as well as the FHLBanks and FHLBanks' Office of Finance, effective July 30, 2008. The Finance Agency's mission is to ensure that the Enterprises and FHLBanks operate in a safe and sound manner so that they serve as a reliable source of liquidity and funding for housing finance and community investment. The Finance Agency establishes policies and regulations governing the operations of the Enterprises and FHLBanks. Each FHLBank operates as a separate entity with its own management, employees, and board of directors.

The FHLBanks are government-sponsored enterprises (GSEs) that serve the public by enhancing the availability of funds for residential mortgages and targeted community development. The Bank provides a readily available, low cost source of funds to its member institutions and eligible housing associates in Iowa, Minnesota, Missouri, North Dakota, and South Dakota. Commercial banks, thrifts, credit unions, insurance companies, and community development financial institutions (CDFIs) may apply for membership. State and local housing associates that meet certain statutory criteria may also borrow from the Bank; while eligible to borrow, housing associates are not members of the Bank and, as such, are not permitted to hold capital stock.

The Bank is a cooperative. This means the Bank is owned by its customers, whom the Bank calls members. As a condition of membership in the Bank, all members must purchase and maintain membership capital stock based on a percentage of their total assets as of the preceding December 31st. Each member is also required to purchase and maintain activity-based capital stock to support certain business activities with the Bank.

The Bank's current members own nearly all of the outstanding capital stock of the Bank. Former members own the remaining capital stock, included in mandatorily redeemable capital stock, to support business transactions still carried on the Bank's Statements of Condition. All stockholders, including current and former members, may receive dividends on their capital stock investment to the extent declared by the Bank's Board of Directors.

Note 1 — Basis of Presentation

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. (GAAP) for interim financial information. Accordingly, they do not include all of the disclosures required by GAAP for annual financial statements and should be read in conjunction with the audited financial statements for the year ended December 31, 2013, which are contained in the Bank's 2013 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 11, 2014 (2013 Form 10-K).

In the opinion of management, the unaudited financial information is complete and reflects all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of results for the interim periods. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year ending December 31, 2014.

Descriptions of the Bank's significant accounting policies are included in “Note 1 — Summary of Significant Accounting Policies” of the Bank's 2013 Form 10-K.

Reclassifications

Certain amounts in the Bank's 2013 financial statements and footnotes have been reclassified to conform to the presentation for the three months ended March 31, 2014.


9


During the first quarter of 2014, the Bank identified certain classification errors in its previously reported Note 10 - Allowance for Credit Losses - Individually Evaluated Impaired Loans for the year ended December 31, 2013 contained in the 2013 Form 10-K. Management has determined after evaluating the quantitative and qualitative aspects of the classification errors that such errors were not material to the previously issued financial statements and footnotes. The Bank will correct the recorded investment classification error in its 2014 first quarter Form 10-Q filing and the average recorded investment balances in its 2014 Form 10-K filing. 

The following table summarizes the revisions to be made to the Bank’s footnote for December 31, 2013 in the 2014 first quarter Form 10-Q (dollars in thousands):
 
Previously Reported
 
Revised
Recorded investment
 
 
 
Impaired loans with an allowance
$
39,715

 
$
19,719

Impaired loans without an allowance
1,125

 
21,121


The following table summarizes the revisions to be made to the Bank’s footnote for the year ended December 31, 2013 in the 2014 Form 10-K filing (dollars in millions):
 
Previously Reported
 
Revised
Average recorded investment on impaired loans with an allowance
$
48.9

 
$
38.9

Average recorded investment on impaired loans without an allowance
1.2

 
11.2


Note 2 — Recently Adopted and Issued Accounting Guidance

ADOPTED ACCOUNTING GUIDANCE

Joint and Several Liability Arrangements

On February 28, 2013, the Financial Accounting Standards Board (FASB) issued guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance was fixed at the reporting date. This guidance requires an entity to measure these obligations as the sum of the amount the entity agreed to pay on the basis of its arrangement among its co-obligors and any additional amount the entity expects to pay on behalf of its co-obligors. In addition, this guidance requires an entity to disclose the nature and amount of the obligations as well as other information about these obligations. This guidance became effective for the Bank beginning on January 1, 2014 and was applied retrospectively to obligations with joint and several liabilities that existed at January 1, 2014. Based on how the Bank previously reported joint and several liability arrangements, the adoption of this guidance did not have an effect on the Bank's financial condition, results of operations, cash flows, or financial statement disclosures.

ISSUED ACCOUNTING GUIDANCE

Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure

On January 17, 2014, the FASB issued guidance clarifying when consumer mortgage loans collateralized by real estate should be reclassified to real estate owned (REO). Specifically, such collateralized mortgage loans should be reclassified to REO when either the creditor obtains legal title to the residential real estate property upon completion of a foreclosure or the borrower conveys all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. This guidance is effective for interim and annual periods beginning on or after December 15, 2014 and may be adopted under either the modified retrospective transition method or the prospective transition method. This guidance is not expected to affect the Bank’s financial condition, results of operations, or cash flows.


10


Finance Agency Advisory Bulletin on Asset Classification

On April 9, 2012, the Finance Agency issued Advisory Bulletin 2012-02, Framework for Adversely Classifying Loans, Other Real Estate Owned, and Other Assets and Listing Assets for Special Mention (AB 2012-02). AB 2012-02 establishes a standard and uniform methodology for classifying assets and prescribes the timing of asset charge-offs, excluding investment securities. The guidance in AB 2012-02 is generally consistent with the Uniform Retail Credit Classification and Account Management Policy issued by the federal banking regulators in June 2000. The adverse classification requirements were implemented as of January 1, 2014; this implementation did not have a material effect on the the Bank's financial condition, results of operations, or cash flows. The charge-off requirements should be implemented no later than January 1, 2015. This guidance will not have a material impact on the Bank's financial condition, results of operations, or cash flows.

Note 3 — Trading Securities

Major Security Types

Trading securities were as follows (dollars in thousands):
 
March 31,
2014
 
December 31,
2013
Non-mortgage-backed securities
 
 
 
Other U.S. obligations
$
264,070

 
$
266,898

GSE obligations
57,166

 
54,971

Other1
269,988

 
263,354

Total non-mortgage-backed securities
591,224

 
585,223

Mortgage-backed securities
 
 
 
GSE - residential
444,349

 
433,150

Total fair value
$
1,035,573

 
$
1,018,373


1
Consists of taxable municipal bonds.
 
Net Gains (Losses) on Trading Securities

During the three months ended March 31, 2014, the Bank recorded net holding gains of $24.2 million on its trading securities compared to net holding losses of $6.9 million for the same period in 2013. The Bank did not sell any trading securities during the three months ended March 31, 2014 and 2013.

Note 4 — Available-for-Sale Securities

Major Security Type

Available-for-sale (AFS) securities were as follows (dollars in thousands):
 
March 31, 2014
 
Amortized
Cost
1
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 

Fair
Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations
$
171,226

 
$
6,031

 
$

 
$
177,257

GSE obligations
1,111,833

 
27,657

 
(3,161
)
 
1,136,329

State or local housing agency obligations
25,978

 

 
(1,107
)
 
24,871

Other2
166,279

 
7,656

 

 
173,935

Total non-mortgage-backed securities
1,475,316

 
41,344

 
(4,268
)
 
1,512,392

Mortgage-backed securities
 
 
 
 
 
 
 
GSE - residential
7,253,423

 
79,402

 
(7,755
)
 
7,325,070

Total
$
8,728,739

 
$
120,746

 
$
(12,023
)
 
$
8,837,462


1
Amortized cost includes adjustments made to the cost basis of an investment for accretion, amortization, and/or fair value hedge accounting adjustments.

2
Consists of taxable municipal bonds.

11


AFS securities were as follows (dollars in thousands):
 
December 31, 2013
 
Amortized
Cost
1
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 

Fair
Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations
$
175,097

 
$
6,474

 
$
(23
)
 
$
181,548

GSE obligations
1,101,693

 
27,845

 
(2,663
)
 
1,126,875

State or local housing agency obligations
24,868

 

 
(1,897
)
 
22,971

Other2
257,584

 
5,994

 
(4
)
 
263,574

Total non-mortgage-backed securities
1,559,242

 
40,313

 
(4,587
)
 
1,594,968

Mortgage-backed securities
 
 
 
 
 
 
 
GSE - residential
6,284,879

 
66,381

 
(13,708
)
 
6,337,552

Total
$
7,844,121

 
$
106,694

 
$
(18,295
)
 
$
7,932,520


1
Amortized cost includes adjustments made to the cost basis of an investment for accretion, amortization, previous other-than-temporary impairment (OTTI) recognized in earnings, and/or fair value hedge accounting adjustments.

2
Consists of Private Export Funding Corporation bonds and taxable municipal bonds.
 
Unrealized Losses

The following tables summarize AFS securities with unrealized losses by major security type and length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands):
 
March 31, 2014
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
GSE obligations
$
284,693

 
$
(1,422
)
 
$
58,550

 
$
(1,739
)
 
$
343,243

 
$
(3,161
)
State or local housing agency obligations
17,918

 
(697
)
 
6,953

 
(410
)
 
24,871

 
(1,107
)
Total non-mortgage-backed securities
302,611

 
(2,119
)
 
65,503

 
(2,149
)
 
368,114

 
(4,268
)
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
GSE - residential
1,540,074

 
(5,557
)
 
564,953

 
(2,198
)
 
2,105,027

 
(7,755
)
Total
$
1,842,685

 
$
(7,676
)
 
$
630,456

 
$
(4,347
)
 
$
2,473,141

 
$
(12,023
)
 
December 31, 2013
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations
$
38,342

 
$
(23
)
 
$

 
$

 
$
38,342

 
$
(23
)
GSE obligations
135,655

 
(1,081
)
 
59,061

 
(1,582
)
 
194,716

 
(2,663
)
State or local housing agency obligations
22,971

 
(1,897
)
 

 

 
22,971

 
(1,897
)
Other
10,190

 
(4
)
 

 

 
10,190

 
(4
)
Total non-mortgage-backed securities
207,158

 
(3,005
)
 
59,061

 
(1,582
)
 
266,219

 
(4,587
)
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
GSE - residential
2,156,010

 
(12,061
)
 
263,983

 
(1,647
)
 
2,419,993

 
(13,708
)
Total
$
2,363,168

 
$
(15,066
)
 
$
323,044

 
$
(3,229
)
 
$
2,686,212

 
$
(18,295
)


12


Contractual Maturity

The following table summarizes AFS securities by contractual maturity. Expected maturities of some securities may differ from contractual maturities as borrowers may have the right to call or prepay obligations with or without call or prepayment fees (dollars in thousands):
 
 
March 31, 2014
 
December 31, 2013
Year of Maturity
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
Due in one year or less
 
$
9,997

 
$
10,011

 
$
9,981

 
$
10,071

Due after one year through five years
 
1,041,437

 
1,064,804

 
1,031,840

 
1,056,323

Due after five years through ten years
 
233,508

 
241,308

 
331,391

 
339,266

Due after ten years
 
190,374

 
196,269

 
186,030

 
189,308

Total non-mortgage-backed securities
 
1,475,316

 
1,512,392

 
1,559,242

 
1,594,968

Mortgage-backed securities
 
7,253,423

 
7,325,070

 
6,284,879

 
6,337,552

Total
 
$
8,728,739

 
$
8,837,462

 
$
7,844,121

 
$
7,932,520


Net Gains on Sale of AFS Securities

During the three months ended March 31, 2014, the Bank received $97.2 million in proceeds from the sale of an AFS security and recognized a gross gain of $0.8 million. During the three months ended March 31, 2013, the Bank did not sell any AFS securities.

Note 5 — Held-to-Maturity Securities

Major Security Types

Held-to-maturity (HTM) securities were as follows (dollars in thousands):
 
March 31, 2014
 
Amortized
Cost
1
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
GSE obligations
$
306,425

 
$
43,463

 
$

 
$
349,888

State or local housing agency obligations
68,259

 
4,643

 

 
72,902

Other2
680

 

 

 
680

Total non-mortgage-backed securities
375,364

 
48,106

 

 
423,470

Mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations - residential
4,745

 
17

 

 
4,762

Other U.S. obligations - commercial
1,914

 
1

 
(1
)
 
1,914

GSE - residential
1,234,260

 
29,039

 
(374
)
 
1,262,925

Private-label - residential
28,948

 
188

 
(555
)
 
28,581

Total mortgage-backed securities
1,269,867

 
29,245

 
(930
)
 
1,298,182

Total
$
1,645,231

 
$
77,351

 
$
(930
)
 
$
1,721,652


1
Amortized cost includes adjustments made to the cost basis of an investment for accretion and/or amortization.

2
Consists of an investment in a Small Business Investment Company.


13


HTM securities were as follows (dollars in thousands):
 
December 31, 2013
 
Amortized
Cost
1
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
GSE obligations
$
306,853

 
$
30,862

 
$

 
$
337,715

State or local housing agency obligations
72,662

 
2,518

 

 
75,180

Other2
807

 

 

 
807

Total non-mortgage-backed securities
380,322

 
33,380

 

 
413,702

Mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations - residential
5,303

 
22

 

 
5,325

Other U.S. obligations - commercial
1,985

 
6

 

 
1,991

GSE - residential
1,360,705

 
31,937

 
(426
)
 
1,392,216

Private-label - residential
29,991

 
63

 
(689
)
 
29,365

Total mortgage-backed securities
1,397,984

 
32,028

 
(1,115
)
 
1,428,897

Total
$
1,778,306

 
$
65,408

 
$
(1,115
)
 
$
1,842,599


1
Amortized cost includes adjustments made to the cost basis of an investment for accretion and/or amortization.

2
Consists of an investment in a Small Business Investment Company.
 
Unrealized Losses

The following tables summarize HTM securities with unrealized losses by major security type and the length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands):
 
March 31, 2014
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations - commercial
$
705

 
$
(1
)
 
$

 
$

 
$
705

 
$
(1
)
GSE - residential
67,265

 
(67
)
 
107,472

 
(307
)
 
174,737

 
(374
)
Private-label - residential

 

 
18,860

 
(555
)
 
18,860

 
(555
)
Total mortgage-backed securities
$
67,970

 
$
(68
)
 
$
126,332

 
$
(862
)
 
$
194,302

 
$
(930
)
 
December 31, 2013
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
GSE - residential
$
71,023

 
$
(54
)
 
$
113,532

 
$
(372
)
 
$
184,555

 
$
(426
)
Private-label - residential

 

 
19,517

 
(689
)
 
19,517

 
(689
)
Total mortgage-backed securities
$
71,023

 
$
(54
)
 
$
133,049

 
$
(1,061
)
 
$
204,072

 
$
(1,115
)


14


Contractual Maturity

The following table summarizes HTM securities by contractual maturity. Expected maturities of some securities may differ from contractual maturities as borrowers may have the right to call or prepay obligations with or without call or prepayment fees (dollars in thousands):
 
 
March 31, 2014
 
December 31, 2013
Year of Maturity
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
Due after one year through five years
 
$
680

 
$
680

 
$
807

 
$
807

Due after ten years
 
374,684

 
422,790

 
379,515

 
412,895

Total non-mortgage-backed securities
 
375,364

 
423,470

 
380,322

 
413,702

Mortgage-backed securities
 
1,269,867

 
1,298,182

 
1,397,984

 
1,428,897

Total
 
$
1,645,231

 
$
1,721,652

 
$
1,778,306

 
$
1,842,599


Note 6 — Other-Than-Temporary Impairment

The Bank evaluates its individual AFS and HTM securities in an unrealized loss position for OTTI on a quarterly basis. As part of its evaluation of securities for OTTI, the Bank considers its intent to sell each debt security and whether it is more likely than not that it will be required to sell the security before its anticipated recovery. If either of these conditions is met, the Bank will recognize an OTTI charge to earnings equal to the entire difference between the security's amortized cost basis and its fair value at the reporting date. For securities in an unrealized loss position that meet neither of these conditions, the Bank performs analyses to determine if any of these securities are other-than-temporarily impaired.
 
Private-Label Mortgage-Backed Securities

On a quarterly basis, the Bank engages other designated FHLBanks to perform cash flow analyses on its private-label mortgage-backed securities (MBS) using two third-party models in order to assess whether the entire amortized cost bases of these securities will be recovered. To ensure consistency in the determination of OTTI, an OTTI Governance Committee, comprised of representation from all 12 FHLBanks, is responsible for reviewing and approving the key modeling assumptions, inputs, and methodologies used by the designated FHLBanks when generating the cash flow projections. As of March 31, 2014, the Bank obtained cash flow analyses for all of its private-label MBS from its designated FHLBanks.

The first third-party model considered borrower characteristics and the particular attributes of the loans underlying the Bank's securities, in conjunction with assumptions about future changes in home prices and interest rates, to project prepayments, defaults, and loss severities. A significant input to the first model was the forecast of future housing price changes for the relevant states and core based statistical areas (CBSAs), which is based upon an assessment of the individual housing markets. CBSAs refer collectively to metropolitan and micropolitan statistical areas as defined by the U.S. Office of Management and Budget. A CBSA must contain at least one urban area with a population of 10,000 or more people.

The OTTI Governance Committee developed a short-term housing price forecast with projected changes ranging from a decrease of three percent to an increase of nine percent over the twelve month period beginning January 1, 2014. For the vast majority of markets, the change in short-term housing price forecast ranges from one percent to four percent. Thereafter, home prices were projected to recover using one of five different recovery paths.

The following table presents projected home price recovery by months following the short-term housing price forecast:
 
 
Recovery Range % (Annualized Rates)
Months
 
Minimum
 
Maximum
1 - 6
 
0.0
 
3.0
7 - 12
 
1.0
 
4.0
13 - 18
 
2.0
 
4.0
19 - 30
 
2.0
 
5.0
31 - 54
 
2.0
 
6.0
Thereafter
 
2.3
 
5.6


15


The month-by-month projections of future loan performance derived from the first model, which reflected projected prepayments, defaults, and loss severities, were then input into a second model that allocated the projected loan level cash flows and losses to the various security classes in the securitization structure in accordance with its prescribed cash flow and loss allocation rules. In a securitization in which the credit enhancement for the senior securities was derived from the presence of subordinate securities, losses were generally allocated first to the subordinate securities until their principal balance was reduced to zero. The projected cash flows were based on a number of assumptions and expectations, and the results of these models can vary significantly with changes in assumptions and expectations. The scenario of cash flows determined based on the model approach reflects a best estimate scenario and includes a base case current-to-trough housing price forecast and a base case housing price recovery path.

The Bank compared the present value of the cash flows expected to be collected with respect to its private-label MBS to the amortized cost bases of the securities to determine whether a credit loss existed. At March 31, 2014, the Bank's cash flow analyses for private-label MBS did not project any credit losses. Even under an adverse scenario that delays recovery of the housing price index, no credit losses were projected. The Bank does not intend to sell its private-label MBS and it is not more likely than not that the Bank will be required to sell its private-label MBS before recovery of their amortized cost bases. As a result, the Bank did not consider any of its private-label MBS to be other-than-temporarily impaired at March 31, 2014.

All Other Investment Securities

On a quarterly basis, the Bank reviews all remaining AFS and HTM securities in an unrealized loss position to determine whether they are other-than temporarily impaired. The following was determined for the Bank's other investment securities in an unrealized loss position at March 31, 2014:

Other U.S. obligations and GSE securities. The unrealized losses were due primarily to interest rate volatility. The strength of the issuers' guarantees through direct obligations or support from the U.S. Government was sufficient to protect the Bank from losses based on current expectations. The Bank expects to recover the amortized cost bases on these securities and neither intends to sell these securities nor considers it more likely than not that it will be required to sell these securities before recovery of their amortized cost bases. As such, the Bank did not consider these securities to be other-than-temporarily impaired at March 31, 2014.

State housing agency obligations and taxable municipal bonds. The unrealized losses were due to changes in interest rates, credit spreads, and illiquidity in the credit markets, and not to a significant deterioration in the fundamental credit quality of the obligations. The creditworthiness of the issuers and the strength of the underlying collateral and credit enhancements was sufficient to protect the Bank from losses based on current expectations. The Bank does not intend to sell these securities nor is it more likely than not that it will be required to sell these securities before recovery of their amortized cost bases. As such, the Bank did not consider these securities to be other-than-temporarily impaired at March 31, 2014.


16


Note 7 — Advances

Contractual Maturity

The following table summarizes the Bank's advances outstanding by contractual maturity (dollars in thousands):
 
 
March 31, 2014
 
December 31, 2013
Year of Contractual Maturity
 
Amount
 
Weighted
Average
Interest
Rate
 
Amount
 
Weighted
Average
Interest
Rate
Overdrawn demand deposit accounts
 
$
54

 
3.28
 
$

 
Due in one year or less
 
7,279,973

 
0.57
 
6,948,856

 
0.60
Due after one year through two years
 
3,484,560

 
1.29
 
4,479,162

 
0.95
Due after two years through three years
 
3,568,432

 
1.57
 
2,936,056

 
1.76
Due after three years through four years
 
3,550,565

 
2.47
 
3,298,142

 
2.28
Due after four years through five years
 
21,622,027

 
0.43
 
20,558,211

 
0.54
Thereafter
 
5,142,719

 
1.08
 
7,139,820

 
0.85
Total par value
 
44,648,330

 
0.85
 
45,360,247

 
0.84
Premiums
 
149

 
 
 
153

 
 
Discounts
 
(7,514
)
 
 
 
(7,879
)
 
 
Fair value hedging adjustments
 
282,821

 
 
 
297,699

 
 
Total
 
$
44,923,786

 
 
 
$
45,650,220

 
 
 
The Bank offers advances to members and eligible housing associates that may be prepaid on pertinent dates (call dates) prior to maturity without incurring prepayment fees (callable advances). In exchange for receiving the right to call the advance on a predetermined call date, the borrower typically pays a higher fixed rate for the advance relative to an equivalent maturity, noncallable, fixed rate advance. If the call option is exercised, replacement funding may be available. Other advances may only be prepaid by paying a fee to the Bank (prepayment fee) that makes the Bank financially indifferent to the prepayment of the advance. At March 31, 2014 and December 31, 2013, the Bank had callable advances outstanding totaling $26.3 billion and $26.4 billion.

The Bank also offers putable advances. With a putable advance, the Bank has the right to terminate the advance from the borrower on predetermined exercise dates, and the borrower may then apply for a new advance at the prevailing market rate. Generally, put options are exercised when interest rates increase. At both March 31, 2014 and December 31, 2013, the Bank had putable advances outstanding totaling $2.4 billion.
 
Prepayment Fees

The Bank charges a prepayment fee for advances that a borrower elects to terminate prior to the stated maturity or outside of a predetermined call or put date. The fees charged are priced to make the Bank financially indifferent to the prepayment of the advance. Prepayment fees are recorded net of fair value hedging adjustments in the Statements of Income. The following table summarizes the Bank's prepayment fees on advances, net (dollars in thousands):
 
For the Three Months Ended
 
March 31,
 
2014
 
2013
Gross prepayment fee income
$
331

 
$
2,524

Fair value hedging adjustments1
(165
)
 
(703
)
Prepayment fees on advances, net
$
166

 
$
1,821


1
Represents the amortization/accretion of fair value hedging adjustments on closed advance hedge relationships resulting from advance prepayments.

For information related to the Bank's credit risk exposure on advances, refer to "Note 9 — Allowance for Credit Losses."


17


Note 8 — Mortgage Loans Held for Portfolio

The Mortgage Partnership Finance (MPF) program (Mortgage Partnership Finance and MPF are registered trademarks of the FHLBank of Chicago) involves investment by the Bank in single family mortgage loans held for portfolio that are either purchased from participating financial institutions (PFIs) or funded by the Bank through PFIs. MPF loans may also be acquired through participations in pools of eligible mortgage loans purchased from other FHLBanks. The Bank's PFIs generally originate, service, and credit enhance mortgage loans that are sold to the Bank. PFIs participating in the servicing release program do not service the loans owned by the Bank. The servicing on these loans is sold concurrently by the PFI to a designated mortgage service provider.

The following table presents information on the Bank's mortgage loans held for portfolio (dollars in thousands):
 
March 31,
2014
 
December 31,
2013
Fixed rate, medium-term single family mortgages1
$
1,611,723

 
$
1,668,190

Fixed rate, long-term single family mortgages
4,806,520

 
4,823,351

Total unpaid principal balance
6,418,243

 
6,491,541

Premiums
79,986

 
80,911

Discounts
(14,816
)
 
(15,652
)
Basis adjustments from mortgage loan commitments
8,530

 
8,493

Total mortgage loans held for portfolio
6,491,943

 
6,565,293

Allowance for credit losses
(7,400
)
 
(8,000
)
Total mortgage loans held for portfolio, net
$
6,484,543

 
$
6,557,293


1
Medium-term is defined as a term of 15 years or less.

The following table presents the Bank's mortgage loans held for portfolio by collateral or guarantee type (dollars in thousands):
 
March 31,
2014
 
December 31,
2013
Conventional loans
$
5,870,487

 
$
5,944,999

Government-insured loans
547,756

 
546,542

Total unpaid principal balance
$
6,418,243

 
$
6,491,541

    
For information related to the Bank's credit risk exposure on mortgage loans held for portfolio, refer to "Note 9 — Allowance for Credit Losses."

Note 9 — Allowance for Credit Losses

The Bank has established an allowance for credit losses methodology for each of its financing receivable portfolio segments: advances, standby letters of credit, and other extensions of credit to borrowers (collectively, credit products), government-insured mortgage loans held for portfolio, conventional mortgage loans held for portfolio, and term securities purchased under agreements to resell.

Credit Products

The Bank manages its credit exposure to credit products through an approach that includes establishing a credit limit for each borrower, ongoing reviews of each borrower's financial condition, and detailed collateral and lending policies to limit risk of loss while balancing borrowers' needs for a reliable source of funding. In addition, the Bank lends to eligible borrowers in accordance with the FHLBank Act, Finance Agency regulations, and other applicable laws.


18


The Bank is required by regulation to obtain sufficient collateral to fully secure credit products. The estimated value of the collateral required to secure each borrower's credit products is calculated by applying collateral discounts, or haircuts, to the unpaid principal balance or market value, if available, of the collateral. Eligible collateral includes (i) whole first mortgages on improved residential real property or securities representing a whole interest in such mortgages, (ii) loans and securities issued, insured, or guaranteed by the U.S. Government or any agency thereof, including MBS issued or guaranteed by Fannie Mae, Freddie Mac, or Government National Mortgage Association and Federal Family Education Loan Program guaranteed student loans, (iii) cash deposited with the Bank, and (iv) other real estate-related collateral acceptable to the Bank provided such collateral has a readily ascertainable value and the Bank can perfect a security interest in such property. In addition, community financial institutions may also pledge collateral consisting of secured small business, small agri-business, or small farm loans. As additional security, the FHLBank Act provides that the Bank has a lien on each member's capital stock investment; however, capital stock cannot be pledged as collateral to secure credit exposures.

Collateral arrangements may vary depending upon borrower credit quality, financial condition and performance, borrowing capacity, and overall credit exposure to the borrower. The Bank can also require additional or substitute collateral to protect its security interest. The Bank periodically evaluates and makes changes to its collateral guidelines and collateral haircuts.

Borrowers may pledge collateral to the Bank by executing a blanket lien, specifically assigning collateral, or placing physical possession of collateral with the Bank or its custodians. The Bank perfects its security interest in all pledged collateral by filing Uniform Commercial Code financing statements or by taking possession or control of the collateral. Under the FHLBank Act, any security interest granted to the Bank by its members, or any affiliates of its members, has priority over the claims and rights of any party (including any receiver, conservator, trustee, or similar party having rights of a lien creditor), unless those claims and rights would be entitled to priority under otherwise applicable law and are held by actual purchasers or by parties that have perfected security interests.
Under a blanket lien, the Bank is granted a security interest in all financial assets of the borrower to fully secure the borrower's obligation. Other than securities and cash deposits, the Bank does not initially take delivery of collateral pledged by blanket lien borrowers. In the event of deterioration in the financial condition of a blanket lien borrower, the Bank has the ability to require delivery of pledged collateral sufficient to secure the borrower's obligation. With respect to non-blanket lien borrowers that are federally insured, the Bank generally requires collateral to be specifically assigned. With respect to non-blanket lien borrowers that are not federally insured (typically insurance companies, CDFIs, and housing associates), the Bank generally takes control of collateral through the delivery of cash, securities, or loans to the Bank or its custodians.

Using a risk-based approach and taking into consideration each borrower's financial strength, the Bank considers the types and level of collateral to be the primary indicator of credit quality on its credit products. At March 31, 2014 and December 31, 2013, the Bank had rights to collateral on a borrower-by-borrower basis with an unpaid principal balance or market value, if available, in excess of its outstanding extensions of credit.

At March 31, 2014 and December 31, 2013, none of the Bank's credit products were past due, on non-accrual status, or considered impaired. In addition, there were no troubled debt restructurings (TDRs) related to credit products during the three months ended March 31, 2014 and 2013.

The Bank has never experienced a credit loss on its credit products. Based upon the Bank's collateral and lending policies, the collateral held as security, and the repayment history on credit products, management has determined that there were no probable credit losses on its credit products as of March 31, 2014 and December 31, 2013. Accordingly, the Bank has not recorded any allowance for credit losses.

Government-Insured Mortgage Loans

The Bank invests in government-insured fixed rate mortgage loans that are insured or guaranteed by the Federal Housing Administration, the Department of Veterans Affairs, and/or the Rural Housing Service of the Department of Agriculture. The servicer provides and maintains insurance or a guaranty from the applicable government agency. The servicer is responsible for compliance with all government agency requirements and for obtaining the benefit of the applicable guarantee or insurance with respect to defaulted government-insured mortgage loans. Any principal losses incurred on these loans that are not recovered from the guarantor are absorbed by the servicers. As such, the Bank only has credit risk for these loans if the servicer fails to pay for losses not covered by the guarantee or insurance. As a result, the Bank did not establish an allowance for credit losses for its government-insured mortgage loans at March 31, 2014 and December 31, 2013. Furthermore, none of these mortgage loans have been placed on non-accrual status because of the U.S. Government guarantee or insurance on these loans and the contractual obligation of the loan servicer to repurchase the loans when certain criteria are met.


19


Conventional Mortgage Loans

The Bank's management of credit risk in the MPF program involves several layers of legal loss protection that are defined in agreements among the Bank and its participating PFIs. For the Bank's conventional MPF loans, the availability of loss protection may differ slightly among MPF products. The Bank's loss protection consists of the following loss layers, in order of priority:

Homeowner Equity.

Primary Mortgage Insurance (PMI). At the time of origination, PMI is required on all loans with homeowner equity of less than 20 percent of the original purchase price or appraised value.

First Loss Account. The first loss account (FLA) is a memorandum account used to track the Bank's potential loss exposure under each master commitment prior to the PFI's credit enhancement obligation. For absorbing certain losses in excess of the FLA, PFIs are paid a credit enhancement fee, a portion of which may be performance-based. The Bank records credit enhancement fees paid to PFIs as a reduction to mortgage loan interest income. Credit enhancement fees paid totaled $1.1 million during both the three months ended March 31, 2014 and 2013. To the extent the Bank experiences losses under the FLA, it may be able to recapture performance-based credit enhancement fees paid to the PFI to offset these losses. The FLA balance for all master commitments with a PFI credit enhancement obligation was $87.9 million and $87.3 million at March 31, 2014 and December 31, 2013.

Credit Enhancement Obligation of PFI. PFIs have a credit enhancement obligation at the time a mortgage loan is purchased to absorb certain losses in excess of the FLA in order to limit the Bank's loss exposure to that of an investor in an MBS that is rated the equivalent of AA by a nationally recognized statistical rating organization (NRSRO). PFIs pledge collateral to secure this obligation.

The Bank utilizes an allowance for credit losses to reserve for estimated losses in its conventional mortgage loan portfolio at the balance sheet date. The measurement of the Bank's allowance for credit losses is determined by (i) reviewing similar conventional mortgage loans for impairment on a collective basis, (ii) reviewing conventional mortgage loans for impairment on an individual basis, (iii) estimating additional credit losses in the conventional mortgage loan portfolio, (iv) considering the recapture of performance-based credit enhancement fees from the PFI, if available, and (v) considering the credit enhancement obligation of the PFI, if estimated losses exceed the FLA.

Collectively Evaluated Conventional Mortgage Loans. The Bank collectively evaluates the majority of its conventional mortgage loan portfolio for impairment and estimates an allowance for credit losses based upon factors that vary by MPF product. These factors include, but are not limited to, (i) loan delinquencies, (ii) loans migrating to collateral-dependent status, (iii) actual historical loss severities, and (iv) certain quantifiable economic factors, such as unemployment rates and home prices. The Bank utilizes a roll-rate methodology when estimating its allowance for credit losses. This methodology projects loans migrating to collateral-dependent status based on historical average rates of delinquency. The Bank then applies a loss severity factor to calculate an estimate of credit losses.

Individually Identified Conventional Mortgage Loans. The Bank individually evaluates certain conventional mortgage loans for impairment, including TDRs and collateral-dependent loans. The Bank's TDRs include loans granted under its temporary loan modification plan and loans discharged under Chapter 7 bankruptcy that have not been reaffirmed by the borrower. The Bank generally measures impairment of TDRs based on the present value of expected future cash flows discounted at the loan's effective interest rate. Collateral-dependent loans are loans in which repayment is expected to be provided solely by the sale of the underlying collateral. The Bank considers TDRs where principal or interest is 60 days or more past due to be collateral-dependent. The Bank measures impairment of collateral-dependent loans based on the estimated fair value of the underlying collateral less selling costs and expected proceeds from PMI.

Estimating Additional Credit Loss in the Conventional Mortgage Loan Portfolio. The Bank may make an adjustment for certain limitations in its estimation of credit losses. This adjustment recognizes the imprecise nature of an estimate and represents a subjective management judgment that is intended to cover losses resulting from other factors that may not be captured in the methodology previously described at the balance sheet date.


20


Performance-Based Credit Enhancement Fees. When reserving for estimated credit losses, the Bank may take into consideration performance-based credit enhancement fees available for recapture from the PFIs. Performance-based credit enhancement fees available for recapture, if any, consist of accrued performance-based credit enhancement fees to be paid to the PFIs and projected performance-based credit enhancement fees to be paid to the PFIs over the next 12 months, less any losses incurred that are in the process of recapture.

Available performance-based credit enhancement fees cannot be shared between master commitments and, as a result, some master commitments may have sufficient performance-based credit enhancement fees to recapture losses while other master commitments may not. At March 31, 2014 and December 31, 2013, the Bank determined that the amount of performance-based credit enhancement fees available for recapture from the PFIs at the master commitment level was immaterial. As such, it did not factor credit enhancement fees into its estimate of the allowance for credit losses.

PFI Credit Enhancement Obligation. When reserving for estimated credit losses, the Bank may take into consideration the PFI credit enhancement obligation, which is intended to absorb losses in excess of the FLA. At March 31, 2014 and December 31, 2013, the Bank determined that the amount of credit enhancement obligation available to offset losses was immaterial. As such, it did not factor credit enhancement obligation into its estimate of the allowance for credit losses.

Allowance for Credit Losses on Conventional Mortgage Loans

The following table presents a rollforward of the allowance for credit losses on the Bank's conventional mortgage loan portfolio (dollars in thousands):
 
For the Three Months Ended
 
March 31,
 
2014
 
2013
Balance, beginning of period
$
8,000

 
$
15,793

Charge-offs
(266
)
 
(540
)
Reversal for credit losses
(334
)
 

Balance, end of period
$
7,400

 
$
15,253


The following table summarizes the allowance for credit losses and recorded investment of the Bank's conventional mortgage loan portfolio by impairment methodology (dollars in thousands):
 
March 31,
2014
 
December 31,
2013
Allowance for credit losses
 
 
 
Collectively evaluated for impairment
$
2,600

 
$
4,500

Individually evaluated for impairment
4,800

 
3,500

Total allowance for credit losses
$
7,400

 
$
8,000

Recorded investment1
 
 
 
Collectively evaluated for impairment
$
5,903,515

 
$
5,996,590

Individually evaluated for impairment, with or without a related allowance
58,816

 
40,840

Total recorded investment
$
5,962,331

 
$
6,037,430


1
Represents the unpaid principal balance adjusted for accrued interest, unamortized premiums, discounts, basis adjustments, and direct write-downs.

The Bank evaluates certain conventional mortgage loans for impairment individually. Prior to January 1, 2014, these loans were limited to TDRs and collateral-dependent loans (i.e., loans in which repayment is expected to be provided solely by the sale of the underlying collateral). Beginning January 1, 2014, the Bank expanded the population of individually evaluated mortgage loans to include loans that are 180 days or more delinquent and loans that are not severely delinquent, but where the borrower has filed for bankruptcy.


21


Credit Quality Indicators. Key credit quality indicators for mortgage loans include the migration of past due loans, loans in process of foreclosure, and non-accrual loans. The tables below summarize the Bank's key credit quality indicators for mortgage loans (dollars in thousands):
 
March 31, 2014
 
Conventional
 
Government Insured
 
Total
Past due 30 - 59 days
$
61,423

 
$
15,575

 
$
76,998

Past due 60 - 89 days
21,655

 
5,259

 
26,914

Past due 90 - 179 days
18,440

 
4,163

 
22,603

Past due 180 days or more
47,508

 
5,315

 
52,823

Total past due loans
149,026

 
30,312

 
179,338

Total current loans
5,813,305

 
532,453

 
6,345,758

Total recorded investment of mortgage loans1
$
5,962,331

 
$
562,765

 
$
6,525,096

 
 
 
 
 
 
In process of foreclosure (included above)2
$
34,792

 
$
2,805

 
$
37,597

Serious delinquency rate3
1.1
%
 
1.7
%
 
1.2
%
Past due 90 days or more and still accruing interest4
$

 
$
9,478

 
$
9,478

Non-accrual mortgage loans5
$
69,284

 
$

 
$
69,284

 
December 31, 2013
 
Conventional
 
Government Insured
 
Total
Past due 30 - 59 days
$
75,521

 
$
19,714

 
$
95,235

Past due 60 - 89 days
21,925

 
7,128

 
29,053

Past due 90 - 179 days
17,864

 
5,515

 
23,379

Past due 180 days or more
50,271

 
4,130

 
54,401

Total past due loans
165,581

 
36,487

 
202,068

Total current loans
5,871,849

 
524,947

 
6,396,796

Total recorded investment of mortgage loans1
$
6,037,430

 
$
561,434

 
$
6,598,864

 
 
 
 
 
 
In process of foreclosure (included above)2
$
37,582

 
$
1,106

 
$
38,688

Serious delinquency rate3
1.1
%
 
1.7
%
 
1.2
%
Past due 90 days or more and still accruing interest4
$

 
$
9,645

 
$
9,645

Non-accrual mortgage loans5
$
71,221

 
$

 
$
71,221


1
Represents the unpaid principal balance adjusted for accrued interest, unamortized premiums, discounts, basis adjustments, and direct write-downs.

2
Includes loans where the decision of foreclosure or similar alternative such as pursuit of deed-in-lieu has been reported. Loans in process of foreclosure are included in past due or current loans depending on their payment status.

3
Represents mortgage loans that are 90 days or more past due or in the process of foreclosure expressed as a percentage of the total recorded investment.

4
Represents government-insured mortgage loans that are 90 days or more past due.

5
Represents conventional mortgage loans that are 90 days or more past due and TDRs.

Individually Evaluated Impaired Loans. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Bank considers all TDRs and collateral-dependent loans (i.e., loans in which repayment is expected to be provided solely by the sale of the underlying collateral) to be impaired. The following table summarizes the recorded investment and related allowance of the Bank's individually evaluated impaired loans (dollars in thousands):
 
March 31, 2014
 
December 31, 2013
 
Recorded Investment
 
Related Allowance
 
Recorded Investment
 
Related Allowance
Impaired loans with an allowance
$
23,575

 
$
4,800

 
$
19,719

 
$
3,500

Impaired loans without an allowance
35,241

 

 
21,121

 

Total
$
58,816

 
$
4,800

 
$
40,840

 
$
3,500



22


The Bank did not recognize any interest income on impaired loans during the three months ended March 31, 2014 and 2013. The average recorded investment on impaired loans with an allowance was $21.6 million and $54.1 million during the three months ended March 31, 2014 and 2013. The average recorded investment on impaired loans without an allowance was $28.2 million and $1.1 million during the three months ended March 31, 2014 and 2013.

Real Estate Owned. At March 31, 2014 and December 31, 2013, the Bank had $10.8 million and $12.2 million of REO recorded as a component of "Other assets" in the Statements of Condition.

Term Securities Purchased Under Agreements to Resell

Term securities purchased under agreements to resell are considered collateralized financing agreements and represent short-term investments. The terms of these investments are structured such that if the market value of the underlying securities decreases below the market value required as collateral, the counterparty must place an equivalent amount of additional securities as collateral or remit an equivalent amount of cash. Otherwise, the dollar value of the resale agreement will decrease accordingly. If an agreement to resell is deemed to be impaired, the difference between the fair value of the collateral and the amortized cost of the agreement will be charged to earnings to establish an allowance for credit losses. Based upon the collateral held as security, the Bank determined that no allowance for credit losses was needed for its term securities purchased under agreements to resell at March 31, 2014 and December 31, 2013.

Off-Balance Sheet Credit Exposures

At March 31, 2014 and December 31, 2013, the Bank did not record a liability to reflect an allowance for credit losses for off-balance sheet credit exposures. For additional information on the Bank's off-balance sheet credit exposures, see "Note 14 — Commitments and Contingencies."

Note 10 — Derivatives and Hedging Activities

Nature of Business Activity

The Bank is exposed to interest rate risk primarily from the effect of interest rate changes on its interest-earning assets and its related funding sources. The goal of the Bank's interest rate risk management strategy is not to eliminate interest rate risk, but to manage it within appropriate limits. To mitigate the risk of loss, the Bank has established policies and procedures, which include guidelines on the amount of exposure to interest rate changes it is willing to accept.

The Bank enters into derivative contracts to manage the interest rate risk exposures inherent in its otherwise unhedged assets and funding positions. Finance Agency regulations and the Bank's Enterprise Risk Management Policy (ERMP) establish guidelines for derivatives, prohibit trading in or the speculative use of derivatives, and limit credit risk arising from derivatives.

The most common ways in which the Bank uses derivatives are to:
 
reduce funding costs by combining a derivative with a consolidated obligation, as the cost of a combined funding structure can be lower than the cost of a comparable consolidated obligation;

reduce the interest rate sensitivity and repricing gaps of assets and liabilities;

preserve a favorable interest rate spread between the yield of an asset (e.g., advance) and the cost of the related liability (e.g., consolidated obligation). Without the use of derivatives, this interest rate spread could be reduced or eliminated when a change in the interest rate on the advance does not match a change in the interest rate on the consolidated obligation;

mitigate the adverse earnings effects of the shortening or extension of certain assets (e.g., mortgage assets) and liabilities; and

manage embedded options in assets and liabilities.


23


Application of Derivatives
 
Derivative instruments are used by the Bank in two ways:
 
as a fair value hedge of an associated financial instrument or firm commitment; or

as an economic hedge to manage certain defined risks in its Statements of Condition. These hedges are primarily used to manage mismatches between the coupon features of the Bank's assets and liabilities and offset prepayment risk in certain assets.

Derivative instruments are used by the Bank when they are considered to be a cost-effective alternative to achieve the Bank's financial and risk management objectives. The Bank reevaluates its hedging strategies from time to time and may change the hedging techniques it uses or adopt new strategies.

The Bank transacts most of its derivative transactions with large banks and major broker-dealers. Over-the-counter derivative transactions may be either executed directly with a counterparty (bilateral derivatives) or cleared through a Futures Commission Merchant (i.e., clearing agent) with a Derivative Clearing Organization (cleared derivatives).

Once a derivative transaction has been accepted for clearing by a Derivative Clearing Organization (Clearinghouse), the derivative transaction is novated and the executing counterparty is replaced with the Clearinghouse. The Clearinghouse notifies the clearing agent of the required initial and variation margin and the clearing agent notifies the Bank of the required initial and variation margin.

Types of Derivatives

The Bank may use the following derivative instruments:

interest rate swaps;

options;

swaptions;

interest rate caps and floors; and

future/forward contracts.

Types of Hedged Items

The Bank documents at inception all relationships between derivatives designated as hedging instruments and hedged items, its risk management objectives and strategies for undertaking various hedge transactions, and its method of assessing effectiveness. This process includes linking all derivatives that are designated as fair value hedges to assets and liabilities in the Statements of Condition or firm commitments. The Bank also formally assesses (both at the hedge's inception and at least quarterly) whether the derivatives it uses in hedging transactions have been effective in offsetting changes in the fair value of hedged items and whether those derivatives are expected to remain effective in future periods. The Bank uses regression analyses to assess the effectiveness of its hedges.

The Bank may have the following types of hedged items:

investment securities;

advances;
       
mortgage loans;
  
consolidated obligations; and
  
firm commitments.


24


Financial Statement Effect and Additional Financial Information

The notional amount of derivatives serves as a factor in determining periodic interest payments and cash flows received and paid. However, the notional amount of derivatives represents neither the actual amounts exchanged nor the overall exposure of the Bank to credit and market risk. The risks of derivatives can be measured meaningfully on a portfolio basis that takes into account the counterparties, the types of derivatives, the items being hedged, and any offsets between the derivatives and the items being hedged.

The following tables summarize the Bank's fair value of derivative instruments, including the effect of netting adjustments and cash collateral. For purposes of this disclosure, the derivative values include the fair value of derivatives and the related accrued interest (dollars in thousands):
 
 
March 31, 2014
Fair Value of Derivative Instruments
 
Notional
Amount
 
Derivative
Assets
 
Derivative
 Liabilities
Derivatives designated as hedging instruments
 
 
 
 
 
 
Interest rate swaps
 
$
29,158,294

 
$
134,156

 
$
377,107

Derivatives not designated as hedging instruments
 
 
 
 
 
 
Interest rate swaps
 
1,239,344

 
41,284

 
33,819

Forward settlement agreements (TBAs)
 
41,500

 
76

 
16

Mortgage delivery commitments
 
43,757

 
25

 
75

Total derivatives not designated as hedging instruments
 
1,324,601

 
41,385

 
33,910

Total derivatives before netting and collateral adjustments
 
$
30,482,895

 
175,541

 
411,017

Netting adjustments
 
 
 
(46,059
)
 
(46,059
)
Cash collateral and related accrued interest
 
 
 
(25,452
)
 
(315,485
)
Total netting adjustments and cash collateral1
 
 
 
(71,511
)
 
(361,544
)
Total derivative assets and total derivative liabilities
 
 
 
$
104,030

 
$
49,473

 
 
December 31, 2013
Fair Value of Derivative Instruments
 
Notional
Amount
 
Derivative
Assets
 
Derivative
 Liabilities
Derivatives designated as hedging instruments
 
 
 
 
 
 
Interest rate swaps
 
$
32,537,432

 
$
181,724

 
$
391,597

Derivatives not designated as hedging instruments
 
 
 
 
 
 
Interest rate swaps
 
1,757,673

 
72,439

 
25,102

Forward settlement agreements (TBAs)
 
28,000

 
160

 
3

Mortgage delivery commitments
 
29,651

 
6

 
124

Total derivatives not designated as hedging instruments
 
1,815,324

 
72,605

 
25,229

Total derivatives before netting and collateral adjustments
 
$
34,352,756

 
254,329

 
416,826

Netting adjustments
 
 
 
(82,293
)
 
(82,293
)
Cash collateral and related accrued interest
 
 
 
(79,025
)
 
(277,113
)
Total netting adjustments and cash collateral1
 
 
 
(161,318
)
 
(359,406
)
Total derivative assets and total derivative liabilities
 
 
 
$
93,011

 
$
57,420


1
Amounts represent the application of the netting requirements that allow the Bank to net settle positive and negative positions and also cash collateral and the related accrued interest held or placed with the same clearing agent and/or counterparty.


25


The following table summarizes the components of “Net (losses) gains on derivatives and hedging activities” as presented in the Statements of Income (dollars in thousands):
 
For the Three Months Ended
 
March 31,
 
2014
 
2013
Derivatives designated as hedging instruments
 
 
 
Interest rate swaps
$
(6,461
)
 
$
(550
)
Derivatives not designated as hedging instruments
 
 
 
Interest rate swaps
(13,087
)
 
12,967

Interest rate caps

 
1,049

Forward settlement agreements (TBAs)
(530
)
 
599

Mortgage delivery commitments
487

 
(681
)
Net interest settlements
(3,493
)
 
(2,454
)
Total net (losses) gains related to derivatives not designated as hedging instruments
(16,623
)
 
11,480

Net (losses) gains on derivatives and hedging activities
$
(23,084
)
 
$
10,930


The following tables summarize, by type of hedged item, the gains (losses) on derivatives and the related hedged items in fair value hedging relationships and the effect of those derivatives on the Bank's net interest income (dollars in thousands):
 
For the Three Months Ended March 31, 2014
Hedged Item Type
(Losses) Gains on
Derivatives
 
Gains (Losses) on
Hedged Items
 
Net Fair Value
Hedge
Ineffectiveness
 
Effect on
Net Interest
Income1
Available-for-sale investments
$
(87,933
)
 
$
80,581

 
$
(7,352
)
 
$
(24,713
)
Advances
13,200

 
(12,767
)
 
433

 
(40,294
)
Consolidated obligation bonds
15,128

 
(14,670
)
 
458

 
11,251

Total
$
(59,605
)
 
$
53,144

 
$
(6,461
)
 
$
(53,756
)
 
For the Three Months Ended March 31, 2013
Hedged Item Type
Gains (Losses) on
Derivatives
 
(Losses) Gains on
Hedged Items
 
Net Fair Value
Hedge
Ineffectiveness
 
Effect on
Net Interest
Income1
Available-for-sale investments
$
2,959

 
$
(2,680
)
 
$
279

 
$
(4,346
)
Advances
45,079

 
(44,139
)
 
940

 
(42,590
)
Consolidated obligation bonds
(24,002
)
 
22,233

 
(1,769
)
 
17,339

Total
$
24,036

 
$
(24,586
)
 
$
(550
)
 
$
(29,597
)
1    The net interest income on derivatives in fair value hedge relationships is included in the interest income or interest expense line item of the respective hedged item type.
 

Managing Credit Risk on Derivatives

The Bank is subject to credit risk due to the risk of nonperformance by counterparties to its derivative contracts. The Bank manages credit risk through credit analyses, collateral requirements, and adherence to the requirements set forth in the Bank's policies, U.S. Commodity Futures Trading Commission regulations, and Finance Agency regulations. For bilateral derivatives, the degree of credit risk depends on the extent to which master netting arrangements are included in these contracts to mitigate the risk. The Bank requires collateral agreements with collateral delivery thresholds on the majority of its bilateral derivatives.

For cleared derivatives, the Clearinghouse is the Bank's counterparty. The requirement that the Bank post initial and variation margin through the clearing agent, to the Clearinghouse, exposes the Bank to institutional credit risk if the clearing agent or the Clearinghouse fails to meet its obligations. The use of cleared derivatives is intended to mitigate credit risk exposure because a central counterparty is substituted for individual counterparties and collateral is posted daily through a clearing agent for changes in the fair value of cleared derivatives.


26


The Bank has analyzed the enforceability of offsetting rights incorporated in its cleared derivative transactions and has determined that the exercise of those offsetting rights by a non-defaulting party under these transactions should be upheld under applicable law upon an event of default, including a bankruptcy, insolvency, or similar proceeding involving the Clearinghouse or the clearing agent, or both. Based on this analysis, the Bank presents a net derivative receivable or payable for all of its transactions through a particular clearing agent with a particular Clearinghouse.

A majority of the Bank's bilateral derivative contracts contain provisions that require the Bank to post additional collateral with its counterparties if there is deterioration in the Bank's credit rating. If the Bank's credit rating is lowered by an NRSRO, the Bank may be required to deliver additional collateral on bilateral derivative instruments in net liability positions. The aggregate fair value of all bilateral derivative instruments with credit-risk related contingent features that were in a net liability position (before cash collateral and related accrued interest) at March 31, 2014 was $264.9 million, for which the Bank posted collateral of $217.6 million in the normal course of business. If the Bank's credit rating had been lowered from its current rating to the next lower rating that would have triggered additional collateral to be delivered, the Bank would have been required to deliver an additional $25.5 million of collateral to its bilateral derivative counterparties at March 31, 2014.

For cleared derivatives, the Clearinghouse determines initial margin requirements and generally credit ratings are not
factored into the initial margin. However, clearing agents may require additional initial margin to be posted based on credit
considerations, including but not limited to, credit rating downgrades. The Bank was not required to post additional
initial margin by its clearing agents at March 31, 2014.

Offsetting of Derivative Assets and Derivative Liabilities

The Bank presents derivative instruments, related cash collateral, including initial and variation margin, received or pledged, and associated accrued interest on a net basis by clearing agent and/or by counterparty when it has met the netting requirements. The following table presents the fair value of derivative instruments meeting or not meeting the netting requirements, including the related collateral received from or pledged to counterparties (dollars in thousands):
 
March 31, 2014
 
December 31, 2013
 
Derivative Assets
 
Derivative Liabilities
 
Derivative Assets
 
Derivative Liabilities
Derivative instruments meeting netting requirements
 
 
 
 
 
 
 
Gross recognized amount
 
 
 
 
 
 
 
Bilateral derivatives
$
163,601

 
$
386,196

 
$
209,378

 
$
411,289

Cleared derivatives
11,915

 
24,746

 
44,945

 
5,413

Total gross recognized amount
175,516

 
410,942

 
254,323

 
416,702

Gross amounts of netting adjustments and cash collateral
 
 
 
 
 
 
 
Bilateral derivatives
(144,635
)
 
(336,798
)
 
(195,177
)
 
(353,993
)
Cleared derivatives
73,124

 
(24,746
)
 
33,859

 
(5,413
)
Total gross amounts of netting adjustments and cash collateral
(71,511
)
 
(361,544
)
 
(161,318
)
 
(359,406
)
Net amounts after netting adjustments
 
 
 
 
 
 
 
Bilateral derivatives
18,966

 
49,398

 
14,201

 
57,296

Cleared derivatives
85,039

 

 
78,804

 

Total net amounts after netting adjustments
104,005

 
49,398

 
93,005

 
57,296

Bilateral derivative instruments not meeting netting requirements1
25

 
75

 
6

 
124

Total derivative assets and total derivative liabilities
 
 
 
 
 
 
 
Bilateral derivatives
18,991

 
49,473

 
14,207

 
57,420

Cleared derivatives
85,039

 

 
78,804

 

Total derivative assets and total derivative liabilities presented in the Statements of Condition2
$
104,030

 
$
49,473

 
$
93,011

 
$
57,420


1
Represents mortgage delivery commitments.

2
Represents the net unsecured amount of credit exposure.


27


Note 11 — Consolidated Obligations

Consolidated obligations consist of bonds and discount notes. The FHLBanks issue consolidated obligations through the Office of Finance as their agent. Bonds are issued primarily to raise intermediate- and long-term funds for the Bank and are not subject to any statutory or regulatory limits on their maturity. Discount notes are issued primarily to raise short-term funds for the Bank and have original maturities of up to one year. Discount notes sell at or below their face amount and are redeemed at par value when they mature.

Although the Bank is primarily liable for the portion of consolidated obligations issued on its behalf, it is also jointly and severally liable with the other FHLBanks for the payment of principal and interest on all FHLBank System consolidated obligations. The Finance Agency, at its discretion, may require any FHLBank to make principal and/or interest payments due on any consolidated obligation, whether or not the primary obligor FHLBank has defaulted on the payment of that consolidated obligation. The Finance Agency has never exercised this discretionary authority. At March 31, 2014 and December 31, 2013, the total par value of outstanding consolidated obligations of the 12 FHLBanks was $753.9 billion and $766.8 billion.

DISCOUNT NOTES

The following table summarizes the Bank's discount notes (dollars in thousands):
 
March 31, 2014
 
December 31, 2013
 
Amount
 
Weighted
Average
Interest
Rate
 
Amount
 
Weighted
Average
Interest
Rate
Par value
$
42,823,217

 
0.09
 
$
38,143,400

 
0.10
Discounts
(7,348
)
 
 
 
(6,748
)
 
 
Total
$
42,815,869

 
 
 
$
38,136,652

 
 

BONDS

The following table summarizes the Bank's bonds outstanding by year of contractual maturity (dollars in thousands):
 
March 31, 2014
 
December 31, 2013
Year of Contractual Maturity
Amount
 
Weighted
Average
Interest
Rate
 
Amount
 
Weighted
Average
Interest
Rate
Due in one year or less
$
11,788,265

 
0.46
 
$
17,437,015

 
0.33
Due after one year through two years
2,199,905

 
3.12
 
2,485,075

 
3.03
Due after two years through three years
2,557,655

 
2.67
 
1,864,840

 
3.48
Due after three years through four years
2,184,880

 
3.85
 
2,080,710

 
4.21
Due after four years through five years
632,795

 
1.65
 
582,735

 
1.60
Thereafter
5,667,660

 
2.98
 
5,545,470

 
2.96
Index amortizing notes
197,246

 
5.21
 
209,600

 
5.21
Total par value
25,228,406

 
1.84
 
30,205,445

 
1.56
Premiums
20,826

 
 
 
22,027

 
 
Discounts
(17,306
)
 
 
 
(17,751
)
 
 
Fair value hedging adjustments
(7,181
)
 
 
 
(14,186
)
 
 
Fair value option adjustments

 
 
 
33

 
 
Total
$
25,224,745

 
 
 
$
30,195,568

 
 

The following table summarizes the Bank's bonds outstanding by call features (dollars in thousands):
 
December 31,
 
2014
 
2013
Noncallable or nonputable
$
21,928,406

 
$
26,765,445

Callable
3,300,000

 
3,440,000

Total par value
$
25,228,406

 
$
30,205,445



28


Extinguishment of Debt
 
 
During the three months ended March 31, 2014, the Bank did not extinguish any debt. During the three months ended March 31, 2013, the Bank extinguished bonds with a total par value of $92.1 million and recognized losses of $15.1 million in other income (loss).

Note 12 — Capital

The Bank is subject to three regulatory capital requirements:

Risk-based capital. The Bank must maintain at all times permanent capital greater than or equal to the sum of its credit, market, and operations risk capital requirements, all calculated in accordance with Finance Agency regulations. Only permanent capital, defined as Class B capital stock, which includes mandatorily redeemable capital stock and retained earnings, can satisfy this risk-based capital requirement.

Regulatory capital. The Bank is required to maintain a minimum four percent capital-to-asset ratio, which is defined as total regulatory capital divided by total assets. Total regulatory capital includes all capital stock, including mandatorily redeemable capital stock, and retained earnings. It does not include accumulated other comprehensive income (AOCI).

Leverage capital. The Bank is required to maintain a minimum five percent leverage ratio, which is defined as the sum of permanent capital weighted 1.5 times and nonpermanent capital weighted 1.0 times, divided by total assets. At March 31, 2014 and December 31, 2013, the Bank did not have any nonpermanent capital.

If the Bank's capital falls below the required levels, the Finance Agency has authority to take actions necessary to return it to levels that it deems to be consistent with safe and sound business operations. The following table shows the Bank's compliance with the Finance Agency's regulatory capital requirements (dollars in thousands):
 
March 31, 2014
 
December 31, 2013
 
Required
 
Actual
 
Required
 
Actual
Regulatory capital requirements
 
 
 
 
 
 
 
Risk-based capital
$
612,723

 
$
3,375,269

 
$
676,384

 
$
3,378,542

Regulatory capital
$
2,915,566

 
$
3,375,269

 
$
2,920,161

 
$
3,378,542

Leverage capital
$
3,644,457

 
$
5,062,903

 
$
3,650,201

 
$
5,067,814

Capital-to-assets ratio
4.00
%
 
4.63
%
 
4.00
%
 
4.63
%
Leverage ratio
5.00
%
 
6.95
%
 
5.00
%
 
6.94
%

The Bank issues a single class of capital stock (Class B capital stock). The Bank's capital stock has a par value of $100 per share, and all shares are issued, redeemed, or repurchased by the Bank at the stated par value. The Bank has two subclasses of capital stock: membership and activity-based. Each member must purchase and hold membership capital stock in an amount equal to 0.12 percent of its total assets as of the preceding December 31st, subject to a cap of $10.0 million and a floor of $10,000. Each member is also required to purchase activity-based capital stock equal to 4.00 percent of its advances and mortgage loans outstanding in the Bank's Statements of Condition. All capital stock issued is subject to a five year notice of redemption period.

The capital stock requirements established in the Bank's Capital Plan are designed so that the Bank can remain adequately capitalized as member activity changes. The Bank's Board of Directors may make adjustments to the capital stock requirements within ranges established in the Capital Plan.

Excess Stock

Capital stock owned by members in excess of their investment requirement is deemed excess capital stock. Under its Capital Plan, the Bank, at its discretion and upon 15 days' written notice, may repurchase excess membership capital stock. The Bank, at its discretion, may also repurchase excess activity-based capital stock to the extent that (i) the excess capital stock balance exceeds an operational threshold set forth in the Capital Plan, which is currently set at zero, or (ii) a member submits a notice to redeem all or a portion of the excess activity-based capital stock. At March 31, 2014 and December 31, 2013, the Bank had no excess capital stock outstanding.


29


Mandatorily Redeemable Capital Stock

The Bank reclassifies capital stock subject to redemption from equity to a liability (mandatorily redeemable capital stock) when a member engages in any of the following activities: (i) submits a written notice to redeem all or part of its capital stock, (ii) submits a written notice of its intent to withdraw from membership, or (iii) terminates its membership voluntarily as a result of a consolidation into a non-member or into a member of another FHLBank. Dividends on mandatorily redeemable capital stock are classified as interest expense in the Statements of Income. At March 31, 2014 and December 31, 2013, the Bank's mandatorily redeemable capital stock totaled $8.5 million and $8.7 million.
 
 
Restricted Retained Earnings

The Bank entered into a Joint Capital Enhancement Agreement (JCE Agreement) with all of the other FHLBanks in February 2011. The JCE Agreement, as amended, is intended to enhance the capital position of the Bank over time. It requires the Bank to allocate 20 percent of its quarterly net income to a separate restricted retained earnings account until the balance of that account equals at least one percent of its average balance of outstanding consolidated obligations for the previous quarter. The restricted retained earnings are not available to pay dividends. At March 31, 2014 and December 31, 2013, the Bank's restricted retained earnings account totaled $58.2 million and $50.8 million.

Accumulated Other Comprehensive Income

The following table summarizes the changes in AOCI (dollars in thousands):
 
Net unrealized gains on AFS securities
(Notes 4 and 6)
 
Pension and postretirement benefits
 
Total AOCI
Balance, December 31, 2012
$
152,781

 
$
(3,143
)
 
$
149,638

Other comprehensive (loss) income before reclassifications
 
 
 
 
 
Net unrealized losses
(2,972
)
 

 
(2,972
)
Reclassifications from other comprehensive income to net income
 
 
 
 
 
Amortization - pension and postretirement

 
224

 
224

Net current period other comprehensive (loss) income
(2,972
)
 
224

 
(2,748
)
Balance, March 31, 2013
$
149,809

 
$
(2,919
)
 
$
146,890

 
 
 
 
 
 
Balance, December 31, 2013
$
88,399

 
$
(1,355
)
 
$
87,044

Other comprehensive income (loss) before reclassifications
 
 
 
 
 
Net unrealized gains
21,150

 

 
21,150

Reclassifications from other comprehensive income to net income
 
 
 
 
 
Net realized gains on sale of securities
(826
)
 

 
(826
)
Amortization - pension and postretirement

 
44

 
44

Net current period other comprehensive income
20,324

 
44

 
20,368

Balance, March 31, 2014
$
108,723

 
$
(1,311
)
 
$
107,412


Note 13 — Fair Value

Fair value amounts are determined by the Bank using available market information and reflect the Bank's best judgment of appropriate valuation methods. The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The inputs are evaluated and an overall level for the fair value measurement is determined. This overall level is an indication of market observability of the fair value measurement for the asset or liability.

The fair value hierarchy prioritizes the inputs used to measure fair value into three broad levels:

Level 1 Inputs. Quoted prices (unadjusted) for identical assets or liabilities in an active market that the Bank can access on the measurement date.



30


Level 2 Inputs. Inputs other than quoted prices within Level 1 that are observable inputs for the asset or liability, either directly or indirectly. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability. Level 2 inputs include the following: (i) quoted prices for similar assets or liabilities in active markets, (ii) quoted prices for identical or similar assets or liabilities in markets that are not active, (iii) inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates and yield curves that are observable at commonly quoted intervals, implied volatilities, and credit spreads), and (iv) market-corroborated inputs.

Level 3 Inputs. Unobservable inputs for the asset or liability.

The Bank reviews its fair value hierarchy classifications on a quarterly basis. Changes in the observability of the valuation inputs may result in a reclassification of certain assets or liabilities. These reclassifications are reported as transfers in/out as of the beginning of the quarter in which the changes occur. There were no such transfers during the three months ended March 31, 2014 and 2013.

The following table summarizes the carrying value, fair value, and fair value hierarchy of the Bank's financial instruments assets and liabilities at March 31, 2014 (dollars in thousands). The fair values do not represent an estimate of the overall market value of the Bank as a going concern, which would take into account future business opportunities and the net profitability of assets and liabilities.
 
 
 
 
Fair Value
Financial Instruments
 
Carrying Value
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustment1
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
 

Cash and due from banks
 
$
361,337

 
$
361,337

 
$

 
$

 
$

 
$
361,337

Interest-bearing deposits
 
1,684

 

 
1,658

 

 

 
1,658

Securities purchased under agreements to resell
 
7,490,000

 

 
7,490,000

 

 

 
7,490,000

Federal funds sold
 
1,875,000

 

 
1,875,000

 

 

 
1,875,000

Trading securities
 
1,035,573

 

 
1,035,573

 

 

 
1,035,573

Available-for-sale securities
 
8,837,462

 

 
8,837,462

 

 

 
8,837,462

Held-to-maturity securities
 
1,645,231

 

 
1,693,071

 
28,581

 

 
1,721,652

Advances
 
44,923,786

 

 
45,055,024

 

 

 
45,055,024

Mortgage loans held for portfolio, net
 
6,484,543

 

 
6,617,422

 
70,280

 

 
6,687,702

Accrued interest receivable
 
81,858

 

 
81,858

 

 

 
81,858

Derivative assets, net
 
104,030

 
76

 
175,465

 

 
(71,511
)
 
104,030

Other assets
 
10,548

 
10,548

 

 

 

 
10,548

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
 
(755,872
)
 

 
(755,872
)
 

 

 
(755,872
)
Discount notes
 
(42,815,869
)
 

 
(42,818,211
)
 

 

 
(42,818,211
)
Bonds
 
(25,224,745
)
 

 
(25,865,708
)
 

 

 
(25,865,708
)
Mandatorily redeemable capital stock
 
(8,479
)
 
(8,479
)
 

 

 

 
(8,479
)
Accrued interest payable
 
(102,842
)
 

 
(102,842
)
 

 

 
(102,842
)
Derivative liabilities, net
 
(49,473
)
 
(16
)
 
(411,001
)
 

 
361,544

 
(49,473
)
Other
 
 
 
 
 
 
 
 
 
 
 
 
Standby letters of credit
 
(1,539
)
 

 

 
(1,539
)
 

 
(1,539
)
Standby bond purchase agreements
 

 

 
3,401

 

 

 
3,401


1
Amounts represent the application of the netting requirements that allow the Bank to net settle positive and negative positions and also cash collateral and the related accrued interest held or placed with the same clearing agent and/or counterparty.

31


The following table summarizes the carrying value, fair value, and fair value hierarchy of the Bank's financial assets and liabilities at December 31, 2013 (dollars in thousands):
 
 
 
 
Fair Value
Financial Instruments
 
Carrying Value
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustment1
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
 
$
448,278

 
$
448,278

 
$

 
$

 
$

 
$
448,278

Interest-bearing deposits
 
1,863

 

 
1,833

 

 

 
1,833

Securities purchased under agreements to resell
 
8,200,000

 

 
8,200,000

 

 

 
8,200,000

Federal funds sold
 
1,200,000

 

 
1,200,000

 

 

 
1,200,000

Trading securities
 
1,018,373

 

 
1,018,373

 

 

 
1,018,373

Available-for-sale securities
 
7,932,520

 

 
7,932,520

 

 

 
7,932,520

Held-to-maturity securities
 
1,778,306

 

 
1,813,234

 
29,365

 

 
1,842,599

Advances
 
45,650,220

 

 
45,751,949

 

 

 
45,751,949

Mortgage loans held for portfolio, net
 
6,557,293

 

 
6,683,555

 
37,340

 

 
6,720,895

Accrued interest receivable
 
72,561

 

 
72,561

 

 

 
72,561

Derivative assets, net
 
93,011

 
160

 
254,169

 

 
(161,318
)
 
93,011

Other assets
 
10,529

 
10,529

 

 

 

 
10,529

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
 
(699,066
)
 

 
(699,066
)
 

 

 
(699,066
)
Discount notes
 
(38,136,652
)
 

 
(38,139,485
)
 

 

 
(38,139,485
)
Bonds
 
(30,195,568
)
 

 
(30,735,638
)
 

 

 
(30,735,638
)
Mandatorily redeemable capital stock
 
(8,719
)
 
(8,719
)
 

 

 

 
(8,719
)
Accrued interest payable
 
(81,420
)
 

 
(81,420
)
 

 

 
(81,420
)
Derivative liabilities, net
 
(57,420
)
 
(3
)
 
(416,823
)
 

 
359,406

 
(57,420
)
Other
 
 
 
 
 
 
 
 
 
 
 
 
Standby letters of credit
 
(1,849
)
 

 

 
(1,849
)
 

 
(1,849
)
Standby bond purchase agreements
 

 

 
3,860

 

 

 
3,860


1
Amounts represent the application of the netting requirements that allow the Bank to net settle positive and negative positions and also cash collateral and the related accrued interest held or placed with the same clearing agent and/or counterparty.

Summary of Valuation Techniques and Primary Inputs
 
Cash and Due from Banks. The fair value equals the carrying value.

Interest-Bearing Deposits. For interest-bearing deposits with less than three months to maturity, the fair value approximates the carrying value. For interest-bearing deposits with more than three months to maturity, the fair value is determined by calculating the present value of the expected future cash flows and reducing the amount for accrued interest receivable.

Securities Purchased under Agreements to Resell. For overnight and term securities purchased under agreements to resell with less than three months to maturity, the fair value approximates the carrying value. For term securities purchased under agreements to resell with more than three months to maturity, the fair value is determined by calculating the present value of the expected future cash flows. The discount rates used in these calculations are the rates for securities with similar terms.

Overnight Federal Funds Sold. The fair value approximates the carrying value.


32


Investment Securities. The Bank's valuation technique incorporates prices from four designated third-party pricing vendors, when available. The pricing vendors generally use various proprietary models to price investment securities. The inputs to those models are derived from various sources including, but not limited to, benchmark securities and yields, reported trades, dealer estimates, issuer spreads, bids, offers, and other market-related data. Since many investment securities do not trade on a daily basis, the pricing vendors use available information, as applicable, such as benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing to determine the prices for individual securities. Each pricing vendor has an established process in place to challenge investment valuations, which facilitates resolution of questionable prices identified by the Bank. Annually, the Bank conducts reviews of the four pricing vendors to confirm and further augment its understanding of the vendors' pricing processes, methodologies, and control procedures for investment securities.

The Bank's valuation technique for estimating the fair values of its investment securities first requires the establishment of a “median” price for each security. If four prices are received, the average of the middle two prices is the median price; if three prices are received, the middle price is the median price; if two prices are received, the average of the two prices is the median price; and if one price is received, it is the median price (and also the final price) subject to validation of outliers.

All prices that are within a specified tolerance threshold of the median price are included in the cluster of prices that are averaged to compute a default price. All prices that are outside the threshold (outliers) are subject to further analysis (including, but not limited to, comparison to prices provided by an additional third-party valuation service, prices for similar securities, and/or non-binding dealer estimates) to determine if an outlier is a better estimate of fair value. If an outlier (or some other price identified in the analysis) is determined to be a better estimate of fair value, then the outlier (or the other price as appropriate) is used as the final price rather than the default price. Alternatively, if the analysis confirms that an outlier (or outliers) is (are) in fact not representative of fair value and the default price is the best estimate, then the default price is used as the final price. In all cases, the final price is used to determine the fair value of the security. In limited instances, when no prices are available from the four designated pricing services, the Bank obtains prices from dealers.

As of March 31, 2014 and December 31, 2013, three or four prices were received for substantially all of the Bank's investment securities and the final prices for substantially all of those securities were computed by averaging the prices received. Based on the Bank's review of the pricing methods and controls employed by the third-party pricing vendors and the relative lack of dispersion among the vendor prices, the Bank believes its final prices are representative of the prices that would have been received if the assets had been sold at the measurement date (i.e., exit prices) and further, that the fair value measurements are classified appropriately in the fair value hierarchy.

As an additional step, the Bank reviews the final fair value estimates of its private-label MBS holdings quarterly for reasonableness using an implied yield test. The Bank calculated an implied yield for each of its private-label MBS using the estimated fair value derived from the process previously described and the security's projected cash flows from the Bank's OTTI process. These yields were compared to the market yield of comparable securities according to dealers and/or other third-party sources. This analysis did not indicate any significant variances. Therefore, the Bank determined that its fair value estimates for private-label MBS were appropriate at March 31, 2014.

Advances. The fair value of advances is determined by calculating the present value of the expected future cash flows, excluding the amount for accrued interest receivable. The discount rates used in these calculations are equivalent to the replacement advance rates for advances with similar terms. In accordance with Finance Agency regulations, advances generally require a prepayment fee sufficient to make the Bank financially indifferent to a borrower's decision to prepay the advances. Therefore, the fair value of advances does not assume prepayment risk.

The Bank uses the following inputs for measuring the fair value of advances:

Consolidated Obligation Curve (CO Curve). The Office of Finance constructs a market-observable curve referred to as the CO Curve. The CO Curve is constructed using the U.S. Treasury Curve as a base curve which is then adjusted by adding indicative spreads obtained largely from market-observable sources. These market indications are generally derived from pricing indications from dealers, historical pricing relationships, recent GSE trades, and secondary market activity. The Bank utilizes the CO Curve as its input to fair value for advances because it represents the Bank's cost of funds and is used to price advances.

Volatility assumption. Market-based expectations of future interest rate volatility implied from current market prices for similar options.

Spread assumption. Represents a spread adjustment to the CO Curve.


33


Mortgage Loans Held for Portfolio. The fair value of mortgage loans held for portfolio is estimated based on quoted market prices of similar mortgage loans available in the market, if available, or modeled prices. The modeled prices start with prices for new MBS issued by GSEs or similar new mortgage loans. The prices are adjusted for credit risk, servicing spreads, seasoning, and cash flow remittances. The prices for new MBS or similar new mortgage loans are highly dependent upon the underlying prepayment assumptions priced in the secondary market. Changes in expected prepayment rates often have a material effect on the fair value estimates.

Impaired Mortgage Loans Held for Portfolio. The fair value of impaired mortgage loans held for portfolio is estimated by obtaining property values from an external pricing vendor. This vendor utilizes multiple pricing models that generally factor in market observable inputs, including actual sales transactions and home price indices, and considers underlying property characteristics. The Bank applies an adjustment to these values to capture certain limitations in the estimation process and takes into consideration estimated selling costs and expected PMI proceeds. In limited instances, the Bank may estimate the fair value of an impaired mortgage loan by calculating the present value of expected future cash flows discounted at the loan's effective interest rate.  

Real Estate Owned. The fair value of REO is estimated using a current property value from the MPF Servicer or a broker price opinion adjusted for estimated selling costs and expected PMI proceeds.

Accrued Interest Receivable and Payable. The fair value approximates the carrying value.

Derivative Assets and Liabilities. The fair value of derivatives is generally estimated using standard valuation techniques such as discounted cash flow analyses and comparisons to similar instruments. In limited instances, fair value estimates for interest-rate related derivatives may be obtained using an external pricing model that utilizes observable market data. The Bank is subject to credit risk in derivatives transactions due to the potential nonperformance of its derivatives counterparties. The use of cleared derivatives is intended to mitigate credit risk exposure because a central counterparty is substituted for individual counterparties and collateral is posted daily, through a clearing agent, for changes in the fair value of cleared derivatives. To mitigate credit risk on bilateral derivatives, the Bank enters into master netting agreements with its counterparties as well as collateral agreements that provide for the delivery of collateral at specified levels tied to those counterparties' credit ratings. The Bank has evaluated the potential for the fair value of its derivatives to be affected by counterparty credit risk and its own credit risk and has determined that no adjustments were significant to the overall fair value measurements.

The fair values of the Bank's derivative assets and derivative liabilities include accrued interest receivable/payable and cash collateral remitted to/received from counterparties. The estimated fair values of the accrued interest receivable/payable and cash collateral approximate their carrying values due to their short-term nature. The fair values of derivatives are netted by clearing agent and/or counterparty if the netting requirements are met. If these netted amounts are positive, they are classified as an asset and, if negative, they are classified as a liability.

The Bank's discounted cash flow model utilizes market-observable inputs (inputs that are actively quoted and can be validated to external sources). The Bank uses the following inputs for measuring the fair value of interest-related derivatives:

Discount rate assumption. The Bank utilizes the OIS curve. 

Forward interest rate assumption. The Bank utilizes the London Interbank Offered Rate (LIBOR) swap curve.

Volatility assumption. Market-based expectations of future interest rate volatility implied from current market prices for similar options.

For forward settlement agreements (TBAs), the Bank utilizes TBA securities prices that are determined by coupon class and expected term until settlement. For mortgage delivery commitments, the Bank utilizes TBA securities prices adjusted for factors such as credit risk and servicing spreads.
 
Other Assets. These represent assets held in a Rabbi Trust for the Bank's nonqualified retirement plan. These assets include cash equivalents and mutual funds, both of which are carried at estimated fair value based on quoted market prices as of the last business day of the reporting period.


34


Deposits. For deposits with three months or less to maturity, the fair value approximates the carrying value. For deposits with more than three months to maturity, the fair value is determined by calculating the present value of the expected future cash flows and reducing the amount for accrued interest payable. The discount rates used in these calculations are the cost of deposits with similar terms.

Consolidated Obligations. The fair value of consolidated obligations is based on prices received from pricing vendors (consistent with the methodology for investment securities discussed above) or determined by calculating the present value of the expected future cash flows and reducing the amount for accrued interest payable. For consolidated obligations elected under the fair value option, fair value includes accrued interest payable. The discount rates used in these calculations are for consolidated obligations with similar terms. The Bank uses the CO Curve and a volatility assumption for measuring the fair value of these consolidated obligations.

Mandatorily Redeemable Capital Stock. The fair value of capital stock subject to mandatory redemption is generally reported at par value. Fair value also includes an estimated dividend earned at the time of reclassification from equity to a liability (if applicable), until such amount is paid. Capital stock can only be acquired by members at par value and redeemed at par value. Capital stock is not publicly traded and no market mechanism exists for the exchange of stock outside the cooperative structure.
 
Standby Letters of Credit. The fair value of standby letters of credit is based on either the fees currently charged for similar agreements or the estimated cost to terminate the agreement or otherwise settle the obligation with the counterparty.

Standby Bond Purchase Agreements. The fair value of standby bond purchase agreements is calculated using the present value of the expected future fees related to the agreements. The discount rates used in the calculations are based on municipal spreads over the U.S. Treasury Curve, which are comparable to discount rates used to value the underlying bonds. Upon purchase of any bonds under these agreements, the Bank estimates fair value using the "Investment Securities" fair value methodology.

Subjectivity of Estimates. Estimates of the fair value of financial assets and liabilities using the methods previously described are highly subjective and require judgments regarding significant matters, such as the amount and timing of future cash flows, prepayment speed assumptions, expected interest rate volatility, possible distributions of future interest rates used to value options, and the selection of discount rates that appropriately reflect market and credit risks. The use of different assumptions could have a material effect on the fair value estimates.


35


Fair Value on a Recurring Basis

The following table summarizes, for each hierarchy level, the Bank's assets and liabilities that are measured at fair value in the Statements of Condition at March 31, 2014 (dollars in thousands):
Recurring Fair Value Measurements
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustment1
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
Trading securities
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations
 
$

 
$
264,070

 
$

 
$

 
$
264,070

GSE obligations
 

 
57,166

 

 

 
57,166

Other non-MBS
 

 
269,988

 

 

 
269,988

GSE MBS - residential
 

 
444,349

 

 

 
444,349

Total trading securities
 

 
1,035,573

 

 

 
1,035,573

Available-for-sale securities
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations
 

 
177,257

 

 

 
177,257

GSE obligations
 

 
1,136,329

 

 

 
1,136,329

State or local housing agency obligations
 

 
24,871

 

 

 
24,871

Other non-MBS
 

 
173,935

 

 

 
173,935

GSE MBS - residential
 

 
7,325,070

 

 

 
7,325,070

Total available-for-sale securities
 

 
8,837,462

 

 

 
8,837,462

Derivative assets, net
 
 
 
 
 
 
 
 
 
 
Interest-rate related
 

 
175,440

 

 
(71,495
)
 
103,945

Forward settlement agreements (TBAs)
 
76

 

 

 
(16
)
 
60

Mortgage delivery commitments
 

 
25

 

 

 
25

Total derivative assets, net
 
76

 
175,465

 

 
(71,511
)
 
104,030

Other assets
 
10,548

 

 

 

 
10,548

Total recurring assets at fair value
 
$
10,624

 
$
10,048,500

 
$

 
$
(71,511
)
 
$
9,987,613

Liabilities
 
 
 
 
 
 
 
 
 
 
Derivative liabilities, net
 
 
 
 
 
 
 
 
 
 
Interest-rate related
 

 
(410,926
)
 

 
361,528

 
(49,398
)
Forward settlement agreements (TBAs)
 
(16
)
 

 

 
16

 

Mortgage delivery commitments
 

 
(75
)
 

 

 
(75
)
Total derivative liabilities, net
 
(16
)
 
(411,001
)
 

 
361,544

 
(49,473
)
Total recurring liabilities at fair value
 
$
(16
)
 
$
(411,001
)
 
$

 
$
361,544

 
$
(49,473
)

1
Amounts represent the application of the netting requirements that allow the Bank to net settle positive and negative positions and also cash collateral and the related accrued interest held or placed with the same clearing agent and/or counterparty.



36


The following table summarizes, for each hierarchy level, the Bank's assets and liabilities that are measured at fair value in the Statements of Condition at December 31, 2013 (dollars in thousands):
Recurring Fair Value Measurements
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustment1
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
Trading securities
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations
 
$

 
$
266,898

 
$

 
$

 
$
266,898

GSE obligations
 

 
54,971

 

 

 
54,971

Other non-MBS
 

 
263,354

 

 

 
263,354

GSE MBS - residential
 

 
433,150

 

 

 
433,150

Total trading securities
 

 
1,018,373

 

 

 
1,018,373

Available-for-sale securities
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations
 

 
181,548

 

 

 
181,548

GSE obligations
 

 
1,126,875

 

 

 
1,126,875

State or local housing agency obligations
 

 
22,971

 

 

 
22,971

Other non-MBS
 

 
263,574

 

 

 
263,574

GSE MBS - residential
 

 
6,337,552

 

 

 
6,337,552

Total available-for-sale securities
 

 
7,932,520

 

 

 
7,932,520

Derivative assets, net
 
 
 
 
 
 
 
 
 
 
Interest-rate related
 

 
254,163

 

 
(161,315
)
 
92,848

Forward settlement agreements (TBAs)
 
160

 

 

 
(3
)
 
157

Mortgage delivery commitments
 

 
6

 

 

 
6

Total derivative assets, net
 
160

 
254,169

 

 
(161,318
)
 
93,011

Other assets
 
10,529

 

 

 

 
10,529

Total recurring assets at fair value
 
$
10,689

 
$
9,205,062

 
$

 
$
(161,318
)
 
$
9,054,433

Liabilities
 
 
 
 
 
 
 
 
 
 
Bonds2
 
$

 
$
(50,033
)
 
$

 
$

 
$
(50,033
)
Derivative liabilities, net
 
 
 
 
 
 
 
 
 
 
Interest-rate related
 

 
(416,699
)
 

 
359,403

 
(57,296
)
Forward settlement agreements (TBAs)
 
(3
)
 

 

 
3

 

Mortgage delivery commitments
 

 
(124
)
 

 

 
(124
)
Total derivative liabilities, net
 
(3
)
 
(416,823
)
 

 
359,406

 
(57,420
)
Total recurring liabilities at fair value
 
$
(3
)
 
$
(466,856
)
 
$

 
$
359,406

 
$
(107,453
)

1
Amounts represent the application of the netting requirements that allow the Bank to net settle positive and negative positions and also cash collateral and the related accrued interest held or placed with the same clearing agent and/or counterparty.

2
Represents bonds recorded under the fair value option.

Fair Value on a Non-Recurring Basis

The Bank measures certain impaired mortgage loans held for portfolio and REO at level 3 fair value on a non-recurring basis. These assets are subject to fair value adjustments in certain circumstances. In the case of impaired mortgage loans, the Bank estimates fair value based primarily on property values from an external pricing vendor. These values are further adjusted by the Bank to capture certain limitations in the estimation process and take into consideration estimated selling costs and expected PMI proceeds. In the case of REO, the Bank estimates fair value based on a current property value from the MPF Servicer or a broker price opinion adjusted for estimated selling costs and expected PMI proceeds.


37


The following table summarizes impaired mortgage loans held for portfolio and REO that were recorded at fair value as a result of a non-recurring change in fair value having been recorded in the quarter then ended (dollars in thousands):
 
March 31,
2014
 
December 31,
2013
Impaired mortgage loans held for portfolio
$
18,775

 
$
37,340

Real estate owned
158

 
571

Total non-recurring assets
$
18,933

 
$
37,911


Fair Value Option

The fair value option provides an irrevocable option to elect fair value as an alternative measurement for selected financial assets, financial liabilities, unrecognized firm commitments, and written loan commitments not previously carried at fair value. It requires entities to display the fair value of those assets and liabilities for which it has chosen to use fair value on the face of the Statements of Condition. Fair value is used for both the initial and subsequent measurement of the designated assets, liabilities, and commitments, with the changes in fair value recognized in net income.

The Bank elected the fair value option for certain bonds that did not qualify for hedge accounting, primarily in an effort to mitigate the potential income statement volatility that can arise from economic hedging relationships in which the carrying value of the hedged item is not adjusted for changes in fair value.

The following table summarizes the activity related to consolidated obligations for which the fair value option has been elected (dollars in thousands):
 
 
For the Three Months Ended
 
 
March 31,
Bonds
 
2014
 
2013
Balance, beginning of period
 
$
50,033

 
$
1,866,985

New bonds elected for fair value option
 

 

Maturities and terminations
 
(50,000
)
 
(715,000
)
Net gains on bonds held at fair value
 
(2
)
 
(643
)
Change in accrued interest
 
(31
)
 
(400
)
Balance, end of period
 
$

 
$
1,150,942

 
For consolidated obligations recorded under the fair value option, the related contractual interest expense is recorded as part of net interest income in the Statements of Income. The remaining changes are recorded as “Net gains on consolidated obligations held at fair value” in the Statements of Income. At March 31, 2014, all bonds previously elected under the fair value option had matured. At December 31, 2013, the Bank determined no credit risk adjustments for nonperformance were necessary to the consolidated obligations recorded under the fair value option.

The following table summarizes the difference between the unpaid principal balance and fair value of outstanding bonds for which the fair value option has been elected (dollars in thousands):
 
March 31,
2014
 
December 31,
2013
Unpaid principal balance
$

 
$
50,000

Fair value

 
50,033

Fair value over unpaid principal balance
$

 
$
33


Note 14 — Commitments and Contingencies

Joint and Several Liability. The 12 FHLBanks have joint and several liability for all consolidated obligations issued. Accordingly, if an FHLBank were unable to repay any consolidated obligation for which it is the primary obligor, each of the other FHLBanks could be called upon by the Finance Agency to repay all or part of such obligations. No FHLBank has ever been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank. At March 31, 2014 and December 31, 2013, the total par value of outstanding consolidated obligations issued on behalf of other FHLBanks for which the Bank is jointly and severally liable was approximately $685.9 billion and $698.5 billion.


38


The following table summarizes additional off-balance sheet commitments for the Bank (dollars in thousands):
 
March 31, 2014
 
December 31, 2013
 
Expire
within one year
 
Expire
after one year
 
Total
 
Total
Standby letters of credit outstanding
$
4,016,546

 
$
42,765

 
$
4,059,311

 
$
4,303,732

Standby bond purchase agreements outstanding
29,737

 
574,536

 
604,273

 
619,338

Commitments to purchase mortgage loans
43,757

 

 
43,757

 
29,651

Commitments to issue bonds
237,300

 

 
237,300

 
29,289

Commitments to issue discount notes

 

 

 
399,831

Other commitments

 
98,475

 
98,475

 
100,000


Standby Letters of Credit. A standby letter of credit is a financing arrangement between the Bank and a member. Standby letters of credit are executed with members for a fee. If the Bank is required to make payment for a beneficiary's draw, the payment is withdrawn from the member's demand account. Any resulting overdraft is converted into a collateralized advance to the member. The original terms of standby letters of credit range from less than one month to 13 years, currently no later than 2020. Unearned fees for standby letters of credit are recorded in “Other liabilities” in the Statements of Condition and amounted to $1.5 million and $1.8 million at March 31, 2014 and December 31, 2013.

The Bank monitors the creditworthiness of its standby letters of credit based on an evaluation of its borrowers. The Bank has established parameters for the measurement, review, classification, and monitoring of credit risk related to these standby letters of credit. Based on management's credit analyses and collateral requirements, the Bank does not deem it necessary to have any provision for credit losses on these standby letters of credit. All standby letters of credit are fully collateralized at the time of issuance. The estimated fair value of standby letters of credit at March 31, 2014 and December 31, 2013 is reported in “Note 13 — Fair Value.”

Standby Bond Purchase Agreements. The Bank has entered into standby bond purchase agreements with state housing associates within its district whereby, for a fee, it agrees to serve as a standby liquidity provider if required, to purchase and hold the housing associate's bonds until the designated marketing agent can find a suitable investor or the housing associate repurchases the bonds according to a schedule established by the agreement. Each standby bond purchase agreement includes the provisions under which the Bank would be required to purchase the bonds. The standby bond purchase commitments entered into by the Bank have original expiration periods of up to seven years, currently no later than 2016. At March 31, 2014 and December 31, 2013, the Bank had standby bond purchase agreements with four housing associates. During the three months ended March 31, 2014 and 2013, the Bank was not required to purchase any bonds under these agreements. For both the three months ended March 31, 2014 and 2013, the Bank received fees for the guarantees that amounted to $0.5 million. The estimated fair value of standby bond purchase agreements at March 31, 2014 and December 31, 2013 is reported in “Note 13 — Fair Value.”

Commitments to Purchase Mortgage Loans. The Bank enters into commitments that unconditionally obligate it to purchase mortgage loans from its members. Commitments are generally for periods not to exceed 45 days. These commitments are considered derivatives and their estimated fair value at March 31, 2014 and December 31, 2013 is reported in “Note 10 — Derivatives and Hedging Activities” as mortgage delivery commitments.

Commitments to Issue Bonds and Discount Notes. At March 31, 2014, the Bank had commitments to issue $237.3 million of consolidated obligation bonds. At December 31, 2013, the Bank had commitments to issue $29.3 million of consolidated obligation bonds and $399.8 million of consolidated obligation discount notes.
 
Other Commitments. On December 30, 2013, the Bank entered into an agreement with the Iowa Finance Authority (IFA) to purchase up to $100.0 million of taxable multi-family mortgage revenue bonds. The agreement expires on June 30, 2015. As of March 31, 2014, the Bank had purchased $1.5 million of bonds under the IFA agreement. These bonds are classified as AFS in the Bank's Statements of Condition.

The Bank is contractually obligated to pay the FHLBank of Chicago a service fee for its participation in the MPF program. This service fee expense is recorded in other expense. Refer to “Note 16 — Transactions with Other FHLBanks” for additional details.


39


In conjunction with its sale of certain mortgage loans to Fannie Mae through the FHLBank of Chicago in 2009, the Bank entered into an agreement with the FHLBank of Chicago on June 11, 2009 to indemnify the FHLBank of Chicago for potential losses on mortgage loans remaining in four master commitments from which the mortgage loans were sold. The Bank agreed to indemnify the FHLBank of Chicago for any losses not otherwise recovered through credit enhancement fees, subject to an indemnification cap of $0.8 million by December 31, 2015 and $0.3 million by December 31, 2020. At March 31, 2014, the FHLBank of Chicago had not requested any indemnification payments from the Bank pursuant to this agreement.
Legal Proceedings. The Bank is not currently aware of any material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which it is a party or of which any of its property is the subject.

Note 15 — Transactions with Stockholders

The Bank is a cooperative whose current members own nearly all of the outstanding capital stock of the Bank. Former members own the remaining capital stock to support business transactions still carried on the Bank's Statements of Condition. All stockholders, including current and former members, may receive dividends on their capital stock investment to the extent declared by the Bank's Board of Directors.

Transactions with Directors' Financial Institutions

In the normal course of business, the Bank extends credit to its members whose directors and officers serve as Bank directors (Directors' Financial Institutions). Finance Agency regulations require that transactions with Directors' Financial Institutions be made on the same terms and conditions as those with any other member.

The following table summarizes the Bank's outstanding transactions with Directors' Financial Institutions (dollars in thousands):
 
 
March 31, 2014
 
December 31, 2013
 
 
Amount
 
% of Total
 
Amount
 
% of Total
Advances
 
700,976

 
1.6
 
614,566

 
1.4
Mortgage loans
 
191,122

 
3.0
 
94,163

 
1.5
Deposits
 
3,044

 
0.4
 
2,550

 
0.4
Capital stock
 
49,524

 
1.8
 
40,982

 
1.5

Business Concentrations

The Bank considers itself to have business concentrations with stockholders owning 10 percent or more of its total capital stock outstanding (including mandatorily redeemable capital stock). At March 31, 2014, the Bank had the following business concentrations with stockholders (dollars in thousands):
 
 
Capital Stock
 
 
 
Mortgage
 
Interest
Stockholder
 
Amount
 
% of Total
 
Advances
 
Loans
 
Income1
Wells Fargo Bank, N.A.
 
$
770,000

 
28.7
 
$
19,000,000

 
$

 
$
12,168

Superior Guaranty Insurance Company2
 
57,157

 
2.1
 

 
1,404,477

 

Total
 
$
827,157

 
30.9
 
$
19,000,000

 
$
1,404,477

 
$
12,168


1
Represents interest income earned on advances during the three months ended March 31, 2014.

2
Superior Guaranty Insurance Company is an affiliate of Wells Fargo Bank, N.A.

At December 31, 2013, the Bank had the following business concentrations with stockholders (dollars in thousands):
 
 
Capital Stock
 
 
 
Mortgage
 
Interest
Stockholder
 
Amount
 
% of Total
 
Advances
 
Loans
 
Income1
Wells Fargo Bank, N.A.
 
$
770,000

 
28.5
 
$
19,000,000

 
$

 
$
14,470

Superior Guaranty Insurance Company2
 
60,130

 
2.2
 

 
1,477,856

 

Total
 
$
830,130

 
30.7
 
$
19,000,000

 
$
1,477,856

 
$
14,470


1
Represents interest income earned on advances during the year ended December 31, 2013.

2
Superior Guaranty Insurance Company is an affiliate of Wells Fargo Bank, N.A.
 

40


Note 16 — Transactions with Other FHLBanks

MPF Mortgage Loans. The Bank pays a service fee to the FHLBank of Chicago for its participation in the MPF program. This service fee expense is recorded in other expense. For the three months ended March 31, 2014 and 2013, the Bank recorded $0.7 million and $0.6 million in service fee expense to the FHLBank of Chicago.

Overnight Funds. The Bank may lend or borrow unsecured overnight funds to or from other FHLBanks. All such transactions are at current market rates. The Bank loaned $10.0 million to the FHLBank of Topeka and borrowed $70.0 million from the FHLBank of Atlanta during the three months ended March 31, 2014. At March 31, 2014, none of these transactions were outstanding on the Bank's Statements of Condition. The Bank did not loan or borrow any funds from other FHLBanks during the three months ended March 31, 2013.
 
 
Debt Transfers. The Bank may transfer debt from time to time in an effort to better match its projected asset cash flows or reduce its future interest costs. These transfers are accounted for in the same manner as debt extinguishments. In connection with these transactions, the assuming FHLBanks become the primary obligors for the transferred debt. During the three months ended March 31, 2014, the Bank did not transfer any debt to other FHLBanks. During the three months ended March 31, 2013, the Bank transferred $80.0 million of par value bonds to the FHLBank of San Francisco and recorded aggregate net losses of $13.9 million through "Net losses on extinguishment of debt" in the Statements of Income.

41


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Our Management's Discussion and Analysis (MD&A) of Financial Condition and Results of Operations should be read in conjunction with our financial statements and condensed notes at the beginning of this Form 10-Q and in conjunction with our MD&A and Annual Report on Form 10-K for the fiscal year ended December 31, 2013, filed with the Securities and Exchange Commission (SEC) on March 11, 2014 (2013 Form 10-K). Our MD&A is designed to provide information that will help the reader develop a better understanding of our financial statements, key financial statement changes from quarter to quarter, and the primary factors driving those changes. Our MD&A is organized as follows:


42


Forward-Looking Information

Statements contained in this report, including statements describing the objectives, projections, estimates, or future predictions in our operations, may be forward-looking statements. These statements may be identified by the use of forward-looking terminology, such as believes, projects, expects, anticipates, estimates, intends, strategy, plan, could, should, may, and will or their negatives or other variations on these terms. By their nature, forward-looking statements involve risk or uncertainty, and actual results could differ materially from those expressed or implied or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. These risks and uncertainties include, but are not limited to, the following:
 
political or economic events, including legislative, regulatory, monetary, judicial, or other developments that affect us, our members, our counterparties, and/or our investors in the consolidated obligations of the 12 Federal Home Loan Banks (FHLBanks);

competitive forces, including without limitation, other sources of funding available to our borrowers that could impact the demand for our advances, other entities purchasing mortgage loans in the secondary mortgage market, and other entities borrowing funds in the capital markets;

risks related to the other 11 FHLBanks that could trigger our joint and several liability for debt issued by the other 11 FHLBanks;

changes in the relative attractiveness of consolidated obligations due to actual or perceived changes in the FHLBanks' credit ratings as well as the U.S. Government's long-term credit rating;

changes in our capital structure and capital requirements;

reliance on a relatively small number of member institutions for a large portion of our advance business;

the volatility of credit quality, market prices, interest rates, and other indices that could affect the value of collateral held by us as security for borrower and counterparty obligations;

general economic and market conditions that could impact the volume of business we do with our members, including, but not limited to, the timing and volatility of market activity, inflation/deflation, employment rates, housing prices, the condition of the mortgage and housing markets on our mortgage-related assets, including the level of mortgage prepayments, and the condition of the capital markets on our consolidated obligations;

the availability of derivative instruments in the types and quantities needed for risk management purposes from acceptable counterparties;

increases in delinquency or loss severity on mortgage loans;

the volatility of reported results due to changes in the fair value of certain assets, liabilities, and derivative instruments;

the ability to develop and support internal controls, information systems, and other operating technologies that effectively manage the risks we face;

the ability to attract and retain key personnel; and

member consolidations and failures.
 
For additional information regarding these and other risks and uncertainties that could cause our actual results to differ materially from the expectations reflected in our forward-looking statements, see “Item 1A. Risk Factors” in our 2013 Form 10-K. You are cautioned not to place undue reliance on any forward-looking statements made by us or on our behalf. Forward-looking statements are made as of the date of this report. We undertake no obligation to update or revise any forward-looking statement.


43


Executive Overview

Our Bank is a member-owned cooperative serving shareholder members in a five-state region (Iowa, Minnesota, Missouri, North Dakota, and South Dakota). Our mission is to provide funding and liquidity to our members and eligible housing associates so that they can meet the housing, economic development, and business needs of the communities they serve. We fulfill our mission by providing liquidity to our members and housing associates through advances, supporting residential mortgage lending through the Mortgage Partnership Finance (MPF) program (Mortgage Partnership Finance and MPF are registered trademarks of the FHLBank of Chicago), and by providing affordable housing programs that create housing opportunities for low and moderate income families. Our members include commercial banks, thrifts, credit unions, insurance companies, and community development financial institutions (CDFIs).

For the three months ended March 31, 2014, we reported net income of $37.0 million compared to $27.3 million for the same period in 2013. Our net income, calculated in accordance with accounting principles generally accepted in the U.S. (GAAP), was primarily driven by net interest income and other income (loss).

Net interest income totaled $52.4 million for the three months ended March 31, 2014 compared to $53.3 million for the same period last year. The slight decrease was primarily due to lower advance prepayment fee income. During the three months ended March 31, 2014, advance prepayment fee income totaled $0.2 million compared to $1.8 million for the same period in 2013. This decrease was partially offset by a decline in interest expense due to lower funding costs.

Our net interest margin was 0.30 percent during the three months ended March 31, 2014 compared with 0.44 percent for the same period in 2013. The decline was primarily due to reduced yields on our interest-earning assets driven by the low interest rate environment. The decline was partially offset by an improvement in the yields on our interest-bearing liabilities. 

Our other income (loss) totaled $3.4 million for the three months ended March 31, 2014 compared to a loss of $7.7 million during the same period last year. The primary drivers of other income (loss) were gains on trading securities, losses on derivatives and hedging activities, and a reduction in losses on the extinguishment of debt as further described below.

Our trading securities are recorded at fair value with changes in fair value reflected through other income (loss). During the three months ended March 31, 2014, we recorded gains on trading securities of $24.2 million compared to losses of $6.9 million during the same period in 2013. These changes in fair value were primarily due to the impact of changes in interest rates and credit spreads on our fixed rate trading securities.

The changes in fair value on trading securities are generally offset by changes in fair value on derivatives and hedging activities. We utilize derivative instruments to manage interest rate risk, including mortgage prepayment risk. Accounting rules require all derivatives to be recorded at fair value and therefore we may be subject to income statement volatility. During the three months ended March 31, 2014, we recorded losses of $23.1 million on our derivatives and hedging activities through other income (loss) compared to gains of $10.9 million during the same period last year. These fair value changes were primarily attributable to the impact of changes in interest rates on interest rate swaps that we utilize to economically hedge our trading securities portfolio as discussed above. Refer to "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — Hedging Activities" for additional discussion on our derivatives and hedging activities, including the net impact of economic hedge relationships.

We extinguish higher-costing debt from time to time in an effort to better match our projected asset cash flows and to reduce our future interest costs. During the three months ended March 31, 2014, we did not extinguish any debt. During the three months ended March 31, 2013, we extinguished $92.1 million of higher-costing consolidated obligations and recorded losses on these debt extinguishments of $15.1 million through other income (loss).
 
Our total assets decreased slightly to $72.9 billion at March 31, 2014 from $73.0 billion at December 31, 2013 due primarily to a decline in advances and mortgage loans, partially offset by an increase in investments. Advances decreased $0.7 billion due to reduced member demand, scheduled maturities, and prepayments. Mortgage loans decreased $0.1 billion due to principal paydowns exceeding mortgage loan purchases. Investments increased $0.7 billion mainly due to the purchase of mortgage-backed securities (MBS) during the quarter. Total capital was $3.5 billion at March 31, 2014 and December 31, 2013. Refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Statements of Condition” for additional discussion on our financial condition.


44


Adjusted Earnings

As part of evaluating financial performance, we adjust GAAP net income before assessments and GAAP net interest income for the impact of (i) market adjustments relating to derivative and hedging activities and instruments held at fair value, (ii) realized gains (losses) on investment securities, and (iii) other unpredictable items, including asset prepayment fee income and debt extinguishment losses. The resulting non-GAAP measure, referred to as our adjusted earnings, reflects both adjusted net interest income and adjusted net income before assessments (adjusted net income).

Because our business model is primarily one of holding assets and liabilities to maturity, management believes that the adjusted earnings measure is helpful in understanding our operating results and provides a meaningful period-to-period comparison of our long-term economic value in contrast to GAAP results, which can be impacted by fair value changes driven by market volatility on financial instruments recorded at fair value or transactions that are considered to be unpredictable. As a result, management uses the adjusted earnings measure to assess performance under our incentive compensation plans and to ensure management remains focused on our long-term value and performance. Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. While this non-GAAP measure can be used to assist in understanding the components of our earnings, it should not be considered a substitute for results reported under GAAP.

As a member-owned cooperative, we endeavor to operate with a low but stable adjusted net interest margin. As indicated in the tables that follow, our adjusted net interest income and adjusted net income remained relatively stable during the three months ended March 31, 2014 when compared to the same period in 2013. Our adjusted net interest margin declined over prior year due to reduced yields on our interest-earning assets driven by the low interest rate environment. The decline was partially offset by an improvement in the yields on our interest-bearing liabilities. The following table summarizes the reconciliation between GAAP net interest income and adjusted net interest income (dollars in millions):
 
For the Three Months Ended
 
March 31,
 
2014
 
2013
GAAP net interest income1
$
52.4

 
$
53.3

Exclude:
 
 
 
Prepayment fees on advances, net
0.2

 
1.8

Include items reclassified from other income (loss):
 
 
 
Net interest expense on economic hedges
(3.5
)
 
(2.5
)
Adjusted net interest income1
$
48.7

 
$
49.0

Adjusted net interest margin
0.27
%
 
0.41
%

1
Amounts calculated are before the reversal for credit losses on mortgage loans.

The following table summarizes the reconciliation between GAAP net income before assessments and adjusted net income (dollars in millions):
 
For the Three Months Ended
 
March 31,
 
2014
 
2013
GAAP net income before assessments
$
41.1

 
$
30.4

Exclude:
 
 
 
Prepayment fees on advances, net
0.2

 
1.8

Net gains (losses) on trading securities
24.2

 
(6.9
)
Net gains on sale of available-for-sale securities
0.8

 

Net gains on consolidated obligations held at fair value

 
0.6

Net (losses) gains on derivatives and hedging activities
(23.1
)
 
10.9

Net losses on extinguishment of debt

 
(15.1
)
Include:
 
 
 
Net interest expense on economic hedges
(3.5
)
 
(2.5
)
Amortization of hedging costs1

 
(1.8
)
Adjusted net income2
$
35.5

 
$
34.8


1
Primarily represents the straight line amortization of upfront fee payments on interest rate caps. The interest rate caps were sold during the second quarter of 2013.

2
Amount is calculated before assessments.


45


For additional discussion on items impacting our GAAP earnings, refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations.”

Conditions in the Financial Markets

THREE MONTHS ENDED MARCH 31, 2014 AND 2013 AND DECEMBER 31, 2013

Economy and Capital Markets

Economic and market data received since the Federal Open Market Committee (FOMC) meeting in January of 2014 indicates that economic activity slowed during the winter months. Conditions in the labor market showed signs of improvement. The unemployment rate, however, remains elevated. Household spending and business fixed investments have continued to advance while the housing sector, though improved from prior years, has slowed somewhat in recent months. Fiscal policy continues to restrain economic growth, although the extent of restraint may be diminishing. Inflation has remained subdued and long-term inflation expectations have remained stable.

In its March 19, 2014 statement, the FOMC stated it expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will improve toward levels the FOMC judges consistent with its dual mandate to foster maximum employment and price stability. The FOMC sees the risks to the outlook for the economy and the labor market as closely balanced. It recognizes that inflation persistently below its two percent objective could pose risks to economic performance, and is monitoring inflation developments carefully for evidence that inflation will move back towards its objective over the medium-term.

Mortgage Markets

The housing market has improved over the past year, as indicated by rising home prices, lower inventories of properties for sale, and increased housing construction activity. However, an exceptionally harsh winter has dampened home buyer sentiment and other housing activities, which are expected to gain momentum in the spring. The outlook for a sustainable recovery in residential sales and home prices remains promising; recently mortgage rates and home prices have stabilized in many areas. As the market has been driven by new originations, credit standards have eased as mortgage lenders compete for new loans.

Interest Rates

The following table shows information on key market interest rates1:
 
First Quarter 2014
3-Month
Average
 
First Quarter 2013
3-Month
Average
 
 March 31, 2014
Ending Rate
 
December 31, 2013
Ending Rate
Federal funds
0.07
%
 
0.14
%
 
0.06
%
 
0.07
%
Three-month LIBOR
0.24

 
0.29

 
0.23

 
0.25

2-year U.S. Treasury
0.36

 
0.25

 
0.42

 
0.38

10-year U.S. Treasury
2.76

 
1.93

 
2.72

 
3.03

30-year residential mortgage note
4.37

 
3.49

 
4.40

 
4.48


1
Source is Bloomberg.

The Federal Reserve's key target interest rate, the Federal funds rate, maintained a range of 0.00 to 0.25 percent during 2014. In its March 19, 2014 statement, the FOMC reaffirmed that the current exceptionally low target range for the Federal funds rate remains appropriate. The FOMC noted it will continue to monitor progress towards its dual mandate to determine how long to maintain the current target range.

Three-month LIBOR has steadily decreased over last year. Average U.S. Treasury yields and mortgage rates were generally higher during 2014 when compared to the prior year. These rates increased during the second half of 2013 as a result of positive labor market data and investor expectations that a brighter outlook of the economy would allow the Federal Reserve to start reducing its asset purchase program, known as Quantitative Easing III (discussed further below).
 

46


The FOMC noted in its March 19, 2014 statement that the ongoing improvement in economic activity and labor market conditions since it began the asset purchase program over a year ago is consistent with growing underlying strength in the broader economy. In light of the cumulative progress towards maximum employment and the improvement in the outlook of labor market conditions, the FOMC decided to make a further measured reduction in the pace of its asset purchases by an additional $5.0 billion in April of 2014. The FOMC agreed to purchase additional agency MBS at a pace of $25.0 billion per month rather than $30.0 billion per month, and add to its holdings of longer-term U.S. Treasury securities at a pace of $30.0 billion per month rather than $35.0 billion per month.

The FOMC is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency MBS in agency MBS and of rolling over maturing U.S. Treasury securities at auction. The FOMC noted that these actions should continue to maintain downward pressure on long-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure inflation, over time, is at the rate most consistent with the FOMC's dual mandate. The FOMC will closely monitor incoming information on economic and financial developments in coming months and will employ its monetary and other policy tools as appropriate, until the outlook for the labor market has improved substantially in the context of price stability.

Funding Spreads

The following table reflects our funding spreads to LIBOR (basis points)1:
 
First Quarter 2014
3-Month
Average
 
First Quarter 2013
3-Month
Average
 
March 31, 2014
Ending Spread
 
December 31, 2013
Ending Spread
3-month
(13.8
)
 
(16.2
)
 
(14.6
)
 
(15.6
)
2-year
(6.5
)
 
(9.6
)
 
(7.2
)
 
(6.7
)
5-year
6.9

 
(1.5
)
 
2.6

 
10.5

10-year
44.9

 
15.8

 
34.7

 
55.8


1
Source is the Office of Finance.

As a result of our credit quality, we generally have ready access to funding at relatively competitive interest rates. During the first quarter of 2014, most of our funding spreads relative to London Interbank Offered Rate (LIBOR) improved when compared to spreads at December 31, 2013. These improvements followed the quick resolution of the debt ceiling debate in February and limited supply of agency issuance 5-years or longer. Throughout the first quarter of 2014, we utilized discount notes and step-up, callable, and term fixed rate consolidated obligation bonds to capture attractive funding, match the repricing structures on advances and investments, and provide additional liquidity.

47


Selected Financial Data

The following tables present selected financial data for the periods indicated (dollars in millions):
Statements of Condition
March 31,
2014
 
December 31,
2013
 
September 30,
2013
 
June 30,
2013
 
March 31,
2013
Investments1
$
20,885

 
$
20,131

 
$
12,336

 
$
12,412

 
$
15,895

Advances
44,924

 
45,650

 
45,787

 
26,513

 
24,802

Mortgage loans held for portfolio, gross
6,492

 
6,565

 
6,603

 
6,726

 
6,786

Allowance for credit losses
(7
)
 
(8
)
 
(14
)
 
(15
)
 
(15
)
Total assets
72,889

 
73,004

 
65,063

 
46,022

 
47,926

Consolidated obligations
 
 
 
 
 
 
 
 
 
Discount notes
42,816

 
38,137

 
28,218

 
5,219

 
5,326

Bonds
25,225

 
30,195

 
32,227

 
36,817

 
38,146

Total consolidated obligations2
68,041

 
68,332

 
60,445

 
42,036

 
43,472

Mandatorily redeemable capital stock
8

 
9

 
13

 
15

 
11

Capital stock — Class B putable
2,670

 
2,692

 
2,690

 
2,069

 
1,970

Retained earnings
697

 
678

 
656

 
639

 
636

Accumulated other comprehensive income
107

 
87

 
73

 
86

 
147

Total capital
3,474

 
3,457

 
3,419

 
2,794

 
2,753


1
Investments include interest-bearing deposits, securities purchased under agreements to resell, Federal funds sold, trading securities, available-for-sale (AFS) securities, and held-to-maturity (HTM) securities.

2
The total par value of outstanding consolidated obligations of the 12 FHLBanks was $753.9 billion, $766.8 billion, $720.7 billion, $704.5 billion, and $666.0 billion at March 31, 2014, December 31, 2013, September 30, 2013, June 30, 2013 and March 31, 2013 respectively.
 
For the Three Months Ended
Statements of Income
March 31,
2014
 
December 31,
2013
 
September 30,
2013
 
June 30,
2013
 
March 31,
2013
Net interest income
$
52.4

 
$
58.4

 
$
50.7

 
$
50.7

 
$
53.3

Reversal for credit losses on mortgage loans
(0.3
)
 
(5.9
)
 

 

 

Other income (loss)1
3.4

 
(3.7
)
 
(3.4
)
 
(19.7
)
 
(7.7
)
Other expense2
15.0

 
19.8

 
13.9

 
13.6

 
15.2

Assessments
4.1

 
4.1

 
3.3

 
1.7

 
3.1

Net income
37.0

 
36.7

 
30.1

 
15.7

 
27.3


 
For the Three Months Ended
Selected Financial Ratios3
March 31,
2014
 
December 31,
2013
 
September 30,
2013
 
June 30,
2013
 
March 31,
2013
Net interest spread4
0.26
%
 
0.29
%
 
0.34
%
 
0.37
%
 
0.37
%
Net interest margin5
0.30

 
0.32

 
0.39

 
0.43

 
0.44

Return on average equity
4.37

 
4.27

 
4.12

 
2.23

 
3.98

Return on average capital stock
5.65

 
5.46

 
5.49

 
3.09

 
5.52

Return on average assets
0.21

 
0.20

 
0.23

 
0.13

 
0.23

Average equity to average assets
4.70

 
4.74

 
5.57

 
5.95

 
5.68

Regulatory capital ratio6
4.63

 
4.63

 
5.16

 
5.92

 
5.46

Dividend payout ratio7
50.97

 
39.31

 
43.39

 
82.47

 
47.97


1
Other income (loss) includes, among other things, net gains (losses) on investment securities, net gains (losses) on derivatives and hedging activities, and net losses on the extinguishment of debt.

2
Other expense includes, among other things, compensation and benefits, professional fees, contractual services, and gains and losses on real estate owned (REO).

3
Amounts used to calculate selected financial ratios are based on numbers in thousands. Accordingly, recalculations using numbers in millions may not produce the same results.

4
Represents yield on total interest-earning assets minus cost of total interest-bearing liabilities.

5
Represents net interest income expressed as a percentage of average interest-earning assets.

6
Represents period-end regulatory capital expressed as a percentage of period-end total assets. Regulatory capital includes all capital stock, mandatorily redeemable capital stock, and retained earnings.

7
Represents dividends declared and paid in the stated period expressed as a percentage of net income in the stated period.

48


Results of Operations

THREE MONTHS ENDED MARCH 31, 2014 AND 2013

Net Income

The following table presents comparative highlights of our net income for the three months ended March 31, 2014 and 2013 (dollars in millions). See further discussion of these items in the sections that follow.
 
For the Three Months Ended
 
March 31,
 
2014
 
2013
 
$ Change
 
% Change
Net interest income
$
52.4

 
$
53.3

 
$
(0.9
)
 
(1.7
)%
Reversal for credit losses on mortgage loans
(0.3
)
 

 
(0.3
)
 
(100.0
)
Other income (loss)
3.4

 
(7.7
)
 
11.1

 
144.2

Other expense
15.0

 
15.2

 
(0.2
)
 
(1.3
)
Assessments
4.1

 
3.1

 
1.0

 
32.3

Net income
$
37.0

 
$
27.3

 
$
9.7

 
35.5
 %

49


Net Interest Income

Our net interest income is impacted by changes in average interest-earning asset and interest-bearing liability balances, and the related yields and costs. The following table presents average balances and rates of major asset and liability categories (dollars in millions):    
 
For the Three Months Ended March 31,
 
2014
 
2013
 
Average
Balance1
 
Yield/Cost
 
Interest
Income/
Expense
 
Average
Balance1
 
Yield/Cost
 
Interest
Income/
Expense
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
311

 
0.06
%
 
$
0.1

 
$
400

 
0.15
%
 
$
0.1

Securities purchased under agreements to resell
7,762

 
0.04

 
0.8

 
5,478

 
0.12

 
1.7

Federal funds sold
2,203

 
0.06

 
0.3

 
1,449

 
0.12

 
0.4

Short-term investments

 

 

 
12

 
0.10

 

Mortgage-backed securities2,3
8,449

 
1.31

 
27.3

 
6,777

 
1.76

 
29.4

    Other investments2,3,4
2,407

 
2.68

 
15.9

 
2,111

 
3.02

 
15.7

Advances3,5
44,873

 
0.48

 
53.0

 
25,506

 
0.80

 
50.3

Mortgage loans6
6,517

 
3.88

 
62.3

 
6,858

 
3.88

 
65.7

Total interest-earning assets
72,522

 
0.89

 
159.7

 
48,591

 
1.36

 
163.3

Non-interest-earning assets
636

 

 

 
512

 

 

Total assets
$
73,158

 
0.89
%
 
$
159.7

 
$
49,103

 
1.35
%
 
$
163.3

Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
Deposits
$
622

 
0.01
%
 
$

 
$
957

 
0.02
%
 
$

Consolidated obligations
 
 
 
 
 
 
 

 
 

 
 

Discount notes3
38,978

 
0.10

 
9.3

 
6,680

 
0.14

 
2.3

Bonds3
29,109

 
1.36

 
97.9

 
37,565

 
1.16

 
107.6

Other interest-bearing liabilities7
9

 
2.00

 
0.1

 
10

 
2.39

 
0.1

Total interest-bearing liabilities
68,718

 
0.63

 
107.3

 
45,212

 
0.99

 
110.0

Non-interest-bearing liabilities
1,002

 

 

 
1,101

 

 

Total liabilities
69,720

 
0.62

 
107.3

 
46,313

 
0.96

 
110.0

Capital
3,438

 

 

 
2,790

 

 

Total liabilities and capital
$
73,158

 
0.59
%
 
$
107.3

 
$
49,103

 
0.91
%
 
$
110.0

Net interest income and spread8
 
 
0.26
%
 
$
52.4

 
 
 
0.37
%
 
$
53.3

Net interest margin9
 
 
0.30
%
 
 
 
 
 
0.44
%
 
 
Average interest-earning assets to interest-bearing liabilities
 
 
105.54
%
 
 
 
 
 
107.47
%
 
 

1
Average balances are calculated on a daily weighted average basis and do not reflect the effect of derivative master netting arrangements with counterparties and/or clearing agents.

2
The average balance of AFS securities is reflected at amortized cost; therefore the resulting yields do not give effect to changes in fair value.

3
Average balances reflect the impact of fair value hedging adjustments and/or fair value option adjustments.

4
Other investments primarily include other U.S. obligations, government-sponsored enterprises (GSE) obligations, state or local housing agency obligations, and taxable municipal bonds.

5
Advance interest income includes prepayment fee income of $0.2 million and $1.8 million for the three months ended March 31, 2014 and 2013.

6
Non-accrual loans are included in the average balance used to determine the average yield.

7
Other interest-bearing liabilities consists of mandatorily redeemable capital stock and borrowings from other FHLBanks.

8
Represents yield on total interest-earning assets minus cost of total interest-bearing liabilities.

9
Represents net interest income expressed as a percentage of average interest-earning assets.


50


The following table presents changes in interest income and interest expense. Changes in interest income and interest expense that are not identifiable as either volume-related or rate-related, but rather equally attributable to both volume and rate changes, are allocated to the volume and rate categories based on the proportion of the absolute value of the volume and rate changes (dollars in millions).
 
Three Months Ended
 
March 31, 2014 vs. March 31, 2013
 
Total Increase
(Decrease) Due to
 
Total Increase
(Decrease)
 
Volume
 
Rate
 
Interest income
 
 
 
 
 
Interest-bearing deposits
$

 
$

 
$

Securities purchased under agreements to resell
0.4

 
(1.3
)
 
(0.9
)
Federal funds sold
0.2

 
(0.3
)
 
(0.1
)
Short-term investments

 

 

Mortgage-backed securities
6.4

 
(8.5
)
 
(2.1
)
Other investments
2.1

 
(1.9
)
 
0.2

Advances
28.1

 
(25.4
)
 
2.7

Mortgage loans
(3.4
)
 

 
(3.4
)
Total interest income
33.8

 
(37.4
)
 
(3.6
)
Interest expense
 
 
 
 
 
Deposits

 

 

Consolidated obligations
 
 
 
 
 
Discount notes
7.9

 
(0.9
)
 
7.0

Bonds
(26.5
)
 
16.8

 
(9.7
)
Other interest-bearing liabilities

 

 

Total interest expense
(18.6
)
 
15.9

 
(2.7
)
Net interest income
$
52.4

 
$
(53.3
)
 
$
(0.9
)
    
NET INTEREST SPREAD

Net interest spread equals the yield on total interest-earning assets minus the cost of total interest-bearing liabilities. For the three months ended March 31, 2014, our net interest spread was 0.26 percent compared to 0.37 percent for the same period in 2013. Our net interest spread was primarily impacted by lower yields on advances and investments, partially offset by improved yields on our consolidated obligations as a result of improved funding costs. The primary components of our interest income and interest expense are discussed below.

Mortgage Loans

Interest income on mortgage loans decreased five percent during the three months ended March 31, 2014 when compared to the same period in 2013. The decrease was due to lower average mortgage loan volumes. Average mortgage loan volumes declined due to principal paydowns exceeding mortgage loan purchases.

Investments

Interest income on investments decreased six percent during the three months ended March 31, 2014 when compared to the same period in 2013. The decrease was due mainly to the low interest rate environment, partially offset by higher average volumes of MBS and other investments. Average MBS and other investment volumes increased due to the purchase of GSE MBS and GSE agency obligations. In addition, average money market volumes increased due primarily to the purchase of money market investments to manage our liquidity position and counterparty credit risk.


51


Advances

Interest income on advances (including prepayment fees on advances, net) increased five percent during the three months ended March 31, 2014 when compared to the same period in 2013. The increase was due to higher average volumes, partially offset by the low interest rate environment and lower advance prepayment fee income. Average advance volumes increased due primarily to borrowings from a depository institution member during the third quarter of 2013. Advance prepayment fee income declined to $0.2 million during the three months ended March 31, 2014 from $1.8 million during the same period in 2013.

Bonds

Interest expense on bonds decreased nine percent during the three months ended March 31, 2014 when compared to the same period in 2013 primarily due to lower average bond volumes. Average bond volumes declined due to our increased utilization of discount notes to capture attractive funding, match repricing structures on advances and investments, and provide additional liquidity.

Discount Notes

Interest expense on discount notes increased 304 percent during the three months ended March 31, 2014 when compared to the same period in 2013 primarily due to higher average volumes. Discount notes were utilized to capture attractive funding, match repricing structures on advances and investments, and provide additional liquidity.

Reversal for Credit Losses on Mortgage Loans

During the three months ended March 31, 2014, we recorded a reversal for credit losses on our mortgage loans of $0.3 million due primarily to a reduction in loan delinquencies and loss severity estimates as well as ongoing improvements in economic indicators and housing market forecasts on our collectively evaluated mortgage loans. In addition, during the fourth quarter of 2013, we began utilizing external property valuations rather than average loss severity rates on our individually evaluated mortgage loans. An improvement in property valuations during the first quarter of 2014 resulted in lower anticipated losses. During the three months ended March 31, 2013, we recorded no provision or reversal for credit losses on our mortgage loans.

Other Income (Loss)

The following table summarizes the components of other income (loss) (dollars in millions):
 
For the Three Months Ended
 
March 31,
 
2014
 
2013
Net gains (losses) on trading securities
$
24.2

 
$
(6.9
)
Net gains on sale of available-for-sale securities
0.8

 

Net gains on consolidated obligations held at fair value

 
0.6

Net (losses) gains on derivatives and hedging activities
(23.1
)
 
10.9

Net losses on extinguishment of debt

 
(15.1
)
Other, net
1.5

 
2.8

Total other income (loss)
$
3.4

 
$
(7.7
)
    
Other income (loss) can be volatile from period to period depending on the type of financial activity recorded. During the three months ended March 31, 2014, other income (loss) was primarily impacted by gains on trading securities, losses on derivatives and hedging activities, and a reduction in losses on the extinguishment of debt.

Trading securities are recorded at fair value with changes in fair value reflected through other income (loss). During the three months ended March 31, 2014, we recorded gains on trading securities of $24.2 million compared to losses of $6.9 million during the same period in 2013. These changes in fair value were primarily due to the impact of changes in interest rates and credit spreads on our fixed rate trading securities.



52


The changes in fair value on trading securities are generally offset by changes in fair value on derivatives and hedging activities. We use derivatives to manage interest rate risk, including mortgage prepayment risk. During the three months ended March 31, 2014 and 2013, gains and losses on our derivatives and hedging activities were primarily attributable to economic derivatives. We recorded losses on economic derivatives of $16.6 million during the three months ended March 31, 2014 through other income (loss) compared to gains of $11.5 million during the same period in 2013. These fair value changes were primarily attributable to the impact of changes in interest rates on interest rate swaps that we utilize to economically hedge our trading securities portfolio. Refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — Hedging Activities” for additional discussion on our derivatives and hedging activities, including the net impact of economic hedge relationships.

We extinguish higher-costing debt from time to time in an effort to better match our projected asset cash flows and to reduce our future interest costs. During the three months ended March 31, 2014, we did not extinguish any debt. During the three months ended March 31, 2013, we extinguished $92.1 million of higher-costing consolidated obligations and recorded losses on these debt extinguishments of $15.1 million through other income (loss).

Hedging Activities

We use derivatives to manage interest rate risk, including mortgage prepayment risk, in our Statements of Condition. Accounting rules affect the timing and recognition of income and expense on derivatives and therefore we may be subject to income statement volatility.

If a hedging activity qualifies for hedge accounting treatment (fair value hedge), we include the periodic cash flow components of the derivative related to interest income or expense in the relevant income statement caption consistent with the hedged asset or liability. We also record the amortization of fair value hedging adjustments from terminated hedges in interest income or expense or other income (loss). Changes in the fair value of both the derivative and the hedged item are recorded as a component of other income (loss) in “Net (losses) gains on derivatives and hedging activities."

If a hedging activity does not qualify for hedge accounting treatment (economic hedge), we record the derivative's components of interest income and expense, together with the effect of changes in fair value as a component of other income (loss) in “Net (losses) gains on derivatives and hedging activities”; however, there is no fair value adjustment for the corresponding asset or liability being hedged unless changes in the fair value of the asset or liability are normally marked to fair value through earnings (i.e., trading securities and fair value option instruments).


53


The following tables categorize the net effect of hedging activities on net income by product (dollars in millions):
 
 
For the Three Months Ended March 31, 2014
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Loans
 
Bonds
 
Balance
Sheet4
 
Total
Net interest income:
 
 
 
 
 
 
 
 
 
 
 
 
Net amortization/accretion1
 
$
(2.1
)
 
$

 
$
(0.4
)
 
$
7.7

 
$

 
$
5.2

Net interest settlements
 
(40.3
)
 
(24.7
)
 

 
11.2

 

 
(53.8
)
Total impact to net interest income
 
(42.4
)
 
(24.7
)
 
(0.4
)
 
18.9

 

 
(48.6
)
Other income (loss):
 
 
 
 
 
 
 
 
 
 
 
 
Net (losses) gains on derivatives and hedging activities:
 
 
 
 
 
 
 
 
 
 
 
 
Gains (losses) on fair value hedges
 
0.4

 
(7.4
)
 

 
0.5

 

 
(6.5
)
(Losses) gains on economic hedges
 
(0.1
)
 
(29.0
)
 

 
12.5

 

 
(16.6
)
Total net (losses) gains on derivatives and hedging activities
 
0.3

 
(36.4
)
 

 
13.0

 

 
(23.1
)
Net gains on trading securities2
 

 
24.2

 

 

 

 
24.2

Net gains on consolidated obligations held at fair value
 

 

 

 

 

 

Total impact to other income (loss)
 
0.3

 
(12.2
)
 

 
13.0

 

 
1.1

Total net effect of hedging activities3
 
$
(42.1
)
 
$
(36.9
)
 
$
(0.4
)
 
$
31.9

 
$

 
$
(47.5
)
 
 
For the Three Months Ended March 31, 2013
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Loans
 
Bonds
 
Balance
Sheet 4
 
Total
Net interest income:
 
 
 
 
 
 
 
 
 
 
 
 
Net amortization/accretion1
 
$
(5.7
)
 
$

 
$
(1.3
)
 
$
13.9

 
$

 
$
6.9

Net interest settlements
 
(42.6
)
 
(4.3
)
 

 
17.3

 

 
(29.6
)
Total impact to net interest income
 
(48.3
)
 
(4.3
)
 
(1.3
)
 
31.2

 

 
(22.7
)
Other income (loss):
 
 
 
 
 
 
 
 
 
 
 
 
Net gains (losses) on derivatives and hedging activities:
 
 
 
 
 
 
 
 
 
 
 
 
Gains (losses) on fair value hedges
 
0.9

 
0.3

 

 
(1.8
)
 

 
(0.6
)
(Losses) gains on economic hedges
 

 
11.7

 
(0.1
)
 
(1.1
)
 
1.0

 
11.5

Total net gains (losses) on derivatives and hedging activities
 
0.9

 
12.0

 
(0.1
)
 
(2.9
)
 
1.0

 
10.9

Net losses on trading securities2
 

 
(6.9
)
 

 

 

 
(6.9
)
Net gains on consolidated obligations held at fair value
 

 

 

 
0.6

 

 
0.6

Net accretion5
 

 

 

 
(0.9
)
 

 
(0.9
)
Total impact to other income (loss)
 
0.9

 
5.1

 
(0.1
)
 
(3.2
)
 
1.0

 
3.7

Total net effect of hedging activities3
 
$
(47.4
)
 
$
0.8

 
$
(1.4
)
 
$
28.0

 
$
1.0

 
$
(19.0
)

1
Represents the amortization/accretion of fair value hedging adjustments on closed hedge relationships included in net interest income.

2
Represents the net gains (losses) on those trading securities in which we have entered into a corresponding economic derivative to hedge the risk of changes in fair value. As a result, this line item may not agree to the Statements of Income.

3
The hedging activity tables do not include the interest component on the related hedged items or the gross advance prepayment fee income on terminated advance hedge relationships.

4
Represents net gain (loss) on interest rate caps. We did not hold any interest rate caps during the first quarter of 2014.

5
Represents the amortization/accretion of fair value hedging adjustments on closed bond hedge relationships included in other income (loss) as a result of debt extinguishments.


54


NET AMORTIZATION/ACCRETION

Amortization/accretion varies from period to period depending on our hedge relationship termination activities. Amortization/accretion on advances, mortgage loans, and consolidated obligation bonds remained fairly stable during the three months ended March 31, 2014 when compared to the same period in 2013 and resulted primarily from the normal amortization of existing fair value hedging adjustments.

NET INTEREST SETTLEMENTS

Net interest settlements represent the interest component on derivatives that qualify for fair value hedge accounting. These amounts vary from period to period depending on our hedging activities and interest rates and are partially offset by the interest component on the related hedged item within net interest income. The hedging activity tables do not include the impact of the interest component on the related hedged item.

GAINS (LOSSES) ON FAIR VALUE HEDGES

Gains (losses) on fair value hedges are driven by hedge ineffectiveness. Hedge ineffectiveness occurs when changes in the fair value of the derivative and the related hedged item do not perfectly offset each other. The primary drivers of hedge ineffectiveness are changes in the benchmark interest rate and volatility. During the three months ended March 31, 2014 and 2013, gains (losses) on fair value hedging relationships remained relatively stable and were the result of normal market activity.

GAINS (LOSSES) ON ECONOMIC HEDGES

We utilize economic derivatives to manage certain risks in our Statements of Condition. Gains and losses on economic derivatives are driven primarily by changes in interest rates and volatility and include interest settlements. Interest settlements represent the interest component on economic derivatives. These amounts vary from period to period depending on our hedging activities and interest rates. The following discussion highlights key items impacting gains and losses on economic derivatives.

Investments
 
We utilize interest rate swaps to economically hedge a portion of our trading securities against changes in fair value. Gains and losses on these economic derivatives are due primarily to changes in interest rates. Gains and losses on our trading securities are due primarily to changes in interest rates and credit spreads. The following table summarizes gains and losses on these economic derivatives as well as the related trading securities (dollars in millions):
 
For the Three Months Ended
 
March 31,
 
2014
 
2013
(Losses) gains on interest rate swaps
$
(23.4
)
 
$
17.1

Interest settlements
(5.6
)
 
(5.4
)
Net (losses) gains on investment derivatives
(29.0
)
 
11.7

Net gains (losses) on related trading securities
24.2

 
(6.9
)
Net (losses) gains on investment hedge relationships
$
(4.8
)
 
$
4.8


Consolidated Obligations
 
We utilize interest rate swaps primarily to economically hedge against changes in fair value on our consolidated obligations elected under the fair value option. Gains and losses on these economic derivatives are due primarily to changes in interest rates. In addition, derivatives used to hedge consolidated obligations in a fair value hedge relationship that fail retrospective hedge effectiveness testing are considered to be ineffective and are required to be accounted for as economic derivatives.


55


The following table summarizes gains and losses on these economic derivatives as well as the related consolidated obligations elected under the fair value option (dollars in millions):
 
For the Three Months Ended
 
March 31,
 
2014
 
2013
Losses on interest rate swaps
$

 
$
(0.9
)
Gains (losses) on interest rate swaps in ineffective fair value hedge relationships
10.3

 
(3.3
)
Interest settlements
2.2

 
3.1

Net gains (losses) on consolidated obligation derivatives
12.5

 
(1.1
)
Net gains on related consolidated obligations elected under the fair value option

 
0.6

Net gains (losses) on consolidated obligation hedge relationships
$
12.5

 
$
(0.5
)

Statements of Condition

MARCH 31, 2014 AND DECEMBER 31, 2013

Financial Highlights

Our total assets decreased slightly to $72.9 billion at March 31, 2014 from $73.0 billion at December 31, 2013. Our total liabilities decreased to $69.4 billion at March 31, 2014 from $69.5 billion at December 31, 2013. Total capital was $3.5 billion at March 31, 2014 and December 31, 2013. See further discussion of changes in our financial condition in the appropriate sections that follow.

Advances

The following table summarizes our advances by type of institution (dollars in millions):
 
March 31,
2014
 
December 31,
2013
Commercial banks
$
27,352

 
$
28,237

Thrifts
1,217

 
1,249

Credit unions
654

 
686

Insurance companies
15,361

 
15,136

Total member advances
44,584

 
45,308

Housing associates
22

 
8

Non-member borrowers
42

 
44

Total par value
$
44,648

 
$
45,360


Our total advance par value decreased slightly at March 31, 2014 when compared to December 31, 2013. The decrease was due to reduced member demand, scheduled maturities, and prepayments.

The following table summarizes our advances by product type (dollars in millions):
 
March 31, 2014
 
December 31, 2013
 
Amount
 
% of Total
 
Amount
 
% of Total
Variable rate
$
28,147

 
63.0
 
$
27,906

 
61.5
Fixed rate
16,077

 
36.0
 
17,054

 
37.6
Amortizing
424

 
1.0
 
400

 
0.9
Total par value
44,648

 
100.0
 
45,360

 
100.0
Discounts
(7
)
 
 
 
(8
)
 
 
Fair value hedging adjustments
283

 
 
 
298

 
 
Total advances
$
44,924

 
 
 
$
45,650

 
 

Fair value hedging adjustments decreased $14.9 million or five percent at March 31, 2014 when compared to December 31, 2013. The decrease was primarily due to fair value net losses on advances in hedge relationships resulting from changes in interest rates.

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At March 31, 2014 and December 31, 2013, advances outstanding to our five largest member borrowers totaled $26.6 billion and $26.7 billion, representing 60 and 59 percent of our total advances outstanding. The following table summarizes advances outstanding to our five largest member borrowers at March 31, 2014 (dollars in millions):
 
Amount
 
% of Total
Wells Fargo Bank, N.A.
$
19,000

 
42.5
Transamerica Life Insurance Company1
2,350

 
5.3
HICA Education Loan Corporation
2,225

 
5.0
Principal Life Insurance Company
1,750

 
3.9
Athene Annuity and Life Company
1,246

 
2.8
Total par value
$
26,571

 
59.5

1
Excludes $400.0 million of outstanding advances with Monumental Life Insurance Company, an affiliate of Transamerica Life Insurance Company.

We manage our credit exposure to advances through an approach that provides for an established credit limit for each borrower, ongoing reviews of each borrower's financial condition, and detailed collateral and lending policies to limit risk of loss while balancing borrowers' needs for a reliable source of funding. In addition, we lend to our borrowers in accordance with the Federal Home Loan Bank Act of 1932 (FHLBank Act), Finance Agency regulations, and other applicable laws.

The FHLBank Act requires that we obtain sufficient collateral on advances to protect against losses. We have never experienced a credit loss on an advance to a member or eligible housing associate. Based upon our collateral and lending policies, the collateral held as security, and the repayment history on advances, management has determined that there were no probable credit losses on our advances as of March 31, 2014 and December 31, 2013. Accordingly, we have not recorded any allowance for credit losses on our advances. See additional discussion regarding our collateral requirements in “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management — Credit Risk — Advances.”

Mortgage Loans

The following table summarizes information on our mortgage loans held for portfolio (dollars in millions):
 
March 31,
2014
 
December 31,
2013
Fixed rate conventional loans
$
5,870

 
$
5,945

Fixed rate government-insured loans
548

 
547

Total unpaid principal balance
6,418

 
6,492

Premiums
80

 
81

Discounts
(15
)
 
(16
)
Basis adjustments from mortgage loan commitments
9

 
8

Total mortgage loans held for portfolio
6,492

 
6,565

Allowance for credit losses
(7
)
 
(8
)
Total mortgage loans held for portfolio, net
$
6,485

 
$
6,557

    
Our mortgage loans declined slightly at March 31, 2014 when compared to December 31, 2013. The decrease was primarily due to principal paydowns exceeding mortgage loan purchases. Throughout the three months ended March 31, 2014, we purchased $123.8 million of mortgage loans from our participating financial institutions (PFIs) and received principal paydowns of $191.6 million. Purchase activity and mortgage prepayments generally declined during 2014 as the exceptionally harsh winter dampened home buyer sentiment and other housing activities.

Our allowance for credit losses declined $0.6 million at March 31, 2014 when compared to December 31, 2013 due to a reversal for credit losses on our mortgage loans of $0.3 million and charge-offs of $0.3 million. The reversal was due to a reduction in loan delinquencies and loss severity estimates as well as ongoing improvements in economic indicators and housing market forecasts on our collectively evaluated mortgage loans. In addition, we began utilizing external property valuations in 2013 rather than average loss severity rates on our individually evaluated mortgage loans. An improvement in property valuations during the first quarter of 2014 resulted in lower anticipated losses. During the three months ended March 31, 2013, we recorded no provision or reversal for credit losses on our mortgage loans. For additional discussion on our mortgage loan credit risk, refer to "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management — Credit Risk — Mortgage Assets.”


57


Investments

The following table summarizes the carrying value of our investments (dollars in millions):
 
March 31, 2014
 
December 31, 2013
 
Amount
 
% of Total
 
Amount
 
% of Total
Short-term investments1
 
 
 
 
 
 
 
Interest-bearing deposits
$
1

 
 
$
1

 
Securities purchased under agreements to resell
7,490

 
35.8
 
8,200

 
40.7
Federal funds sold
1,875

 
9.0
 
1,200

 
6.0
Total short-term investments
9,366

 
44.8
 
9,401

 
46.7
Long-term investments2
 
 
 
 
 
 
 
Interest-bearing deposits
1

 
 
1

 
Mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations - residential
5

 
 
5

 
Other U.S. obligations - commercial
2

 
 
2

 
GSE - residential
9,003

 
43.1
 
8,132

 
40.4
Private-label - residential
29

 
0.2
 
30

 
0.2
Total mortgage-backed securities
9,039

 
43.3
 
8,169

 
40.6
Non-mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations
441

 
2.1
 
448

 
2.2
GSE obligations
1,500

 
7.2
 
1,489

 
7.4
State or local housing agency obligations
93

 
0.5
 
95

 
0.5
Other
445

 
2.1
 
528

 
2.6
Total non-mortgage-backed securities
2,479

 
11.9
 
2,560

 
12.7
Total long-term investments
11,519

 
55.2
 
10,730

 
53.3
Total investments
$
20,885

 
100.0
 
$
20,131

 
100.0

1
Short-term investments have original maturities of less than one year.

2
Long-term investments have original maturities of greater than one year.

Our investments increased slightly when compared to December 31, 2013. The increase was primarily due to the purchase of GSE MBS during the quarter. At March 31, 2014, we had GSE MBS purchases with a total par value of $389.7 million that had traded but not yet settled. These investments have been recorded as "available-for-sale securities" in our Statements of Condition with a corresponding payable recorded in "other liabilities".

We evaluate AFS and HTM securities in an unrealized loss position for OTTI on at least a quarterly basis. As part of our OTTI evaluation, we consider our intent to sell each debt security and whether it is more likely than not that we will be required to sell the security before its anticipated recovery. If either of these conditions is met, we will recognize an OTTI charge to earnings equal to the entire difference between the security's amortized cost basis and its fair value at the reporting date. For securities in an unrealized loss position that meet neither of these conditions, we perform analyses to determine if any of these securities are other-than-temporarily impaired.

Refer to “Item 1. Financial Statements — Note 6 — Other-Than-Temporary Impairment” for additional information on our OTTI analysis performed at March 31, 2014. As a result of our analysis, we determined that all gross unrealized losses on our investment portfolio are temporary. We do not intend to sell these securities, and it is not more likely than not that we will be required to sell these securities before recovery of their amortized cost bases. As a result, we did not consider any of these securities to be other-than-temporarily impaired at March 31, 2014.
 
Consolidated Obligations

Consolidated obligations, which include bonds and discount notes, are the primary source of funds to support our advances, mortgage loans, and investments. At March 31, 2014 and December 31, 2013, the par value of consolidated obligations for which we are primarily liable totaled $68.0 billion and $68.3 billion.


58


DISCOUNT NOTES

The following table summarizes our discount notes, all of which are due within one year (dollars in millions):
 
March 31, 2014
 
December 31, 2013
Par value
$
42,823

 
$
38,144

Discounts
(7
)
 
(7
)
Total
$
42,816

 
$
38,137

    
Our discount notes increased $4.7 billion or 12 percent at March 31, 2014 when compared to December 31, 2013. The increase was primarily due to our increased utilization of shorter-term discount notes to capture attractive funding, match repricing structures on advances and investments, and provide additional liquidity.

For additional information on our discount notes, refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Liquidity — Sources of Liquidity.”

BONDS

The following table summarizes information on our bonds (dollars in millions):
 
March 31,
2014
 
December 31, 2013
Total par value
$
25,228

 
$
30,205

Premiums
21

 
22

Discounts
(17
)
 
(18
)
Fair value hedging adjustments
(7
)
 
(14
)
Total bonds
$
25,225

 
$
30,195


Our bonds decreased $5.0 billion or 16 percent at March 31, 2014 when compared to December 31, 2013. The decrease was primarily due to our increased utilization of shorter-term discount notes to capture attractive funding, match repricing structures on advances and investments, and provide additional liquidity.

Fair value hedging adjustments decreased $7.0 million or 50 percent at March 31, 2014 when compared to December 31, 2013. The decrease was primarily due to a decline in cumulative fair value adjustments on bonds in hedge relationships resulting from changes in interest rates.

Deposits

Deposit levels will vary based on member alternatives for short-term investments. Our deposits increased $0.1 billion or eight percent at March 31, 2014 when compared to December 31, 2013 due to an increase in interest-bearing deposits, including overnight, demand, and term deposits.



59


Capital

The following table summarizes information on our capital (dollars in millions):
 
March 31,
2014
 
December 31,
2013
Capital stock
$
2,670

 
$
2,692

Retained earnings
697

 
678

Accumulated other comprehensive income
107

 
87

Total capital
$
3,474

 
$
3,457


Our capital increased $17.3 million or one percent at March 31, 2014 when compared to December 31, 2013. The improvement was primarily due to an increase in accumulated other comprehensive income (AOCI) and retained earnings, partially offset by lower capital stock outstanding. AOCI increased due to an increase in unrealized gains on AFS securities resulting primarily from changes in interest rates. Retained earnings increased due to net income earned in excess of dividends paid. Capital stock outstanding decreased primarily due to lower activity-based capital stock held during the quarter as a result of decreased advance activity. Refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Capital — Capital Stock” for additional information on our capital stock activity.

Derivatives

We use derivatives to manage interest rate risk, including mortgage prepayment risk, in our Statements of Condition. The notional amount of derivatives serves as a factor in determining periodic interest payments and cash flows received and paid. However, the notional amount of derivatives represents neither the actual amounts exchanged nor our overall exposure to credit and market risk. The following table categorizes the notional amount of our derivatives by type (dollars in millions):
 
March 31,
2014
 
December 31,
2013
Interest rate swaps
 
 
 
Noncallable
$
24,617

 
$
28,533

Callable by counterparty
5,728

 
5,680

Callable by the Bank
52

 
82

Total interest rate swaps
30,397

 
34,295

Forward settlement agreements (TBAs)
42

 
28

Mortgage delivery commitments
44

 
30

Total notional amount
$
30,483

 
$
34,353

    
The notional amount of our derivative contracts decreased $3.9 billion or 11 percent at March 31, 2014 when compared to December 31, 2013. The decrease was a result of us shifting our funding strategy during the first quarter. During the quarter, we focused more on short-term discount notes, which are typically not hedged, to capture attractive funding, match repricing structures on advances and investments, and provide additional liquidity.

Liquidity and Capital Resources

Our liquidity and capital positions are actively managed in an effort to preserve stable, reliable, and cost-effective sources of funds to meet current and projected future operating financial commitments, as well as regulatory, liquidity, and capital requirements.

LIQUIDITY

Sources of Liquidity

We utilize several sources of liquidity to carry out our business activities. These include, but are not limited to, proceeds from the issuance of consolidated obligations, payments collected on advances and mortgage loans, proceeds from the maturity or sale of investment securities, member deposits, proceeds from the issuance of capital stock, and current period earnings.

60


Our primary source of liquidity is proceeds from the issuance of consolidated obligations (bonds and discount notes) in the capital markets. Although we are primarily liable for the portion of consolidated obligations that are issued on our behalf, we are also jointly and severally liable with the other 11 FHLBanks for the payment of principal and interest on all consolidated obligations issued by the FHLBank System. At March 31, 2014 and December 31, 2013, the total par value of outstanding consolidated obligations for which we are primarily liable was $68.0 billion and $68.3 billion. At March 31, 2014 and December 31, 2013, the total par value of outstanding consolidated obligations issued on behalf of other FHLBanks for which we are jointly and severally liable was approximately $685.9 billion and $698.5 billion.

During the three months ended March 31, 2014, proceeds from the issuance of bonds and discount notes were $4.0 billion and $36.8 billion compared to $11.6 billion and $20.6 billion for the same period in 2013. The expectation of higher interest rates and a reduction in U.S. Treasury bill issuances led to continued investor demand for our short-term debt. As a result, we continued to issue shorter-term discount notes and step-up, callable, and term fixed rate consolidated obligation bonds to capture attractive funding, match repricing structures on advances and investments, and provide additional liquidity.

Our ability to raise funds in the capital markets as well as our cost of borrowing may be affected by our credit ratings. As of April 30, 2014, our consolidated obligations were rated AA+/A-1+ by Standard and Poor's and Aaa/P-1 by Moody's and both ratings had a stable outlook. For further discussion of how credit rating changes may impact us in the future, refer to “Item 1A. Risk Factors” in our 2013 Form 10-K.

The Office of Finance and FHLBanks have contingency plans in place that prioritize the allocation of proceeds from the issuance of consolidated obligations during periods of financial distress when consolidated obligations cannot be issued in sufficient amounts to satisfy all FHLBank demand. In the event of significant market disruptions or local disasters, our President or his designee is authorized to establish interim borrowing relationships with other FHLBanks. To provide further access to funding, the FHLBank Act also authorizes the U.S. Treasury to directly purchase new issue consolidated obligations of the GSEs, including FHLBanks, up to an aggregate principal amount of $4.0 billion. As of April 30, 2014, no purchases had been made by the U.S. Treasury under this authorization.

Uses of Liquidity

We use our available liquidity, including proceeds from the issuance of consolidated obligations, primarily to repay consolidated obligations, fund advances, and purchase investments. During the three months ended March 31, 2014, payments on consolidated obligations totaled $41.1 billion compared to $31.6 billion for the same period in 2013. A portion of these payments were due to the call and extinguishment of certain higher-costing par value bonds in an effort to better match our projected asset cash flows and reduce our future interest costs. During the three months ended March 31, 2014 and 2013, we called bonds with a total par value of $1.3 billion and $0.8 billion. We did not extinguish any bonds during the three months ended March 31, 2014. We extinguished bonds with a total par value of $92.1 million during the three months ended March 31, 2013.

During the three months ended March 31, 2014, advance disbursements totaled $15.2 billion compared to $11.0 billion for the same period in 2013. The increase was due to increased short-term liquidity borrowings from depository institution members.

During the three months ended March 31, 2014, investment purchases (excluding overnight investments) totaled $57.1 billion compared to $21.6 billion for the same period in 2013. Investment purchases increased primarily due to the purchase of money market investments in an effort to manage our liquidity position and counterparty credit risk.

We also use liquidity to purchase mortgage loans, repay member deposits, pledge collateral to derivative counterparties, redeem or repurchase capital stock, pay expenses, and pay dividends.


61


Liquidity Requirements
Finance Agency regulations mandate three liquidity requirements. First, we are required to maintain contingent liquidity sufficient to meet our liquidity needs, which shall, at a minimum, cover five calendar days of inability to access the consolidated obligation debt markets. Second, we are required to have available at all times an amount greater than or equal to members' current deposits invested in advances with maturities not to exceed five years, deposits in banks or trust companies, and obligations of the U.S. Treasury. Third, we are required to maintain, in the aggregate, unpledged qualifying assets in an amount at least equal to the amount of our participation in total consolidated obligations outstanding. At March 31, 2014 and December 31, 2013 and throughout the three months ended March 31, 2014, we were in compliance with all three of the Finance Agency liquidity requirements.

In addition to the liquidity measures previously discussed, the Finance Agency has provided us with guidance to maintain sufficient liquidity in an amount at least equal to our anticipated cash outflows under two different scenarios. One scenario (roll-off scenario) assumes that we cannot access the capital markets to issue debt for a period of 10 to 20 days with initial guidance set at 15 days and that during that time members do not renew any maturing, prepaid, and called advances. The second scenario (renew scenario) assumes that we cannot access the capital markets to issue debt for a period of three to seven days with initial guidance set at five days and that during that time we will automatically renew maturing and called advances for all members except very large, highly-rated members. This guidance is designed to protect against temporary disruptions in the debt markets that could lead to a reduction in market liquidity and thus the inability for us to provide advances to our members. At March 31, 2014 and December 31, 2013 and throughout the three months ended March 31, 2014, we were in compliance with this liquidity guidance.

CAPITAL

Capital Requirements

We are subject to three regulatory capital requirements. First, the FHLBank Act requires that we maintain at all times permanent capital greater than or equal to the sum of our credit, market, and operations risk capital requirements, all calculated in accordance with Finance Agency regulations. Only permanent capital, defined as Class B capital stock, which includes mandatorily redeemable capital stock and retained earnings, can satisfy this risk-based capital requirement. Second, the FHLBank Act requires a minimum four percent capital-to-asset ratio, which is defined as total regulatory capital divided by total assets. Total regulatory capital includes all capital stock, including mandatorily redeemable capital stock, and retained earnings. It does not include AOCI. Third, the FHLBank Act imposes a five percent minimum leverage ratio, which is defined as the sum of permanent capital weighted 1.5 times and nonpermanent capital weighted 1.0 times, divided by total assets. At March 31, 2014 and December 31, 2013, we were in compliance with all three of the Finance Agency's regulatory capital requirements. Refer to "Item 1. Financial Statements — Note 12 — Capital" for additional information.

Capital Stock
Our capital stock has a par value of $100 per share, and all shares are issued, redeemed, and repurchased only at the stated par value. We have two subclasses of capital stock: membership and activity-based. Each member must purchase and hold membership capital stock in an amount equal to 0.12 percent of its total assets as of the preceding December 31st, subject to a cap of $10.0 million and a floor of $10,000. Each member is also required to purchase activity-based capital stock equal to 4.00 percent of its advances and mortgage loans outstanding. All capital stock issued is subject to a five year notice of redemption period.

The capital stock requirements established in our Capital Plan are designed so that we remain adequately capitalized as member activity changes. Our Board of Directors may make adjustments to the capital stock requirements within ranges established in our Capital Plan.
Capital stock owned by members in excess of their capital stock requirement is deemed excess capital stock. Under our Capital Plan, we, at our discretion and upon 15 days' written notice, may repurchase excess membership capital stock. We, at our discretion, may also repurchase excess activity-based capital stock to the extent that (i) the excess capital stock balance exceeds an operational threshold set forth in the Capital Plan, which is currently set at zero, or (ii) a member submits a notice to redeem all or a portion of the excess activity-based capital stock. At March 31, 2014 and December 31, 2013, we had no excess capital stock outstanding.

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The following table summarizes our regulatory capital stock by type of member (dollars in millions):
 
March 31, 2014
 
December 31, 2013
Commercial banks
$
1,589

 
$
1,619

Thrifts
94

 
96

Credit unions
106

 
106

Insurance companies
881

 
871

Total GAAP capital stock
2,670

 
2,692

Mandatorily redeemable capital stock
8

 
9

Total regulatory capital stock
$
2,678

 
$
2,701


Retained Earnings
Our Enterprise Risk Management Policy (ERMP) requires a minimum retained earnings level based on the level of market risk, credit risk, and operational risk within the Bank. If realized financial performance results in actual retained earnings below the minimum level, we will establish an action plan as determined by our Board of Directors to enable us to return to our targeted level of retained earnings within twelve months. At March 31, 2014, our actual retained earnings were above the minimum level, and therefore no action plan was necessary.
The Bank entered into a Joint Capital Enhancement Agreement (JCE Agreement) with all of the other FHLBanks in February 2011. The JCE Agreement, as amended, is intended to enhance our capital position over time. It requires us to allocate 20 percent of our quarterly net income to a separate restricted retained earnings account until the balance of that account equals at least one percent of our average balance of outstanding consolidated obligations for the previous quarter. The restricted retained earnings are not available to pay dividends. At March 31, 2014 and December 31, 2013, our restricted retained earnings balance totaled $58.2 million and $50.8 million. For more information on our JCE Agreement, refer to "Item 1. Business — Retained Earnings" in our 2013 Form 10-K.

Dividends

Our Board of Directors believes any excess returns on capital stock above an appropriate benchmark rate that are not retained for capital growth should be returned to members that utilize our product and service offerings. Our current dividend philosophy is to pay a membership capital stock dividend similar to a benchmark rate of interest, such as average three-month LIBOR, and an activity-based capital stock dividend, when possible, at least 50 basis points in excess of the membership capital stock dividend. Our actual dividend payout is determined quarterly by our Board of Directors, based on policies, regulatory requirements, financial projections, and actual performance.

The following table summarizes dividend-related information (dollars in millions):
 
For the Three Months Ended
 
March 31,
 
2014
 
2013
Aggregate cash dividends paid
$
18.9

 
$
13.1

Effective combined annualized dividend rate paid on capital stock
2.80
%
 
2.60
%
Annualized dividend rate paid on membership capital stock
0.50
%
 
0.50
%
Annualized dividend rate paid on activity-based capital stock
3.50
%
 
3.50
%
Average three-month LIBOR
0.24
%
 
0.29
%

Critical Accounting Policies and Estimates

For a discussion of our critical accounting policies and estimates, refer to our 2013 Form 10-K. There have been no material changes to our critical accounting policies and estimates during the three months ended March 31, 2014.


63


Legislative and Regulatory Developments

Proposed Rule on Responsibilities of Boards of Directors; Corporate Practices and Corporate Governance Matters

On January 28, 2014, the Finance Agency published a proposed rule to relocate and consolidate existing Federal Housing Finance Board and Office of Federal Housing Enterprise Oversight regulations pertaining to director responsibilities, corporate practices, and corporate governance matters for Fannie Mae, Freddie Mac and the FHLBanks (each a "regulated entity"). In addition, the proposed rule would make certain amendments or additions to the corporate governance rules currently applicable to the FHLBanks, including provisions to:

Revise existing risk management provisions to better align them with more recent proposals of the Federal Reserve Board, including requirements that the entities adopt an enterprise wide risk management program and have a Chief Risk Officer with certain enumerated responsibilities;

Require each entity to establish a compliance program headed by a compliance officer who reports directly to the chief executive officer;

Require each entity’s board to establish committees specifically responsible for the following matters: (a) risk management; (b) audit; (c) compensation; and (d) corporate governance, although not necessarily with those specific committee names;

Require each FHLBank to designate in its bylaws a body of law to follow for corporate governance and indemnification practices and procedures for which no federal law controls, choosing from (a) the law of the jurisdiction in which the FHLBank maintains its principal office; (b) the Delaware General Corporation Law; or (c) the Revised Model Business Corporation Act. The proposed rule states that the Finance Agency has the authority to review a regulated entity’s indemnification policies, procedures and practices and may limit or prohibit indemnification payments in support of the safe and sound operations of the regulated entity.

Comments on the proposed rule are due by May 15, 2014.

Finance Agency Final Rule on Executive Compensation

On January 28, 2014, the Finance Agency issued a final rule setting forth requirements and processes with respect to compensation provided to executive officers by FHLBanks and the Office of Finance. The final rule addresses the authority of the Director of the Finance Agency to review the compensation arrangements of executive officers of the FHLBanks and to prohibit an FHLBank or the Office of Finance from providing compensation to any executive officer that the Director of the Finance Agency determines is not reasonable and comparable with compensation for employment in other similar businesses involving similar duties and responsibilities.

The final rule also addresses the Director’s authority to approve, in advance, agreements or contracts of executive officers that provide compensation in connection with termination of employment. The final rule became effective on February 27, 2014.

Finance Agency Final Rule on Golden Parachute Payments.

On January 28, 2014, the Finance Agency issued a final rule setting forth the standards that the Director of the Finance Agency will take into consideration when determining whether to limit or prohibit golden parachute payments. The primary impact of this final rule is to better conform existing Finance Agency regulations on golden parachutes with FDIC golden parachute regulations and to further limit golden parachute payments made by an FHLBank or the Office of Finance that is assigned a less than satisfactory composite Finance Agency examination rating. The final rule became effective on February 27, 2014.



64


Risk Management
    
We have risk management policies, established by our Board of Directors, that monitor and control our exposure to market, liquidity, credit, operational, and business risk, as well as capital adequacy. Our primary objective is to manage our assets and liabilities in ways that protect the par redemption value of our capital stock from risks, including fluctuations in market interest rates and spreads.

We periodically evaluate our risk management policies in order to respond to changes in our financial position and general market conditions. Our key risk measures are Market Value of Capital Stock (MVCS) Sensitivity and Economic Value of Capital Stock (EVCS).

MARKET RISK

We define market risk as the risk that MVCS or net income will change as a result of changes in market conditions, such as interest rates, spreads, and volatilities. Interest rate risk, including mortgage prepayment risk, was our predominant type of market risk exposure during the three months ended March 31, 2014 and 2013. Our general approach toward managing interest rate risk is to acquire and maintain a portfolio of assets and liabilities, which, taken together, limit our expected exposure to interest rate risk. Management regularly reviews our sensitivity to interest rate changes by monitoring our market risk measures in parallel and non-parallel interest rate shifts and spread and volatility movements.

Market Value of Capital Stock Sensitivity
  
We define MVCS as an estimate of the market value of assets minus the market value of liabilities divided by the total shares of capital stock outstanding. It represents an estimation of the “liquidation value” of one share of our capital stock if all assets and liabilities were liquidated at current market prices. MVCS does not represent our long-term value, as it takes into account short-term market price fluctuations. These fluctuations are often unrelated to the long-term value of the cash flows from our assets and liabilities.

The MVCS calculation uses market prices, as well as interest rates and volatilities, and assumes a static balance sheet. The timing and variability of balance sheet cash flows are calculated by an internal model. To ensure the accuracy of the MVCS calculation, we reconcile the computed market prices of complex instruments, such as derivatives and mortgage assets, to market observed prices or dealers' quotes.

Interest rate risk stress tests of MVCS involve instantaneous parallel and non-parallel shifts in interest rates. The resulting percentage change in MVCS from the base case value is an indication of longer-term repricing risk and option risk embedded in the balance sheet.

To protect the MVCS from large interest rate swings, we use hedging transactions, such as entering into or canceling interest rate swaps, caps, and floors, issuing fixed rate and callable debt, and altering the funding structures supporting MBS and MPF purchases.

We monitor and manage to the MVCS policy limits to ensure the stability of the Bank's value. As of March 31, 2014, the policy limits for MVCS are 2.2 percent, 5 percent, and 12 percent declines from the base case in the up and down 50, 100, and 200 basis point parallel interest rate shift scenarios and 2.5 percent, 5.5 percent, and 13 percent declines from the base case in the up and down 50, 100, and 200 basis point non-parallel interest rate shift scenarios. Any breach of policy limits requires an immediate action to bring the exposure back within policy limits, as well as a report to the Board of Directors.

During the first quarter of 2008, due to the low interest rate environment, our Board of Directors suspended indefinitely the policy limit pertaining to the down 200 basis point parallel interest rate shift scenario. In October 2012, our Board of Directors amended the suspension by approving a rule for compliance to the down 200 basis point scenario that reinstates/suspends the associated policy limit when the 10-year swap rate increases above/drops below 2.50 percent and remains so for five consecutive days. At March 31, 2014 and December 31, 2013, the 10-year swap rate was above 2.50 percent and therefore the associated policy limit was applicable.


65


The following tables show our base case and change from base case MVCS in dollars per share and percent change respectively, based on outstanding shares, including shares classified as mandatorily redeemable, assuming instantaneous parallel shifts in interest rates at March 31, 2014 and December 31, 2013:
 
Market Value of Capital Stock (dollars per share)
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
March
$
114.0

 
$
119.8

 
$
121.8

 
$
122.1

 
$
122.0

 
$
121.4

 
$
118.9

December
$
114.8

 
$
120.1

 
$
121.5

 
$
121.2

 
$
120.3

 
$
119.1

 
$
115.8

 
% Change from Base Case
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
March
(6.7
)%
 
(1.9
)%
 
(0.2
)%
 
%
 
(0.1
)%
 
(0.6
)%
 
(2.6
)%
December
(5.3
)%
 
(0.9
)%
 
0.3
 %
 
%
 
(0.7
)%
 
(1.7
)%
 
(4.4
)%

The following tables show our base case and change from base case MVCS in dollars per share and percent change respectively, based on outstanding shares, including shares classified as mandatorily redeemable, assuming instantaneous non-parallel shifts in interest rates at March 31, 2014 and December 31, 2013:
 
Market Value of Capital Stock (dollars per share)
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
March
$
122.3

 
$
123.2

 
$
123.0

 
$
122.1

 
$
121.2

 
$
119.4

 
$
116.2

December
$
122.0

 
$
122.7

 
$
122.3

 
$
121.2

 
$
120.0

 
$
117.7

 
$
115.8

 
% Change from Base Case
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
March
0.2
%
 
0.9
%
 
0.7
%
 
%
 
(0.8
)%
 
(2.2
)%
 
(4.9
)%
December
0.7
%
 
1.2
%
 
0.9
%
 
%
 
(1.0
)%
 
(2.9
)%
 
(4.4
)%

The increase in our base case MVCS at March 31, 2014 when compared to December 31, 2013 was primarily attributable to the following factors:

Option-adjusted spread: The spread between mortgage interest rates and LIBOR, adjusted for the mortgage prepayment option, decreased at March 31, 2014 when compared to December 31, 2013. This had a positive impact on MVCS as it increased the value of mortgage-related assets.

Adjusted net income earned, net of dividend. During the first quarter of 2014, our adjusted net income earned, net of dividend, increased our market value of equity, thereby increasing MVCS. For additional information on our adjusted net income measure, refer to "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Executive Overview — Adjusted Earnings."

Slope of yield curves. The slope of the yield curves used to discount cash flows flattened at March 31, 2014 when compared to December 31, 2013. This had a positive impact on MVCS as the flattening of the yield curves increased the value of long-term mortgage-related assets and reduced the value of short-term funding.

The increase in our base case MVCS at March 31, 2014 was partially offset by decreased funding costs relative to the LIBOR swap curve. Our funding costs relative to the LIBOR swap curve decreased at March 31, 2014 when compared to December 31, 2013, thereby increasing the present value of our liabilities that fund mortgage-related assets. This had a negative impact on MVCS.

Projected Income Sensitivity

We monitor projected 24-month income sensitivity to limit short-term earnings volatility of the Bank. The projected 24-month income simulation policy limit is based on forward interest rates and business assumptions.The income sensitivity policy limit specifies a floor on projected earned dividend for each shock scenario. Earned dividend is computed as an annualized ratio of projected net income to average projected capital stock over the projection horizon. We were in compliance with the projected 24-month income simulation policy limit at March 31, 2014 and December 31, 2013.


66


CAPITAL ADEQUACY

An adequate capital position is necessary for providing safe and sound operations of the Bank. To ensure we remain adequately capitalized in a wide range of interest rate scenarios, we measure and monitor EVCS and retained earnings, and maintain capital levels in accordance with Finance Agency regulations.

Economic Value of Capital Stock

We define EVCS as the net present value of expected future cash flows of our assets and liabilities, discounted at our cost of funds, divided by the total shares of capital stock outstanding. This method reduces the impact of day-to-day price changes that cannot be attributed to any of the standard market factors, such as movements in interest rates or volatilities. Thus, EVCS provides an estimated measure of the long-term value of one share of our capital stock.

The following table shows EVCS in dollars per share based on outstanding shares, including shares classified as mandatorily redeemable, at March 31, 2014 and December 31, 2013:
Economic Value of Capital Stock (dollars per share)
March
$
129.9

December
$
123.5

    
The increase in our EVCS at March 31, 2014 when compared to December 31, 2013 was primarily attributable to the following factors:
 
Decreased funding costs relative to the LIBOR swap curve. Our funding costs relative to the LIBOR swap curve decreased at March 31, 2014 when compared to December 31, 2013. This had a positive impact on EVCS mainly through its impact on the value of mortgage-related assets and their associated funding.

Slope of yield curves. The slope of the yield curves used to discount cash flows flattened at March 31, 2014 when compared to December 31, 2013. This had a positive impact on EVCS as the flattening of the yield curves increased the value of long-term mortgage-related assets and reduced the value of short-term funding.

Retained Earnings Minimum Level and Regulatory Capital Requirements

Our ERMP provides policy limits and requires a minimum level of retained earnings based on the level of market risk, credit risk, and operational risk within the Bank. We are also subject to three regulatory capital requirements. For additional information on compliance with these requirements, refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Capital".

LIQUIDITY RISK

We define liquidity risk as the risk that we will be unable to meet our obligations as they come due or meet the credit needs of our members and housing associates in a timely and cost efficient manner. To manage this risk, we maintain liquidity in accordance with Finance Agency regulations. For additional information on compliance with these requirements, refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Liquidity — Liquidity Requirements".

CREDIT RISK

We define credit risk as the potential that our borrowers or counterparties will fail to meet their obligations in accordance with agreed upon terms. Our primary credit risks arise from our ongoing lending, investing, and hedging activities. Our overall objective in managing credit risk is to operate a sound credit granting process and to maintain appropriate credit administration, measurement, and monitoring practices.

Advances

We manage our credit exposure to advances through an approach that provides for an established credit limit for each borrower, ongoing reviews of each borrower's financial condition, and detailed collateral and lending policies to limit risk of loss while balancing borrowers' needs for a reliable source of funding. In addition, we lend to our borrowers in accordance with the FHLBank Act, Finance Agency regulations, and other applicable laws.

67


We are required by regulation to obtain sufficient collateral to fully secure our advances and other credit products. Eligible collateral includes (i) whole first mortgages on improved residential real property or securities representing a whole interest in such mortgages, (ii) loans and securities issued, insured, or guaranteed by the U.S. Government or any agency thereof, including MBS issued or guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae and Federal Family Education Loan Program (FFFELP) guaranteed student loans, (iii) cash deposited with us, and (iv) other real estate-related collateral acceptable to us provided such collateral has a readily ascertainable value and we can perfect a security interest in such property. Community Financial Institutions (CFIs) may also pledge collateral consisting of secured small business, small agri-business, or small farm loans. As additional security, the FHLBank Act provides that we have a lien on each borrower's capital stock investment; however, capital stock cannot be pledged as collateral to secure credit exposures.

Borrowers may pledge collateral to us by executing a blanket lien, specifically assigning collateral, or placing physical possession of collateral with us or our custodians. We perfect our security interest in all pledged collateral by filing Uniform Commercial Code financing statements or taking possession or control of the collateral. Under the FHLBank Act, any security interest granted to us by our members, or any affiliates of our members, has priority over the claims and rights of any other party (including any receiver, conservator, trustee, or similar party having rights of a lien creditor), unless those claims and rights would be entitled to priority under otherwise applicable law and are held by actual purchasers or by parties that have perfected security interests.

Under a blanket lien, we are granted a security interest in all financial assets of the borrower to fully secure the borrower's obligation. Other than securities and cash deposits, we do not initially take delivery of collateral pledged by blanket lien borrowers. In the event of deterioration in the financial condition of a blanket lien borrower, we have the ability to require delivery of pledged collateral sufficient to secure the borrower's obligation. With respect to non-blanket lien borrowers that are federally insured, we generally require collateral to be specifically assigned. With respect to non-blanket lien borrowers that are not federally insured (typically insurance companies, CDFIs, and housing associates), we generally take control of collateral through the delivery of cash, securities, or loans to us or our custodians.

Although management has policies and procedures in place to manage credit risk, we may be exposed to this risk if our outstanding advance value exceeds the liquidation value of our collateral. We mitigate this risk by applying collateral discounts or haircuts to the unpaid principal balance or market value, if available, of the collateral to determine the advance equivalent value of the collateral securing each borrower's obligation. The amount of these discounts will vary based on the type of collateral and security agreement. We determine these discounts or haircuts using data based upon historical price changes, discounted cash flow analyses, and loan level modeling.

At March 31, 2014 and December 31, 2013, borrowers pledged $156.5 billion and $140.1 billion of collateral (net of applicable discounts) to support activity with us, including advances. Borrowers pledge collateral in excess of their collateral requirement mainly to demonstrate available liquidity and to borrow additional amounts in the future.

Mortgage Assets

We are exposed to mortgage asset credit risk through our participation in the MPF program and investments in MBS. Mortgage asset credit risk is the risk that we will not receive timely payments of principal and interest due from mortgage borrowers because of borrower defaults. Credit risk on mortgage assets is affected by a number of factors, including loan type, borrower's credit history, and other factors such as home price fluctuations, unemployment levels, and other economic factors in the local market or nationwide.

MPF LOANS

Through our participation in the MPF program, we invest in conventional and government-insured residential mortgage loans that are acquired through or purchased from a PFI. There are six loan products under the MPF program: Original MPF, MPF 100, MPF 125, MPF Plus, MPF Government, and MPF Xtra. While still held in our Statements of Condition, we currently do not offer the MPF 100 or MPF Plus loan products. MPF Xtra loan products are passed through to a third-party investor and are not maintained in our Statements of Condition.


68


The following table presents the unpaid principal balance of our MPF portfolio by product type (dollars in millions):
Product Type
 
March 31, 2014
 
December 31, 2013
Original MPF
 
$
844

 
$
842

MPF 100
 
34

 
35

MPF 125
 
3,624

 
3,629

MPF Plus
 
1,368

 
1,439

MPF Government
 
548

 
547

Total unpaid principal balance
 
$
6,418

 
$
6,492


We manage the credit risk on mortgage loans acquired in the MPF program by (i) using agreements to establish credit risk sharing responsibilities with our PFIs, (ii) monitoring the performance of the mortgage loan portfolio and creditworthiness of PFIs, and (iii) establishing credit loss reserves to reflect management's estimate of probable credit losses inherent in the portfolio.

Government-Insured Mortgage Loans. For our government-insured mortgage loans, our loss protection consists of the loan guarantee and contractual obligation of the loan servicer to repurchase the loan when certain criteria are met. Therefore, we have not recorded any allowance for credit losses on government-insured mortgage loans.

Conventional Mortgage Loans. For our conventional mortgage loans, we have several layers of legal loss protection that are defined in agreements among us and our PFIs. These loss layers may vary depending on the MPF product alternatives selected and consist of (i) homeowner equity, (ii) PMI, (iii) a FLA, and (iv) a credit enhancement obligation of the PFI. For a detailed discussion of these loss layers, refer to “Item 1. Financial Statements — Note 9 — Allowance for Credit Losses.”

Allowance for Credit Losses. We utilize an allowance for credit losses to reserve for estimated losses in our conventional mortgage portfolio. During the three months ended March 31, 2014, we recorded a reversal for credit losses on our mortgage loans of $0.3 million due primarily to a reduction in loan delinquencies and loss severity estimates as well as ongoing improvements in economic indicators and housing market forecasts on our collectively evaluated mortgage loans. In addition, during the fourth quarter of 2013 we began utilizing external property valuations rather than average loss severity rates on our individually evaluated mortgage loans. An improvement in property valuations during the first quarter of 2014 resulted in lower anticipated losses. During the three months ended March 31, 2013, we recorded no provision or reversal for credit losses on our mortgage loans. Refer to “Item 1. Financial Statements — Note 9 — Allowance for Credit Losses” for additional information on our allowance for credit losses.

The following table presents a rollforward of the allowance for credit losses on our conventional mortgage loans (dollars in millions):
 
For the Three Months Ended
 
March 31,
 
2014
 
2013
Balance, beginning of period
$
8.0

 
$
15.8

Charge-offs1
(0.3
)
 
(0.5
)
Reversal for credit losses on mortgage loans
(0.3
)
 

Balance, end of period
$
7.4

 
$
15.3


1
At March 31, 2014, charge-offs were less than $1.0 million.

Non-Accrual Loans and Delinquencies. We place a conventional mortgage loan on non-accrual status if it is determined that either the collection of interest or principal is doubtful or interest or principal is 90 days or more past due. We do not place a government-insured mortgage loan on non-accrual status due to the U.S. Government guarantee of the loan and contractual obligation of the loan servicer to repurchase the loan when certain criteria are met. Refer to “Item 1. Financial Statements — Note 9 — Allowance for Credit Losses” for a summary of our non-accrual loans and mortgage loan delinquencies.


69


MORTGAGE-BACKED SECURITIES

We limit our investments in MBS to those guaranteed by the U.S. Government, issued by a GSE, or that carry the highest investment grade rating by a nationally recognized statistical rating organization (NRSRO) at the time of purchase. We are exposed to credit risk to the extent these MBS fail to perform adequately. We perform ongoing analysis on these investments to determine potential credit issues. At March 31, 2014 and December 31, 2013, we owned $9.0 billion and $8.2 billion of MBS, of which approximately 99.7 percent and 99.6 percent were guaranteed by the U.S. Government or issued by GSEs and 0.3 percent and 0.4 percent were private-label MBS.

Our private-label MBS are variable rate securities backed by prime loans that were securitized prior to 2004. We record these investments as HTM. The following table summarizes characteristics of our private-label MBS (dollars in millions):
 
 
March 31, 2014
Credit rating:
 
 
 A
 
$
9

BBB
 
17

BB
 
3

Total unpaid principal balance
 
$
29

 
 
 
Amortized cost
 
$
29

Gross unrealized gains
 

Gross unrealized losses
 

Fair value
 
$
29

 
 
 
Weighted average percentage of fair value to unpaid principal balance
 
99
%
Original weighted average FICO® score
 
725

Original weighted average credit support1
 
4
%
Weighted average credit support2
 
12
%
Weighted average collateral delinquency rate3
 
8
%

1
Based on the credit support at the time of issuance and is calculated using the original unpaid principal balance of the individual securities.

2
Based on the credit support as of March 31, 2014 and is calculated using the current unpaid principal balance of the individual securities.

3
Represents the percentage of underlying loans that are 60 days or more past due.

At March 31, 2014, we did not consider any of our private-label MBS to be other-than-temporarily impaired. For more information on our evaluation of OTTI, refer to “Item 1. Financial Statements — Note 6 — Other-Than-Temporary Impairment.”

Investments

We maintain an investment portfolio primarily to provide investment income and liquidity. Our primary credit risk on investments is the counterparties' ability to meet repayment terms. We mitigate this credit risk by investing in highly-rated investments, establishing unsecured credit limits, and actively monitoring the credit quality of our counterparties. This monitoring typically includes an assessment of each counterparty's financial performance, capital adequacy, and sovereign support. As a result of this monitoring, we may limit exposures or suspend existing counterparties.

Finance Agency regulations limit the type of investments we may purchase. We are prohibited from investing in financial instruments issued by non-U.S. entities other than those issued by U.S. branches and agency offices of foreign commercial banks. Our unsecured credit exposures to U.S. branches and agency offices of foreign commercial banks include the risk that, as a result of political or economic conditions in a country, the counterparty may be unable to meet their contractual repayment obligations. Our unsecured credit exposures to domestic counterparties and U.S. subsidiaries of foreign commercial banks include the risk that these counterparties have extended credit to foreign counterparties. We were in compliance with the above regulation and did not own any financial instruments issued by non-U.S. entities, other than those issued by U.S. branches and agency offices of foreign commercial banks, as of March 31, 2014.


70


Finance Agency regulations also include limits on the amount of unsecured credit we may extend to a counterparty or to a group of affiliated counterparties. This limit is based on a percentage of eligible regulatory capital and the counterparty's overall credit rating. Under these regulations, the level of eligible regulatory capital is determined as the lesser of our total regulatory capital or the eligible amount of regulatory capital of the counterparty. The eligible amount of regulatory capital is then multiplied by a stated percentage. The percentage that we may offer for term extensions of unsecured credit ranges from one to 15 percent based on the counterparty's credit rating. Our total overnight unsecured exposure to a counterparty may not exceed twice the regulatory limit for term exposures, or a total of two to 30 percent of the eligible amount of regulatory capital, based on the counterparty's credit rating. At March 31, 2014, we were in compliance with the regulatory limits established for unsecured credit.

Our short-term portfolio may include, but is not limited to, interest-bearing deposits, Federal funds sold, securities purchased under agreements to resell, certificates of deposit, and commercial paper. Our long-term portfolio may include, but is not limited to, other U.S. obligations, GSE obligations, state or local housing agency obligations, taxable municipal bonds, and MBS. We face credit risk from unsecured exposures primarily within our short-term portfolio. While unsecured, we do not consider investments issued or guaranteed by the U.S. Government, an agency or instrumentality of the U.S. Government, or the FDIC to be a credit risk exposure.

Our unsecured credit exposure currently consists of the following overnight investment types:

Federal funds sold. Unsecured loans of reserve balances at the Federal Reserve Banks between financial institutions.

Commercial paper. Unsecured debt issued by corporations, typically for the financing of accounts receivable, inventories, and meeting short-term liabilities.

At March 31, 2014, our unsecured investment exposure consisted of overnight Federal funds sold. The following table presents our unsecured investment exposure by counterparty credit rating and domicile at March 31, 2014 (excluding accrued interest receivable) (dollars in millions):
 
 
Credit Rating1
Domicile of Counterparty
 
AA
 
A
 
BBB
 
Total
Domestic
 
$

 
$
75

 
$
300

 
$
375

U.S. subsidiaries of foreign commercial banks
 

 
300

 

 
300

Total domestic and U.S. subsidiaries of foreign commercial banks
 

 
375

 
300

 
675

U.S. branches and agency offices of foreign commercial banks
 
 
 
 
 
 
 
 
Australia
 
300

 

 

 
300

Canada
 

 
600

 

 
600

Norway
 

 
300

 

 
300

Total U.S. branches and agency offices of foreign commercial banks
 
300

 
900

 

 
1,200

Total unsecured investment exposure
 
$
300

 
$
1,275

 
$
300

 
$
1,875


1
Represents the lowest credit rating available for each investment based on an NRSRO.


71


The following tables summarize the carrying value of our investments by credit rating (dollars in millions):
 
March 31, 2014
 
Credit Rating1
 
AAA
 
AA
 
A
 
BBB
 
BB
 
Unrated
 
Total
Interest-bearing deposits2
$

 
$
2

 
$

 
$

 
$

 
$

 
$
2

Securities purchased under agreements to resell
2,915

 
950

 
2,375

 

 

 
1,250

 
7,490

Federal funds sold

 
300

 
1,275

 
300

 

 

 
1,875

Investment securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
 
 
GSE - residential

 
9,003

 

 

 

 

 
9,003

Other U.S. obligations - residential

 
5

 

 

 

 

 
5

Other U.S. obligations - commercial

 
2

 

 

 

 

 
2

Private-label - residential

 

 
10

 
16

 
3

 

 
29

Total mortgage-backed securities

 
9,010

 
10

 
16

 
3

 

 
9,039

Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations

 
441

 

 

 

 

 
441

GSE obligations

 
1,500

 

 

 

 

 
1,500

State or local housing agency obligations
23

 
70

 

 

 

 

 
93

Other3
342

 
102

 

 

 

 
1

 
445

Total non-mortgage-backed securities
365

 
2,113

 

 

 

 
1

 
2,479

Total investments4
$
3,280

 
$
12,375

 
$
3,660

 
$
316

 
$
3

 
$
1,251

 
$
20,885

 
December 31, 2013
 
Credit Rating1
 
AAA
 
AA
 
A
 
BBB
 
BB
 
Unrated
 
Total
Interest-bearing deposits2
$

 
$
2

 
$

 
$

 
$

 
$

 
$
2

Securities purchased under agreements to resell

 
3,700

 
3,300

 

 

 
1,200

 
8,200

Federal funds sold

 

 
900

 
300

 

 

 
1,200

Investment securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
 
 
GSE - residential

 
8,132

 

 

 

 

 
8,132

Other U.S. obligations - residential

 
5

 

 

 

 

 
5

Other U.S. obligations - commercial

 
2

 

 

 

 

 
2

Private-label - residential

 

 
10

 
17

 
3

 

 
30

Total mortgage-backed securities

 
8,139

 
10

 
17

 
3

 

 
8,169

Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations

 
448

 

 

 

 

 
448

GSE obligations

 
1,489

 

 

 

 

 
1,489

State or local housing agency obligations
23

 
72

 

 

 

 

 
95

Other3
331

 
196

 

 

 

 
1

 
528

Total non-mortgage-backed securities
354

 
2,205

 

 

 

 
1

 
2,560

Total investments4
$
354

 
$
14,046

 
$
4,210

 
$
317

 
$
3

 
$
1,201

 
$
20,131


1
Represents the lowest credit rating available for each investment based on an NRSRO.

2
Interest bearing deposits are rated AA because they are guaranteed by the FDIC up to $250,000.

3
Other "unrated" investment represents an equity investment in a SBIC.

4
At March 31, 2014 and December 31, 2013, nine and six percent of our total investments were unsecured.
    
Our total investments increased at March 31, 2014 when compared to December 31, 2013 due primarily to the purchase of certain GSE MBS during the quarter.


72


Derivatives

We execute most of our derivative transactions with large banks and major broker-dealers. Over-the-counter derivative transactions may be either executed directly with a counterparty (bilateral derivatives) or cleared through a Futures Commission Merchant (i.e., clearing agent), with a Derivative Clearing Organization (cleared derivatives).

We are subject to credit risk due to the risk of nonperformance by counterparties to our derivative agreements. The amount of credit risk on derivatives depends on the extent to which netting procedures and collateral requirements are used and are effective in mitigating the risk. We manage credit risk through credit analyses, collateral requirements, and adherence to the requirements set forth in our policies and Finance Agency regulations.

Bilateral Derivatives. Due to risk of nonperformance by the counterparties to our derivative agreements, we generally require collateral on bilateral derivative agreements. The amount of net unsecured credit exposure that is permissible with respect to each counterparty depends on the credit rating of that counterparty. A counterparty generally must deliver collateral to us if the total market value of our exposure to that counterparty rises above a specific trigger point. As a result of these risk mitigation initiatives, we do not anticipate any credit losses on our bilateral derivative agreements.

Cleared Derivatives. For cleared derivatives, the Clearinghouse is our counterparty. We are subject to risk of nonperformance by the Clearinghouse and clearing agent. The requirement that we post initial and variation margin through the clearing agent, to the Clearinghouse, exposes us to institutional credit risk in the event that the clearing agent or the Clearinghouse fails to meet its obligations. However, the use of cleared derivatives is intended to mitigate credit risk exposure because a central counterparty is substituted for individual counterparties and collateral is posted daily, through a clearing agent, for changes in the fair value of cleared derivatives. We do not anticipate any credit losses on our cleared derivatives.

The contractual or notional amount of derivatives reflects our involvement in the various classes of financial instruments. Our maximum credit risk is the estimated cost of replacing derivatives if there is a default, minus the value of any related collateral, including initial and variation margin. In determining maximum credit risk, we consider accrued interest receivables and payables as well as our ability to net settle positive and negative positions with the same counterparty and/or clearing agent when netting requirements are met.

The following table shows our derivative counterparty credit exposure (dollars in millions):
 
 
March 31, 2014
Credit Rating1
 
Notional Amount
 
Net Derivatives
Fair Value Before Collateral
 
Cash Collateral Pledged
To (From) Counterparty
 
Net Credit Exposure
 to Counterparties
Non-member counterparties:
 
 
 
 
 
 
 
 
Asset positions with credit exposure
 
 
 
 
 
 
 
 
Bilateral derivatives
 
 
 
 
 
 
 
 
AA
 
$
830

 
$
8

 
$
(7
)
 
$
1

   A
 
5,442

 
34

 
(18
)
 
16

   Cleared derivatives2
 
3,947

 

 
19

 
19

Liability positions with credit exposure
 
 
 
 
 
 
 
 
Bilateral derivatives
 
 
 
 
 
 
 
 
   A
 
3,292

 
(96
)
 
98

 
2

BBB3
 
147

 
(6
)
 
6

 

Cleared derivatives
 
11,904

 
(13
)
 
79

 
66

Total derivative positions with credit exposure to non-member counterparties
 
25,562

 
(73
)
 
177

 
104

Member institutions3,4
 
19

 

 

 

Total
 
25,581

 
$
(73
)
 
$
177

 
$
104

Derivative positions without credit exposure
 
4,902

 
 
 
 
 
 
Total notional
 
$
30,483

 
 
 
 
 
 

1
Represents the lowest credit rating available for each counterparty based on an NRSRO.

2
Represents derivative transactions cleared with Clearinghouses, which are not rated.

3
Net credit exposure is less than $1.0 million.

4
Represents mortgage delivery commitments with our member institutions.

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The following table shows our derivative counterparty credit exposure (dollars in millions):

 
 
December 31, 2013
Credit Rating1
 
Notional Amount
 
Net Derivatives
Fair Value Before Collateral
 
Cash Collateral Pledged
To (From) Counterparty
 
Net Credit Exposure
to Counterparties

Non-member counterparties:
 
 
 
 
 
 
 
 
Asset positions with credit exposure
 
 
 
 
 
 
 
 
Bilateral derivatives
 
 
 
 
 
 
 
 
AA
 
$
721

 
$
14

 
$
(13
)
 
$
1

   A
 
3,208

 
51

 
(41
)
 
10

   Cleared derivatives2
 
18,980

 
40

 
39

 
79

Liability positions with credit exposure
 
 
 
 
 
 
 


Bilateral derivatives
 
 
 
 
 
 
 
 
   A
 
3,095

 
(68
)
 
71

 
3

BBB3
 
2,853

 
(69
)
 
69

 

Total derivative positions with credit exposure to non-member counterparties
 
28,857

 
(32
)
 
125

 
93

Member institutions3,4
 
4

 

 

 

Total
 
28,861

 
$
(32
)
 
$
125

 
$
93

Derivative positions without credit exposure
 
5,492

 
 
 
 
 


Total notional
 
$
34,353

 


 


 



1
Represents the lowest credit rating available for each counterparty based on an NRSRO.

2
Represents derivative transactions cleared with Clearinghouses, which are not rated.

3
Net credit exposure is less than $1.0 million.

4
Represents mortgage delivery commitments with our member institutions.


OPERATIONAL RISK

We define operational risk as the risk of loss or harm from inadequate or failed processes, people, and/or systems, including those emanating from external sources. Operational risk is inherent in all of our business activities and processes. Management has established policies and procedures to reduce the likelihood of operational risk and designed our annual risk assessment process to provide ongoing identification, measurement, and monitoring of operational risk.

BUSINESS RISK

We define business risk as the risk of an adverse impact on our financial condition or profitability resulting from external factors that may occur in both the short- and long-term. Business risk includes political, strategic, reputation, regulatory, and/or environmental factors, many of which are beyond our control. From time to time, proposals are made, or legislative and regulatory changes are considered, which could affect our cost of doing business or other aspects of our business. We control business risk through strategic and annual business planning and monitoring of our external environment. For additional information on some of the more important risks we face, refer to "Item 1A. Risk Factors in our 2013 Form 10-K."

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

See “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management — Market Risk” and the sections referenced therein for quantitative and qualitative disclosures about market risk.


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ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Management is responsible for establishing and maintaining a system of disclosure controls and procedures designed to ensure that information required to be disclosed in reports we file or submit under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms; and (ii) accumulated and communicated to our management, including our president and chief executive officer (CEO) and chief financial officer (CFO), as appropriate, to allow timely decisions regarding required disclosure.

Management has evaluated the effectiveness of the design and operation of our disclosure controls and procedures with the participation of the president and CEO and CFO as of the end of the quarterly period covered by this report. Based on that evaluation, the president and CEO and CFO have concluded that our disclosure controls and procedures were effective as of the end of the fiscal quarter covered by this report.

Internal Control Over Financial Reporting

For the first quarter of 2014, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are not currently aware of any pending or threatened legal proceedings against us, other than ordinary routine litigation incidental to our business, that could have a material adverse effect on our financial condition, results of operations, or cash flows.

ITEM 1A. RISK FACTORS

For a discussion of our risk factors, refer to our 2013 Form 10-K. There have been no material changes to our risk factors during the three months ended March 31, 2014.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None.


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ITEM 6. EXHIBITS

3.1
Organization Certificate of the Federal Home Loan Bank of Des Moines dated October 13, 19321
3.2
Bylaws of the Federal Home Loan Bank of Des Moines, as amended and restated effective February 26, 20092
4.1
Federal Home Loan Bank of Des Moines Capital Plan, as amended, approved by the Federal Housing Finance Agency on August 5, 2011 and effective September 5, 20113
10.1
Federal Home Loan Bank of Des Moines 2014 Incentive Plan Document, effective January 1, 20144
31.1
Certification of the President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of the Executive Vice President and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of the President and Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of the Executive Vice President and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101
The following financial information from the Bank's First Quarter 2014 Form 10-Q, formatted in XBRL (Extensible Business Reporting Language): (i) Statements of Condition at March 31, 2014 and December 31, 2013, (ii) Statements of Income for the Three Months Ended March 31, 2014 and 2013, (iii) Statements of Comprehensive Income for the Three Months Ended March 31, 2014 and 2013, (iv) Statements of Capital as of March 31, 2014 and March 31, 2013, (v) Statements of Cash Flows for the Three Months Ended March 31, 2014 and 2013, and (vi) Condensed Notes to the Unaudited Financial Statements

1
Incorporated by reference to the correspondingly numbered exhibit to our Registration Statement on Form 10 filed with the SEC on May 12, 2006 (Commission File No. 000-51999).

2
Incorporated by reference to the correspondingly numbered exhibit to our Form 8-K filed with the SEC on March 2, 2009 (Commission File No. 000-51999).

3
Incorporated by reference to exhibit 99.2 of our Form 8-K filed with the SEC on July 17, 2013 (Commission File No. 000-51999).

4
Incorporated by reference to exhibit 10.1 of our Form 8-K filed with the SEC on April 17, 2014 (Commission File No. 000-51999).

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

FEDERAL HOME LOAN BANK OF DES MOINES
 
 
(Registrant)
 
 
 
 
 
 
 
Date:
 
May 9, 2014
 
 
 
 
 
 
 
 
 
 
 
 
By:
 
/s/ Richard S. Swanson
 
 
 
 
Richard S. Swanson
President and Chief Executive Officer
(Principal Executive Officer)
 
 
 
 
 
 
 
By:
 
/s/ Ardis E. Kelley
 
 
 
 
Ardis E. Kelley
Senior Vice President and Chief Accounting Officer
(Principal Accounting Officer)
 
 
 


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